Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2013

OR

 

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

For the transition period from              to              .

Commission file number 1-14536

 

 

PartnerRe Ltd.

(Exact name of registrant as specified in its charter)

 

 

 

Bermuda   Not Applicable
(State of incorporation)   (I.R.S. Employer Identification No.)

90 Pitts Bay Road, Pembroke, HM08, Bermuda

(Address of principal executive offices) (Zip Code)

(441) 292-0888

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

 

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, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of the registrant’s common shares (par value $1.00 per share) outstanding, net of treasury shares, as of October 30, 2013 was 53,191,934.

 

 

 


Table of Contents

PartnerRe Ltd.

INDEX TO FORM 10-Q

 

          Page  
PART I—FINANCIAL INFORMATION   
ITEM 1.    Financial Statements   
   Report of Independent Registered Public Accounting Firm      3   
   Condensed Consolidated Balance Sheets—September 30, 2013 (Unaudited) and December 31, 2012      4   
  

Condensed Consolidated Statements of Operations and Comprehensive Income —Three Months and Nine Months Ended September 30, 2013 and 2012 (Unaudited)

     5   
  

Condensed Consolidated Statements of Shareholders’ Equity—Nine Months Ended September 30, 2013 and 2012 (Unaudited)

     6   
  

Condensed Consolidated Statements of Cash Flows—Nine Months Ended September 30, 2013 and 2012 (Unaudited)

     7   
   Notes to Condensed Consolidated Financial Statements (Unaudited)      8   
ITEM 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      31   
ITEM 3.    Quantitative and Qualitative Disclosures About Market Risk      82   
ITEM 4.    Controls and Procedures      85   
PART II—OTHER INFORMATION   
ITEM 1.    Legal Proceedings      85   
ITEM 1A.    Risk Factors      85   
ITEM 2.    Unregistered Sales of Equity Securities and Use of Proceeds      86   
ITEM 3.    Defaults upon Senior Securities      86   
ITEM 4.    Mine Safety Disclosures      86   
ITEM 5.    Other Information      86   
ITEM 6.    Exhibits      86   
   Signatures      87   
   Exhibit Index      88   

 

2


Table of Contents

PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of PartnerRe Ltd.

We have reviewed the accompanying condensed consolidated balance sheet of PartnerRe Ltd. and subsidiaries (the “Company”) as of September 30, 2013, and the related condensed consolidated statements of operations and comprehensive income for the three-month and nine-month periods ended September 30, 2013 and 2012, and of shareholders’ equity, and of cash flows for the nine-month periods ended September 30, 2013 and 2012. These interim condensed consolidated financial statements are the responsibility of the Company’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of PartnerRe Ltd. and subsidiaries as of December 31, 2012 and the related consolidated statements of operations and comprehensive income (loss), shareholders’ equity, and of cash flows for the year then ended (not presented herein); and in our report dated February 26, 2013, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2012 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

 

/s/ Deloitte & Touche Ltd.

Deloitte & Touche Ltd.

Hamilton, Bermuda

November 1, 2013

 

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Table of Contents

PartnerRe Ltd.

Condensed Consolidated Balance Sheets

(Expressed in thousands of U.S. dollars, except parenthetical share and per share data)

 

     September 30,
2013
    December 31,
2012
 
     (Unaudited)     (Audited)  

Assets

    

Investments:

    

Fixed maturities, trading securities, at fair value (amortized cost: 2013, $13,395,474; 2012, $13,653,615)

   $ 13,680,838     $ 14,395,315  

Short-term investments, trading securities, at fair value (amortized cost: 2013, $36,791; 2012, $150,634)

     36,781       150,552  

Equities, trading securities, at fair value (cost: 2013, $1,036,972; 2012, $1,000,326)

     1,122,084       1,094,002  

Other invested assets

     268,097       333,361  
  

 

 

   

 

 

 

Total investments

     15,107,800       15,973,230  

Funds held – directly managed (cost: 2013, $800,634; 2012, $895,261)

     813,497       930,741  

Cash and cash equivalents, at fair value, which approximates amortized cost

     1,551,062       1,121,705  

Accrued investment income

     175,164       184,315  

Reinsurance balances receivable

     2,564,015       1,991,991  

Reinsurance recoverable on paid and unpaid losses

     339,169       348,086  

Funds held by reinsured companies

     831,704       805,489  

Deferred acquisition costs

     680,972       568,391  

Deposit assets

     347,419       257,208  

Net tax assets

     13,688       25,098  

Goodwill

     456,380       456,380  

Intangible assets

     193,134       214,270  

Other assets

     64,203       103,528  
  

 

 

   

 

 

 

Total assets

   $ 23,138,207     $ 22,980,432  
  

 

 

   

 

 

 

Liabilities

    

Unpaid losses and loss expenses

   $ 10,564,542     $ 10,709,371  

Policy benefits for life and annuity contracts

     1,908,575       1,813,244  

Unearned premiums

     1,997,853       1,534,625  

Other reinsurance balances payable

     232,711       238,578  

Deposit liabilities

     330,233       252,217  

Net tax liabilities

     293,797       387,647  

Accounts payable, accrued expenses and other

     365,331       290,265  

Debt related to senior notes

     750,000       750,000  

Debt related to capital efficient notes

     70,989       70,989  
  

 

 

   

 

 

 

Total liabilities

     16,514,031       16,046,936  
  

 

 

   

 

 

 

Shareholders’ Equity

    

Common shares (par value $1.00; issued: 2013, 86,425,676 shares; 2012, 85,459,905 shares)

     86,426       85,460  

Preferred shares (par value $1.00; issued and outstanding: 2013, 34,150,000 shares; 2012, 35,750,000 shares; aggregate liquidation value: 2013, $853,750; 2012, $893,750)

     34,150       35,750  

Additional paid-in capital

     3,880,412       3,861,844  

Accumulated other comprehensive (loss) income

     (6,027     10,597  

Retained earnings

     5,183,219       4,952,002  

Common shares held in treasury, at cost (2013, 33,197,911 shares; 2012, 26,550,530 shares)

     (2,606,493     (2,012,157
  

 

 

   

 

 

 

Total shareholders’ equity attributable to PartnerRe Ltd.

     6,571,687       6,933,496  

Noncontrolling interests

     52,489       —    
  

 

 

   

 

 

 

Total shareholders’ equity

     6,624,176       6,933,496  
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 23,138,207     $ 22,980,432  
  

 

 

   

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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Table of Contents

PartnerRe Ltd.

Condensed Consolidated Statements of Operations and Comprehensive Income (Unaudited)

(Expressed in thousands of U.S. dollars, except share and per share data)

 

     For the three
months ended
September 30,
2013
    For the three
months ended
September 30,
2012
    For the nine
months ended
September 30,
2013
    For the nine
months ended
September 30,
2012
 

Revenues

        

Gross premiums written

   $ 1,281,477     $ 1,056,076     $ 4,378,944     $ 3,786,802  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums written

   $ 1,264,775     $ 1,043,240     $ 4,210,525     $ 3,652,571  

Decrease (increase) in unearned premiums

     156,694       193,851       (433,740     (334,772
  

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums earned

     1,421,469       1,237,091       3,776,785       3,317,799  

Net investment income

     121,811       135,266       370,017       435,669  

Net realized and unrealized investment gains (losses)

     16,118       257,429       (260,154     488,296  

Other income

     5,399       2,744       13,205       8,143  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     1,564,797       1,632,530       3,899,853       4,249,907  

Expenses

        

Losses and loss expenses and life policy benefits

     750,999       721,137       2,278,793       2,003,759  

Acquisition costs

     282,948       247,058       758,890       691,388  

Other operating expenses

     108,467       94,697       369,340       299,055  

Interest expense

     12,233       12,224       36,694       36,668  

Amortization of intangible assets

     7,045       8,893       21,136       26,679  

Net foreign exchange losses (gains)

     1,279       2,015       9,822       (3,165
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     1,162,971       1,086,024       3,474,675       3,054,384  

Income before taxes and interest in earnings of equity investments

     401,826       546,506       425,178       1,195,523  

Income tax expense

     70,232       64,149       37,338       181,458  

Interest in earnings of equity investments

     5,941       4,349       9,677       8,929  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     337,535       486,706       397,517       1,022,994  

Net income attributable to noncontrolling interests

     (4,112           (5,296     —    
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to PartnerRe Ltd.

     333,423       486,706       392,221       1,022,994  

Preferred dividends

     14,184       15,405       43,678       46,216  

Loss on redemption of preferred shares

     —         —         9,135       —    
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to PartnerRe Ltd. common shareholders

   $ 319,239     $ 471,301     $ 339,408     $ 976,778  
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

        

Net income attributable to PartnerRe Ltd.

   $ 333,423     $ 486,706     $ 392,221     $ 1,022,994  

Change in currency translation adjustment

     14,432       32,992       (16,912     31,042  

Change in unfunded pension obligation, net of tax

     114       (590     980       (165

Change in unrealized losses on investments

     (229     (237     (692     (718
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive income (loss), net of tax

     14,317       32,165       (16,624     30,159  
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income attributable to PartnerRe Ltd.

   $ 347,740     $ 518,871     $ 375,597     $ 1,053,153  
  

 

 

   

 

 

   

 

 

   

 

 

 

Per share data attributable to PartnerRe Ltd. common shareholders

        

Net income per common share:

        

Basic net income

   $ 5.95     $ 7.62     $ 6.04     $ 15.34  

Diluted net income

   $ 5.84     $ 7.53     $ 5.93     $ 15.19  

Weighted average number of common shares outstanding

     53,671,245       61,837,328       56,176,260       63,679,114  

Weighted average number of common shares and common share equivalents outstanding

     54,625,151       62,606,761       57,217,561       64,284,125  

Dividends declared per common share

   $ 0.64     $ 0.62     $ 1.92     $ 1.86  

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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Table of Contents

PartnerRe Ltd.

Condensed Consolidated Statements of Shareholders’ Equity (Unaudited)

(Expressed in thousands of U.S. dollars)

 

     For the nine
months ended
September 30,
2013
    For the nine
months ended
September 30,
2012
 

Common shares

    

Balance at beginning of period

   $ 85,460     $ 84,767  

Issuance of common shares

     966       437  
  

 

 

   

 

 

 

Balance at end of period

     86,426       85,204  

Preferred shares

    

Balance at beginning of period

     35,750       35,750  

Issuance of preferred shares

     10,000       —    

Redemption of preferred shares

     (11,600     —    
  

 

 

   

 

 

 

Balance at end of period

     34,150       35,750  

Additional paid-in capital

    

Balance at beginning of period

     3,861,844       3,803,796  

Issuance of common shares

     56,568       36,845  

Issuance of preferred shares

     231,265       —     

Redemption of preferred shares

     (269,265     —     
  

 

 

   

 

 

 

Balance at end of period

     3,880,412       3,840,641  

Accumulated other comprehensive (loss) income

    

Balance at beginning of period

     10,597       (12,644

Currency translation adjustment

    

Balance at beginning of period

     32,755       4,267  

Change in currency translation adjustment

     (16,912     31,042  
  

 

 

   

 

 

 

Balance at end of period

     15,843       35,309  

Unfunded pension obligation

    

Balance at beginning of period

     (27,370     (23,076

Change in unfunded pension obligation

     980       (165
  

 

 

   

 

 

 

Balance at end of period (net of tax: 2013, $7,752; 2012, $6,605)

     (26,390     (23,241

Unrealized gain on investments

    

Balance at beginning of period

     5,212       6,165  

Change in unrealized losses on investments

     (692     (718
  

 

 

   

 

 

 

Balance at end of period (net of tax: 2013 and 2012: $nil)

     4,520       5,447  
  

 

 

   

 

 

 

Balance at end of period

     (6,027     17,515  

Retained earnings

    

Balance at beginning of period

     4,952,002       4,035,103  

Net income

     397,517       1,022,994  

Net income attributable to noncontrolling interests

     (5,296     —     

Dividends on common shares

     (108,191     (118,152

Dividends on preferred shares

     (43,678     (46,216

Loss on redemption of preferred shares

     (9,135     —     
  

 

 

   

 

 

 

Balance at end of period

     5,183,219       4,893,729  

Common shares held in treasury

    

Balance at beginning of period

     (2,012,157     (1,479,230

Repurchase of common shares

     (594,336     (314,607
  

 

 

   

 

 

 

Balance at end of period

     (2,606,493     (1,793,837
  

 

 

   

 

 

 

Total shareholders’ equity attributable to PartnerRe Ltd.

   $ 6,571,687     $ 7,079,002  

Noncontrolling interests

     52,489       —     
  

 

 

   

 

 

 

Total shareholders’ equity

   $ 6,624,176     $ 7,079,002  
  

 

 

   

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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Table of Contents

PartnerRe Ltd.

Condensed Consolidated Statements of Cash Flows (Unaudited)

(Expressed in thousands of U.S. dollars)

 

     For the nine
months ended
September 30,
2013
    For the nine
months ended
September 30,
2012
 

Cash flows from operating activities

    

Net income

   $ 397,517     $ 1,022,994  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Amortization of net premium on investments

     119,468       99,722  

Amortization of intangible assets

     21,136       26,679  

Net realized and unrealized investment losses (gains)

     260,154       (488,296

Changes in:

    

Reinsurance balances, net

     (592,380     (202,270

Reinsurance recoverable on paid and unpaid losses, net of ceded premiums payable

     65,593       59,536  

Funds held by reinsured companies and funds held – directly managed

     76,159       110,096  

Deferred acquisition costs

     (111,562     (51,722

Net tax assets and liabilities

     (83,379     89,900  

Unpaid losses and loss expenses including life policy benefits

     (65,725     (557,411

Unearned premiums

     433,740       334,772  

Other net changes in operating assets and liabilities

     63,014       25,355  
  

 

 

   

 

 

 

Net cash provided by operating activities

     583,735       469,355  

Cash flows from investing activities

    

Sales of fixed maturities

     5,831,364       5,016,192  

Redemptions of fixed maturities

     1,002,991       705,423  

Purchases of fixed maturities

     (6,501,873     (5,649,511

Sales and redemptions of short-term investments

     290,011       61,903  

Purchases of short-term investments

     (176,339     (176,068

Sales of equities

     595,848       574,612  

Purchases of equities

     (556,303     (577,652

Other, net

     98,813       33,891  
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     584,512       (11,210

Cash flows from financing activities

    

Dividends paid to shareholders

     (151,869     (164,368

Repurchase of common shares

     (619,534     (312,291

Issuance of common shares

     37,193       19,117  

Net proceeds from issuance of preferred shares

     241,265       —    

Repurchase of preferred shares

     (290,000     —    

Sale of shares to noncontrolling interests

     47,136       —    
  

 

 

   

 

 

 

Net cash used in financing activities

     (735,809     (457,542

Effect of foreign exchange rate changes on cash

     (3,081     (6,498

Increase (decrease) in cash and cash equivalents

     429,357       (5,895

Cash and cash equivalents—beginning of period

     1,121,705       1,342,257  
  

 

 

   

 

 

 

Cash and cash equivalents—end of period

   $ 1,551,062     $ 1,336,362  
  

 

 

   

 

 

 

Supplemental cash flow information:

    

Taxes paid

   $ 148,522     $ 105,059  

Interest paid

   $ 24,630     $ 24,630  

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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Table of Contents

PartnerRe Ltd.

Notes to Condensed Consolidated Financial Statements (Unaudited)

1. Organization

PartnerRe Ltd. (the Company) predominantly provides reinsurance and certain specialty insurance lines on a worldwide basis through its principal wholly-owned subsidiaries, including Partner Reinsurance Company Ltd., Partner Reinsurance Europe SE and Partner Reinsurance Company of the U.S. Risks reinsured include, but are not limited to, property, casualty, motor, agriculture, aviation/space, catastrophe, credit/surety, engineering, energy, marine, specialty property, specialty casualty, multiline and other lines, mortality, longevity, accident and health and alternative risk products. The Company’s alternative risk products include weather and credit protection to financial, industrial and service companies on a worldwide basis.

Effective December 31, 2012, the Company completed the acquisition of Presidio Reinsurance Group, Inc. (Presidio), a California-based U.S. specialty accident and health reinsurance and insurance writer. The Condensed Consolidated Statements of Operations and Cash Flows include the results of Presidio from January 1, 2013.

2. Significant Accounting Policies

The Company’s Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. The Condensed Consolidated Financial Statements include the accounts of the Company and its subsidiaries. Intercompany accounts and transactions have been eliminated. To facilitate comparison of information across periods, certain reclassifications have been made to prior year amounts to conform to the current year’s presentation.

The preparation of financial statements in conformity with U.S. GAAP requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. While Management believes that the amounts included in the Condensed Consolidated Financial Statements reflect its best estimates and assumptions, actual results could differ from those estimates. The Company’s principal estimates include:

 

    Unpaid losses and loss expenses;

 

    Policy benefits for life and annuity contracts;

 

    Gross and net premiums written and net premiums earned;

 

    Recoverability of deferred acquisition costs;

 

    Recoverability of deferred tax assets;

 

    Valuation of goodwill and intangible assets; and

 

    Valuation of certain assets and derivative financial instruments that are measured using significant unobservable inputs.

In the opinion of Management, all adjustments (which include normal recurring adjustments) necessary for a fair presentation of results for the interim periods have been made. As the Company’s reinsurance operations are exposed to low-frequency, high-severity risk events, some of which are seasonal, results for certain interim periods may include unusually low loss experience, while results for other interim periods may include significant catastrophic losses. Consequently, the Company’s results for interim periods are not necessarily indicative of results for the full year. These Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

3. Fair Value

(a) Fair Value of Financial Instrument Assets

The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value by maximizing the use of observable inputs and minimizing the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing an asset or liability based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about what market participants would use in pricing the asset or liability based on the best information available in the circumstances. 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.

 

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Table of Contents

The Company determines the appropriate level in the hierarchy for each financial instrument that it measures at fair value. In determining fair value, the Company uses various valuation approaches, including market, income and cost approaches. The hierarchy is broken down into three levels based on the observability of inputs as follows:

 

    Level 1 inputs—Unadjusted, quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.

The Company’s financial instruments that it measures at fair value using Level 1 inputs generally include: equities and real estate investment trusts listed on a major exchange, exchange traded funds and exchange traded derivatives, including futures that are actively traded.

 

    Level 2 inputs—Quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in inactive markets and significant directly or indirectly observable inputs, other than quoted prices, used in industry accepted models.

The Company’s financial instruments that it measures at fair value using Level 2 inputs generally include: U.S. government issued bonds; U.S. government sponsored enterprises bonds; U.S. state, territory and municipal entities bonds; Non-U.S. sovereign government, supranational and government related bonds consisting primarily of bonds issued by non-U.S. national governments and their agencies, non-U.S. regional governments and supranational organizations; investment grade and high yield corporate bonds; catastrophe bonds; mortality bonds; asset-backed securities; mortgage-backed securities; certain equities traded on foreign exchanges; certain fixed income mutual funds; foreign exchange forward contracts; over-the-counter derivatives such as foreign currency option contracts, credit default swaps, interest rate swaps and to-be-announced mortgage-backed securities (TBAs).

 

    Level 3 inputs—Unobservable inputs.

The Company’s financial instruments that it measures at fair value using Level 3 inputs generally include: inactively traded fixed maturities including U.S. state, territory and municipal bonds; privately issued corporate securities; special purpose financing asset-backed bonds; unlisted equities; real estate and certain other mutual fund investments; inactively traded weather derivatives; notes and loan receivables, notes securitizations, annuities and residuals, private equities and longevity and other total return swaps.

The Company’s policy is to recognize transfers between the hierarchy levels at the beginning of the period.

 

9


Table of Contents

The Company’s financial instruments measured at fair value include investments classified as trading securities, certain other invested assets and the segregated investment portfolio underlying the funds held – directly managed account. At September 30, 2013 and December 31, 2012, the Company’s financial instruments measured at fair value were classified between Levels 1, 2 and 3 as follows (in thousands of U.S. dollars):

 

September 30, 2013

   Quoted prices in
active markets for
identical assets
(Level 1)
    Significant other
observable inputs
(Level 2)
    Significant
unobservable
inputs

(Level 3)
    Total  

Fixed maturities

        

U.S. government and government sponsored enterprises

   $ —        $ 1,495,749     $  —        $ 1,495,749  

U.S. states, territories and municipalities

     —          16,659       289,135       305,794  

Non-U.S. sovereign government, supranational and government related

     —          2,343,751       —          2,343,751  

Corporate

     —          5,942,359       99,627       6,041,986  

Asset-backed securities

     —          704,174       453,753       1,157,927  

Residential mortgage-backed securities

     —          2,293,874       —          2,293,874  

Other mortgage-backed securities

     —          41,757       —          41,757  
  

 

 

   

 

 

   

 

 

   

 

 

 

Fixed maturities

   $  —        $ 12,838,323     $ 842,515     $ 13,680,838  

Short-term investments

   $  —        $ 36,781     $  —        $ 36,781  

Equities

        

Real estate investment trusts

   $ 168,985     $ —        $  —        $ 168,985  

Energy

     156,254       —          —          156,254  

Finance

     105,025       10,057       14,285       129,367  

Consumer noncyclical

     119,194       —          —          119,194  

Communications

     64,026       —          2,143       66,169  

Technology

     51,535       —          9,150       60,685  

Industrials

     45,181       —          —          45,181  

Consumer cyclical

     44,566       —          —          44,566  

Utilities

     38,481       —          —          38,481  

Insurance

     36,481       —          —          36,481  

Other

     20,559       —          —          20,559  

Mutual funds and exchange traded funds

     48,126       180,362       7,674       236,162  
  

 

 

   

 

 

   

 

 

   

 

 

 

Equities

   $ 898,413     $ 190,419     $ 33,252     $ 1,122,084  

Other invested assets

        

Derivative assets

        

Foreign exchange forward contracts

   $  —        $ 4,188     $  —        $ 4,188  

Credit default swaps (assumed risks)

     —          49       —          49  

Insurance-linked securities

     —          —          175       175  

Interest rate swaps

     —          150       —          150  

TBAs

     —          7,256       —          7,256  

Other

        

Notes and loan receivables and notes securitization

     —          —          47,781       47,781  

Annuities and residuals

     —          —          26,939       26,939  

Private equities

     —          —          21,878       21,878  

Derivative liabilities

        

Foreign exchange forward contracts

     —          (5,470     —          (5,470

Foreign currency option contracts

     —          (821     —          (821

Futures contracts

     (61,909     —          —          (61,909

Credit default swaps (protection purchased)

     —          (231     —          (231

Insurance-linked securities

     —          —          (390     (390

Total return swaps

     —          —          (732     (732

Interest rate swaps

     —          (4,614     —          (4,614
  

 

 

   

 

 

   

 

 

   

 

 

 

Other invested assets

   $ (61,909   $ 507     $ 95,651     $ 34,249  

Funds held – directly managed

        

U.S. government and government sponsored enterprises

   $  —        $ 167,808     $  —        $ 167,808  

U.S. states, territories and municipalities

     —          —          298       298  

Non-U.S. sovereign government, supranational and government related

     —          192,823       —          192,823  

Corporate

     —          258,946       —          258,946  

Short-term investments

     —          2,389       —          2,389  

Other invested assets

     —          —          15,566       15,566  
  

 

 

   

 

 

   

 

 

   

 

 

 

Funds held – directly managed

   $  —        $ 621,966     $ 15,864     $ 637,830  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 836,504     $ 13,687,996     $ 987,282     $ 15,511,782  

 

10


Table of Contents

December 31, 2012

   Quoted prices in
active markets
for identical
assets (Level 1)
    Significant other
observable inputs
(Level 2)
    Significant
unobservable
inputs

(Level 3)
    Total  

Fixed maturities

        

U.S. government and government sponsored enterprises

   $ —       $ 1,130,924     $ —       $ 1,130,924  

U.S. states, territories and municipalities

     —         10,151       233,235       243,386  

Non-U.S. sovereign government, supranational and government related

     —          2,375,673       —          2,375,673  

Corporate

     —          6,554,934       100,904       6,655,838  

Asset-backed securities

     —          400,336       323,134       723,470  

Residential mortgage-backed securities

     —          3,199,924       —          3,199,924  

Other mortgage-backed securities

     —          66,100       —          66,100  
  

 

 

   

 

 

   

 

 

   

 

 

 

Fixed maturities

   $  —        $ 13,738,042     $ 657,273     $ 14,395,315  

Short-term investments

   $  —        $ 150,552     $  —        $ 150,552  

Equities

        

Consumer noncyclical

   $ 130,526     $  —        $  —        $ 130,526  

Energy

     118,213       —          —          118,213  

Finance

     79,456       7,472       13,477       100,405  

Technology

     71,927       —          6,987       78,914  

Real estate investment trusts

     66,846       —          —          66,846  

Communications

     65,722       —          —          65,722  

Consumer cyclical

     62,526       —          —          62,526  

Industrials

     59,242       —          —          59,242  

Insurance

     39,132       —          —          39,132  

Other

     60,913       —          —          60,913  

Mutual funds and exchange traded funds

     34,053       270,246       7,264       311,563  
  

 

 

   

 

 

   

 

 

   

 

 

 

Equities

   $ 788,556     $ 277,718     $ 27,728     $ 1,094,002  

Other invested assets

        

Derivative assets

        

Foreign exchange forward contracts

   $  —        $ 7,889     $  —        $ 7,889  

Foreign currency option contracts

     —          1,410       —          1,410  

Futures contracts

     1,956       —          —          1,956  

Credit default swaps (protection purchased)

     —          6       —          6  

Credit default swaps (assumed risks)

     —          512       —          512  

Total return swaps

     —          —          6,630       6,630  

TBAs

     —          115       —          115  

Other

        

Notes and loan receivables and notes securitization

     —          —          34,902       34,902  

Annuities and residuals

     —          —          46,882       46,882  

Private equities

     —          —          1,404       1,404  

Derivative liabilities

        

Foreign exchange forward contracts

     —          (17,395     —          (17,395

Foreign currency option contracts

     —          (186     —          (186

Futures contracts

     (1,352     —          —          (1,352

Credit default swaps (protection purchased)

     —          (807     —          (807

Insurance-linked securities

     —          —          (2,173     (2,173

Total return swaps

     —          —          (546     (546

Interest rate swaps

     —          (7,880     —          (7,880

TBAs

     —          (163     —          (163
  

 

 

   

 

 

   

 

 

   

 

 

 

Other invested assets

   $ 604     $ (16,499   $ 87,099     $ 71,204  

Funds held – directly managed

        

U.S. government and government sponsored enterprises

   $  —        $ 218,696     $  —        $ 218,696  

U.S. states, territories and municipalities

     —          —          345       345  

Non-U.S. sovereign government, supranational and government related

     —          233,987       —          233,987  

Corporate

     —          362,243       —          362,243  

Other invested assets

     —          —          17,976       17,976  
  

 

 

   

 

 

   

 

 

   

 

 

 

Funds held – directly managed

   $  —        $ 814,926     $ 18,321     $ 833,247  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 789,160     $ 14,964,739     $ 790,421     $ 16,544,320  

 

11


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At September 30, 2013 and December 31, 2012, the aggregate carrying amounts of items included in Other invested assets that the Company did not measure at fair value were $233.9 million and $262.2 million, respectively, which related to the Company’s investments that are accounted for using the cost method of accounting, equity method of accounting or investment company accounting.

In addition to the investments underlying the funds held – directly managed account held at fair value of $637.8 million and $833.2 million at September 30, 2013 and December 31, 2012, respectively, the funds held – directly managed account also included cash and cash equivalents, carried at fair value, of $33.9 million and $53.7 million, respectively, and accrued investment income of $8.9 million and $10.2 million, respectively. At September 30, 2013 and December 31, 2012, the aggregate carrying amounts of items included in the funds held – directly managed account that the Company did not measure at fair value were $132.9 million and $33.6 million, respectively, which primarily related to other assets and liabilities held by Colisée Re related to the underlying business, which are carried at cost (see Note 5 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012).

At September 30, 2013 and December 31, 2012, substantially all of the accrued investment income in the Condensed Consolidated Balance Sheets related to the Company’s investments and the investments underlying the funds held – directly managed account for which the fair value option was elected.

During the three months and nine months ended September 30, 2013 and the three months ended September 30, 2012, there were no transfers between Level 1 and Level 2. During the nine months ended September 30, 2012, certain equities traded on foreign exchanges with a fair value of $1.1 million were transferred from Level 2 to Level 1 given they were trading in an active market at September 30, 2012.

Disclosures about the fair value of financial instruments that the Company does not measure at fair value exclude insurance contracts and certain other financial instruments. At September 30, 2013 and December 31, 2012, the fair values of financial instrument assets recorded in the Condensed Consolidated Balance Sheets not described above, approximate their carrying values.

 

12


Table of Contents

The following tables are reconciliations of the beginning and ending balances for all financial instruments measured at fair value using Level 3 inputs for the three months ended September 30, 2013 and 2012 (in thousands of U.S. dollars):

 

For the three months ended

September 30, 2013

   Balance at
beginning
of period
     Realized and
unrealized
investment
gains (losses)
included in
net income
    Purchases
and
issuances
     Settlements
and

sales (1)
    Net
transfers
into/ (out of)
Level 3
     Balance
at end
of period
    Change in
unrealized
investment
gains (losses)
relating to
assets held at
end of period
 

Fixed maturities

                 

U.S. states, territories and municipalities

   $ 219,163      $ 8,431     $ 61,706      $ (165   $ —         $ 289,135     $ 8,431  

Corporate

     99,896        (269     —          —          —           99,627       (269

Asset-backed securities

     426,288        4,800       86,442        (63,777     —           453,753       (3,043
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Fixed maturities

   $ 745,347      $ 12,962     $ 148,148      $ (63,942   $ —         $ 842,515     $ 5,119  

Equities

                 

Finance

   $ 13,000      $ 1,285     $  —         $  —        $ —         $ 14,285     $ 1,285  

Communications

     2,040        103       —           —          —           2,143       103  

Technology

     8,012        1,138       —           —          —           9,150       1,138  

Mutual funds and exchange traded funds

     7,549        125       —           —          —           7,674       125  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Equities

   $ 30,601      $ 2,651     $  —         $  —        $ —         $ 33,252     $ 2,651  

Other invested assets

                 

Derivatives, net

   $ 2,333      $ (1,885   $  —         $ (1,395   $ —         $ (947   $ (140

Notes and loan receivables and notes securitization

     44,224        3,250       1,248        (941     —           47,781       3,250  

Annuities and residuals

     30,555        413       —           (4,029     —           26,939       166  

Private equities

     21,100        (299     1,077        —          —           21,878       (299
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Other invested assets

   $ 98,212      $ 1,479     $ 2,325      $ (6,365   $ —         $ 95,651     $ 2,977  

Funds held – directly managed

                 

U.S. states, territories and municipalities

   $ 337      $ (39   $  —         $  —        $ —         $ 298     $ (39

Other invested assets

     15,207        1,045       —           (686     —           15,566       1,045  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Funds held – directly managed

   $ 15,544      $ 1,006     $  —         $ (686   $ —         $ 15,864     $ 1,006  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total

   $ 889,704      $ 18,098     $ 150,473      $ (70,993   $ —         $ 987,282     $ 11,753  

 

(1) Settlements and sales of asset-backed securities and derivatives include sales of $13.7 million and $1.4 million, respectively.

 

13


Table of Contents

For the three months ended

September 30, 2012

   Balance at
beginning
of period
     Realized and
unrealized
investment
gains (losses)
included in
net income
    Purchases
and
issuances
     Settlements
and

sales
    Net
transfers
(out of)/ into
Level 3
    Balance
at end of
period
     Change in
unrealized
investment gains
(losses) relating
to assets held

at end of period
 

Fixed maturities

                 

U.S. states, territories and municipalities

   $ 117,235      $ 1,618     $ 90,050      $ (83   $  —        $ 208,820      $ 1,618  

Corporate

     111,070        681       56        (3,250     —          108,557        582  

Asset-backed securities

     290,371        699       59,724        (21,605     —          329,189        739  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Fixed maturities

   $ 518,676      $ 2,998     $ 149,830      $ (24,938   $  —        $ 646,566      $ 2,939  

Equities

                 

Finance

   $ 19,422      $ 750     $  —         $  —        $ (6,800   $ 13,372      $ 750  

Technology

     7,192        (99     —           —          —          7,093        (99

Mutual funds and exchange traded funds

     6,760        311       —           —          —          7,071        311  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Equities

   $ 33,374      $ 962     $  —         $  —        $ (6,800   $ 27,536      $ 962  

Other invested assets

                 

Derivatives, net

   $ 1,207      $ 3,152     $  —         $  —        $  —        $ 4,359      $ 4,168  

Notes and loan receivables and notes securitization

     44,304        3,473       1,209        (19,958     —          29,028        1,654  

Annuities and residuals

     27,225        6,314       23,642        (14,899     —          42,282        2,641  

Private equities

     1,000        (141     450        —          —          1,309        (141
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Other invested assets

   $ 73,736      $ 12,798     $ 25,301      $ (34,857   $  —        $ 76,978      $ 8,322  

Funds held – directly managed

                 

U.S. states, territories and municipalities

   $ 321      $ 8     $  —         $  —        $  —        $ 329      $ 8  

Other invested assets

     15,076        2,460       —           —          —          17,536        2,460  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Funds held – directly managed

   $ 15,397      $ 2,468     $  —         $  —        $  —        $ 17,865      $ 2,468  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ 641,183      $ 19,226     $ 175,131      $ (59,795   $ (6,800   $ 768,945      $ 14,691  

During the three months ended September 30, 2012, an equity traded on a foreign exchange with a fair value of $6.8 million was transferred from Level 3 into Level 2 given it was valued using observable inputs at September 30, 2012.

 

14


Table of Contents

The following tables are reconciliations of the beginning and ending balances for all financial instruments measured at fair value using Level 3 inputs for the nine months ended September 30, 2013 and 2012 (in thousands of U.S. dollars):

 

For the nine months ended

September 30, 2013

   Balance at
beginning
of period
     Realized and
unrealized
investment
(losses) gains
included in
net income
    Purchases
and
issuances (1)
     Settlements
and

sales (2)
    Net
transfers
into/ (out of)
Level 3
     Balance
at end
of period
    Change in
unrealized
investment
(losses) gains
relating to
assets held at
end of period
 

Fixed maturities

                 

U.S. states, territories and municipalities

   $ 233,235      $ (5,427   $ 61,706      $ (379   $ —         $ 289,135     $ (5,427

Corporate

     100,904        (1,277     —           —          —           99,627       (1,277

Asset-backed securities

     323,134        478       241,607        (111,466     —           453,753       (7,182
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Fixed maturities

   $ 657,273      $ (6,226   $ 303,313      $ (111,845   $ —         $ 842,515     $ (13,886

Equities

                 

Finance

   $ 13,477      $ 808     $  —         $  —        $ —         $ 14,285     $ 808  

Communications

     —           103       2,040        —          —           2,143       103  

Technology

     6,987        2,163       —           —          —           9,150       2,163  

Mutual funds and exchange traded funds

     7,264        410       —           —          —           7,674       410  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Equities

   $ 27,728      $ 3,484     $ 2,040      $  —        $ —         $ 33,252     $ 3,484  

Other invested assets

                 

Derivatives, net

   $ 3,911      $ (6,084   $ 121      $ 1,105     $ —         $ (947   $ (349

Notes and loan receivables and notes securitization

     34,902        1,867       14,598        (3,586     —           47,781       1,867  

Annuities and residuals

     46,882        506       —           (20,449     —           26,939       481  

Private equities

     1,404        (3,811     24,285        —          —           21,878       (3,811
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Other invested assets

   $ 87,099      $ (7,522   $ 39,004      $ (22,930   $ —         $ 95,651     $ (1,812

Funds held – directly managed

                 

U.S. states, territories and municipalities

   $ 345      $ (47   $  —         $  —        $ —         $ 298     $ (47

Other invested assets

     17,976        (1,653     —           (757     —           15,566       (589
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Funds held – directly managed

   $ 18,321      $ (1,700   $  —         $ (757   $ —         $ 15,864     $ (636
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total

   $ 790,421      $ (11,964   $ 344,357      $ (135,532   $ —         $ 987,282     $ (12,850

 

(1) Purchases and issuances of derivatives include issuances of $0.8 million.
(2) Settlements and sales of asset-backed securities, derivatives and annuities and residuals include sales of $13.7 million, $1.4 million and $6.3 million, respectively.

 

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For the nine months ended

September 30, 2012

   Balance at
beginning
of period
     Realized and
unrealized
investment
gains (losses)
included in
net income
    Purchases
and
issuances (1)
    Settlements
and

sales
    Net
transfers
(out of)/ into
Level 3
    Balance
at end
of period
     Change in
unrealized
investment
gains (losses)
relating to
assets held at
end of period
 

Fixed maturities

                

U.S. states, territories and municipalities

   $ 111,415      $ 2,900     $ 94,750     $ (245   $  —        $ 208,820      $ 2,900  

Corporate

     111,700        111       120       (3,374     —          108,557        (2

Asset-backed securities

     257,415        8,892       142,314       (79,432     —          329,189        8,771  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Fixed maturities

   $ 480,530      $ 11,903     $ 237,184     $ (83,051   $  —        $ 646,566      $ 11,669  

Equities

                

Finance

   $ 9,670      $ 3,702     $ 6,800     $  —        $ (6,800   $ 13,372      $ 3,702  

Technology

     —           (99     7,192       —          —          7,093        (99

Mutual funds and exchange traded funds

     6,495        576       —          —          —          7,071        576  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Equities

   $ 16,165      $ 4,179     $ 13,992     $  —        $ (6,800   $ 27,536      $ 4,179  

Other invested assets

                

Derivatives, net

   $ 5,622      $ 4,157     $ (5,420   $  —        $  —        $ 4,359      $ 4,874  

Notes and loan receivables and notes securitization

     63,565        9,944       36,834       (81,315     —          29,028        2,402  

Annuities and residuals

     27,840        8,661       25,065       (19,284     —          42,282        3,543  

Private equities

     —           (141     1,450       —          —          1,309        (141
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Other invested assets

   $ 97,027      $ 22,621     $ 57,929     $ (100,599   $  —        $ 76,978      $ 10,678  

Funds held – directly managed

                

U.S. states, territories and municipalities

   $ 334      $ (5   $  —        $  —        $  —        $ 329      $ (5

Other invested assets

     15,433        2,103       —          —          —          17,536        2,103  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Funds held – directly managed

   $ 15,767      $ 2,098     $  —        $  —        $  —        $ 17,865      $ 2,098  
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ 609,489      $ 40,801     $ 309,105     $ (183,650   $ (6,800   $ 768,945      $ 28,624  

 

(1) Purchases and issuances of derivatives includes issuances of $5.7 million.

During the nine months ended September 30, 2012, an equity traded on a foreign exchange with a fair value of $6.8 million was transferred from Level 3 into Level 2 given it was valued using observable inputs at September 30, 2012.

The following tables show the significant unobservable inputs used in the valuation of financial instruments measured at fair value using Level 3 inputs at September 30, 2013 and December 31, 2012 (in thousands of U.S. dollars):

 

September 30, 2013

   Fair value    

Valuation techniques

  

Unobservable inputs

   Range
(Weighted average)
 

Fixed maturities

          

U.S. states, territories and municipalities

   $ 289,135     Discounted cash flow    Credit spreads      2.8% - 10.1% (3.7%)  

Asset-backed securities – interest only

     25     Discounted cash flow    Credit spreads      6.0% - 11.2% (9.0%)  
        Prepayment speed      20.0% (20.0%)  

Asset-backed securities – other

     453,728     Discounted cash flow    Credit spreads      4.0% - 12.2% (7.2%)  

Equities

          

Finance

     14,285     Weighted market    Net income multiple      14.6 (14.6)  
         comparables    Tangible book value multiple      1.1 (1.1)  
        Liquidity discount      25.0% (25.0%)  
        Comparable return      10.0% (10.0%)  

Technology

     9,150     Weighted market    Revenue multiple      2.0 (2.0)  
         comparables    Adjusted earnings multiple      12.9 (12.9)  
        Liquidity discount      25.0% (25.0%)  
        Comparable return      14.2% (14.2%)  

Communications

     2,143     Weighted market    Adjusted earnings multiple      10.2 (10.2)  
         comparables    Comparable return      5% (5%)  

Other invested assets

          

Total return swaps

     (732   Discounted cash flow    Credit spreads      20.2% (20.2%)  

 

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Notes and loan receivables

     27,674      Discounted cash flow    Credit spreads      17.5% (17.5%)  
         Gross revenue/fair value      1.2 - 1.6 (1.5)  

Notes securitization

     20,107      Discounted cash flow    Credit spreads      6.4% (6.4%)  

Annuities and residuals

     26,939      Discounted cash flow    Credit spreads      4.6% - 9.0% (6.4%)  
         Prepayment speed      0% - 15.0% (7.0%)  
         Constant default rate      0.3% - 35.0% (13.0%)  

Private equity

     15,259      Liquidation analysis    Net assets, as reported      100.0% (100.0%)  
         Recoverability of intangible assets      0% (0%)  

Private equity fund

     6,619      Lag reported market value    Net asset value, as reported      100.0% (100.0%)  
         Market adjustments      2.4% - 9.7% (4.6%)  

Funds held – directly managed

           

Other invested assets

     15,566      Lag reported market value    Net asset value, as reported      100.0% (100.0%)  
         Market adjustments      -12.9% - 0% (-11.4%)  

December 31, 2012

   Fair value     

Valuation techniques

  

Unobservable inputs

   Range
(Weighted average)
 

Fixed maturities

           

U.S. states, territories and municipalities

   $ 233,235      Discounted cash flow    Credit spreads      2.8% - 4.5% (3.7%)  

Asset-backed securities – interest only

     12,625      Discounted cash flow    Credit spreads      6.8% - 11.7% (9.1%)  
         Prepayment speed      20.0% (20.0%)  

Asset-backed securities – other

     310,509      Discounted cash flow    Credit spreads      4.0% - 12.2% (7.6%)  

Equities

           

Finance

     13,477      Weighted market      
          comparables    Comparable return      0.8% (0.8%)  

Technology

     6,987      Weighted market      
          comparables    Comparable return      -1.5% (-1.5%)  

Other invested assets

           

Total return swaps

     6,084      Discounted cash flow    Credit spreads      2.6% - 4.6% (3.2%)  

Notes and loan receivables

     24,902      Discounted cash flow    Credit spreads      17.5% (17.5%)  
         Gross revenue/fair value      1.7 - 2.1 (1.8)  

Notes securitization

     10,000      Discounted cash flow    Credit spreads      6.5% (6.5%)  

Annuities and residuals

     46,882      Discounted cash flow    Credit spreads      4.7% - 9.9% (7.2%)  
         Prepayment speed      0% - 15.0% (7.6%)  
         Constant default rate      2.3% - 35.0% (13.2%)  

Private equity fund

     1,404      Lag reported market value    Net asset value, as reported      100.0% (100.0%)  
         Market adjustments      7.3% (7.3%)  

Funds held – directly managed

           

Other invested assets

     17,976      Lag reported market value    Net asset value, as reported      100.0% (100.0%)  
         Market adjustments      -38.1% - 0% (-12.1%)  

The tables above do not include financial instruments that are measured using unobservable inputs (Level 3) where the unobservable inputs were obtained from external sources and used without adjustment. These financial instruments include mortality bonds (included within corporate fixed maturities), mutual fund investments (included within equities), and certain insurance-linked securities (included within other invested assets).

The Company has established a Valuation Committee which is responsible for determining the Company’s invested asset valuation policy and related procedures, for reviewing significant changes in the fair value measurements of securities classified as Level 3 from period to period, and for reviewing in accordance with the invested asset valuation policy an independent internal peer analysis that is performed on the fair value measurements of all securities that are classified as Level 3. The Valuation Committee is comprised of members of the Company’s senior management team and meets on a quarterly basis. The Company’s invested asset valuation policy is monitored by the Company’s Audit Committee of the Board of Directors (Board) and approved annually by the Company’s Risk and Finance Committee of the Board.

 

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Changes in the fair value of the Company’s financial instruments subject to the fair value option during the three months and nine months ended September 30, 2013 and 2012 were as follows (in thousands of U.S. dollars):

 

     For the three
months ended
September 30, 2013
    For the three
months ended
September 30, 2012
     For the nine
months ended
September 30, 2013
    For the nine
months ended
September 30, 2012
 

Fixed maturities and short-term investments

   $ 10,259     $ 150,046      $ (457,168   $ 230,862  

Equities

     (891     51,260        (8,540     69,068  

Other invested assets

     3,021       1,574        (4,047     19,734  

Funds held – directly managed

     (907     9,425        (22,322     18,216  
  

 

 

   

 

 

    

 

 

   

 

 

 

Total

   $ 11,482     $ 212,305      $ (492,077   $ 337,880  

All of the above changes in fair value are included in the Condensed Consolidated Statements of Operations under the caption Net realized and unrealized investment gains (losses).

The following methods and assumptions were used by the Company in estimating the fair value of each class of financial instrument recorded in the Condensed Consolidated Balance Sheets. There have been no material changes in the Company’s valuation techniques during the periods presented.

Fixed maturities

 

    U.S. government and government sponsored enterprises—U.S. government and government sponsored enterprises securities consist primarily of bonds issued by the U.S. Treasury, corporate debt securities issued by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, the Federal Home Loan Bank and the Private Export Funding Corporation. These securities are generally priced by independent pricing services. The independent pricing services may use actual transaction prices for securities that have been actively traded. For securities that have not been actively traded, each pricing source has its own proprietary method to determine the fair value, which may incorporate option adjusted spreads (OAS), interest rate data and market news. The Company generally classifies these securities in Level 2.

 

    U.S. states, territories and municipalities—U.S. states, territories and municipalities securities consist primarily of bonds issued by U.S. states, territories and municipalities. These securities are generally priced by independent pricing services using the techniques described for U.S. government and government sponsored enterprises above. The Company generally classifies these securities in Level 2. Certain of the bonds that are issued by municipal housing authorities are not actively traded and are priced based on internal models using unobservable inputs. Accordingly, the Company classifies these securities in Level 3. The significant unobservable input used in the fair value measurement of these U.S. states, territories and municipalities securities classified as Level 3 is credit spreads. A significant increase (decrease) in credit spreads in isolation could result in a significantly lower (higher) fair value measurement.

 

    Non-U.S. sovereign government, supranational and government related—Non-U.S. sovereign government, supranational and government related securities consist primarily of bonds issued by non-U.S. national governments and their agencies, non-U.S. regional governments and supranational organizations. These securities are generally priced by independent pricing services using the techniques described for U.S. government and government sponsored enterprises above. The Company generally classifies these securities in Level 2.

 

    Corporate—Corporate securities consist primarily of bonds issued by U.S. and foreign corporations covering a variety of industries and issuing countries. These securities are generally priced by independent pricing services and brokers. The pricing provider incorporates information including credit spreads, interest rate data and market news into the valuation of each security. The Company generally classifies these securities in Level 2. When a corporate security is inactively traded or the valuation model uses unobservable inputs, the Company classifies the security in Level 3.

 

    Asset-backed securities—Asset-backed securities primarily consist of bonds issued by U.S. and foreign corporations that are backed by student loans, automobile loans, credit card receivables, equipment leases, and special purpose financing. With the exception of special purpose financing, these asset-backed securities are generally priced by independent pricing services and brokers. The pricing provider applies dealer quotes and other available trade information, prepayment speeds, yield curves and credit spreads to the valuation. The Company generally classifies these securities in Level 2. Special purpose financing securities are generally inactively traded and are priced based on valuation models using unobservable inputs. The Company generally classifies these securities in Level 3. The significant unobservable inputs used in the fair value measurement of these asset-backed securities classified as Level 3 are prepayment speeds and credit spreads. Significant increases (decreases) in these prepayment speeds and credit spreads in isolation could result in a significantly lower (higher) fair value measurement.

 

    Residential mortgage-backed securities—Residential mortgage-backed securities primarily consist of bonds issued by the Government National Mortgage Association, the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, as well as private, non-agency issuers. With the exception of private, non-agency issuers, these residential mortgage-backed securities are generally priced by independent pricing services and brokers. When current market trades are not available, the pricing provider or the Company will employ proprietary models with observable inputs including other trade information, prepayment speeds, yield curves and credit spreads. The Company generally classifies these securities in Level 2.

 

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Table of Contents
    Other mortgage-backed securities—Other mortgage-backed securities primarily consist of commercial mortgage-backed securities. These securities are generally priced by independent pricing services and brokers. The pricing provider applies dealer quotes and other available trade information, prepayment speeds, yield curves and credit spreads to the valuation. The Company generally classifies these securities in Level 2.

In general, the methods employed by the independent pricing services to determine the fair value of the securities that have not been actively traded involve the use of “matrix pricing” in which the independent pricing source applies the credit spread for a comparable security that has traded recently to the current yield curve to determine a reasonable fair value. The Company uses a pricing service ranking to consistently select the most appropriate pricing service in instances where it receives multiple quotes on the same security. When fair values are unavailable from these independent pricing sources, quotes are obtained directly from broker-dealers who are active in the corresponding markets. Most of the Company’s fixed maturities are priced from the pricing services or dealer quotes. The Company will typically not make adjustments to prices received from pricing services or dealer quotes; however, in instances where the quoted external price for a security uses significant unobservable inputs, the Company will classify that security as Level 3. The methods used to develop and substantiate the unobservable inputs used are based on the Company’s valuation policy and are dependent upon the facts and circumstances surrounding the individual investments which are generally transaction specific. The Company’s inactively traded fixed maturities are classified as Level 3. For all fixed maturity investments, the bid price is used for estimating fair value.

To validate prices, the Company compares the fair value estimates to its knowledge of the current market and will investigate prices that it considers not to be representative of fair value. The Company also reviews an internally generated fixed maturity price validation report which converts prices received for fixed maturity investments from the independent pricing sources and from broker-dealers quotes and plots OAS and duration on a sector and rating basis. The OAS is calculated using established algorithms developed by an independent risk analytics platform vendor. The OAS on the fixed maturity price validation report are compared for securities in a similar sector and having a similar rating, and outliers are identified and investigated for price reasonableness. In addition, the Company completes quantitative analyses to compare the performance of each fixed maturity investment portfolio to the performance of an appropriate benchmark, with significant differences identified and investigated.

Short term investments

Short term investments are valued in a manner similar to the Company’s fixed maturity investments and are generally classified in Level 2.

Equities

Equity securities include U.S. and foreign common and preferred stocks, mutual funds and exchange traded funds. Equities and exchange traded funds are generally classified in Level 1 as the Company uses prices received from independent pricing sources based on quoted prices in active markets. Equities classified as Level 2 are generally mutual funds invested in fixed income securities, where the net asset value of the fund is provided on a daily basis, and common stocks traded in inactive markets. Equities classified as Level 3 are generally mutual funds invested in securities other than the common stock of publicly traded companies, where the net asset value is not provided on a daily basis, and inactively traded common stocks. The significant unobservable inputs used in the fair value measurement of inactively traded common stocks classified as Level 3 include market return information, weighted using management’s judgment, from comparable selected publicly traded companies in the same industry, in a similar region and of a similar size, including net income multiples, tangible book value multiples, revenue multiples and adjusted earnings multiples. Significant increases (decreases) in any of these inputs could result in a significantly higher (lower) fair value measurement. Significant unobservable inputs used in measuring the fair value measurement of inactively traded common stocks also include a liquidity discount. A significant increase (decrease) in the liquidity discount could result in a significantly lower (higher) fair value measurement.

To validate prices, the Company completes quantitative analyses to compare the performance of each equity investment portfolio to the performance of an appropriate benchmark, with significant differences identified and investigated.

Other invested assets

The Company’s exchange traded derivatives, such as futures are generally classified as Level 1 as their fair values are quoted prices in active markets. The Company’s foreign exchange forward contracts, foreign currency option contracts, credit default swaps, interest rate swaps and TBAs are generally classified as Level 2 within the fair value hierarchy and are priced by independent pricing services.

Included in the Company’s Level 3 classification, in general, are certain inactively traded weather derivatives; notes and loan receivables, notes securitizations, annuities and residuals, private equities and longevity and other total return swaps. For Level 3 instruments, the Company will generally (i) receive a price based on a manager’s or trustee’s valuation for the asset; (ii) perform a

 

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liquidation analysis using investee company financial statements, that are generally audited on an annual basis, adjusted if necessary for the recoverability of intangible assets; (iii) develop an internal discounted cash flow model to measure fair value; or (iv) use market return information, adjusted if necessary and weighted using management’s judgment, from comparable selected publicly traded equity funds, in a similar region and of a similar size. Where the Company receives prices from the manager or trustee, these prices are based on the manager’s or trustee’s estimate of fair value for the assets and are generally audited on an annual basis. Where the Company develops its own discounted cash flow models, the inputs will be specific to the asset in question, based on appropriate historical information, adjusted as necessary, and using appropriate discount rates. The significant unobservable inputs used in the fair value measurement of other invested assets classified as Level 3 include credit spreads, prepayment speeds, constant default rates and gross revenue to fair value ratios. Significant increases (decreases) in any of these inputs in isolation could result in a significantly lower (higher) fair value measurement. Significant unobservable inputs used in the fair value measurement of other invested assets classified as Level 3 also include an assessment of the recoverability of intangible assets and market return information, weighted using management’s judgment, from comparable selected publicly traded companies in the same industry, in a similar region and of a similar size. Significant increase (decrease) in these inputs in isolation could result in a significantly higher (lower) fair value measurement. As part of the Company’s modeling to determine the fair value of an investment, the Company considers counterparty credit risk as an input to the model, however, the majority of the Company’s counterparties are investment grade rated institutions and the failure of any one counterparty would not have a significant impact on the Company’s consolidated financial statements.

To validate prices, the Company will compare them to benchmarks, where appropriate, or to the business results generally within that asset class and specifically to those particular assets.

Funds held – directly managed

The segregated investment portfolio underlying the funds held – directly managed account is comprised of fixed maturities and other invested assets which are fair valued on a basis consistent with the methods described above. Substantially all fixed maturities and short-term investments within the funds held – directly managed account are classified as Level 2 within the fair value hierarchy.

The other invested assets within the segregated investment portfolio underlying the funds held – directly managed account, which are classified as Level 3 investments, are primarily real estate mutual fund investments carried at fair value. For the real estate mutual fund investments, the Company receives a price based on the real estate fund manager’s valuation for the asset and further adjusts the price, if necessary, based on appropriate current information on the real estate market. Significant increases (decreases) to the adjustment to the real estate fund manager’s valuation could result in a significantly lower (higher) fair value measurement.

To validate prices within the segregated investment portfolio underlying the funds held – directly managed account, the Company utilizes the methods described above.

(b) Fair Value of Financial Instrument Liabilities

At September 30, 2013 and December 31, 2012, the fair values of financial instrument liabilities recorded in the Condensed Consolidated Balance Sheets approximate their carrying values, with the exception of the debt related to senior notes (Senior Notes) and the debt related to capital efficient notes (CENts).

The following methods and assumptions were used by the Company in estimating the fair value of each class of financial instrument liability recorded in the Condensed Consolidated Balance Sheets for which the Company does not measure that instrument at fair value:

 

    the fair value of the Senior Notes was calculated based on discounted cash flow models using observable market yields and contractual cash flows based on the aggregate principal amount outstanding of $250 million from PartnerRe Finance A LLC and $500 million from PartnerRe Finance B LLC at September 30, 2013 and December 31, 2012; and

 

    the fair value of the CENts was calculated based on discounted cash flow models using observable market yields and contractual cash flows based on the aggregate principal amount outstanding of $63 million from PartnerRe Finance II Inc. at September 30, 2013 and December 31, 2012.

The carrying values and fair values of the Senior Notes and CENts at September 30, 2013 and December 31, 2012 were as follows (in thousands of U.S. dollars):

 

     September 30, 2013      December 31, 2012  
     Carrying Value      Fair Value      Carrying Value      Fair Value  

Debt related to senior notes (1)

   $ 750,000      $ 852,507      $ 750,000      $ 859,367  

Debt related to capital efficient notes (2)

     63,384        61,853        63,384        66,990  

 

(1) PartnerRe Finance A LLC and PartnerRe Finance B LLC, the issuers of the Senior Notes, do not meet consolidation requirements under U.S. GAAP. Accordingly, the Company shows the related intercompany debt of $750 million in its Condensed Consolidated Balance Sheets at September 30, 2013 and December 31, 2012.

 

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(2) PartnerRe Finance II Inc., the issuer of the CENts, does not meet consolidation requirements under U.S. GAAP. Accordingly, the Company shows the related intercompany debt of $71 million in its Condensed Consolidated Balance Sheets at September 30, 2013 and December 31, 2012.

At September 30, 2013, the Company’s debt related to the Senior Notes and CENts was classified as Level 2 in the fair value hierarchy.

Disclosures about the fair value of financial instrument liabilities exclude insurance contracts and certain other financial instruments.

4. Derivatives

The Company’s derivative instruments are recorded in the Condensed Consolidated Balance Sheets at fair value, with changes in fair value mainly recognized in either net foreign exchange gains and losses or net realized and unrealized investment gains and losses in the Condensed Consolidated Statements of Operations or accumulated other comprehensive income or loss in the Condensed Consolidated Balance Sheets, depending on the nature of the derivative instrument. The Company’s objectives for holding or issuing these derivatives are as follows:

Foreign Exchange Forward Contracts

The Company utilizes foreign exchange forward contracts as part of its overall currency risk management and investment strategies. From time to time, the Company also utilizes foreign exchange forward contracts to hedge a portion of its net investment exposure resulting from the translation of its foreign subsidiaries and branches whose functional currency is other than the U.S. dollar.

Foreign Currency Option Contracts and Futures Contracts

The Company utilizes foreign currency option contracts to mitigate foreign currency risk. The Company uses exchange traded treasury note futures contracts to manage portfolio duration and commodity and equity futures to hedge certain investments. The Company also uses commodities futures to replicate the investment return on certain benchmarked commodities.

Credit Default Swaps

The Company purchases protection through credit default swaps to mitigate the risk associated with its underwriting operations, most notably in the credit/surety line, and to manage market exposures.

The Company also assumes credit risk through credit default swaps to replicate investment positions. The original term of these credit default swaps is generally five years or less and there are no recourse provisions associated with these swaps. While the Company would be required to perform under exposure assumed through credit default swaps in the event of a default on the underlying issuer, no issuer was in default at September 30, 2013. The counterparties on the Company’s assumed credit default swaps are all investment grade rated financial institutions.

Insurance-Linked Securities

The Company enters into various weather derivatives and longevity total return swaps for which the underlying risks reference parametric weather risks for the weather derivatives and longevity risk for the longevity total return swaps.

Total Return and Interest Rate Swaps and Interest Rate Derivatives

The Company enters into total return swaps referencing various project, investments and principal finance obligations. The Company enters into interest rate swaps to mitigate the interest rate risk on certain of the total return swaps and certain fixed maturity investments. The Company also uses other interest rate derivatives to mitigate exposure to interest rate volatility.

 

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To-Be-Announced Mortgage-Backed Securities

The Company utilizes TBAs as part of its overall investment strategy and to enhance investment performance.

The net fair values and the related net notional values of derivatives included in the Company’s Condensed Consolidated Balance Sheets at September 30, 2013 and December 31, 2012 were as follows (in thousands of U.S. dollars):

 

     Asset      Liability     Net derivatives  
     derivatives      derivatives     Net notional         

September 30, 2013

   at fair value      at fair value     exposure      Fair value  

Foreign exchange forward contracts

   $ 4,188      $ (5,470   $ 2,069,416      $ (1,282

Foreign currency option contracts

     —          (821     93,438        (821

Futures contracts

     —           (61,909     4,527,222        (61,909

Credit default swaps (protection purchased)

     —           (231     34,000        (231

Credit default swaps (assumed risks)

     49        —          5,000        49  

Insurance-linked securities (1)

     175        (390     140,744        (215

Total return swaps

     —           (732     7,657        (732

Interest rate swaps (2)

     150        (4,614     60,080        (4,464

TBAs

     7,256        —          192,040        7,256  
  

 

 

    

 

 

      

 

 

 

Total derivatives

   $ 11,818      $ (74,167      $ (62,349
     Asset      Liability     Net derivatives  
     derivatives      derivatives     Net notional         

December 31, 2012

   at fair value      at fair value     exposure      Fair value  

Foreign exchange forward contracts

   $ 7,889      $ (17,395   $ 2,170,914      $ (9,506

Foreign currency option contracts

     1,410        (186     133,377        1,224  

Futures contracts

     1,956        (1,352     3,981,107        604  

Credit default swaps (protection purchased)

     6        (807     55,000        (801

Credit default swaps (assumed risks)

     512        —          17,500        512  

Insurance-linked securities (1)

     —           (2,173     135,964        (2,173

Total return swaps

     6,630        (546     68,730        6,084  

Interest rate swaps (2)

     —           (7,880     —           (7,880

TBAs

     115        (163     155,760        (48
  

 

 

    

 

 

      

 

 

 

Total derivatives

   $ 18,518      $ (30,502      $ (11,984

 

(1) At September 30, 2013 and December 31, 2012, insurance-linked securities include a longevity swap for which the notional amount is not reflective of the overall potential exposure of the swap. As such, the Company has included the probable maximum loss under the swap within the net notional exposure as an approximation of the notional amount.
(2) The Company enters into interest rate swaps to mitigate notional exposures on certain total return swaps and certain fixed maturities. Accordingly, the notional value of interest rate swaps on certain total return swaps is not presented separately in the table.

The fair value of all derivatives at September 30, 2013 and December 31, 2012 is recorded in Other invested assets in the Company’s Condensed Consolidated Balance Sheets. At September 30, 2013 and December 31, 2012, none of the Company’s derivatives were designated as hedges.

 

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The gains and losses in the Condensed Consolidated Statements of Operations for derivatives not designated as hedges for the three months and nine months ended September 30, 2013 and 2012 were as follows (in thousands of U.S. dollars):

 

     For the three     For the three     For the nine     For the nine  
     months ended     months ended     months ended     months ended  
     September 30, 2013     September 30, 2012     September 30, 2013     September 30, 2012  

Foreign exchange forward contracts

   $ 17     $ 21,976     $ (36,457   $ 41,686  

Foreign currency option contracts

     (799     1,061       (4,639     2,559  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total included in net foreign exchange gains and losses

   $ (782   $ 23,037     $ (41,096   $ 44,245  

Futures contracts

   $ (30,233   $ (14,979   $ 55,143     $ (34,758

Credit default swaps (protection purchased)

     (6     (250     (126     (861

Credit default swaps (assumed risks)

     7       398       122       1,709  

Insurance-linked securities

     (110     3,934       (660     5,160  

Total return swaps

     (1,762     (773     (5,421     (1,242

Interest rate swaps

     240       (200     3,416       (402

TBAs

     3,858       2,568       (5,839     7,446  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total included in net realized and unrealized investment gains and losses

   $ (28,006   $ (9,302   $ 46,635     $ (22,948

Total derivatives

   $ (28,788   $ 13,735     $ 5,539     $ 21,297  

Offsetting of Derivatives

The gross and net fair values of derivatives that are subject to offsetting in the Condensed Consolidated Balance Sheets at September 30, 2013 and December 31, 2012 were as follows (in thousands of U.S. dollars):

 

           Gross      Net amounts of     Gross amounts not offset         
     Gross     amounts      assets/ liabilities     in the balance sheet         
     amounts     offset in the      presented in the     Financial     Cash collateral         

September 30, 2013

   recognized (1)     balance sheet      balance sheet     instruments     received/pledged      Net amount  

Total derivative assets

   $ 11,818     $  —         $ 11,818     $ 1,739     $  —         $ 13,557  

Total derivative liabilities

   $ (74,167   $  —        $ (74,167   $ (1,739   $ 4,260      $ (71,646

December 31, 2012

              

Total derivative assets

   $ 18,518     $  —         $ 18,518     $ (12,051   $  —         $ 6,467  

Total derivative liabilities

   $ (30,502   $  —         $ (30,502   $ 12,051     $  —         $ (18,451

 

(1) Amounts include all derivative instruments, irrespective of whether there is a legally enforceable master netting arrangement in place.

Generally, credit default swaps, total return swaps and interest rate swaps are subject to a master netting or similar agreements as they are entered into using International Swaps and Derivatives Association agreements which provide for the ability to settle the derivative asset and liability with each counterparty on a net basis. Futures contracts and foreign exchange forward contracts are traded on a regulated exchange which permits netting.

5. Shareholders’ Equity

Series F Non-Cumulative Redeemable Preferred Shares

On February 14, 2013, the Company issued Series F non-cumulative redeemable preferred shares (Series F preferred shares) as follows (in millions of U.S. dollars or shares, except percentage amounts):

 

     Series F  

Date of issuance

     February 2013   

Number of preferred shares issued

     10.0  

Annual dividend rate

     5.875

Total consideration

   $ 242.3  

Underwriting discounts and commissions

   $ 7.7  

Aggregate liquidation value

   $ 250.0  

 

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The net proceeds received were used, together with available cash, to redeem the Series C Cumulative Redeemable Preferred Shares (Series C preferred shares). On or after March 1, 2018, the Company may redeem the Series F preferred shares in whole at any time, or in part from time to time, at $25.00 per share, plus an amount equal to the portion of the quarterly dividend attributable to the then-current dividend period to, but excluding, the redemption date. The Company may also redeem the Series F preferred shares at any time upon the occurrence of a certain “capital disqualification event” or certain changes in tax law. Dividends on the Series F preferred shares are non-cumulative and are payable quarterly.

In the event of liquidation of the Company, the Series F preferred shares rank on parity with each of the other series of preferred shares and would rank senior to the common shares, and holders thereof would receive a distribution of $25.00 per share, or the aggregate liquidation value, plus declared but unpaid dividends, if any.

Series C Cumulative Redeemable Preferred Shares

On March 18, 2013, the Company redeemed the Series C preferred shares for the aggregate liquidation value of $290 million plus accrued dividends. In connection with the redemption, the Company recognized a loss of $9.1 million related to the original issuance costs of the Series C preferred shares and calculated as a difference between the redemption price and the consideration received after underwriting discounts and commissions. The loss was recognized in determining the net income attributable to PartnerRe Ltd. common shareholders.

6. Net Income per Share

The reconciliation of basic and diluted net income per share for the three months and nine months ended September 30, 2013 and 2012 is as follows (in thousands of U.S. dollars, except per share amounts):

 

     For the three
months ended
September 30, 2013
    For the three
months ended
September 30, 2012
    For the nine
months ended
September 30, 2013
    For the nine
months ended
September 30, 2012
 

Numerator:

  

   

Net income attributable to PartnerRe Ltd.

   $ 333,423     $ 486,706     $ 392,221     $ 1,022,994  

Less: preferred dividends

     (14,184     (15,405     (43,678     (46,216

Less: loss on redemption of preferred shares

     —          —          (9,135     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to PartnerRe Ltd. common shareholders

   $ 319,239     $ 471,301     $ 339,408     $ 976,778  
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Weighted number of common shares outstanding—basic

     53,671,245       61,837,328       56,176,260       63,679,114  

Share options and other (1)

     953,906       769,433       1,041,301       605,011  
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average number of common shares and common share equivalents outstanding—diluted

     54,625,151       62,606,761       57,217,561       64,284,125  
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic net income per share

   $ 5.95     $ 7.62     $ 6.04     $ 15.34  

Diluted net income per share(1)

   $ 5.84     $ 7.53     $ 5.93     $ 15.19  

 

(1) At September 30, 2013 and 2012, share based awards to purchase 140.5 thousand and 1,233.3 thousand common shares, respectively, were excluded from the calculation of diluted weighted average number of common shares and common share equivalents outstanding because their exercise prices were greater than the average market price of the common shares.

7. Noncontrolling Interests

During March 2013, the Company formed Lorenz Re Ltd. (Lorenz Re), a Bermuda domiciled special purpose insurer to provide additional capacity to the Company for a diversified portfolio of catastrophe reinsurance treaties over a multi-year period on a fully collateralized reinsurance basis. The original business was written by the Company and was ceded to Lorenz Re effective April 1, 2013.

In conjunction with the formation of Lorenz Re, the Company and third party investors each contributed 50% of Lorenz Re’s non-voting redeemable preferred share capital of approximately $75 million. On May 1, 2013, the Company sold $10.5 million of its original investment in Lorenz Re to third party investors. The Company did not record any gain or loss on the sale of this investment. Lorenz Re’s preferred shares are expected to be redeemed following the commutation of the portfolio back to the Company on or before June 1, 2016.

Lorenz Re is considered to be a variable interest entity. The Company has concluded that it is the primary beneficiary as it has the power to direct and has more than an insignificant economic interest in the activities of Lorenz Re. Lorenz Re is consolidated by the Company and all inter-company balances and transactions are eliminated. Net income and shareholders’ equity attributable to Lorenz Re’s third party investors are recorded in the Condensed Consolidated Financial Statements as noncontrolling interests.

 

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At September 30, 2013, the total assets of Lorenz Re were $100.9 million, primarily consisting of cash and investments, and the total liabilities were $18.9 million, primarily consisting of unearned premiums and unpaid losses and loss expenses. The assets of Lorenz Re can only be used to settle the liabilities of Lorenz Re and there is no recourse to the Company for any liabilities of Lorenz Re.

The reconciliation of the beginning and ending balance of the noncontrolling interests in Lorenz Re for the nine months ended September 30, 2013 is as follows (in thousands of U.S. dollars):

 

     Total  
     2013  

Balance at January 1

   $ —    

Net income attributable to noncontrolling interests

     5,296  

Sale of shares to noncontrolling interests

     47,193  
  

 

 

 

Balance at September 30

   $ 52,489  

8. Commitments and Contingencies

(a) Concentration of Credit Risk

Financing receivables

Included in the Company’s Other invested assets are certain notes receivable which meet the definition of financing receivables and are accounted for using the cost method of accounting. These notes receivable are collateralized by commercial or residential property. The Company utilizes a third party consultant to determine the initial investment criteria and to monitor the subsequent performance of the notes receivable. The process undertaken prior to the investment in these notes receivable includes an examination of the underlying collateral. The Company reviews its receivable positions on at least a quarterly basis using actual redemption experience. At September 30, 2013 and December 31, 2012, based on the latest available information, the Company recorded an allowance for credit losses related to these notes receivable of $2.7 million and $3.0 million, respectively.

The Company monitors the performance of the notes receivable based on the type of underlying collateral and by assigning a “performing” or a “non-performing” indicator of credit quality to each individual receivable. At September 30, 2013, the Company’s notes receivable of $33.3 million were all performing and were collateralized by residential property and commercial property of $25.5 million and $7.8 million, respectively. At December 31, 2012, the Company’s notes receivable of $46.7 million were all performing and were collateralized by residential property and commercial property of $31.3 million and $15.4 million, respectively.

The Company purchased $1.9 million and $29.0 million of financing receivables during the three months and nine months ended September 30, 2013, respectively. The Company purchased $0.2 million and $37.6 million of financing receivables during the three months and nine months ended September 30, 2012, respectively. There were no sales of financing receivables during the three months and nine months ended September 30, 2013 and 2012, however, the outstanding balances were reduced by settlements of the underlying debt.

(b) Employment Agreements

In April 2013, the Company announced the restructuring of its business support operations into a single integrated worldwide support platform and changes to the structure of its Global Non-life Operations. The restructuring includes involuntary and voluntary employee termination plans in certain jurisdictions (collectively, termination plans) and certain real estate related costs. Employees affected by the termination plans have varying leaving dates, largely through to mid-2014. The Company expects to incur a charge, totaling between $60 million and $70 million to be incurred primarily in 2013 with the remainder expected to be incurred in 2014.

During the three months and nine months ended September 30, 2013, the Company recorded pre-tax charges of $2.4 million and $45.7 million, respectively, related to the expected costs of the restructuring, which were primarily related to the termination plans, within other operating expenses. The continuing salary and other employment benefit costs related to the affected employees will be expensed as the employee remains with the Company and provides service.

In connection with the restructuring, and included within the total expected costs of between $60 million and $70 million announced by the Company in April 2013, the Company expects to incur a charge of approximately $10 million related to certain real estate costs in the fourth quarter of 2013, with further real estate related charges totaling between $5 million and $10 million expected to be incurred in 2014.

 

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Table of Contents

(c) Legal Proceedings

There has been no significant change in legal proceedings at September 30, 2013 compared to December 31, 2012. See Note 17(e) to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

(d) Taxation

As part of the 2014 Budget proposals, the French government has proposed tax legislation changes. These proposals would temporarily increase the corporation income tax rate from 36% to 38% and could limit the deductibility of interest payments to non-French affiliates. These changes may be effective retroactively to January 1, 2013. These proposals have not been enacted into the French tax code and, therefore, may be modified during the French legislative process. It is expected that the 2014 Budget proposals, including any tax proposals, will be finalized and enacted into law in December 2013. The Company is in the process of monitoring and evaluating the impact of these developments on its operations. The Company may incur a charge in the fourth quarter of 2013 relating to these tax proposals, which may be material, when these proposed tax changes are finalized and enacted into the French tax code. The Company is not currently able to determine a reasonable estimate of the amount of the charge given the uncertainty that exists related to these proposals.

9. Credit Agreements

In the normal course of its operations, the Company enters into agreements with financial institutions to obtain unsecured and secured credit facilities. These facilities are used primarily for the issuance of letters of credit, although a portion of these facilities may also be used for liquidity purposes.

On April 18, 2013, the Company modified its existing three-year syndicated unsecured credit facility to reduce the available facility from $500 million to $50 million and reduce its access to a revolving line of credit from $375 million to $50 million. This facility expired on July 15, 2013 and was not renewed.

See Note 18 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 for further information related to the credit facilities available to the Company.

10. Segment Information

The Company monitors the performance of its operations in three segments, Non-life, Life and Health and Corporate and Other as described in Note 20 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. The Non-life segment is further divided into four sub-segments: North America, Global (Non-U.S.) P&C, Global Specialty and Catastrophe. Following the acquisition of Presidio on December 31, 2012, Presidio’s results are included in the Life and Health segment. Effective January 1, 2013, the Life segment is referred to as Life and Health to reflect the inclusion of Presidio’s results following its acquisition and the Global (Non-U.S.) Specialty sub-segment is referred to as Global Specialty.

Since the Company does not manage its assets by segment, net investment income is not allocated to the Non-life segment. However, because of the interest-sensitive nature of some of the Company’s Life and Health products, net investment income is considered in Management’s assessment of the profitability of the Life and Health segment. The following items are not considered in evaluating the results of the Non-life and Life and Health segments: net realized and unrealized investment gains and losses, interest expense, amortization of intangible assets, net foreign exchange gains and losses, income tax expense or benefit and interest in earnings and losses of equity investments. Segment results are shown before consideration of intercompany transactions.

Management measures results for the Non-life segment on the basis of the loss ratio, acquisition ratio, technical ratio, other operating expense ratio and combined ratio (all defined below). Management measures results for the Non-life sub-segments on the basis of the loss ratio, acquisition ratio and technical ratio. Management measures results for the Life and Health segment on the basis of the allocated underwriting result, which includes revenues from net premiums earned, other income or loss and allocated net investment income for Life and Health, and expenses from life policy benefits, acquisition costs and other operating expenses.

 

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Table of Contents

The following tables provide a summary of the segment results for the three months and nine months ended September 30, 2013 and 2012 (in millions of U.S. dollars, except ratios):

Segment Information

For the three months ended September 30, 2013

 

     North
America
    Global
(Non-U.S.)
P&C
    Global
Specialty
    Catastrophe     Total
Non-life
segment
    Life
and Health
segment
    Corporate
and Other
    Total  

Gross premiums written

   $ 409     $ 157     $ 396     $ 79     $ 1,041     $ 235     $ 5     $ 1,281  

Net premiums written

   $ 408     $ 157     $ 389     $ 72     $ 1,026     $ 234     $ 5     $ 1,265  

Decrease (increase) in unearned premiums

     17       38       (7     99       147       9       —          156  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums earned

   $ 425     $ 195     $ 382     $ 171     $ 1,173     $ 243     $ 5     $ 1,421  

Losses and loss expenses and life policy benefits

     (197     (90     (228     (42     (557     (195     1       (751

Acquisition costs

     (101     (50     (92     (16     (259     (24     —          (283
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Technical result

   $ 127     $ 55     $ 62     $ 113     $ 357     $ 24     $ 6     $ 387  

Other income

             2       3       —          5  

Other operating expenses

             (62     (17     (29     (108
          

 

 

   

 

 

   

 

 

   

 

 

 

Underwriting result

           $ 297     $ 10       n/a      $ 284  

Net investment income

               15       107       122  
            

 

 

   

 

 

   

 

 

 

Allocated underwriting result (1)

             $ 25       n/a        n/a   

Net realized and unrealized investment gains

                 16       16  

Interest expense

                 (12     (12

Amortization of intangible assets

                 (7     (7

Net foreign exchange losses

                 (1     (1

Income tax expense

                 (70     (70

Interest in earnings of equity investments

                 6       6  
              

 

 

   

 

 

 

Net income

                 n/a      $ 338  
              

 

 

   

 

 

 

Loss ratio (2)

     46.3 %     46.0 %     59.8 %     24.5 %     47.5 %      

Acquisition ratio (3)

     23.9       25.7       24.0       9.0       22.1        
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

Technical ratio (4)

     70.2 %     71.7 %     83.8 %     33.5 %     69.6 %      

Other operating expense ratio (5)

             5.3        
          

 

 

       

Combined ratio (6)

             74.9 %      
          

 

 

       

 

(1) Allocated underwriting result is defined as net premiums earned, other income or loss and allocated net investment income less life policy benefits, acquisition costs and other operating expenses.
(2) Loss ratio is obtained by dividing losses and loss expenses by net premiums earned.
(3) Acquisition ratio is obtained by dividing acquisition costs by net premiums earned.
(4) Technical ratio is defined as the sum of the loss ratio and the acquisition ratio.
(5) Other operating expense ratio is obtained by dividing other operating expenses by net premiums earned.
(6) Combined ratio is defined as the sum of the technical ratio and the other operating expense ratio.

 

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Table of Contents

Segment Information

For the three months ended September 30, 2012

 

     North
America
    Global
(Non-U.S.)
P&C
    Global
Specialty
    Catastrophe     Total
Non-life

segment
    Life
and Health
segment
    Corporate
and Other
    Total  

Gross premiums written

   $ 311     $ 123     $ 360     $ 75     $ 869      $ 187     $  —        $ 1,056  

Net premiums written

   $ 311     $ 122     $ 354     $ 69     $ 856      $ 187     $  —        $ 1,043  

Decrease in unearned premiums

     24       50       9       99       182        8       4       194  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums earned

   $ 335     $ 172     $ 363     $ 168     $ 1,038      $ 195     $ 4     $ 1,237  

Losses and loss expenses and life policy benefits

     (251     (110     (161     (39     (561     (157     (3     (721

Acquisition costs

     (83     (42     (79     (15     (219     (27     (1     (247
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Technical result

   $ 1     $ 20     $ 123     $ 114     $ 258      $ 11     $  —        $ 269  

Other income

             1        1       1       3  

Other operating expenses

             (58     (12     (25     (95
          

 

 

   

 

 

   

 

 

   

 

 

 

Underwriting result

           $ 201      $  —          n/a      $ 177  

Net investment income

               15       120       135  
            

 

 

   

 

 

   

 

 

 

Allocated underwriting result

             $ 15       n/a        n/a   

Net realized and unrealized investment gains

                 257       257  

Interest expense

                 (12     (12

Amortization of intangible assets

                 (9     (9

Net foreign exchange losses

                 (2     (2

Income tax expense

                 (64     (64

Interest in earnings of equity investments

                 5       5  
              

 

 

   

 

 

 

Net income

                 n/a      $ 487  
              

 

 

   

 

 

 

Loss ratio

     74.9     63.9     44.4     23.3 %     54.1       

Acquisition ratio

     24.8       24.9       21.7       8.8       21.1         
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

Technical ratio

     99.7     88.8     66.1     32.1     75.2      

Other operating expense ratio

             5.5        
          

 

 

       

Combined ratio

             80.7      
          

 

 

       

 

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Table of Contents

Segment Information

For the nine months ended September 30, 2013

 

     North
America
    Global
(Non-U.S.)
P&C
    Global
Specialty
    Catastrophe     Total
Non-life
segment
    Life
and Health
segment
    Corporate
and Other
    Total  

Gross premiums written

   $ 1,228     $ 690     $ 1,253     $ 478     $ 3,649     $ 722     $ 8     $ 4,379  

Net premiums written

   $ 1,215     $ 682     $ 1,159     $ 433     $ 3,489     $ 715     $ 7     $ 4,211  

Increase in unearned premiums

     (99     (152     (68     (97     (416     (17     (1     (434
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums earned

   $ 1,116     $ 530     $ 1,091     $ 336     $ 3,073     $ 698     $ 6     $ 3,777  

Losses and loss expenses and life policy benefits

     (682     (263     (697     (81     (1,723     (558     2       (2,279

Acquisition costs

     (253     (134     (257     (33     (677     (82     —          (759
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Technical result

   $ 181     $ 133     $ 137     $ 222     $ 673     $ 58     $ 8     $ 739  

Other income

             3       9       1       13  

Other operating expenses

             (189     (52     (128     (369
          

 

 

   

 

 

   

 

 

   

 

 

 

Underwriting result

           $ 487     $ 15       n/a     $ 383  

Net investment income

               45       325       370  
            

 

 

   

 

 

   

 

 

 

Allocated underwriting result

             $ 60       n/a       n/a  

Net realized and unrealized investment losses

                 (260     (260

Interest expense

                 (37     (37

Amortization of intangible assets

                 (21     (21

Net foreign exchange losses

                 (10     (10

Income tax expense

                 (37     (37

Interest in earnings of equity investments

                 10       10  
              

 

 

   

 

 

 

Net income

                 n/a     $ 398  
              

 

 

   

 

 

 

Loss ratio

     61.1 %     49.7 %  

 

63.9

%

 

 

24.2

%

 

 

56.1

%

     

Acquisition ratio

     22.7       25.2       23.6       9.7       22.0        
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

Technical ratio

     83.8 %     74.9 %     87.5 %     33.9 %     78.1 %      

Other operating expense ratio

             6.1        
          

 

 

       

Combined ratio

             84.2 %      
          

 

 

       

 

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Segment Information

For the nine months ended September 30, 2012

 

     North
America
    Global
(Non-U.S.)
P&C
    Global
Specialty
    Catastrophe     Total
Non-life
segment
    Life
and Health
segment
    Corporate
and Other
    Total  

Gross premiums written

   $ 924     $ 600     $ 1,178     $ 475     $ 3,177     $ 604     $ 6     $ 3,787  

Net premiums written

   $ 922     $ 596     $ 1,098     $ 429     $ 3,045     $ 601     $ 6     $ 3,652  

Increase in unearned premiums

     (59     (100     (64     (98     (321     (12     (1     (334
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums earned

   $ 863     $ 496     $ 1,034     $ 331     $ 2,724     $ 589     $ 5     $ 3,318  

Losses and loss expenses and life policy benefits

     (568     (327     (569     (58     (1,522     (479     (3     (2,004

Acquisition costs

     (218     (120     (241     (30     (609     (82     —          (691
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Technical result

   $ 77     $ 49     $ 224     $ 243     $ 593     $ 28     $ 2     $ 623  

Other income

             2       3       3       8  

Other operating expenses

             (187     (38     (74     (299
          

 

 

   

 

 

   

 

 

   

 

 

 

Underwriting result

           $ 408     $ (7     n/a     $ 332  

Net investment income

               49       387       436  
            

 

 

   

 

 

   

 

 

 

Allocated underwriting result

             $ 42       n/a       n/a  

Net realized and unrealized investment gains

                 488       488  

Interest expense

                 (37     (37

Amortization of intangible assets

                 (27     (27

Net foreign exchange gains

                 3       3  

Income tax expense

                 (181     (181

Interest in earnings of equity investments

                 9       9  
              

 

 

   

 

 

 

Net income

                 n/a     $ 1,023  
              

 

 

   

 

 

 

Loss ratio

     65.9 %     65.9 %     55.1 %     17.4 %     55.9 %      

Acquisition ratio

     25.2       24.3       23.3       9.1       22.3        
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

       

Technical ratio

     91.1 %     90.2 %     78.4 %     26.5 %     78.2 %      

Other operating expense ratio

             6.9        
          

 

 

       

Combined ratio

             85.1 %      
          

 

 

       

10. Subsequent Events

At September 30, 2013, the Company had an equity investment in Essent Group Ltd. (Essent), a non-public U.S. mortgage guaranty insurance company, which was recorded at cost of $36 million. Essent became a publicly traded company on October 30, 2013 and, as a result, from this date the Company will record its investment in Essent at fair value, which was approximately $105 million based on the closing market price on October 31, 2013. The Company will report this unrealized gain and any subsequent changes in the fair value of this investment in net realized and unrealized investment gains and losses in the Consolidated Statements of Operations.

 

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Table of Contents
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Executive Overview

The Company is a leading global reinsurer, with a broadly diversified and balanced portfolio of traditional reinsurance risks and capital markets risks.

Successful risk management is the foundation of the Company’s value proposition, with diversification of risks at the core of its risk management strategy. The Company’s ability to succeed in the risk assumption and management business is dependent on its ability to accurately analyze and quantify risk, to understand volatility and how risks aggregate or correlate, and to establish the appropriate capital requirements and limits for the risks assumed. All risks, whether they are reinsurance related risks or capital market risks, are managed by the Company within an integrated framework of policies and processes to ensure the intelligent and consistent evaluation and valuation of risk, and to ultimately provide an appropriate return to shareholders. The Company’s Risk Management framework is discussed below and further in Risk Management in Item 1 of Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

A discussion of the Company’s long-term objective and annualized growth in Diluted Tangible Book Value per Share plus dividends, the metric that Management uses to measure its success in achieving its long-term objective, are described below in Key Financial Measures.

Overview of the Results of Operations for the Three Months and Nine Months Ended September 30, 2013

The Company measures its performance in several ways. Among the performance measures accepted under U.S. GAAP is diluted net income or loss per share, a measure that focuses on the return provided to the Company’s common shareholders. Diluted net income or loss per share is obtained by dividing net income or loss attributable to PartnerRe Ltd. common shareholders by the weighted average number of common shares and common share equivalents outstanding. Net income or loss attributable to PartnerRe Ltd. common shareholders is defined as net income or loss less preferred dividends and loss on redemption of preferred shares. See the discussion of the non-GAAP performance measures that the Company uses (operating earnings or loss and Operating ROE) and the reconciliation of those non-GAAP performance measures to the most directly comparable GAAP measures in Key Financial Measures below.

The following key factors affected the year over year comparison of the Company’s results and are discussed in more detail in Review of Net Income below.

Large catastrophic and large loss events

Given the Company’s reinsurance operations are exposed to low frequency and high severity risk events, some of which are seasonal, results for certain periods may include unusually low loss experience, while results for other periods may include significant catastrophic losses. Consequently, the Company’s results for interim periods may be volatile from period to period and are not necessarily indicative of results for the full year. The results for the three months and nine months ended September 30, 2013 and 2012 demonstrate this volatility. During the three months ended September 30, 2013, the Company incurred losses of $55 million, net of retrocession and reinstatement premiums, related to the hailstorm that affected large parts of Germany in July 2013 (German Hailstorm). During the nine months ended September 30, 2013, the Company incurred losses of $156 million, net of retrocession and reinstatement premiums, related to the combined impact of the extensive flooding in Alberta, Canada (Alberta Floods) in June 2013, the German Hailstorm and the floods that impacted large areas of Central Europe in June 2013 (European Floods). The results for the three months and nine months ended September 30, 2012 included large losses of $85 million in the agriculture line of business of the Company’s North America sub-segment related to the severe drought conditions in the U.S. during 2012 (U.S. drought).

 

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The following tables reflect the impact of large catastrophic losses related to the German Hailstorm in the three months ended September 30, 2013 and Alberta Floods, German Hailstorm and European Floods in the nine months ended September 30, 2013 on the Company’s technical result, pre-tax net income, loss ratio, technical ratio and combined ratio by segment and sub-segment for the three months and nine months ended September 30, 2013, and the large catastrophic losses by event for the nine months ended September 30, 2013 (in millions of U.S. dollars):

 

Three months ended September 30, 2013

   North
America
    Global
(Non-U.S.)
P&C
    Global
Specialty
    Catastrophe     Total
Non-life
segment
    Life
and Health
segment
     Corporate
and Other
     Total  

Gross losses and loss expenses and life policy benefits

   $ —       $ 3     $  —       $ 57     $ 60     $ —        $ —        $ 60  

Reinsurance recoverable

     —         —         —         (4     (4     —          —          (4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Net losses and loss expenses and life policy benefits

   $ —       $ 3     $  —       $ 53     $ 56     $ —        $ —        $ 56  

Reinstatement premiums

     —         —         —         (1     (1     —          —          (1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Impact on technical result and pre-tax net income

   $ —       $ 3     $ —       $ 52     $ 55     $ —        $ —        $ 55  

Impact on the loss ratio

     —       1.5     —       30.7     4.7        

Impact on the technical ratio

     —         1.5       —         30.7       4.7          

Impact on the combined ratio

             4.7           

Nine months ended September 30, 2013

   North
America
    Global
(Non-U.S.)
P&C
    Global
Specialty
    Catastrophe     Total
Non-life
segment
    Life and
Health
segment
     Corporate
and Other
     Total  

Gross losses and loss expenses and life policy benefits

   $ 16     $ 14     $ 21     $ 128     $ 179     $ —        $ —        $ 179  

Reinsurance recoverable

     —         —         —         (10     (10     —          —          (10
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Net losses and loss expenses and life policy benefits

   $ 16     $ 14     $ 21     $ 118     $ 169     $ —        $ —        $ 169  

Reinstatement premiums

     —         —         —         (13     (13     —          —          (13
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Impact on technical result and pre-tax net income

   $ 16     $ 14     $ 21     $ 105     $ 156     $ —        $ —        $ 156  

Impact on the loss ratio

     1.4     2.6     1.9     35.5     5.3        

Impact on the technical ratio

     1.4       2.6       1.9       35.1       5.2          

Impact on the combined ratio

             5.2           

 

Nine months ended September 30, 2013

   Total (1)  

Alberta Floods

   $ 55  

German Hailstorm

     55  

European Floods

     46  
  

 

 

 

Impact on pre-tax net income

   $ 156  

 

(1) Large catastrophic losses are shown net of any reinsurance, reinstatement premiums and profit commissions.

Volatility in capital markets

The results for the nine months ended September 30, 2013 and 2012 and for the three months ended September 30, 2012 were impacted by the volatility in the capital markets primarily as result of increases in risk-free interest rates during 2013 and narrowing spreads in 2012. The results for the three months ended September 30, 2013 were less impacted given the overall changes in interest rates, credit spreads and equity markets were more modest.

Restructuring charges

In April 2013, the Company announced the restructuring of its business support operations into a single integrated worldwide support platform and changes to the structure of its Global Non-life Operations. The restructuring includes involuntary and voluntary employee termination plans in certain jurisdictions (collectively, termination plans) and certain real estate related costs. Employees affected by the termination plans have varying leaving dates, largely through to mid-2014. The Company expects to incur a charge, totaling between $60 million and $70 million to be incurred primarily in 2013 with the remainder expected to be incurred in 2014. During the three months and nine months ended September 30, 2013, the Company recorded pre-tax charges of approximately $2 million and $46 million, respectively, related to the expected costs of the restructuring, which were primarily related to the termination plans, within other operating expenses. The continuing salary and other employment benefit costs related to the affected employees will be expensed as the employee remains with the Company and provides service.

 

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In connection with the restructuring, and included within the total expected costs of between $60 million and $70 million announced by the Company in April 2013, the Company expects to incur a charge of approximately $10 million related to certain real estate costs in the fourth quarter of 2013, with further real estate related charges totaling between $5 million and $10 million expected to be incurred in 2014.

Acquisition of Presidio

Effective December 31, 2012, the Company completed the acquisition of Presidio Reinsurance Group, Inc. (Presidio), a California-based U.S. specialty accident and health reinsurance and insurance writer. The Condensed Consolidated Statements of Operations and Cash Flows, and the Life and Health segment, include the results of Presidio from January 1, 2013.

Net income

Net income, net income attributable to noncontrolling interests, preferred dividends, loss on redemption of preferred shares, net income attributable to PartnerRe Ltd. common shareholders and diluted net income per share for the three months and nine months ended September 30, 2013 and 2012 were as follows (in millions of U.S. dollars, except per share data):

 

     For the three
months ended
September 30,
2013
     For the three
months ended
September 30,
2012
     For the nine
months ended
September 30,
2013
     For the nine
months ended
September 30,
2012
 

Net income

   $ 338      $ 487      $ 398      $ 1,023  

Less: net income attributable to noncontrolling interests

     5        —          6        —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income attributable to PartnerRe Ltd.

     333        487        392        1,023  

Less: preferred dividends

     14        15        44        46  

Less: loss on redemption of preferred shares

     —          —          9        —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income attributable to PartnerRe Ltd. common shareholders

   $ 319      $ 472      $ 339       $ 977  

Diluted net income per share attributable to PartnerRe Ltd. common shareholders

   $ 5.84      $ 7.53      $ 5.93      $ 15.19  

Three-month result

The decrease in net income of $149 million, from $487 million in the three months ended September 30, 2012 to $338 million in the same period of 2013 resulted primarily from:

 

    a decrease of $241 million in pre-tax net realized and unrealized investment gains, mainly as a result of narrowing credit spreads in the three months ended September 30, 2012 compared to modest changes in interest rates, credit spreads and equity markets in the same period of 2013; partially offset by

 

    an increase of $96 million in the Non-life underwriting result, which was mainly driven by an increase in combined favorable prior year and prior quarters’ loss development and a relatively lower level of catastrophic losses related to the German Hailstorm in the three months ended September 30, 2013 compared to large losses related to the U.S. drought in the same period of 2012.

The decrease in net income attributable to PartnerRe Ltd. common shareholders and diluted net income per share for the three months ended September 30, 2013 compared to the same period of 2012 was primarily due to the above factors. For diluted net income per share specifically, the decrease was partially offset by the accretive impact of a reduction in the diluted number of common shares and common share equivalents outstanding as a result of share repurchases.

Nine-month result

The decrease in net income of $625 million, from $1,023 million in the nine months ended September 30, 2012 to $398 million in the same period of 2013 resulted primarily from:

 

    an increase of $748 million in pre-tax net realized and unrealized investment losses, mainly as a result of increases in the U.S. and European risk-free interest rates during 2013 compared to narrowing spreads and improvements in equity markets in 2012;

 

    a decrease of $66 million in net investment income, driven by lower reinvestment rates; and

 

    an increase of $54 million in other operating expenses included in Corporate and Other, driven by the charge related to the costs of the restructuring described above; partially offset by

 

    a decrease of $144 million in income tax expense, resulting from a lower pre-tax net income in the nine months ended September 30, 2013 compared to the same period of 2012; and

 

 

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Table of Contents
    an increase of $79 million in the Non-life underwriting result, which was mainly driven by an increase in favorable prior year loss development.

The decrease in net income attributable to PartnerRe Ltd. common shareholders and diluted net income per share for the nine months ended September 30, 2013 compared to the same period of 2012 was primarily due to the above factors. For diluted net income per share specifically, the decrease was partially offset by the accretive impact of a reduction in the diluted number of common shares and common share equivalents outstanding as a result of share repurchases.

The factors affecting the year over year comparison of the Company’s results are discussed below in Review of Net Income, Results by Segment and Financial Condition, Liquidity and Capital Resources, and may continue to affect our results of operations and financial condition in the future.

Key Financial Measures

In addition to the Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Operations and Comprehensive Income, Management uses certain key measures to evaluate its financial performance and the overall growth in value generated for the Company’s common shareholders.

The Company’s long-term objective is to manage a portfolio of diversified risks that will create total shareholder value. The Company measures its success in achieving its long-term objective by targeting a return, which is variable and can be adjusted by Management, in excess of a referenced risk-free rate over the reinsurance cycle. The return, which is currently targeted at 700 basis points in excess of the referenced risk-free rate, is calculated using compound annual growth in diluted tangible book value per common share and common share equivalents outstanding plus dividends per common share (annualized growth in Diluted Tangible Book Value per Share plus dividends). Management uses annualized growth in Diluted Tangible Book Value per Share plus dividends as its prime measure of long-term financial performance and believes this measure aligns the Company’s stated long-term objective with the measure most investors use to evaluate total shareholder value creation given that it focuses on the tangible value of total shareholder returns, excluding the impact of goodwill and intangibles. Given the Company’s profitability in any particular quarterly or annual period can be significantly affected by the level of large catastrophic losses, Management assesses this long-term objective over the reinsurance cycle as the Company’s performance during any particular quarterly or annual period is not necessarily indicative of its performance over the longer-term reinsurance cycle.

While annualized growth in Diluted Tangible Book Value per Share plus dividends is the Company’s prime financial measure, management also uses other key financial measures to monitor performance as set forth below, together with definitions of their calculations, at September 30, 2013 and December 31, 2012 and for the three months and nine months ended September 30, 2013 and 2012:

 

     September 30, 2013     December 31, 2012  

Diluted tangible book value per common share and common share equivalents outstanding(1)

   $ 94.86     $ 90.86  

Annualized growth in diluted tangible book value per common share and common share equivalents outstanding plus dividends(2)

     8.7  

 

     For the three
months ended
September 30, 2013
    For the three
months ended
September 30, 2012
    For the nine
months ended
September 30, 2013
    For the nine
months ended
September 30, 2012
 

Operating earnings attributable to PartnerRe Ltd. common shareholders (in millions of U.S. dollars)(3)

   $ 311     $ 244     $ 564     $ 568  

Annualized operating return on beginning diluted book value per common share and common share equivalents outstanding(4)

     22.6     18.4     13.0     13.9

Combined ratio(5)

     74.9 %      80.7     84.2     85.1

 

(1) Diluted tangible book value per common share and common share equivalents outstanding (Diluted Tangible Book Value per Share) is calculated using common shareholders’ equity attributable to PartnerRe Ltd. (total shareholders’ equity less noncontrolling interests and the aggregate liquidation value of preferred shares) less goodwill and intangible assets, net of tax, divided by the weighted average number of common shares and common share equivalents outstanding (assuming exercise of all stock-based awards and other dilutive securities). The presentation of Diluted Tangible Book Value per Share is a non-GAAP financial measure within the meaning of Regulation G (see Comment on Non-GAAP Measures below) and is reconciled to the most directly comparable GAAP financial measure below.

 

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Table of Contents
(2) Annualized growth in diluted tangible book value per common share and common share equivalents outstanding plus dividends (annualized growth in Diluted Tangible Book Value per Share plus dividends) is calculated using Diluted Tangible Book Value per Share plus dividends per common share divided by Diluted Tangible Book Value per Share at the beginning of the year and annualizing. The presentation of annualized growth in Diluted Tangible Book Value per Share plus dividends is a non-GAAP financial measure within the meaning of Regulation G (see Comment on Non-GAAP Measures below) and is reconciled to the most directly comparable GAAP financial measure below.
(3) Operating earnings attributable to PartnerRe Ltd. common shareholders (operating earnings) is calculated as net income or loss available to PartnerRe Ltd. common shareholders excluding net realized and unrealized gains or losses on investments, net of tax (except where the Company has made a strategic investment in an insurance or reinsurance related investee), net foreign exchange gains or losses, net of tax, loss on redemption of preferred shares and the interest in earnings or losses of equity investments, net of tax (except where the Company has made a strategic investment in an insurance or reinsurance related investee and where the Company does not control the investee’s activities), and is calculated after preferred dividends. The presentation of operating earnings or loss is a non-GAAP financial measure within the meaning of Regulation G (see Comment on Non-GAAP Measures below) and is reconciled to the most directly comparable GAAP financial measure below.
(4) Annualized operating return on beginning diluted book value per common share and common share equivalents outstanding (Operating ROE) is calculated using annualized operating earnings or loss, as defined above, per diluted common share and common share equivalents outstanding, divided by diluted book value per common share and common share equivalents outstanding as of the beginning of the year, as defined above. The presentation of Operating ROE is a non-GAAP financial measure within the meaning of Regulation G (see Comment on Non-GAAP Measures below) and is reconciled to the most directly comparable GAAP financial measure below.
(5) The combined ratio of the Non-life segment is calculated as the sum of the technical ratio (losses and loss expenses and acquisition costs divided by net premiums earned) and the other operating expense ratio (other operating expenses divided by net premiums earned).

Diluted Tangible Book Value per Share: Diluted Tangible Book Value per Share focuses on the underlying fundamentals of the Company’s financial position and performance without the impact of goodwill or intangible assets. As discussed above, the Company uses this measure as the basis for its prime measure of long-term shareholder value creation, growth in Diluted Tangible Book Value per Share plus dividends. Management believes that Diluted Tangible Book Value per Share aligns the Company’s stated long-term objectives with the measure most investors use to evaluate total shareholder value creation and that it focuses on the tangible value of shareholder returns, excluding the impact of goodwill and intangibles. Diluted Tangible Book Value per Share is impacted by the Company’s net income or loss, capital resources management and external factors such as foreign exchange, interest rates, credit spreads and equity markets, which can drive changes in realized and unrealized gains or losses on its investment portfolio.

The following table shows the Diluted Tangible Book Value per Share at September 30, 2013 and December 31, 2012 and the calculation of the annualized growth in Diluted Tangible Book Value per Share plus dividends for the nine months ended September 30, 2013. As described above, this metric is a long-term performance measure, however, the below table shows the annualized total shareholder value creation for the current period in order for the shareholders to monitor its performance.

 

     September 30, 2013     December 31, 2012  

Diluted tangible book value per common share and share equivalents outstanding

   $ 94.86     $ 90.86  

Dividends per common share for the nine months ended September 30, 2013

     1.92    
  

 

 

   

Diluted tangible book value per share plus dividends

   $ 96.78    

Annualized growth in diluted tangible book value per share plus dividends

     8.7  

The Company’s Diluted Tangible Book Value per Share increased by 4.4% to $94.86 at September 30, 2013 from $90.86 at December 31, 2012 primarily due to net income attributable to PartnerRe Ltd. and the accretive impact of the share repurchases, which were partially offset by dividends on the common and preferred shares. The annualized growth in Diluted Tangible Book Value per Share plus dividends was 8.7% for the nine months ended September 30, 2013 and was driven by the same factors as the Diluted Tangible Book Value per Share.

Over the past five years, since September 30, 2008, the Company has generated a compound annualized growth in Diluted Tangible Book Value per Share plus dividends in excess of 13%.

 

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The presentation of Diluted Tangible Book Value per Share is a non-GAAP financial measure within the meaning of Regulation G and should be considered in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP (see Comment on Non-GAAP Measures). The table below provides a reconciliation of Diluted Tangible Book Value per Share to the most directly comparable GAAP financial measure, diluted book value per common share and common share equivalents outstanding, at September 30, 2013 and December 31, 2012 (in millions of U.S. dollars):

 

     September 30, 2013      December 31, 2012  

Diluted book value per common share and common share equivalents outstanding(1)

   $ 105.53      $ 100.84  

Less: goodwill and other intangible assets, net of tax

     10.67        9.98  
  

 

 

    

 

 

 

Diluted tangible book value per share

   $ 94.86      $ 90.86  

 

(1) Diluted book value per common share and common share equivalents outstanding (Diluted Book Value per Share) is calculated using common shareholders’ equity attributable to PartnerRe Ltd. (total shareholders’ equity less noncontrolling interests and the aggregate liquidation value of preferred shares) divided by the weighted average number of common shares and common share equivalents outstanding (assuming exercise of all stock-based awards and other dilutive securities).

Operating earnings attributable to PartnerRe Ltd. common shareholders (operating earnings): Management uses operating earnings to measure its financial performance as this measure focuses on the underlying fundamentals of the Company’s operations by excluding net realized and unrealized gains or losses on investments (except where the Company has made a strategic investment in an investee whose operations are insurance or reinsurance related and where the Company does not control the investee’s activities), net foreign exchange gains or losses, loss on redemption of preferred shares and certain interest in earnings or losses of equity investments (except where the Company has made a strategic investment in an investee whose operations are insurance or reinsurance related and where the Company does not control the investee’s activities). Net realized and unrealized gains or losses on investments in any particular period are not indicative of the performance of, and distort trends in, the Company’s business as they predominantly result from general economic and financial market conditions, and the timing of realized gains or losses on investments is largely opportunistic. Net foreign exchange gains or losses are not indicative of the performance of, and distort trends in, the Company’s business as they predominantly result from general economic and foreign exchange market conditions. Loss on the redemption of preferred shares is not indicative of the performance of, and distorts trends in, the Company’s business as it resulted from general economic and financial market conditions, and the timing of the loss on redemption was largely opportunistic. Interest in earnings or losses of equity investments are also not indicative of the performance of, or trends in, the Company’s business where the investee’s operations are not insurance or reinsurance related and where the Company does not control the investee companies’ activities. Management believes that the use of operating earnings or loss enables investors and other users of the Company’s financial information to analyze its performance in a manner similar to how Management analyzes performance. Management also believes that this measure follows industry practice and, therefore, allows the users of financial information to compare the Company’s performance with its industry peer group, and that the equity analysts and certain rating agencies which follow the Company, and the insurance industry as a whole, generally exclude these items from their analyses for the same reasons.

Operating earnings increased by $67 million, from $244 million in the three months ended September 30, 2012 to $311 million in the same period of 2013. The increase was primarily due to an improvement in the Non-life underwriting result, driven by a higher level of favorable prior year and prior quarters’ loss development, which was partially offset by an increase in the income tax expense associated with the higher level of pre-tax operating earnings.

Operating earnings decreased by $4 million, from $568 million in the nine months ended September 30, 2012 to $564 million in the same period of 2013. The decrease was primarily due to a decline in net investment income driven by lower reinvestment rates, and higher operating expenses driven by a charge related to the restructuring. These decreases were partially offset by an increase in Non-life and Life underwriting results, driven by a higher level of favorable prior year loss development, and a decrease in the income tax expense associated with the lower level of pre-tax operating earnings.

The other lesser factors contributing to the increases or decreases in operating earnings in the three months and nine months ended September 30, 2013 compared to the same periods of 2012 are further described in Review of Net Income below.

 

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The presentation of operating earnings attributable to PartnerRe Ltd. common shareholders is a non-GAAP financial measure within the meaning of Regulation G and should be considered in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP (see Comment on Non-GAAP Measures). The table below provides a reconciliation of operating earnings to the most directly comparable GAAP financial measure for the three months and nine months ended September 30, 2013 and 2012 (in millions of U.S. dollars):

 

    For the three
months ended
September 30, 2013
    For the three
months ended
September 30, 2012
    For the nine
months ended
September 30, 2013
    For the nine
months ended
September 30, 2012
 

Net income attributable to PartnerRe Ltd.

  $ 333     $ 487     $ 392     $ 1,023  

Less:

       

Net realized and unrealized investment (losses) gains, net of tax

    (1     222       (219     400  

Net foreign exchange gains (losses), net of tax

    5       2       (1     1  

Interest in earnings of equity investments, net of tax

    4       4       4       8  

Dividends to preferred shareholders

    14       15       44       46  
 

 

 

   

 

 

   

 

 

   

 

 

 

Operating earnings attributable to PartnerRe Ltd. common shareholders

  $ 311     $ 244     $ 564     $ 568  

Operating ROE: Management uses annualized Operating ROE as a measure of profitability that focuses on the return to common shareholders on an annual basis. To support the Company’s growth objectives, most economic decisions, including capital attribution and underwriting pricing decisions, incorporate an Operating ROE impact analysis. For the purpose of that analysis, an appropriate amount of capital (equity) is attributed to each transaction for determining the transaction’s priced return on attributed capital. Subject to an adequate return for the risk level as well as other factors, such as the contribution of each risk to the overall risk level and risk diversification, capital is attributed to the transactions generating the highest priced return on deployed capital. Management’s challenge consists of (i) attributing an appropriate amount of capital to each transaction based on the risk created by the transaction, (ii) properly estimating the Company’s overall risk level and the impact of each transaction on the overall risk level, (iii) assessing the diversification benefit, if any, of each transaction, and (iv) deploying available capital. The risk for the Company lies in mis-estimating any one of these factors, which are critical in calculating a meaningful priced return on deployed capital, and entering into transactions that do not contribute to the Company’s growth objectives. The Company’s Operating ROE’s for quarterly periods are annualized.

Annualized Operating ROE increased from 18.4% in the three months ended September 30, 2012 to 22.6% in the same period of 2013. The increase in annualized Operating ROE was primarily due to the increase in operating earnings in the three months ended September 30, 2013 compared to the same period of 2012, as described above, and was partially offset by a higher beginning diluted book value per share at January 1, 2013 compared to January 1, 2012. The factors contributing to increases or decreases in operating earnings are described further in Review of Net Income below.

Annualized Operating ROE decreased modestly from 13.9% in the nine months ended September 30, 2012 to 13.0% in the same period of 2013. The decrease in annualized Operating ROE was primarily due to the modest decline in operating earnings in the nine months ended September 30, 2013 compared to the same period of 2012, as described above, and also due to a higher beginning diluted book value per share at January 1, 2013 compared to January 1, 2012. The factors contributing to increases or decreases in operating earnings are described further in Review of Net Income below.

 

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The presentation of Operating ROE is a non-GAAP financial measure within the meaning of Regulation G and should be considered in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP (see Comment on Non-GAAP Measures). The table below provides a reconciliation of Operating ROE to the most directly comparable GAAP financial measure for the three months and nine months ended September 30, 2013 and 2012:

 

     For the three
months ended
September 30, 2013
    For the three
months ended
September 30, 2012
    For the nine
months ended
September 30, 2013
    For the nine
months ended
September 30, 2012
 

Annualized return on beginning diluted book value per common share calculated with net income per share attributable to common shareholders

     23.2     35.5     7.8     23.9

Less:

        

Annualized net realized and unrealized investment (losses) gains, net of tax, on beginning diluted book value per common share

     (0.1     16.7       (5.1     9.8  

Annualized net foreign exchange gains, net of tax, on beginning diluted book value per common share

     0.4       0.1       —         —    

Annualized net interest in earnings of equity investments, net of tax, on beginning diluted book value per common share

     0.3       0.3       0.1       0.2  

Annualized loss on redemption of preferred shares, on beginning diluted book value per common share

     —         —         (0.2     —    
  

 

 

   

 

 

   

 

 

   

 

 

 

Annualized operating return on beginning diluted book value per common share

     22.6     18.4     13.0     13.9

Combined ratio: The combined ratio is used industry-wide as a measure of underwriting profitability for Non-life business. A combined ratio under 100% indicates underwriting profitability, as the total losses and loss expenses, acquisition costs and other operating expenses are less than the premiums earned on that business. While an important metric of underwriting profitability, the combined ratio does not reflect all components of profitability, as it does not recognize the impact of investment income earned on premiums between the time premiums are received and the time loss payments are ultimately made to clients. The key challenges in managing the combined ratio metric consist of (i) focusing on underwriting profitable business even in the weaker part of the reinsurance cycle, as opposed to growing the book of business at the cost of profitability, (ii) diversifying the portfolio to achieve a good balance of business, with the expectation that underwriting losses in certain lines or markets may potentially be offset by underwriting profits in other lines or markets, and (iii) maintaining control over expenses.

The Non-life combined ratio decreased by 5.8 points, from 80.7% in the three months ended September 30, 2012 to 74.9% in the same period of 2013. The decrease in the combined ratio for the three months ended September 30, 2013 compared to the same period of 2012 primarily reflected the increase in net favorable prior year loss development and a lower level of large and catastrophic losses.

The Non-life combined ratio decreased by 0.9 points, from 85.1% in the nine months ended September 30, 2012 to 84.2% in the same period of 2013. The modest decrease in the combined ratio in the nine months ended September 30, 2013 compared to the same period of 2012 was primarily due to the increase in net favorable prior year loss development and a lower other operating expense ratio driven by an increased level of net premiums earned, which was partially offset by a higher level of large catastrophic losses and large losses. The impact on the combined ratio of the catastrophic events for each period is analyzed above.

The other lesser factors contributing to increases or decreases in the combined ratio are described further in Review of Net Income below.

The Company uses the combined ratio to measure its overall underwriting profitability for its Non-life segment as a whole. Given the Company does not allocate operating expenses to its Non-life sub-segments, Management measures the underwriting profitability of the Non-life sub-segments by using the technical result and technical ratio as described in Results by Segment below.

 

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Other Key Financial Measures

In addition to using the annualized growth in Diluted Tangible Book Value per Share plus dividends as the Company’s prime financial long-term measure, and diluted tangible book value per common share and common share equivalents outstanding (Diluted Tangible Book Value per Share) as the basis for this measure, the Company uses other metrics to monitor its financial performance and to measure total shareholder value. Other such metrics used by Management include, but are not limited to, diluted book value per common share and common share equivalents outstanding (Diluted Book Value per Share) and Diluted Tangible Book Value per Share plus the discount in Non-life loss reserves per common share and common share equivalents outstanding (Diluted Tangible Book Value plus the discount in Non-life reserves). Diluted Book Value per Share is a similar metric to Diluted Tangible Book Value per Share, except that it includes the impact on book value of goodwill and intangible assets. Diluted Tangible Book Value plus the discount in Non-life loss reserves is a shorter-term metric that adjusts the Company’s Diluted Tangible Book Value per Share for the impact that changes in interest rates have on the time value of money that is embedded in the Company’s Non-life loss reserves.

Comment on Non-GAAP Measures

Throughout this filing, the Company’s results of operations have been presented in the way that Management believes will be the most meaningful and useful to investors, analysts, rating agencies and others who use financial information in evaluating the performance of the Company. This presentation includes the use of Diluted Tangible Book Value per Share, Diluted Tangible Book Value per Share plus dividends, operating earnings or loss and Operating ROE that are not calculated under standards or rules that comprise U.S. GAAP. These measures are referred to as non-GAAP financial measures within the meaning of Regulation G. Management believes that these non-GAAP financial measures are important to investors, analysts, rating agencies and others who use the Company’s financial information and will help provide a consistent basis for comparison between years and for comparison with the Company’s peer group, although non-GAAP measures may be defined or calculated differently by other companies. Investors should consider these non-GAAP measures in addition to, and not as a substitute for, measures of financial performance prepared in accordance with GAAP. A reconciliation of these measures to the most directly comparable U.S. GAAP financial measures, diluted book value per share, net income or loss and return on beginning common shareholders’ equity calculated with net income or loss attributable to common shareholders, is presented above.

Risk Management

In the reinsurance industry, the core of the business model is the assumption and management of risk. A key challenge is to create economic value through the intelligent and optimal assumption and management of reinsurance and capital markets and investment risks while limiting and mitigating those risks that can destroy tangible as well as intangible value, those risks for which the organization is not sufficiently compensated, and those risks that could threaten the ability of the Company to achieve its objectives. While many companies start with a return goal and then attempt to shed risks that may derail that goal, the Company starts with a capital-based risk appetite and then looks for risks that meet its return targets within that framework. Management believes that this construct allows the Company to balance the cedants’ need for certainty of claims payment with the shareholders’ need for an adequate return.

All business decisions entail a risk/return trade-off, and these decisions are applicable to the Company’s risks. In the context of assumed business risks, this requires an accurate evaluation of risks to be assumed, and a determination of the appropriate economic returns required as fair compensation for such risks.

The Company’s results are primarily determined by how well the Company understands, prices and manages assumed risk. Management also believes that every organization faces numerous risks that could threaten the successful achievement of a company’s goals and objectives. These include choice of strategy and markets, economic and business cycles, competition, changes in regulation, data quality and security, fraud, business interruption and management continuity; all factors which can be viewed as either strategic, financial, or operational risks that are common to any industry. See Risk Factors in Item 1A of Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. For additional information related to the Company’s risk management approach, see Business—Risk Management in Item 1 of Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

Assumed Risks

Central to the Company’s assumed risk framework is its risk appetite. The Company’s risk appetite is a statement of how much and how often the Company will tolerate operating losses and economic losses during an annual period. The Company’s risk appetite is expressed as the maximum operating loss and the maximum economic loss that the Board is willing to incur. The Company’s risk appetite is approved by the Board on an annual basis.

The Company establishes key risk limits for any risk source deemed by Management to have the potential to cause operating losses or economic losses greater than the Company’s risk appetite. The Risk and Finance Committee of the Board (Risk and Finance Committee) approves the key risk limits. Executive and Business Unit Management may set additional specific and aggregate risk limits within the key risk limits approved by the Risk and Finance Committee. The actual level of risk is dependent on current market conditions and the need for balance in the Company’s portfolio of risks. On a periodic basis, Management reviews and reports to the Risk and Finance Committee the actual limits deployed against the approved limits.

 

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Management established key risk limits that are approved by the Risk and Finance Committee for eight risk sources at December 31, 2012. For a detailed discussion of these eight risk sources see Business—Risk Management in Item 1 of Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

During the nine months ended September 30, 2013, the Company added agriculture risk to its Risk Management framework, as the ninth key risk. The risk limit for agriculture risk was approved by the Risk and Finance Committee. The following discussion updates Risk Management in Item 1 of Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

Agriculture Risk

The Company defines this risk as the risk that losses from multi-peril crop insurance materially exceed the net premiums that are received to cover such risks, which may result in operating and economic losses to the Company. Multi-peril crop underwriting losses of the magnitude that have the potential to exceed the Company’s risk appetite are associated with the systemic impacts of severe weather events, particularly drought or flooding, over a large geographic area. Localized events such as convective thunderstorms or hail, while potentially devastating, are unlikely to have the large geographic footprint necessary to create material losses exceeding the net premiums collected.

Multi-peril crop risk is managed through geographic diversification both within individual countries and across countries. This is accomplished through the allocation and tracking of capacity across exposure zones (defined as individual countries) and is accompanied by regular extreme event modeling, and a combination of quantitative and qualitative analysis.

The Company utilizes probable maximum loss estimates, net of retrocession, to manage its exposures. The limit approved measure is aggregated by contract within an exposure zone to establish the total exposures. Actual exposures deployed and estimated probable maximum losses in a specific zone will vary from period to period depending on Management’s assessment of current market conditions, the results from exposure modeling, and other analysis.

The following table shows the limits approved by the Risk and Finance Committee and the actual limits deployed at September 30, 2013 and December 31, 2012:

 

     September 30, 2013      December 31, 2012  
     Limit
approved
     Actual
deployed
     Limit
approved
     Actual
deployed
 

Natural Catastrophe Risk

   $  2.3 billion      $ 1.5 billion      $ 2.3 billion      $ 1.6 billion  

Long Tail Reinsurance Risk

   $  1.2 billion      $ 0.8 billion      $ 1.2 billion      $ 0.7 billion  

Market Risk

   $  3.4 billion      $ 2.7 billion      $ 3.4 billion      $ 2.5 billion  

Equity and equity-like sublimit

   $  2.8 billion      $ 1.9 billion      $ 2.8 billion      $ 1.7 billion  

Interest Rate Risk (duration)

     5.0 years        2.7 years        5.0 years        2.7 years  

Default and Credit Spread Risk

   $  9.5 billion      $ 6.6 billion      $ 9.5 billion      $ 7.1 billion  

Trade Credit Underwriting Risk

   $  0.9 billion      $ 0.7 billion      $ 0.9 billion      $ 0.6 billion  

Longevity Risk

   $  2.0 billion      $ 1.2 billion      $ 2.0 billion      $ 1.1 billion  

Pandemic Risk

   $  1.3 billion      $ 0.6 billion      $ 1.3 billion      $ 0.6 billion  

Agriculture Risk

   $  0.3 billion      $ 0.1 billion        

With respect to the Natural Catastrophe Risk, see Natural Catastrophe Probable Maximum Loss (PML) below for a discussion of the Company’s estimated exposures for selected peak industry natural catastrophe perils at July 1, 2013. For a discussion of operational and financial risks, other underwriting risks and exposure controls, retrocessions and claims, see Business—Risk Management in Item 1 of Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

Natural Catastrophe Probable Maximum Loss (PML)

The following discussion of the Company’s natural catastrophe probable maximum loss (PML) information contains forward-looking statements based upon assumptions and expectations concerning the potential effect of future events that are subject to uncertainties. See Item 1A of Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 for a list of the Company’s risk factors. Any of these risk factors could result in actual losses that are materially different from the Company’s PML estimates below.

Natural catastrophe risk is a source of significant aggregate exposure for the Company and is managed by setting risk appetite and limits, as discussed above. The peril zones in the disclosure below are major peril zones for the industry. The Company has exposures in other peril zones that can potentially generate losses greater than the PML estimates below. The Company’s PMLs represent an estimate of loss for a single event for a given return period. The table below discloses the Company’s 1-in-250 and 1-in-500 year return period estimated loss for a single occurrence of a natural catastrophe event in a one-year period. For risk management purposes, the Company focuses more on the 1-in-250 PML estimate for wind perils and the 1-in-500 PML for earthquake perils.

 

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The PML estimates below include all significant exposure from our Non-life and Life and Health business operations. This includes coverage for property, marine, energy, aviation, engineering, workers’ compensation and mortality. In addition, the PML estimates include the contractual limits of insurance-linked securities. The PML estimates do not include casualty coverage that could be exposed as a result of a catastrophic event. In addition, they do not include estimates for contingent losses to insureds that are not directly impacted by the event (e.g. loss of earnings due to disruption in supply lines).

For additional information related to the Company’s natural catastrophe PML information and definitions, see Business—Natural Catastrophe Probable Maximum Loss (PML) in Item 1 of Part I of the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

The table below shows the Company’s single occurrence estimated net PML exposures (pre-tax and net of retrocession and reinstatement premiums) for certain selected peak industry natural catastrophe perils at July 1, 2013 (in millions of U.S. dollars):

 

          Single Occurrence
Estimated Net Exposure
 

Zone

   Peril    1-in-250 year PML      1-in-500 year PML
(Earthquake Perils  Only)
 

U.S. Southeast

   Hurricane    $ 1,054        —    

U.S. Northeast

   Hurricane      1,121        —    

U.S. Gulf Coast

   Hurricane      1,025        —    

Caribbean

   Hurricane      276        —    

Europe

   Windstorm      872        —    

Japan

   Typhoon      124        —    

California

   Earthquake      575      $ 679  

British Columbia

   Earthquake      305        513  

Japan

   Earthquake      435        457  

Australia

   Earthquake      418        552  

New Zealand

   Earthquake      250        272  

The Company estimates that the incremental loss at the 1-in-250 year return period from a U.S. hurricane impacting more than one of the three hurricane risk zones in the U.S. would be 20% higher than the PML of the largest zone impacted. In addition, there is the potential for a hurricane to impact the Caribbean peril zone and one or more U.S. hurricane peril zones.

Critical Accounting Policies and Estimates

Critical Accounting Policies and Estimates of the Company at September 30, 2013 have not changed materially compared to December 31, 2012. The following discussion updates specific information related to the Company’s estimates for losses and loss expenses and life policy benefits and valuation of investments and funds held – directly managed, including certain derivative financial instruments. See Critical Accounting Policies and Estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 for a discussion of the Company’s other critical accounting policies which are not specifically updated in this report given they have not changed materially compared to December 31, 2012.

Losses and Loss Expenses and Life Policy Benefits

Losses and Loss Expenses

Because a significant amount of time can elapse between the assumption of risk, occurrence of a loss event, the reporting of the event to an insurance company (the primary company or the cedant), the subsequent reporting to the reinsurance company (the reinsurer) and the ultimate payment of the claim on the loss event by the reinsurer, the Company’s liability for unpaid losses and loss expenses (loss reserves) is based largely upon estimates. The Company categorizes loss reserves into three types of reserves: reported outstanding loss reserves (case reserves), additional case reserves (ACRs) and incurred but not reported (IBNR) reserves. The Company updates its estimates for each of the aforementioned categories on a quarterly basis using information received from its cedants. The Company also estimates the future unallocated loss adjustment expenses (ULAE) associated with the loss reserves and these form part of the Company’s loss adjustment expense reserves. The Company’s Non-life loss reserves for each category and sub-segment are reported in the table included later in this section.

The amount of time that elapses before a claim is reported to the cedant and then subsequently reported to the reinsurer is commonly referred to in the industry as the reporting tail. For all lines, the Company’s objective is to estimate ultimate losses and loss expenses. Total loss reserves are then calculated by subtracting losses paid. Similarly, IBNR reserves are calculated by subtraction of case reserves and ACRs from total loss reserves.

 

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The Company analyzes its ultimate losses and loss expenses after consideration of the loss experience of various reserving cells. The Company assigns treaties to reserving cells and allocates losses from the treaty to the reserving cell. The reserving cells are selected in order to ensure that the underlying treaties have homogeneous loss development characteristics (e.g., reporting tail) but are large enough to make estimation of trends credible. The selection of reserving cells is reviewed annually and changes over time as the business of the Company evolves. For each reserving cell, the Company’s estimates of loss reserves are reached after a review of the results of several commonly accepted actuarial projection methodologies. In selecting its best estimate, the Company considers the appropriateness of each methodology to the individual circumstances of the reserving cell and underwriting year for which the projection is made.

See Critical Accounting Policies and Estimates—Losses and Loss Expenses and Life Policy Benefits in Item 7 of Part II of the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 for additional information on the reserving methodologies employed by the Company, the principal reserving methods used for the reserving lines, the principal parameter assumptions underlying the methods and the main underlying factors upon which the estimates of reserving parameters are predicated.

The Company’s best estimate of total loss reserves is typically in excess of the midpoint of the actuarial ultimate liability estimate. The Company believes that there is potentially significant risk in estimating loss reserves for long-tail lines of business and for immature underwriting years that may not be adequately captured through traditional actuarial projection methodologies as these methodologies usually rely heavily on projections of prior year trends into the future. In selecting its best estimate of future liabilities, the Company considers both the results of actuarial point estimates of loss reserves as well as the potential variability of these estimates as captured by a reasonable range of actuarial liability estimates. The selected best estimates of reserves are always within the reasonable range of estimates indicated by the Company’s actuaries.

During the three months and nine months ended September 30, 2013 and 2012, the Company reviewed its estimate for prior year losses for the Non-life segment (defined below in Results by Segment) and, in light of developing data, adjusted its ultimate loss ratios for prior accident years. The following table summarizes the net prior year favorable loss development for each sub-segment of the Company’s Non-life segment for the three months and nine months ended September 30, 2013 and 2012 (in millions of U.S. dollars):

 

     For the three
months ended
September 30, 2013
     For the three
months ended
September 30, 2012
     For the nine
months ended
September 30, 2013
     For the nine
months ended
September 30, 2012
 

Net Non-life prior year favorable loss development:

           

North America

   $ 94      $ 67      $ 155      $ 167  

Global (Non-U.S.) P&C

     37        28        131        74  

Global Specialty

     78        91        166        205  

Catastrophe

     29        3        96        22  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total net Non-life prior year favorable loss development

   $ 238      $ 189      $ 548      $ 468  

The net Non-life prior year favorable loss development for the three months and nine months ended September 30, 2013 and 2012 was driven by the following factors (in millions of U.S. dollars):

 

     For the three
months ended
September 30, 2013
    For the three
months ended
September 30, 2012