AWH-2014.9.30-10Q
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 ____________________________________
Form 10-Q
(Mark One)
  þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2014
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to              
Commission file number: 001-32938
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
(Exact Name of Registrant as Specified in Its Charter)
Switzerland
98-0681223
(State or Other Jurisdiction of
(I.R.S. Employer
Incorporation or Organization)
Identification No.)
Lindenstrasse 8
6340 Baar
Zug, Switzerland
(Address of Principal Executive Offices and Zip Code)

41-41-768-1080
(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ
Accelerated filer ¨
Non-accelerated filer ¨
Smaller reporting company ¨
(Do not check if a smaller reporting company)            
                                                     
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
As of October 13, 2014, 96,409,738 common shares were outstanding.

Table of Contents

TABLE OF CONTENTS
PART I
 
 
 
 
Item 1.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
PART II
 
 
 
 
Item 1.        
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
 
 
 
 

-i-
Table of Contents

PART I
FINANCIAL INFORMATION
Item 1.
Financial Statements.
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
as of September 30, 2014 and December 31, 2013
(Expressed in thousands, except share and per share amounts)
 
As of
 
As of
 
September 30,
2014
 
December 31,
2013
ASSETS:
 
 
 
Fixed maturity investments trading, at fair value (amortized cost: 2014: $6,074,752; 2013: $6,065,350)
$
6,128,237

 
$
6,100,798

Equity securities trading, at fair value (cost: 2014: $901,300; 2013: $647,301)
945,076

 
699,846

Other invested assets
929,201

 
911,392

Total investments
8,002,514

 
7,712,036

Cash and cash equivalents
831,270

 
531,936

Restricted cash
178,958

 
149,393

Insurance balances receivable
926,183

 
664,731

Funds held
405,703

 
632,430

Prepaid reinsurance
376,651

 
340,992

Reinsurance recoverable
1,349,009

 
1,234,504

Accrued investment income
30,554

 
32,236

Net deferred acquisition costs
171,827

 
126,661

Goodwill
278,085

 
268,376

Intangible assets
46,931

 
48,831

Balances receivable on sale of investments
60,122

 
76,544

Net deferred tax assets
41,312

 
37,469

Other assets
110,449

 
89,691

Total assets
$
12,809,568

 
$
11,945,830

LIABILITIES:
 
 
 
Reserve for losses and loss expenses
$
6,052,263

 
$
5,766,529

Unearned premiums
1,716,927

 
1,396,256

Reinsurance balances payable
203,428

 
173,023

Balances due on purchases of investments
166,026

 
104,740

Senior notes
798,725

 
798,499

Dividends payable
21,686

 
16,732

Accounts payable and accrued liabilities
176,914

 
170,225

Total liabilities
$
9,135,969

 
$
8,426,004

Commitments and contingencies

 

SHAREHOLDERS’ EQUITY:
 
 
 
Common shares: 2014: par value CHF 4.10 per share and 2013: par value CHF 4.10 per share (2014: 100,775,256; 2013: 103,477,452 shares issued and 2014: 96,382,238; 2013: 100,253,646 shares outstanding)
407,990

 
418,988

Treasury shares, at cost (2014: 4,393,018; 2013: 3,223,806)
(134,633
)
 
(79,992
)
Retained earnings
3,400,242

 
3,180,830

Total shareholders’ equity
3,673,599

 
3,519,826

Total liabilities and shareholders’ equity
$
12,809,568

 
$
11,945,830


See accompanying notes to the consolidated financial statements.

1
Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
for the three and nine months ended September 30, 2014 and 2013
(Expressed in thousands, except share and per share amounts)
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
REVENUES:
 
 
 
 
 
 
 
Gross premiums written
$
707,884

 
$
580,893

 
$
2,369,682

 
$
2,183,174

Premiums ceded
(139,142
)
 
(127,816
)
 
(475,402
)
 
(453,823
)
Net premiums written
568,742

 
453,077

 
1,894,280

 
1,729,351

Change in unearned premiums
(27,005
)
 
57,696

 
(285,011
)
 
(248,079
)
Net premiums earned
541,737

 
510,773

 
1,609,269

 
1,481,272

Net investment income
43,412

 
39,271

 
127,824

 
110,294

Net realized investment (losses) gains
(35,136
)
 
27,487

 
104,286

 
(8,074
)
Other income
1,032

 
—

 
1,032

 
—

 
551,045

 
577,531

 
1,842,411

 
1,583,492

EXPENSES:
 
 
 
 
 
 
 
Net losses and loss expenses
336,090

 
276,970

 
926,231

 
807,276

Acquisition costs
72,403

 
65,114

 
214,404

 
186,416

General and administrative expenses
88,294

 
88,553

 
264,822

 
251,818

Other expense
6,575

 
—

 
6,575

 
—

Amortization of intangible assets
633

 
633

 
1,900

 
1,900

Interest expense
14,325

 
14,094

 
43,451

 
42,416

Foreign exchange loss
278

 
4,353

 
978

 
7,361

 
518,598

 
449,717

 
1,458,361

 
1,297,187

Income before income taxes
32,447

 
127,814

 
384,050

 
286,305

Income tax expense
1,532

 
4,971

 
24,300

 
6,332

NET INCOME
30,915

 
122,843

 
359,750

 
279,973

 
 
 
 
 
 
 
 
Other comprehensive income
—

 
—

 
—

 
—

COMPREHENSIVE INCOME
$
30,915

 
$
122,843

 
$
359,750

 
$
279,973

PER SHARE DATA
 
 
 
 
 
 
 
Basic earnings per share
$
0.32

 
$
1.20

 
$
3.67

 
$
2.72

Diluted earnings per share
$
0.31

 
$
1.18

 
$
3.60

 
$
2.66

Weighted average common shares outstanding
96,458,231

 
101,974,077

 
97,926,378

 
103,020,681

Weighted average common shares and common share equivalents outstanding
98,444,238

 
104,184,579

 
99,965,296

 
105,393,276

Dividends paid per share
$
0.225

 
$
0.167

 
$
0.559

 
$
0.292


See accompanying notes to the consolidated financial statements.

2
Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
for the nine months ended September 30, 2014 and 2013
(Expressed in thousands)
 
 
Share
Capital
 
Treasury
Shares
 
Retained
Earnings
 
Total
December 31, 2013
$
418,988

 
$
(79,992
)
 
$
3,180,830

 
$
3,519,826

Net income
—

 
—

 
359,750

 
359,750

Dividends
—

 
—

 
(60,017
)
 
(60,017
)
Stock compensation
—

 
17,235

 
1,333

 
18,568

Share repurchases
—

 
(164,528
)
 
—

 
(164,528
)
Shares cancelled
(10,998
)
 
92,652

 
(81,654
)
 
—

September 30, 2014
$
407,990

 
$
(134,633
)
 
$
3,400,242

 
$
3,673,599

 
 
 
 
 
 
 
 
December 31, 2012
$
454,980

 
$
(113,818
)
 
$
2,985,173

 
$
3,326,335

Net income
—

 
—

 
279,973

 
279,973

Dividends — par value reduction
(12,981
)
 
—

 
—

 
(12,981
)
Dividends
—

 
—

 
(34,069
)
 
(34,069
)
Stock compensation
—

 
26,093

 
(18,278
)
 
7,815

Share repurchases
—

 
(123,145
)
 
—

 
(123,145
)
Shares cancelled
(17,162
)
 
125,025

 
(107,863
)
 
—

September 30, 2013
$
424,837

 
$
(85,845
)
 
$
3,104,936

 
$
3,443,928

 
See accompanying notes to the consolidated financial statements.

3
Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
for the nine months ended September 30, 2014 and 2013
(Expressed in thousands)
 
Nine Months Ended 
 September 30,
 
2014
 
2013
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:
 
 
 
Net income
$
359,750

 
$
279,973

Adjustments to reconcile net income to cash provided by operating activities:
 
 
 
Net realized gains on sales of investments
(118,640
)
 
(76,104
)
Mark to market adjustments
(5,634
)
 
80,136

Stock compensation expense
10,822

 
9,282

Undistributed loss (income) of equity method investments
10,452

 
(4,313
)
Changes in:
 
 
 
Reserve for losses and loss expenses, net of reinsurance recoverables
171,229

 
50,308

Unearned premiums, net of prepaid reinsurance
285,012

 
248,079

Insurance balances receivable
(260,627
)
 
(229,580
)
Funds held
226,727

 
(38,763
)
Reinsurance balances payable
30,405

 
57,379

Net deferred acquisition costs
(45,166
)
 
(37,941
)
Net deferred tax assets
(3,511
)
 
(16,252
)
Accounts payable and accrued liabilities
4,473

 
(18,540
)
Other items, net
4,441

 
34,508

Net cash provided by operating activities
669,733

 
338,172

CASH FLOWS (USED IN) PROVIDED BY INVESTING ACTIVITIES:
 
 
 
Purchases of trading securities
(5,608,594
)
 
(4,955,817
)
Purchases of other invested assets
(242,227
)
 
(211,501
)
Sales of trading securities
5,500,176

 
5,137,280

Sales of other invested assets
243,123

 
189,155

Purchases of fixed assets
(14,490
)
 
(4,171
)
Change in restricted cash
(29,565
)
 
(74,032
)
Net cash paid for acquisitions
(2,565
)
 
—

Net cash (used in) provided by investing activities
(154,142
)
 
80,914

CASH FLOWS USED IN FINANCING ACTIVITIES:
 
 
 
Dividends paid - partial par value reduction
—

 
(12,981
)
Dividends paid
(55,064
)
 
(17,117
)
Proceeds from the exercise of stock options
7,640

 
8,465

Share repurchases
(166,207
)
 
(120,163
)
Net cash used in financing activities
(213,631
)
 
(141,796
)
Effect of exchange rate changes on foreign currency cash
(2,626
)
 
(6,122
)
NET INCREASE IN CASH AND CASH EQUIVALENTS
299,334

 
271,168

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
531,936

 
681,879

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
831,270

 
$
953,047

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for income taxes
$
18,052

 
$
17,249

Cash paid for interest expense
$
45,750

 
$
45,750

See accompanying notes to the consolidated financial statements.

4
Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)
1. GENERAL

Allied World Assurance Company Holdings, AG, a Swiss holding company (“Allied World Switzerland”), through its wholly-owned subsidiaries (collectively, the “Company”), provides property and casualty insurance and reinsurance on a worldwide basis. References to $ are to the lawful currency of the United States and to CHF are to the lawful currency of Switzerland.

The Company has reached definitive agreements to acquire the Hong Kong and Singapore operations of Royal & Sun Alliance Insurance plc for approximately $211,000, at current exchange rates, subject to adjustments at closing. In addition to the purchase price, the Company expects to contribute an additional $90,000 to capitalize the business on an ongoing basis. Subject to regulatory approvals in both Hong Kong and Singapore, as well as court approval in Singapore, the acquisition is expected to be completed in the first half of 2015.

2. BASIS OF PREPARATION AND CONSOLIDATION

These unaudited condensed consolidated financial statements include the accounts of the Company and have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with Article 10 of Regulation S-X as promulgated by the U.S. Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these unaudited condensed consolidated financial statements reflect all adjustments that are normal and recurring in nature and necessary for a fair presentation of financial position and results of operations as of the end of and for the periods presented. The results of operations for any interim period are not necessarily indicative of the results for a full year.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The significant estimates reflected in the Company’s financial statements, include, but are not limited to:

•
The premium estimates for certain reinsurance agreements,
•
Recoverability of deferred acquisition costs,
•
The reserve for outstanding losses and loss expenses,
•
Valuation of ceded reinsurance recoverables,
•
Determination of impairment of goodwill and other intangible assets, and
•
Valuation of financial instruments.

Intercompany accounts and transactions have been eliminated on consolidation and all entities meeting consolidation requirements have been included in the unaudited condensed consolidated financial statements.

On May 1, 2014, the shareholders approved a 3-for-1 stock split of the Company's common shares. All historical share and per share amounts reflect the effect of the stock split.

These unaudited condensed consolidated financial statements, including these notes, should be read in conjunction with the Company’s audited consolidated financial statements, and related notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.
3. NEW ACCOUNTING PRONOUNCEMENTS
In April 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update 2014-08, "Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity" ("ASU 2014-08"). ASU 2014-08 changes the requirements for reporting discontinued operations, such that a disposal of a component of the Company's operations is required to be reported as discontinued operations if the disposal represents a strategic shift that has, or will have, a major effect on the Company's operations and financial results. Examples of strategic shifts that could have a major effect on

5
Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


the Company's operations could include a disposal of a major geographical area, a major line of business, a major equity method investment, or other major parts of the Company. ASU 2014-08 is effective for all disposals that occur after January 1, 2015. The Company does not believe the adoption of ASU 2014-08 will have a material impact on future financial statements and related disclosures.
In May 2014, the FASB issued Accounting Standards Update 2014-09, "Revenue from Contracts with Customers" ("ASU 2014-09"). ASU 2014-09 provides a framework, through a five-step process, for recognizing revenue from customers, improves comparability and consistency of recognizing revenue across entities, industries, jurisdictions and capital markets, and requires enhanced disclosures. Certain contracts with customers are specifically excluded from the scope of ASU 2014-09, including; amongst others, insurance contracts accounted for under Accounting Standard Codification 944, Financial Services - Insurance. ASU 2014-09 is effective on January 1, 2017 with retrospective adoption required for the comparative periods. The Company is currently assessing the impact the adoption of ASU 2014-09 will have on future financial statements and related disclosures.
In August 2014, the FASB issued Accounting Standards Update 2014-15, "Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern" ("ASU 2014-15"). Currently, there is no guidance under U.S. GAAP regarding management's responsibility to assess whether there is substantial doubt about an entity's ability to continue as a going concern. Under ASU 2014-15, the Company will be required to assess its ability to continue as a going concern each interim and annual reporting period and provide certain disclosures if there is substantial doubt about the entity's ability to continue as a going concern, including management's plan to alleviate the substantial doubt. ASU 2014-15 is effective on January 1, 2017 and early adoption is permitted. The Company is currently assessing the impact the adoption of ASU 2014-15 will have on future financial statements and related disclosures.

4. INVESTMENTS

a) Trading Securities

Securities accounted for at fair value with changes in fair value recognized in the unaudited condensed consolidated statements of operations and comprehensive income (“consolidated income statements”) by category are as follows:
 
September 30, 2014
 
December 31, 2013
 
Fair Value
 
Amortized Cost
 
Fair Value
 
Amortized Cost
U.S. Government and Government agencies
$
1,184,115

 
$
1,186,185

 
$
1,676,788

 
$
1,684,832

Non-U.S. Government and Government agencies
219,287

 
229,792

 
191,776

 
197,082

States, municipalities and political subdivisions
260,690

 
251,628

 
231,555

 
234,406

Corporate debt:
 
 
 
 
 
 
 
Financial institutions
1,194,949

 
1,185,637

 
958,794

 
943,518

Industrials
1,202,906

 
1,201,341

 
1,174,047

 
1,165,448

Utilities
125,513

 
125,202

 
69,426

 
69,658

Mortgage-backed
1,240,362

 
1,196,683

 
1,292,502

 
1,267,863

Asset-backed
700,415

 
698,284

 
505,910

 
502,543

Total fixed maturity investments
$
6,128,237

 
$
6,074,752

 
$
6,100,798

 
$
6,065,350

 
September 30, 2014
 
December 31, 2013
 
Fair Value
 
Original Cost
 
Fair Value
 
Original Cost
Equity securities
$
945,076

 
$
901,300

 
$
699,846

 
$
647,301

Other invested assets
806,124

 
701,794

 
764,081

 
658,683

 
$
1,751,200

 
$
1,603,094

 
$
1,463,927

 
$
1,305,984


Other invested assets, included in the table above, include investments in private equity funds, hedge funds and a high yield loan fund that are accounted for at fair value, but excludes other private securities described below in Note 4(b) that are accounted for using the equity method of accounting.


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


b) Other Invested Assets

Details regarding the carrying value, redemption characteristics and unfunded investment commitments of the other invested assets portfolio as of September 30, 2014 and December 31, 2013 were as follows:

Investment Type
Carrying Value as of September 30, 2014
 
Investments
with
Redemption
Restrictions
 
Estimated
Remaining
Restriction
Period
 
Investments
without
Redemption
Restrictions
 
Redemption
Frequency(1)
 
Redemption
Notice
Period(1)
 
Unfunded
Commitments
Private equity
$
179,196

 
$
179,196

 
2 - 9 Years
 
$
—

 
 
 
 
 
$
223,030

Mezzanine debt
114,399

 
114,399

 
5 - 9 Years
 
—

 
 
 
 
 
251,486

Distressed
9,516

 
9,516

 
4 Years
 
—

 
 
 
 
 
5,119

Total private equity
303,111

 
303,111

 
 
 
—

 
 
 
 
 
479,635

Distressed
173,111

 
173,111

 
1 Year
 
—

 
 
 
 
 
—

Equity long/short
111,627

 
86,721

 
1 Year
 
24,906

 
Quarterly
 
30 -60 Days
 
—

Multi-strategy
81,576

 
—

 
 
 
81,576

 
Quarterly
 
45 -90 Days
 
—

Relative value credit
105,155

 
—

 
 
 
105,155

 
Quarterly
 
60 Days
 
—

Total hedge funds
471,469

 
259,832

 
 
 
211,637

 
 
 
 
 
—

High yield loan fund
31,544

 
—

 
 
 
31,544

 
Monthly
 
30 days
 
—

Total other invested assets at fair value
806,124

 
562,943

 
 
 
243,181

 
 
 
 
 
479,635

Other private securities
123,077

 
—

 
 
 
123,077

 
 
 
 
 
—

Total other invested assets
$
929,201

 
$
562,943

 
 
 
$
366,258

 
 
 
 
 
$
479,635


Investment Type
Carrying Value as of December 31, 2013
 
Investments
with
Redemption
Restrictions
 
Estimated
Remaining
Restriction
Period
 
Investments
without
Redemption
Restrictions
 
Redemption
Frequency(1)
 
Redemption
Notice
Period(1)
 
Unfunded
Commitments
Private equity
$
144,422

 
$
144,422

 
2 - 9 Years
 
$
—

 
 
 
 
 
$
263,519

Mezzanine debt
64,627

 
64,627

 
8 - 9 Years
 
—

 
 
 
 
 
198,756

Distressed
7,776

 
7,776

 
4 Years
 
—

 
 
 
 
 
5,249

Total private equity
216,825

 
216,825

 
 
 
—

 
 
 
 
 
467,524

Distressed
151,227

 
151,227

 
1 - 2 Years
 
—

 
 
 
 
 
—

Equity long/short
99,365

 
—

 
 
 
99,365

 
Quarterly
 
30 -60 Days
 
—

Multi-strategy
136,958

 
—

 
 
 
136,958

 
Quarterly
 
45 -90 Days
 
—

Event driven
14,018

 
—

 
 
 
14,018

 
Annual
 
60 Days
 
—

Relative value credit
113,730

 
—

 
 
 
113,730

 
Quarterly
 
60 Days
 
—

Total hedge funds
515,298

 
151,227

 
 
 
364,071

 
 
 
 
 
—

High yield loan fund
31,958

 
—

 
 
 
31,958

 
Monthly
 
30 days
 
—

Total other invested assets at fair value
764,081

 
368,052

 
 
 
396,029

 
 
 
 
 
467,524

Other private securities
147,311

 
—

 
 
 
147,311

 
 
 
 
 
—

Total other invested assets
$
911,392

 
$
368,052

 
 
 
$
543,340

 
 
 
 
 
$
467,524

_______________________
(1)
The redemption frequency and notice periods only apply to the investments without redemption restrictions. Some or all of these investments may be subject to a gate as described below.

In general, the Company has invested in hedge funds that require at least 30 days’ notice of redemption and may be redeemed on a monthly, quarterly, semi-annual, annual or longer basis, depending on the fund. Certain hedge funds have lock-

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


up periods ranging from one to three years from initial investment. A lock-up period refers to the initial amount of time an investor is contractually required to invest before having the ability to redeem. Funds that provide for periodic redemptions may, depending on the funds’ governing documents, have the ability to deny or delay a redemption request, called a “gate.” The fund may implement this restriction because the aggregate amount of redemption requests as of a particular date exceeds a specified level, generally ranging from 15% to 25% of the fund’s net assets. The gate is a method for executing an orderly redemption process to reduce the possibility of adversely affecting investors in the fund. Typically, the imposition of a gate delays a portion of the requested redemption, with the remaining portion settled in cash sometime after the redemption date. Certain funds may impose a redemption fee on early redemptions. Interests in private equity funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.

The following describes each investment type:

•
Private equity funds: Primary funds may invest in companies and general partnership interests. Secondary funds buy limited partnership interests from existing limited partners of primary private equity funds. As owners of private equity funds seek liquidity, they can sell their existing investments, plus any remaining commitment, to secondary market participants. These funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.
•
Mezzanine debt funds: Mezzanine debt funds primarily focus on providing capital to upper middle market and middle market companies and private equity sponsors, in connection with leveraged buyouts, mergers and acquisitions, recapitalizations, growth financings and other corporate transactions. The most common position in the capital structure will be between the senior secured debt holder and the equity; however, the funds will utilize a flexible approach when structuring investments, which may include secured debt, subordinated debt, preferred stock and/or private equity. These funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.
•
Distressed funds: In distressed debt investing, managers take positions in the debt of companies experiencing significant financial difficulties, including bankruptcy, or in certain positions of the capital structure of structured securities. The manager relies on the fundamental analysis of these securities, including the claims on the assets and the likely return to bondholders. Certain funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.
•
Equity long/short funds: In equity long/short funds, managers take long positions in companies they deem to be undervalued and short positions in companies they deem to be overvalued. Long/short managers may invest in countries, regions or sectors and vary by their use of leverage and by their targeted net long position.
•
Multi-strategy funds: These funds may utilize many strategies employed by specialized funds including distressed investing, equity long/short, merger arbitrage, convertible arbitrage, fixed income arbitrage and macro trading.
•
Event driven funds: Event driven strategies seek to deploy capital into specific securities whose returns are affected by a specific event that affects the value of one or more securities of a company. Returns for such securities are linked primarily to the specific outcome of the events and not by the overall direction of the bond or stock markets. Examples could include mergers and acquisitions (arbitrage), corporate restructurings and spin-offs, and capital structure arbitrage.
•
Relative value credit funds: These funds seek to take exposure to credit-sensitive securities, long and/or short, based upon credit analysis of issuers and securities and credit market views.
•
High yield loan fund: A long-only private mutual fund that invests in high yield fixed income securities.
•
Other private securities: These securities include strategic non-controlling minority investments in private asset management companies and other insurance related investments that are accounted for using the equity method of accounting.


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



c) Net Investment Income
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Fixed maturity investments
$
38,762

 
$
31,179

 
$
110,998

 
$
96,366

Equity securities
3,711

 
6,110

 
12,876

 
13,718

Other invested assets: hedge funds and private equity
2,249

 
3,812

 
8,767

 
6,001

Other invested assets: other private securities
3,292

 
1,997

 
7,291

 
5,115

Cash and cash equivalents
552

 
302

 
1,562

 
1,319

Expenses
(5,154
)
 
(4,129
)
 
(13,670
)
 
(12,225
)
Net investment income
$
43,412

 
$
39,271

 
$
127,824

 
$
110,294


Net investment income from other invested assets: other private securities included the distributed and undistributed net income from investments accounted for using the equity method of accounting. The income reported for other invested assets: other private securities for the nine months ended September 30, 2014 included a loss of $9,348 recorded for an equity method investment due to impairment charges that it recorded.

d) Components of Realized Gains and Losses

 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Gross realized gains on sale of invested assets
$
28,773

 
$
51,915

 
$
146,780

 
$
154,387

Gross realized losses on sale of invested assets
(9,955
)
 
(40,770
)
 
(26,228
)
 
(82,812
)
Net realized and unrealized gains (losses) on derivatives
2,171

 
(4,169
)
 
(24,469
)
 
3,392

Mark-to-market (losses) gains:
 
 
 
 
 
 
 
Fixed maturity investments, trading
(40,843
)
 
30,383

 
18,039

 
(101,205
)
Equity securities, trading
(8,479
)
 
(17,198
)
 
(8,768
)
 
(18,555
)
Other invested assets, trading
(6,803
)
 
7,326

 
(1,068
)
 
36,719

Net realized investment (losses) gains
$
(35,136
)
 
$
27,487

 
$
104,286

 
$
(8,074
)

e) Pledged Assets

As of September 30, 2014 and December 31, 2013, $3,082,601 and $2,894,401, respectively, of cash and cash equivalents and investments were deposited, pledged or held in trust accounts in favor of ceding companies and other counterparties or government authorities to comply with reinsurance contract provisions, insurance laws and other contract provisions.

In addition, as of September 30, 2014 and December 31, 2013, a further $543,828 and $1,053,632, respectively, of cash and cash equivalents and investments were pledged as collateral for the Company’s letter of credit facilities. See Note 10(d) to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 for details on the Company’s credit facilities.

5. DERIVATIVE INSTRUMENTS

As of September 30, 2014 and December 31, 2013, none of the Company’s derivatives were designated as hedges for accounting purposes. The following table summarizes information on the location and amounts of derivative fair values on the unaudited condensed consolidated balance sheets (“consolidated balance sheets”):
 

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


 
September 30, 2014
 
December 31, 2013
 
Asset
Derivative 
Notional
Amount
 
Asset
Derivative 
Fair Value 
 
Liability
Derivative 
Notional
Amount
 
Liability
Derivative 
Fair Value
 
Asset
Derivative 
Notional
Amount
 
Asset
Derivative 
Fair Value
 
Liability
Derivative 
Notional
Amount
 
Liability
Derivative
Fair Value 
Foreign exchange contracts
$
38,940

 
$
814

 
$
2,355

 
$
22

 
$
294,788

 
$
6,254

 
$
122,439

 
$
1,176

Interest rate swaps
565,600

 
414

 
—

 
—

 
491,400

 
6,829

 
40,000

 
4,214

Total derivatives
$
604,540

 
$
1,228

 
$
2,355

 
$
22

 
$
786,188

 
$
13,083

 
$
162,439

 
$
5,390


Derivative assets and derivative liabilities are classified within “other assets” or “accounts payable and accrued liabilities” on the consolidated balance sheets.

The following table provides the net realized and unrealized gains (losses) on derivatives not designated as hedges recorded on the consolidated income statements:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Foreign exchange contracts
$
1,886

 
$
(2,336
)
 
$
(580
)
 
$
(1,091
)
Total included in foreign exchange loss
1,886

 
(2,336
)
 
(580
)
 
(1,091
)
Put options
—

 
—

 
—

 
(3,822
)
Foreign exchange contracts
1,701

 
(4,164
)
 
857

 
1,925

Interest rate futures and swaps
470

 
(5
)
 
(25,325
)
 
5,289

Total included in net realized investment gains (losses)
2,171

 
(4,169
)
 
(24,468
)
 
3,392

Total realized and unrealized gains (losses) on derivatives
$
4,057

 
$
(6,505
)
 
$
(25,048
)
 
$
2,301


The loss related to interest rate future and swap contracts for the nine months ended September 30, 2014 was the result of selling interest rate future and swap contracts to reduce the duration of the investment portfolio. Given the decrease in interest rates during the year, the Company recorded a loss related to these interest rate future and swap contracts.

Derivative Instruments Not Designated as Hedging Instruments

The Company is exposed to foreign currency risk in its investment portfolio. Accordingly, the fair values of the Company’s investment portfolio are partially influenced by the change in foreign exchange rates. These foreign currency hedging activities have not been designated as specific hedges for financial reporting purposes.

The Company’s insurance and reinsurance subsidiaries and branches operate in various foreign countries and consequently the Company’s underwriting portfolio is exposed to foreign currency risk. The Company manages foreign currency risk by seeking to match liabilities under the insurance policies and reinsurance contracts that it writes and that are payable in foreign currencies with cash and investments that are denominated in such currencies. When necessary, the Company may also use derivatives to economically hedge un-matched foreign currency exposures, specifically forward contracts and currency options.

The Company also purchases and sells interest rate future and interest rate swap contracts to actively manage the duration and yield curve positioning of its fixed income portfolio. Interest rate futures and interest rate swaps can efficiently increase or decrease the overall duration of the portfolio. Additionally, interest rate future and interest rate swap contracts can be utilized to obtain the desired position along the yield curve in order to protect against certain future yield curve shapes.

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

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


6. FAIR VALUE OF FINANCIAL INSTRUMENTS

In accordance with U.S. GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. There is a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon whether the inputs to the valuation of an asset or liability are observable or unobservable in the market at the measurement date, with quoted market prices being the highest level (Level 1) and unobservable inputs being the lowest level (Level 3). A fair value measurement will fall within the level of the hierarchy based on the input that is significant to determining such measurement. The three levels are defined as follows:
 
•
Level 1: Observable inputs to the valuation methodology that are quoted prices (unadjusted) for identical assets or liabilities in active markets.
•
Level 2: Observable inputs to the valuation methodology other than quoted market prices (unadjusted) for identical assets or liabilities in active markets. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical assets in markets that are not active and inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
•
Level 3: Inputs to the valuation methodology that are unobservable for the asset or liability.

The following table shows the fair value of the Company’s financial instruments and where in the fair value hierarchy the fair value measurements are included as of the dates indicated below:
September 30, 2014
 
Carrying
Amount
 
Total
Fair Value
 
Level 1
 
Level 2
 
Level 3
Fixed maturity investments:
 
 
 
 
 
 
 
 
 
 
U.S. Government and Government agencies
 
$
1,184,115

 
$
1,184,115

 
$
998,487

 
$
185,628

 
$
—

Non-U.S. Government and Government agencies
 
219,287

 
219,287

 
—

 
219,287

 
—

States, municipalities and political subdivisions
 
260,690

 
260,690

 
—

 
260,690

 
—

Corporate debt
 
2,523,368

 
2,523,368

 
—

 
2,523,368

 
—

Mortgage-backed
 
1,240,362

 
1,240,362

 
—

 
1,120,454

 
119,908

Asset-backed
 
700,415

 
700,415

 
—

 
609,045

 
91,370

Total fixed maturity investments
 
6,128,237

 
6,128,237

 
998,487

 
4,918,472

 
211,278

Equity securities
 
945,076

 
945,076

 
907,041

 
—

 
38,035

Other invested assets
 
806,124

 
806,124

 
—

 
—

 
806,124

Total investments
 
$
7,879,437

 
$
7,879,437

 
$
1,905,528

 
$
4,918,472

 
$
1,055,437

Derivative assets:
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
814

 
$
814

 
$
—

 
$
814

 
$
—

Interest rate swaps
 
414

 
414

 
—

 
414

 
—

Derivative liabilities:
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
22

 
$
22

 
$
—

 
$
22

 
$
—

Interest rate swaps
 
—

 
—

 
—

 
—

 
—

Senior notes
 
$
798,725

 
$
888,370

 
$
—

 
$
888,370

 
$
—


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


December 31, 2013
 
Carrying
Amount
 
Total
Fair Value
 
Level 1
 
Level 2
 
Level 3
Fixed maturity investments:
 
 
 
 
 
 
 
 
 
 
U.S. Government and Government agencies
 
$
1,676,788

 
$
1,676,788

 
$
1,370,088

 
$
306,700

 
$
—

Non-U.S. Government and Government agencies
 
191,776

 
191,776

 
—

 
191,776

 
—

States, municipalities and political subdivisions
 
231,555

 
231,555

 
—

 
231,555

 
—

Corporate debt
 
2,202,267

 
2,202,267

 
—

 
2,202,267

 
—

Mortgage-backed
 
1,292,502

 
1,292,502

 
—

 
1,145,164

 
147,338

Asset-backed
 
505,910

 
505,910

 
—

 
412,497

 
93,413

Total fixed maturity investments
 
6,100,798

 
6,100,798

 
1,370,088

 
4,489,959

 
240,751

Equity securities
 
699,846

 
699,846

 
625,942

 
—

 
73,904

Other invested assets
 
764,081

 
764,081

 
—

 
—

 
764,081

Total investments
 
$
7,564,725

 
$
7,564,725

 
$
1,996,030

 
$
4,489,959

 
$
1,078,736

Derivative assets:
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
6,254

 
$
6,254

 
$
—

 
$
6,254

 
$
—

Interest rate swaps
 
6,829

 
6,829

 
—

 
6,829

 
—

Derivative liabilities:
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
1,176

 
$
1,176

 
$
—

 
$
1,176

 
$
—

Interest rate swaps
 
$
4,214

 
$
4,214

 
$
—

 
$
4,214

 
$
—

Senior notes
 
$
798,499

 
$
897,601

 
$
—

 
$
897,601

 
$
—


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

The following describes the valuation techniques used by the Company to determine the fair value of financial instruments held as of the balance sheet date.

Recurring Fair Value of Financial Instruments

U.S. Government and Government agencies: Comprised primarily of bonds issued by the U.S. Treasury, the Federal Home Loan Bank, the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association. The fair values of the Company’s U.S. government securities are based on quoted market prices in active markets and are included in the Level 1 fair value hierarchy. The Company believes the market for U.S. Treasury securities is an actively traded market given the high level of daily trading volume. The fair values of U.S. government agency securities are priced using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are included in the Level 2 fair value hierarchy.

Non-U.S. Government and Government agencies: Comprised of fixed income obligations of non-U.S. governmental entities. The fair values of these securities are based on prices obtained from international indices and are included in the Level 2 fair value hierarchy.

States, municipalities and political subdivisions: Comprised of fixed income obligations of U.S.-domiciled state and municipality entities. The fair values of these securities are based on prices obtained from the new issue market, and are included in the Level 2 fair value hierarchy.

Corporate debt: Comprised of bonds issued by or loan obligations of corporations that are diversified across a wide range of issuers and industries. The fair values of corporate debt that are short-term are priced using spread above the LIBOR yield curve, and the fair values of corporate debt that are long-term are priced using the spread above the risk-free yield curve. The

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


spreads are sourced from broker-dealers, trade prices and the new issue market. As the significant inputs used to price corporate bonds are observable market inputs, the fair values of corporate debt are included in the Level 2 fair value hierarchy.

Mortgage-backed: Primarily comprised of residential and commercial mortgages originated by both U.S. government agencies (such as the Federal National Mortgage Association) and non-U.S. government agencies. The fair values of mortgage-backed securities originated by U.S. government agencies and non-U.S. government agencies are based on a pricing model that incorporates prepayment speeds and spreads to determine the appropriate average life of mortgage-backed securities. The spreads are sourced from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the mortgage-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the mortgage-backed securities are broker-dealer quotes and the Company is not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 hierarchy.

Asset-backed: Principally comprised of bonds backed by pools of automobile loan receivables, home equity loans, credit card receivables and collateralized loan obligations originated by a variety of financial institutions. The fair values of asset-backed securities are priced using prepayment speed and spread inputs that are sourced from the new issue market or broker-dealer quotes. As the significant inputs used to price the asset-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the asset-backed securities are broker-dealer quotes and the Company is not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 hierarchy.

Equity securities: Comprised of common and preferred stocks and mutual funds. Equities are generally included in the Level 1 fair value hierarchy as prices are obtained from market exchanges in active markets. Non-U.S. mutual funds where the net asset value is not provided on a daily basis are included in the Level 3 fair value hierarchy.

Other invested assets: Comprised of funds invested in a range of diversified strategies. In accordance with U.S. GAAP, the fair values of the funds are based on the net asset value ("NAV") of the funds as reported by the fund manager. The fair value of these investments are included in the Level 3 fair value hierarchy as the Company believes NAV is an unobservable input and these securities are not redeemable in the near term.

Derivative instruments: The fair value of foreign exchange contracts, interest rate futures and interest rate swaps are priced from quoted market prices for similar exchange-traded derivatives and pricing valuation models that utilize independent market data inputs. The fair value of derivatives are included in the Level 2 fair value hierarchy.

Senior notes: The fair value of the senior notes is based on reported trades. The fair value of the senior notes is included in the Level 2 fair value hierarchy.

Non-recurring Fair Value of Financial Instruments

The Company measures the fair value of certain assets on a non-recurring basis, generally quarterly, annually or when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. These assets include investments accounted for using the equity method, goodwill and intangible assets. The Company uses a variety of techniques to measure the fair value of these assets when appropriate, as described below:

Investments accounted for using the equity method: When the Company determines that the carrying value of these assets may not be recoverable, the Company records the assets at fair value with the loss recognized in income. In such cases, the Company measures the fair value of these assets using discounted cash flow models and market multiple models.

Goodwill and intangible assets: The Company tests goodwill and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable, but at least annually for goodwill and indefinite-lived intangibles. If the Company determines that goodwill and intangible assets may be impaired, the Company uses techniques, including discounted expected future cash flows and market multiple models, to measure fair value.

 

13
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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


Rollforward of Level 3 Financial Instruments

The following is a reconciliation of the beginning and ending balance of financial instruments using significant unobservable inputs (Level 3):
Three Months Ended September 30, 2014
Other invested
assets
 
Mortgage-backed
 
Asset-backed
 
Equities
Opening balance
$
804,505

 
$
146,801

 
$
71,232

 
$
34,863

Realized and unrealized gains (losses) included in net income
6,797

 
(882
)
 
(253
)
 
3,172

Purchases
78,629

 
16,311

 
18,021

 
—

Sales
(83,807
)
 
(28,761
)
 
(9,970
)
 
—

Transfers into Level 3 from Level 2
—

 
1,628

 
17,863

 
—

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

 
(15,189
)
 
(5,523
)
 
—

Ending balance
$
806,124

 
$
119,908

 
$
91,370

 
$
38,035

Three Months Ended September 30, 2013
 
 
 
 
 
 
 
Opening balance
$
714,391

 
$
198,003

 
$
61,285

 
$
53,499

Realized and unrealized gains (losses) included in net income
9,403

 
464

 
(313
)
 
3,972

Purchases
67,554

 
69,775

 
16,969

 
10,000

Sales
(24,277
)
 
(79,001
)
 
(1,302
)
 
—

Transfers into Level 3 from Level 2
—

 
13

 
3,394

 
—

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

 
—

 
—

 
—

Ending balance
$
767,071

 
$
189,254

 
$
80,033

 
$
67,471

Nine Months Ended September 30, 2014
Other invested
assets
 
Mortgage-backed
 
Asset-backed
 
Equities
Opening balance
$
764,081

 
$
147,338

 
$
93,413

 
$
73,904

Realized and unrealized gains (losses) included in net income
51,921

 
3,654

 
(659
)
 
(6,572
)
Purchases
267,549

 
34,187

 
35,526

 
—

Sales
(277,427
)
 
(65,038
)
 
(19,871
)
 
(29,297
)
Transfers into Level 3 from Level 2
—

 
1,253

 
13,923

 
—

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

 
(1,486
)
 
(30,962
)
 
—

Ending balance
$
806,124

 
$
119,908

 
$
91,370

 
$
38,035

Nine Months Ended September 30, 2013
 
 
 
 
 
 
 
Opening balance
$
655,888

 
$
167,825

 
$
62,246

 
$
54,680

Realized and unrealized gains (losses) included in net income
53,365

 
(5,910
)
 
(791
)
 
2,791

Purchases
237,506

 
102,369

 
42,956

 
10,000

Sales
(179,688
)
 
(69,968
)
 
(26,728
)
 
—

Transfers into Level 3 from Level 2
—

 
5,073

 
2,350

 
—

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

 
(10,135
)
 
—

 
—

Ending balance
$
767,071

 
$
189,254

 
$
80,033

 
$
67,471

_______________________ 
(1)
Transfers out of Level 3 are primarily attributable to the availability of market observable information.

The Company attempts to verify the significant inputs used by broker-dealers in determining the fair value of the securities priced by them. If the Company could not obtain sufficient information to determine if the broker-dealers were using significant observable inputs, then such securities have been transferred to the Level 3 fair value hierarchy. The Company believes the prices obtained from the broker-dealers are the best estimate of fair value of the securities being priced as the broker-dealers are typically involved in the initial pricing of the security, and the Company has compared the price per the broker-dealer to other pricing sources and noted no material differences. The Company recognizes transfers between levels at the end of the reporting period. There were no transfers between Level 1 and Level 2 during the period.

14
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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


The Company’s external investment accounting service provider receives prices from internationally recognized independent pricing services to measure the fair values of its fixed maturity investments. Pricing sources are evaluated and selected in a manner to ensure that the most reliable sources are used. The Company uses a pricing service ranking to consistently select the most appropriate pricing service in instances where it receives multiple quotes on the same security. The Company obtains multiple quotes for the majority of its securities. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. Each pricing service has its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of “matrix pricing” in which the independent pricing service uses observable market inputs, including, but not limited to, reported trades, benchmark yields, broker-dealer quotes, interest rates, prepayment speeds, default rates and such other inputs as are available from market sources to determine a reasonable fair value.

All of the Company’s securities classified as Level 3, other than investments in other invested assets, are valued based on unadjusted broker-dealer quotes. This includes less liquid securities such as lower quality asset-backed securities, commercial mortgage-backed securities and residential mortgage-backed securities. The primary valuation inputs include monthly payment information, the probability of default, loss severity rates and estimated prepayment rates. Significant changes in these inputs in isolation would result in a significantly lower or higher fair value measurement. In general, a change in the assumption of the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity in an event of default and prepayment rates.

The Company records the unadjusted price provided and validates this price through a process that includes, but is not limited to, monthly and/or quarterly: (i) comparison of prices between two independent sources, with significant differences requiring additional price sources; (ii) quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to their target benchmark, with significant differences identified and investigated); (iii) evaluation of methodologies used by external parties to calculate fair value, including a review of the inputs used for pricing; (iv) comparing the price to the Company’s knowledge of the current investment market; and (v) back-testing, which includes randomly selecting purchased or sold securities and comparing the executed prices to the fair value estimates from the pricing service. In addition to internal controls, management relies on the effectiveness of the valuation controls in place at the Company’s external investment accounting service provider (supported by a Statement on Standards for Attestation Engagements No. 16 report) in conjunction with regular discussion and analysis of the investment portfolio’s structure and performance.

7. RESERVE FOR LOSSES AND LOSS EXPENSES

The reserve for losses and loss expenses consists of the following:
 
September 30,
2014
 
December 31,
2013
Outstanding loss reserves
$
1,585,900

 
$
1,520,867

Reserves for losses incurred but not reported
4,466,363

 
4,245,662

Reserve for losses and loss expenses
$
6,052,263

 
$
5,766,529


















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


The table below is a reconciliation of the beginning and ending liability for unpaid losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables.
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Gross liability at beginning of period
$
5,935,678

 
$
5,696,865

 
$
5,766,529

 
$
5,645,549

Reinsurance recoverable at beginning of period
(1,301,742
)
 
(1,179,525
)
 
(1,234,504
)
 
(1,141,110
)
Net liability at beginning of period
4,633,936

 
4,517,340

 
4,532,025

 
4,504,439

Net losses incurred related to:
 
 
 
 
 
 
 
Current year
382,970

 
338,420

 
1,067,111

 
961,224

Prior years
(46,880
)
 
(61,450
)
 
(140,880
)
 
(153,948
)
Total incurred
336,090

 
276,970

 
926,231

 
807,276

Net paid losses related to:
 
 
 
 
 
 
 
Current year
53,596

 
30,399

 
80,401

 
54,983

Prior years
202,626

 
213,252

 
666,555

 
696,137

Total paid
256,222

 
243,651

 
746,956

 
751,120

Foreign exchange revaluation
(10,550
)
 
4,088

 
(8,046
)
 
(5,848
)
Net liability at end of period
4,703,254

 
4,554,747

 
4,703,254

 
4,554,747

Reinsurance recoverable at end of period
1,349,009

 
1,226,034

 
1,349,009

 
1,226,034

Gross liability at end of period
$
6,052,263

 
$
5,780,781

 
$
6,052,263

 
$
5,780,781


For the three months ended September 30, 2014, the Company recognized unfavorable prior year reserve development in its U.S. insurance segment and net favorable reserve development in its international insurance and reinsurance segments. The net unfavorable prior year reserve development for the U.S. insurance segment primarily related to the 2011 through 2013 loss years was due to a higher level of reported claims in the healthcare line of business and net unfavorable prior year reserve development for the 2005 loss year primarily related to the professional liability line of business. The net favorable reserve development in the international insurance segment was primarily due to lower than expected loss emergence across most lines of business and loss years partially offset by unfavorable prior reserve development for the 2012 loss year related to adverse development on two reported claims in our professional liability line of business. The net favorable reserve development in the reinsurance segment was primarily due to lower than expected loss activity in the property reinsurance line of business for the 2013 loss year.

For the nine months ended September 30, 2014, the Company recognized unfavorable prior year reserve development in its U.S. insurance segment and net favorable reserve development in its international insurance and reinsurance segments. The net unfavorable prior year reserve development in the U.S. insurance segment primarily related to the 2011 through 2013 loss years in our healthcare lines of business and was due to higher than expected loss frequency and severity. The net favorable prior year reserve development in the international insurance segment was primarily due to favorable reserve development for the 2007 loss year in the professional liability line of business, net favorable development for the 2009 and 2010 loss years due to actual loss emergence being lower than anticipated across several lines of business, net unfavorable development for the 2012 loss year in the professional liability line of business and the unfavorable reserve development for the 2013 loss year in the healthcare line of business. The net favorable reserve development in the reinsurance segment was primarily due to lower than expected loss activity in the property reinsurance line of business for the 2013 loss year.

For the three months ended September 30, 2013, the Company had net favorable reserve development in its international insurance and reinsurance segments due to actual loss emergence being lower than initially expected. The majority of the net favorable reserve development was recognized in the 2007 through 2011 loss years across most lines of business. In addition, the reinsurance segment recognized net favorable reserve development for the 2012 loss year due to the low level of reported property losses. This was partially offset by unfavorable development in the U.S. insurance segment in the 2011 and 2012 loss years primarily due to a higher level of reported claims for certain healthcare, errors and omissions and private/not for profit directors’ and officers’ lines of business.


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


For the nine months ended September 30, 2013, the Company had net favorable reserve development in its international insurance and reinsurance segments due to actual loss emergence being lower than initially expected for most loss years. The reinsurance segment recognized net favorable reserve development for the 2012 loss year due to the low level of reported property losses. This was partially offset by adverse development in the U.S. insurance segment in the 2011 and 2012 loss years for certain healthcare, errors and omissions and not-for-profit directors’ and officers’ classes of business.

While the Company at times has experienced favorable reserve development in its insurance and reinsurance lines, there is no assurance that conditions and trends that have affected the development of liabilities in the past will continue. It is not appropriate to extrapolate future redundancies based on prior years’ development. The methodology of estimating loss reserves is periodically reviewed to ensure that the key assumptions used in the actuarial models continue to be appropriate.

8. INCOME TAXES

Under Swiss law, a resident company is subject to income tax at the federal, cantonal and communal levels that is levied on net income. Income attributable to permanent establishments or real estate located abroad is excluded from the Swiss tax base. Allied World Switzerland is a holding company and, therefore, is exempt from cantonal and communal income tax. As a result, Allied World Switzerland is subject to Swiss income tax only at the federal level. Allied World Switzerland is a resident of the Canton of Zug and, as such, is subject to an annual cantonal and communal capital tax on its taxable equity. One of Allied World Switzerland's subsidiaries is a Swiss operating company, which is a resident in the Canton of Zug. The operating company is subject to federal, cantonal and communal income tax and to annual cantonal and communal capital tax.

Under current Bermuda law, Allied World Assurance Company Holdings, Ltd (“Allied World Bermuda”) and its Bermuda subsidiaries are not required to pay taxes in Bermuda on either income or capital gains. Allied World Bermuda and Allied World Assurance Company, Ltd have received an assurance from the Bermuda Minister of Finance under the Exempted Undertakings Tax Protection Act 1966 of Bermuda, that in the event of any such taxes being imposed, Allied World Bermuda and Allied World Assurance Company, Ltd will be exempted until March 2035.

Certain subsidiaries of Allied World Switzerland file U.S. federal income tax returns and various U.S. state income tax returns, as well as income tax returns in Canada, Hong Kong, Ireland, Labuan, the United Kingdom, Singapore and Switzerland. To the best of the Company’s knowledge, there are no income tax examinations pending by any tax authority.

Management has deemed all material tax positions to have a greater than 50% likelihood of being sustained based on technical merits if challenged. The Company does not expect any material unrecognized tax benefits within 12 months of September 30, 2014.
9. SHAREHOLDERS’ EQUITY

a) Authorized shares

The issued share capital consists of the following:
 
September 30,
2014
 
December 31,
2013
Common shares issued and fully paid, 2014: CHF 4.10 per share; 2013: CHF 4.10 per share
100,775,256

 
103,477,452

Share capital at end of period
$
407,990

 
$
418,988


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


 
Nine Months Ended September 30, 2014
Shares issued at beginning of period
103,477,452

Shares cancelled
(2,702,196
)
Total shares issued at end of period
100,775,256

Treasury shares issued at beginning of period
3,223,806

Shares repurchased
4,616,543

Shares issued out of treasury
(745,135
)
Shares cancelled
(2,702,196
)
Total treasury shares at end of period
4,393,018

Total shares outstanding at end of period
96,382,238


During the nine months ended September 30, 2014, 2,702,196 shares repurchased and designated for cancellation were constructively retired and cancelled.

b) Dividends

The Company paid the following dividends during the nine months ended September 30, 2014:
Dividend Paid
 
Dividend
Per
Share
 
Total
Amount
Paid
January 2, 2014
 
$
0.167

 
$
16,732

April 3, 2014
 
$
0.167

 
$
16,495

July 2, 2014
 
$
0.225

 
$
21,870


On May 2, 2013, the shareholders approved the Company’s proposal to pay cash dividends in the form of a distribution out of general legal reserve from capital contributions. The distribution amounts were paid to shareholders in quarterly dividends of $0.167 per share in July 2013, October 2013, January 2014 and April 2014.

On May 1, 2014, the shareholders approved the Company’s proposal to pay cash dividends in the form of a distribution out of general legal reserve from capital contributions. The distribution amount will be paid to shareholders in quarterly dividends of $0.225 per share. The first dividend was on July 2, 2014 and the second dividend was on October 2, 2014. The Company expects to distribute the remaining dividends in January 2015 and April 2015.

c) Share Repurchases

On May 1, 2014, the shareholders approved a new share repurchase program in order for the Company to repurchase up to $500,000 of its common shares. This new share repurchase program supersedes the 2012 share repurchase program and no further repurchases will be made under the 2012 share repurchase program. Repurchases may be effected from time to time through open market purchases, privately negotiated transactions, tender offers or otherwise. The timing, form and amount of the share repurchases under the program will depend on a variety of factors, including market conditions, the Company’s capital position, legal requirements and other factors. Under the terms of this share repurchase program, the first three million of common shares repurchased will remain in treasury and will be used by the Company to satisfy share delivery obligations under its equity-based compensation plans. Any additional common shares repurchased will be designated for cancellation at acquisition and will be canceled upon shareholder approval. Shares repurchased and designated for cancellation are constructively retired and recorded as a share cancellation.






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


The Company’s share repurchases were as follows:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Common shares repurchased
654,851

 
1,282,164

 
4,616,543

 
4,103,499

Total cost of shares repurchased
$
24,996

 
$
40,574

 
$
164,528

 
$
123,145

Average price per share
$
38.17

 
$
31.64

 
$
35.64

 
$
30.01


10. EMPLOYEE BENEFIT PLANS

a) Restricted stock units and performance-based equity awards

Restricted stock units ("RSUs") vest pro-rata over four years from the date of grant. The compensation expense for the RSUs is based on the fair market value of Allied World Switzerland’s common shares at the date of grant. The Company estimates the expected forfeitures of RSUs at the date of grant and recognizes compensation expense only for those awards that the Company expects to vest. The forfeiture assumption is ultimately adjusted to the actual forfeiture rate.

Performance-based equity awards represent the right to receive a number of common shares in the future, based upon the achievement of established performance criteria during an applicable performance period. For the performance-based equity awards granted in 2014, 2013 and 2012, the Company anticipates that the performance goals are likely to be achieved. Based on the performance goals, the performance-based equity awards granted in 2014, 2013 and 2012 are expensed at 100%, 100% and 135%, respectively, of the fair value of Allied World Switzerland's common shares on the date of grant. The expense is recognized over the performance period.

The activity related to the Company’s RSUs awards is as follows:
 
Nine Months Ended September 30, 2014
 
Number of Awards
 
Weighted
Average
Grant Date
Fair Value
Outstanding at beginning of period
143,697

 
$
21.69

RSUs granted
454,176

 
33.56

RSUs forfeited
(8,061
)
 
(31.71
)
RSUs fully vested
(77,700
)
 
(21.68
)
Outstanding at end of period
512,112

 
$
32.06


The activity related to the Company’s performance-based equity awards is as follows:
 
Nine Months Ended September 30, 2014
 
Number of Awards
 
Weighted
Average
Grant Date
Fair Value
Outstanding at beginning of period
804,519

 
$
23.21

Performance-based equity awards granted
166,302

 
33.56

Additional awards granted due to achievement of performance criteria
104,895

 
20.50

Performance-based equity awards forfeited
(1,848
)
 
(25.28
)
Performance-based equity awards fully vested
(454,440
)
 
(20.50
)
Outstanding at end of period
619,428

 
$
27.51




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


b) Cash-equivalent stock awards

As part of the Company’s annual year-end compensation awards, the Company granted both awards classified as equity and cash-equivalent stock awards. The cash-equivalent awards were granted to employees who received RSUs and performance-based equity awards in tandem with stock-based awards. The cash-equivalent RSU awards vest pro-rata over four years from the date of grant. The cash-equivalent performance-based equity awards vest after a three-year performance period. The amount payable per unit awarded will be equal to the price per share of Allied World Switzerland’s common shares, and as such the Company measures the value of the award each reporting period based on the period-ending share price. The effects of changes in the share price at each period-end during the service period are recognized as changes in compensation expense ratably over the service period. The liability is included in “accounts payable and accrued liabilities” in the consolidated balance sheets and changes in the liability are recorded in “general and administrative expenses” in the consolidated income statements.

The activity related to the Company's cash-equivalent RSUs and performance-based awards is as follows:
 
RSU's
 
Performance-based Awards
Nine Months Ended September 30, 2014
Number of Awards
 
Weighted Average Grant Date Fair Value
 
Number of Awards
 
Weighted Average Grant Date Fair Value
Outstanding at beginning of period
2,049,084

 
$
24.69

 
1,031,961

 
23.67

Granted
438,162

 
33.56

 
249,438

 
33.56

Additional awards granted due to achievement of performance criteria
—

 
—

 
104,895

 
20.50

Forfeited
(50,106
)
 
(26.75
)
 
(2,769
)
 
(25.28
)
Fully vested
(752,668
)
 
(22.51
)
 
(454,440
)
 
(20.50
)
Outstanding at end of period
1,684,472

 
$
27.98

 
929,085

 
$
27.51


c) Total Stock Related Compensation Expense

The following table shows the total stock-related compensation expense relating to the stock options, RSUs and cash equivalent awards.
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Stock options
$
424

 
$
647

 
$
1,564

 
$
2,662

RSUs and performance-based equity awards
2,767

 
2,070

 
9,258

 
6,621

Cash-equivalent stock awards
8,433

 
13,699

 
25,930

 
34,666

Total
$
11,624

 
$
16,416

 
$
36,752

 
$
43,949


11. EARNINGS PER SHARE

The following table sets forth the comparison of basic and diluted earnings per share:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Basic earnings per share:
 
 
 
 
 
 
 
Net income
$
30,915

 
$
122,843

 
$
359,750

 
$
279,973

Weighted average common shares outstanding
96,458,231

 
101,974,077

 
97,926,378

 
103,020,681

Basic earnings per share
$
0.32

 
$
1.20

 
$
3.67

 
$
2.72


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


 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Diluted earnings per share:
 
 
 
 
 
 
 
Net income
$
30,915

 
$
122,843

 
$
359,750

 
$
279,973

Weighted average common shares outstanding
96,458,231

 
101,974,077

 
97,926,378

 
103,020,681

Share equivalents:
 
 
 
 
 
 
 
Stock options
1,430,243

 
1,500,342

 
1,449,641

 
1,492,374

RSUs and performance-based equity awards
541,711

 
708,399

 
575,675

 
877,107

Employee share purchase plan
14,053

 
1,761

 
13,602

 
3,114

Weighted average common shares and common share equivalents outstanding - diluted
98,444,238

 
104,184,579

 
99,965,296

 
105,393,276

Diluted earnings per share
$
0.31

 
$
1.18

 
$
3.60

 
$
2.66


For the three months ended September 30, 2014, and 2013, there were no common shares considered anti-dilutive and therefore excluded from the calculation of the diluted earnings per share.

For the nine months ended September 30, 2014 and 2013, there were no common shares considered anti-dilutive and therefore excluded from the calculation of the diluted earnings per share.

12. SEGMENT INFORMATION

The determination of reportable segments is based on how senior management monitors the Company’s underwriting operations. Management monitors the performance of its direct underwriting operations based on the geographic location of the Company’s offices, the markets and customers served and the type of accounts written. The Company is currently organized into three operating segments: U.S. insurance, international insurance and reinsurance. All lines of business fall within these classifications.

The U.S. insurance segment includes the Company’s direct specialty insurance operations in the United States and Canada, as well as the Company's claim administration services operations. The Company acquired the remaining interest in a claims administration services company it did not own in May 2014 and recorded goodwill of $9,709 related to the transaction. The U.S. insurance segment provides both direct property and specialty casualty insurance primarily to non-Fortune 1000 North American domiciled accounts, as well as third-party claims administration services.

The international insurance segment includes the Company’s direct insurance operations in Bermuda, Europe, and Asia Pacific, which includes offices in Australia, Hong Kong and Singapore. This segment primarily provides both direct property and casualty insurance to Fortune 1000 North American domiciled accounts from the Bermuda office and direct property and specialty casualty insurance to non-North American domiciled accounts from the European and Asia Pacific offices.

The reinsurance segment includes the Company’s reinsurance operations in the United States, Bermuda, Europe and Singapore. This segment provides reinsurance of property, general casualty, professional liability, specialty lines and property catastrophe coverages written by insurance companies. The Company presently writes reinsurance on both a treaty and a facultative basis, targeting several niche reinsurance markets.

Responsibility and accountability for the results of underwriting operations are assigned by major line of business within each segment. Because the Company does not manage its assets by segment, investment income, interest expense and total assets are not allocated to individual reportable segments. General and administrative expenses are allocated to segments based on various factors, including staff count and each segment’s proportional share of gross premiums written.

The Company measures its segment profit or loss as underwriting income or loss plus other insurance-related income and expenses, which may include the net earnings from our claims administration services operations and other income or expense that is not directly related to our underwriting operations. Management measures results for each segment's underwriting income or loss on the basis of the “loss and loss expense ratio,” “acquisition cost ratio,” “general and administrative expense ratio”, “expense ratio” and the “combined ratio.” The “loss and loss expense ratio” is derived by dividing net losses and loss

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


expenses by net premiums earned. The “acquisition cost ratio” is derived by dividing acquisition costs by net premiums earned. The “general and administrative expense ratio” is derived by dividing general and administrative expenses by net premiums earned. The expense ratio is the sum of the acquisition cost ratio and the general and administrative expense ratio. The “combined ratio” is the sum of the “loss and loss expense ratio,” the “acquisition cost ratio” and the “general and administrative expense ratio.”

The following tables provide a summary of the segment results:
Three Months Ended September 30, 2014
 
U.S. Insurance
 
International
Insurance
 
Reinsurance
 
Total
Gross premiums written
 
$
386,681

 
$
144,236

 
$
176,967

 
$
707,884

Net premiums written
 
321,713

 
87,820

 
159,209

 
568,742

Net premiums earned
 
224,764

 
94,013

 
222,960

 
541,737

Net losses and loss expenses
 
(153,010
)
 
(55,814
)
 
(127,266
)
 
(336,090
)
Acquisition costs
 
(31,131
)
 
(1,209
)
 
(40,063
)
 
(72,403
)
General and administrative expenses
 
(41,730
)
 
(27,993
)
 
(18,571
)
 
(88,294
)
Underwriting (loss) income
 
(1,107
)
 
8,997

 
37,060

 
44,950

Other insurance-related income
 
1,032

 
—

 
—

 
1,032

Other insurance-related expenses
 
(1,270
)
 
(5,305
)
 
—

 
(6,575
)
Segment (loss) income
 
$
(1,345
)
 
$
3,692

 
$
37,060

 
$
39,407

Net investment income
 
 
 
 
 
 
 
43,412

Net realized investment losses
 
 
 
 
 
 
 
(35,136
)
Amortization of intangible assets
 
 
 
 
 
 
 
(633
)
Interest expense
 
 
 
 
 
 
 
(14,325
)
Foreign exchange loss
 
 
 
 
 
 
 
(278
)
Income before income taxes
 
 
 
 
 
 
 
$
32,447

 
 
 
 
 
 
 
 
 
Loss and loss expense ratio
 
68.1
%
 
59.4
%
 
57.1
%
 
62.0
%
Acquisition cost ratio
 
13.9
%
 
1.3
%
 
18.0
%
 
13.4
%
General and administrative expense ratio
 
18.6
%
 
29.8
%
 
8.3
%
 
16.3
%
Expense ratio
 
32.5
%
 
31.1
%
 
26.3
%
 
29.7
%
Combined ratio
 
100.6
%
 
90.5
%
 
83.4
%
 
91.7
%

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


Three Months Ended September 30, 2013
 
U.S. Insurance
 
International
Insurance
 
Reinsurance
 
Total
Gross premiums written
 
$
308,709

 
$
132,881

 
$
139,303

 
$
580,893

Net premiums written
 
238,792

 
75,632

 
138,653

 
453,077

Net premiums earned
 
207,602

 
87,554

 
215,617

 
510,773

Net losses and loss expenses
 
(141,222
)
 
(31,094
)
 
(104,654
)
 
(276,970
)
Acquisition costs
 
(28,426
)
 
282

 
(36,970
)
 
(65,114
)
General and administrative expenses
 
(41,616
)
 
(26,450
)
 
(20,487
)
 
(88,553
)
Underwriting (loss) income
 
(3,662
)
 
30,292

 
53,506

 
80,136

Other insurance-related income
 
—

 
—

 
—

 
—

Other insurance-related expenses
 
—

 
—

 
—

 
—

Segment (loss) income
 
$
(3,662
)
 
$
30,292

 
$
53,506

 
$
80,136

Net investment income
 
 
 
 
 
 
 
39,271

Net realized investment gains
 
 
 
 
 
 
 
27,487

Amortization of intangible assets
 
 
 
 
 
 
 
(633
)
Interest expense
 
 
 
 
 
 
 
(14,094
)
Foreign exchange loss
 
 
 
 
 
 
 
(4,353
)
Income before income taxes
 
 
 
 
 
 
 
$
127,814

 
 
 
 
 
 
 
 
 
Loss and loss expense ratio
 
68.0
%
 
35.5
 %
 
48.5
%
 
54.2
%
Acquisition cost ratio
 
13.7
%
 
(0.3
)%
 
17.1
%
 
12.7
%
General and administrative expense ratio
 
20.0
%
 
30.2
 %
 
9.5
%
 
17.3
%
Expense ratio
 
33.7
%
 
29.9
 %
 
26.6
%
 
30.0
%
Combined ratio
 
101.7
%
 
65.4
 %
 
75.1
%
 
84.2
%


23
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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


Nine Months Ended September 30, 2014
 
U.S. Insurance
 
International
Insurance
 
Reinsurance
 
Total
Gross premiums written
 
$
998,051

 
$
483,079

 
$
888,552

 
$
2,369,682

Net premiums written
 
746,403

 
285,450

 
862,427

 
1,894,280

Net premiums earned
 
651,480

 
271,557

 
686,232

 
1,609,269

Net losses and loss expenses
 
(440,491
)
 
(115,299
)
 
(370,441
)
 
(926,231
)
Acquisition costs
 
(88,311
)
 
(835
)
 
(125,258
)
 
(214,404
)
General and administrative expenses
 
(125,760
)
 
(82,164
)
 
(56,898
)
 
(264,822
)
Underwriting (loss) income
 
(3,082
)
 
73,259

 
133,635

 
203,812

Other insurance-related income
 
1,032

 
—

 
—

 
1,032

Other insurance-related expenses
 
(1,270
)
 
(5,305
)
 
—

 
(6,575
)
Segment (loss) income
 
$
(3,320
)
 
$
67,954

 
$
133,635

 
$
198,269

Net investment income
 
 
 
 
 
 
 
127,824

Net realized investment gains
 
 
 
 
 
 
 
104,286

Amortization of intangible assets
 
 
 
 
 
 
 
(1,900
)
Interest expense
 
 
 
 
 
 
 
(43,451
)
Foreign exchange loss
 
 
 
 
 
 
 
(978
)
Income before income taxes
 
 
 
 
 
 
 
$
384,050

 
 
 
 
 
 
 
 
 
Loss and loss expense ratio
 
67.6
%
 
42.5
%
 
54.0
%
 
57.6
%
Acquisition cost ratio
 
13.6
%
 
0.3
%
 
18.3
%
 
13.3
%
General and administrative expense ratio
 
19.3
%
 
30.3
%
 
8.3
%
 
16.5
%
Expense ratio
 
32.9
%
 
30.6
%
 
26.6
%
 
29.8
%
Combined ratio
 
100.5
%
 
73.1
%
 
80.6
%
 
87.4
%


24
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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


Nine Months Ended September 30, 2013
 
U.S. Insurance
 
International
Insurance
 
Reinsurance
 
Total
Gross premiums written
 
$
872,024

 
$
453,990

 
$
857,160

 
$
2,183,174

Net premiums written
 
652,464

 
259,771

 
817,116

 
1,729,351

Net premiums earned
 
593,477

 
258,809

 
628,986

 
1,481,272

Net losses and loss expenses
 
(398,910
)
 
(90,997
)
 
(317,369
)
 
(807,276
)
Acquisition costs
 
(78,824
)
 
1,489

 
(109,081
)
 
(186,416
)
General and administrative expenses
 
(119,514
)
 
(75,374
)
 
(56,930
)
 
(251,818
)
Underwriting (loss) income
 
(3,771
)
 
93,927

 
145,606

 
235,762

Other insurance-related income
 
—

 
—

 
—

 
—

Other insurance-related expenses
 
—

 
—

 
—

 
—

Segment (loss) income
 
$
(3,771
)
 
$
93,927

 
$
145,606

 
$
235,762

Net investment income
 
 
 
 
 
 
 
110,294

Net realized investment losses
 
 
 
 
 
 
 
(8,074
)
Amortization of intangible assets
 
 
 
 
 
 
 
(1,900
)
Interest expense
 
 
 
 
 
 
 
(42,416
)
Foreign exchange loss
 
 
 
 
 
 
 
(7,361
)
Income before income taxes
 
 
 
 
 
 
 
$
286,305

 
 
 
 
 
 
 
 
 
Loss and loss expense ratio
 
67.2
%
 
35.2
 %
 
50.5
%
 
54.5
%
Acquisition cost ratio
 
13.3
%
 
(0.6
)%
 
17.3
%
 
12.6
%
General and administrative expense ratio
 
20.1
%
 
29.1
 %
 
9.1
%
 
17.0
%
Expense ratio
 
33.4
%
 
28.5
 %
 
26.4
%
 
29.6
%
Combined ratio
 
100.6
%
 
63.7
 %
 
76.9
%
 
84.1
%

The following table shows an analysis of the Company’s gross premiums written by geographic location of the Company’s subsidiaries and branches. All intercompany premiums have been eliminated.
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
United States
$
483,992

 
$
377,618

 
$
1,447,652

 
$
1,296,212

Bermuda
109,503

 
111,103

 
525,005

 
550,815

Europe
64,947

 
52,004

 
245,931

 
198,747

Asia Pacific
45,070

 
40,168

 
142,798

 
137,400

Canada
4,372

 
—

 
8,296

 
—

Total gross premiums written
$
707,884

 
$
580,893

 
$
2,369,682

 
$
2,183,174


Europe includes gross premiums written attributable to Switzerland of $11,130 and $10,509 for the three months ended September 30, 2014 and 2013, respectively and $65,684 and $57,183 for the nine months ended September 30, 2014 and 2013.

13. COMMITMENTS AND CONTINGENCIES

The Company, in common with the insurance industry in general, is subject to litigation and arbitration in the normal course of its business. These legal proceedings generally relate to claims asserted by or against the Company in the ordinary course of insurance or reinsurance operations. Estimated amounts payable under these proceedings are included in the reserve for losses and loss expenses in the Company’s consolidated balance sheets. As of September 30, 2014, the Company was not a

25
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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


party to any material legal proceedings arising outside the ordinary course of business that management believes will have a material adverse effect on the Company’s results of operations, financial position or cash flow.

14. CONDENSED CONSOLIDATED GUARANTOR FINANCIAL STATEMENTS

The following tables present unaudited condensed consolidating financial information as of September 30, 2014 and December 31, 2013 and for the three and nine months ended September 30, 2014 and 2013 for Allied World Switzerland (the “Parent Guarantor”) and Allied World Bermuda (the “Subsidiary Issuer”). The Subsidiary Issuer is a direct, 100%-owned subsidiary of the Parent Guarantor. Investments in subsidiaries are accounted for by the Parent Guarantor under the equity method for purposes of the supplemental consolidating presentation. Earnings of subsidiaries are reflected in the Parent Guarantor’s investment accounts and earnings. The Parent Guarantor fully and unconditionally guarantees the senior notes issued by the Subsidiary Issuer.

Unaudited Condensed Consolidating Balance Sheet:
As of September 30, 2014
Allied World
Switzerland
(Parent
Guarantor)
 
Allied World
Bermuda
(Subsidiary
Issuer)
 
Other Allied
World
Subsidiaries
 
Consolidating
Adjustments
 
Allied World
Switzerland
Consolidated
ASSETS:
 
 
 
 
 
 
 
 
 
Investments
$
—

 
$
—

 
$
8,002,514

 
$
—

 
$
8,002,514

Cash and cash equivalents
38,196

 
2,329

 
790,745

 
—

 
831,270

Insurance balances receivable
—

 
—

 
926,183

 
—

 
926,183

Funds held
—

 
—

 
405,703

 
—

 
405,703

Reinsurance recoverable
—

 
—

 
1,349,009

 
—

 
1,349,009

Net deferred acquisition costs
—

 
—

 
171,827

 
—

 
171,827

Goodwill and intangible assets
—

 
—

 
325,016

 
—

 
325,016

Balances receivable on sale of investments
—

 
—

 
60,122

 
—

 
60,122

Investments in subsidiaries
3,644,932

 
4,255,136

 
—

 
(7,900,068
)
 
—

Due from subsidiaries
18,497

 
407

 
15,508

 
(34,412
)
 
—

Other assets
2,009

 
3,576

 
732,339

 
—

 
737,924

Total assets
$
3,703,634

 
$
4,261,448

 
$
12,778,966

 
$
(7,934,480
)
 
$
12,809,568

LIABILITIES:
 
 
 
 
 
 
 
 
 
Reserve for losses and loss expenses
$
—

 
$
—

 
$
6,052,263

 
$
—

 
$
6,052,263

Unearned premiums
—

 
—

 
1,716,927

 
—

 
1,716,927

Reinsurance balances payable
—

 
—

 
203,428

 
—

 
203,428

Balances due on purchases of investments
—

 
—

 
166,026

 
—

 
166,026

Senior notes
—

 
798,725

 
—

 
—

 
798,725

Due to subsidiaries
6,826

 
8,682

 
18,904

 
(34,412
)
 
—

Other liabilities
23,209

 
12,513

 
162,878

 
—

 
198,600

Total liabilities
30,035

 
819,920

 
8,320,426

 
(34,412
)
 
9,135,969

Total shareholders’ equity
3,673,599

 
3,441,528

 
4,458,540

 
(7,900,068
)
 
3,673,599

Total liabilities and shareholders’ equity
$
3,703,634

 
$
4,261,448

 
$
12,778,966

 
$
(7,934,480
)
 
$
12,809,568

 

26
Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


As of December 31, 2013
Allied World
Switzerland
(Parent
Guarantor)
 
Allied World
Bermuda
(Subsidiary
Issuer)
 
Other Allied
World
Subsidiaries
 
Consolidating
Adjustments
 
Allied World
Switzerland
Consolidated
ASSETS:
 
 
 
 
 
 
 
 
 
Investments
$
—

 
$
—

 
$
7,712,036

 
$
—

 
$
7,712,036

Cash and cash equivalents
10,790

 
2,775

 
518,371

 
—

 
531,936

Insurance balances receivable
—

 
—

 
664,731

 
—

 
664,731

Funds held
—

 
—

 
632,430

 
—

 
632,430

Reinsurance recoverable
—

 
—

 
1,234,504

 
—

 
1,234,504

Net deferred acquisition costs
—

 
—

 
126,661

 
—

 
126,661

Goodwill and intangible assets
—

 
—

 
317,207

 
—

 
317,207

Balances receivable on sale of investments
—

 
—

 
76,544

 
—

 
76,544

Investments in subsidiaries
3,413,001

 
4,018,619

 
—

 
(7,431,620
)
 
—

Due from subsidiaries
111,172

 
122,846

 
123,479

 
(357,497
)
 
—

Other assets
1,757

 
4,671

 
643,353

 
—

 
649,781

Total assets
$
3,536,720

 
$
4,148,911

 
$
12,049,316

 
$
(7,789,117
)
 
$
11,945,830

LIABILITIES:
 
 
 
 
 
 
 
 
 
Reserve for losses and loss expenses
$
—

 
$
—

 
$
5,766,529

 
$
—

 
$
5,766,529

Unearned premiums
—

 
—

 
1,396,256

 
—

 
1,396,256

Reinsurance balances payable
—

 
—

 
173,023

 
—

 
173,023

Balances due on purchases of investments
—

 
—

 
104,740

 
—

 
104,740

Senior notes
—

 
798,499

 
—

 
—

 
798,499

Due to subsidiaries
12,945

 
110,534

 
234,018

 
(357,497
)
 
—

Other liabilities
3,949

 
17,797

 
165,211

 
—

 
186,957

Total liabilities
16,894

 
926,830

 
7,839,777

 
(357,497
)
 
8,426,004

Total shareholders’ equity
3,519,826

 
3,222,081

 
4,209,539

 
(7,431,620
)
 
3,519,826

Total liabilities and shareholders’ equity
$
3,536,720

 
$
4,148,911

 
$
12,049,316

 
$
(7,789,117
)
 
$
11,945,830


The investment in subsidiaries and total shareholders' equity balances reported above in the Unaudited Condensed Consolidating Balance Sheet for Allied World Bermuda (Subsidiary Issuer) as of December 31, 2013 were reduced by $776,000 from the previously reported amounts to properly record intercompany dividends as a reduction in the investment in subsidiaries balance due to a miscalculation. Since the intercompany dividends were eliminated in consolidation there was no impact to consolidated total shareholders' equity.

27
Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


Unaudited Condensed Consolidating Statement of Operations and Comprehensive Income:
 
Three Months Ended September 30, 2014
Allied World
Switzerland
(Parent
Guarantor)
 
Allied World
Bermuda
(Subsidiary
Issuer)
 
Other Allied
World
Subsidiaries
 
Consolidating
Adjustments
 
Allied World
Switzerland
Consolidated
Net premiums earned
$
—

 
$
—

 
$
541,737

 
$
—

 
$
541,737

Net investment income
2

 
—

 
43,410

 
—

 
43,412

Net realized investment gains (losses)
—

 
—

 
(35,136
)
 
—

 
(35,136
)
Other income
—

 
—

 
1,032

 
—

 
1,032

Net losses and loss expenses
—

 
—

 
(336,090
)
 
—

 
(336,090
)
Acquisition costs
—

 
—

 
(72,403
)
 
—

 
(72,403
)
General and administrative expenses
(8,285
)
 
(182
)
 
(79,827
)
 
—

 
(88,294
)
Other expense
—

 
—

 
(6,575
)
 
—

 
(6,575
)
Amortization of intangible assets
—

 
—

 
(633
)
 
—

 
(633
)
Interest expense
—

 
(13,855
)
 
(470
)
 
—

 
(14,325
)
Foreign exchange gain (loss)
16

 
47

 
(341
)
 
—

 
(278
)
Income tax (expense) benefit
—

 
—

 
(1,532
)
 
—

 
(1,532
)
Equity in earnings of consolidated subsidiaries
39,182

 
49,491

 
—

 
(88,673
)
 
—

NET INCOME (LOSS)
$
30,915

 
$
35,501

 
$
53,172

 
$
(88,673
)
 
$
30,915

Other comprehensive income
—

 
—

 
—

 
—

 
—

COMPREHENSIVE INCOME (LOSS)
$
30,915

 
$
35,501

 
$
53,172

 
$
(88,673
)
 
$
30,915

Three Months Ended September 30, 2013
Allied World
Switzerland
(Parent
Guarantor)
 
Allied World
Bermuda
(Subsidiary
Issuer)
 
Other Allied
World
Subsidiaries
 
Consolidating
Adjustments
 
Allied World
Switzerland
Consolidated
Net premiums earned
$
—

 
$
—

 
$
510,773

 
$
—

 
$
510,773

Net investment income
3

 
—

 
39,268

 
—

 
39,271

Net realized investment gains (losses)
—

 
—

 
27,487

 
—

 
27,487

Other income
—

 
—

 
—

 
—

 
—

Net losses and loss expenses
—

 
—

 
(276,970
)
 
—

 
(276,970
)
Acquisition costs
—

 
—

 
(65,114
)
 
—

 
(65,114
)
General and administrative expenses
(7,323
)
 
(4,961
)
 
(76,269
)
 
—

 
(88,553
)
Other expense
—

 
—

 
—

 
—

 
—

Amortization of intangible assets
—

 
—

 
(633
)
 
—

 
(633
)
Interest expense
—

 
(13,838
)
 
(256
)
 
—

 
(14,094
)
Foreign exchange gain (loss)
(13
)
 
(212
)
 
(4,128
)
 
—

 
(4,353
)
Income tax (expense) benefit
—

 
—

 
(4,971
)
 
—

 
(4,971
)
Equity in earnings of consolidated subsidiaries
130,176

 
150,653

 
—

 
(280,829
)
 
—

NET INCOME (LOSS)
$
122,843

 
$
131,642

 
$
149,187

 
$
(280,829
)
 
$
122,843

Other comprehensive income
—

 
—

 
—

 
—

 
—

COMPREHENSIVE INCOME (LOSS)
$
122,843

 
$
131,642

 
$
149,187

 
$
(280,829
)
 
$
122,843



28
Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


Nine Months Ended September 30, 2014
Allied World
Switzerland
(Parent
Guarantor)
 
Allied World
Bermuda
(Subsidiary
Issuer)
 
Other Allied
World
Subsidiaries
 
Consolidating
Adjustments
 
Allied World
Switzerland
Consolidated
Net premiums earned
$
—

 
$
—

 
$
1,609,269

 
$
—

 
$
1,609,269

Net investment income
6

 
—

 
127,818

 
—

 
127,824

Net realized investment gains (losses)
—

 
—

 
104,286

 
—

 
104,286

Other income
—

 
—

 
1,032

 
—

 
1,032

Net losses and loss expenses
—

 
—

 
(926,231
)
 
—

 
(926,231
)
Acquisition costs
—

 
—

 
(214,404
)
 
—

 
(214,404
)
General and administrative expenses
(28,012
)
 
(919
)
 
(235,891
)
 
—

 
(264,822
)
Other expense
—

 
—

 
(6,575
)
 
—

 
(6,575
)
Amortization of intangible assets
—

 
—

 
(1,900
)
 
—

 
(1,900
)
Interest expense
—

 
(41,556
)
 
(1,895
)
 
—

 
(43,451
)
Foreign exchange gain (loss)
12

 
68

 
(1,058
)
 
—

 
(978
)
Income tax (expense) benefit
(86
)
 
—

 
(24,214
)
 
—

 
(24,300
)
Equity in earnings of consolidated subsidiaries
387,830

 
419,294

 
—

 
(807,124
)
 
—

NET INCOME (LOSS)
$
359,750

 
$
376,887

 
$
430,237

 
$
(807,124
)
 
$
359,750

Other comprehensive income
—

 
—

 
—

 
—

 
—

COMPREHENSIVE INCOME (LOSS)
$
359,750

 
$
376,887

 
$
430,237

 
$
(807,124
)
 
$
359,750


Nine Months Ended September 30, 2013
Allied World
Switzerland
(Parent
Guarantor)
 
Allied World
Bermuda
(Subsidiary
Issuer)
 
Other Allied
World
Subsidiaries
 
Consolidating
Adjustments
 
Allied World
Switzerland
Consolidated
Net premiums earned
$
—

 
$
—

 
$
1,481,272

 
$
—

 
$
1,481,272

Net investment income
11

 
4

 
110,279

 
—

 
110,294

Net realized investment gains (losses)
—

 
—

 
(8,074
)
 
—

 
(8,074
)
Other income
—

 
—

 
—

 
—

 
—

Net losses and loss expenses
—

 
—

 
(807,276
)
 
—

 
(807,276
)
Acquisition costs
—

 
—

 
(186,416
)
 
—

 
(186,416
)
General and administrative expenses
(26,875
)
 
(5,873
)
 
(219,070
)
 
—

 
(251,818
)
Other expense
—

 
—

 
—

 
—

 
—

Amortization of intangible assets
—

 
—

 
(1,900
)
 
—

 
(1,900
)
Interest expense
—

 
(41,503
)
 
(913
)
 
—

 
(42,416
)
Foreign exchange gain (loss)
261

 
(935
)
 
(6,687
)
 
—

 
(7,361
)
Income tax (expense) benefit
—

 
—

 
(6,332
)
 
—

 
(6,332
)
Equity in earnings of consolidated subsidiaries
306,576

 
353,280

 
—

 
(659,856
)
 
—

NET INCOME (LOSS)
$
279,973

 
$
304,973

 
$
354,883

 
$
(659,856
)
 
$
279,973

Other comprehensive income
—

 
—

 
—

 
—

 
—

COMPREHENSIVE INCOME (LOSS)
$
279,973

 
$
304,973

 
$
354,883

 
$
(659,856
)
 
$
279,973






29
Table of Contents
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in thousands, except share, per share, percentage and ratio information)


Unaudited Condensed Consolidating Statement of Cash Flows:
Nine Months Ended September 30, 2014
Allied World
Switzerland
(Parent
Guarantor)
 
Allied World
Bermuda
(Subsidiary
Issuer)
 
Other Allied
World
Subsidiaries
 
Consolidating
Adjustments
 
Allied World
Switzerland
Consolidated
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES
$
241,037

 
$
263,554

 
$
737,516

 
$
(575,000
)
 
$
667,107

CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
 
 
 
 
 
 
 
 
 
Purchases trading securities
—

 
—

 
(5,608,594
)
 
—

 
(5,608,594
)
Purchases of other invested assets
—

 
—

 
(242,227
)
 
—

 
(242,227
)
Sales of trading securities
—

 
—

 
5,500,176

 
—

 
5,500,176

Sales of other invested assets
—

 
—

 
243,123

 
—

 
243,123

Other
—

 
—

 
(46,620
)
 
—

 
(46,620
)
Net cash provided by (used in) investing activities
—

 
—

 
(154,142
)
 
—

 
(154,142
)
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
 
 
 
 
 
 
 
 


Dividends paid
(55,064
)
 
—

 
—

 
—

 
(55,064
)
Intercompany dividends paid
—

 
(264,000
)
 
(311,000
)
 
575,000

 
—

Proceeds from the exercise of stock options
7,640

 
—

 
—

 
—

 
7,640

Share repurchases
(166,207
)
 
—

 
—

 
—

 
(166,207
)
Net cash provided by (used in) financing activities
(213,631
)
 
(264,000
)
 
(311,000
)
 
575,000

 
(213,631
)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
27,406

 
(446
)
 
272,374

 
—

 
299,334

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
10,790

 
2,775

 
518,371

 
—

 
531,936

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
38,196

 
$
2,329

 
$
790,745

 
$
—

 
$
831,270


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


Nine Months Ended September 30, 2013
Allied World
Switzerland
(Parent
Guarantor)
 
Allied World
Bermuda
(Subsidiary
Issuer)
 
Other Allied
World
Subsidiaries
 
Consolidating
Adjustments
 
Allied World
Switzerland
Consolidated
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:
$
177,859

 
$
226,564

 
$
431,127

 
$
(503,500
)
 
$
332,050

CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
 
 
 
 
 
 
 
 
 
Purchases of trading securities
—

 
—

 
(4,955,817
)
 
—

 
(4,955,817
)
Purchases of other invested assets
—

 
—

 
(211,501
)
 
—

 
(211,501
)
Sales of trading securities
—

 
—

 
5,137,280

 
—

 
5,137,280

Sales of other invested assets
—

 
—

 
189,155

 
—

 
189,155

Other
—

 
—

 
(78,203
)
 
—

 
(78,203
)
Net cash provided by (used in) investing activities
—

 
—

 
80,914

 
—

 
80,914

CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
 
 
 
 
 
 
 
 


Dividends paid - partial par value reduction
(12,981
)
 
—

 
—

 
—

 
(12,981
)
Dividends paid
(17,117
)
 
—

 
—

 
—

 
(17,117
)
Intercompany dividends paid
—

 
(229,500
)
 
(274,000
)
 
503,500

 
—

Proceeds from the exercise of stock options
8,465

 
—

 
—

 
—

 
8,465

Share repurchases
(120,163
)
 
—

 
—

 
—

 
(120,163
)
Net cash provided by (used in) financing activities
(141,796
)
 
(229,500
)
 
(274,000
)
 
503,500

 
(141,796
)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
36,063

 
(2,936
)
 
238,041

 
—

 
271,168

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
19,997

 
11,324

 
650,558

 
—

 
681,879

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
56,060

 
$
8,388

 
$
888,599

 
$
—

 
$
953,047


Notes to Parent Company Condensed Financial Information

a) Dividends

Allied World Switzerland received cash dividends from its subsidiaries of $264,000 and $229,500 for the nine months ended September 30, 2014 and 2013, respectively. Such dividends are included in “cash flows provided by (used in) operating activities” in the unaudited condensed consolidating cash flows.

15. SUBSEQUENT EVENTS

On October 2, 2014, the Company paid a quarterly dividend of $0.225 per share to shareholders of record on September 23, 2014.

In October 2014, the Company, through its subsidiary Allied World Financial Services, Inc., acquired a minority interest in Blue Vista Capital Management, LLC ("Blue Vista"). Blue Vista invests across real estate asset classes and capital structures through limited partnerships and separate accounts. As part of the acquisition, the Company has agreed to invest $225,000 to various funds managed by Blue Vista over the next several years.

Effective December 31, 2014, the Company will reorganize how it manages its business, and as a result it will realign its executive management team and change its reportable segments to correspond to the reorganization. The Company's Bermuda direct insurance operations, which had previously been included in the international insurance segment, will now be combined with the U.S. insurance segment and renamed North American Insurance. The remaining direct insurance operations of the international insurance segment will be renamed Global Markets Insurance. The reinsurance segment will remain unchanged.

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


The newly created segments will be presented in the Company's financial statements beginning with the period ended December 31, 2014 and prior periods will be recast to conform to the new presentation.




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Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q. References in this Form 10-Q to the terms “we,” “us,” “our,” the “Company” or other similar terms mean the consolidated operations of Allied World Assurance Company Holdings, AG, a Swiss holding company, and our consolidated subsidiaries, unless the context requires otherwise. References in this Form 10-Q to the term “Allied World Switzerland” or “Holdings” means only Allied World Assurance Company Holdings, AG. References to “Allied World Bermuda” mean only Allied World Assurance Company Holdings, Ltd, a Bermuda holding company. References to “our insurance subsidiaries” may include our reinsurance subsidiaries. References in this Form 10-Q to $ are to the lawful currency of the United States and to CHF are to the lawful currency of Switzerland. References in this Form 10-Q to Holdings’ “common shares” mean its registered voting shares.

Note on Forward-Looking Statement

This Form 10-Q and other publicly available documents may include, and our officers and representatives may from time to time make, projections concerning financial information and statements concerning future economic performance and events, plans and objectives relating to management, operations, products and services, and assumptions underlying these projections and statements. These projections and statements are forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995 and are not historical facts but instead represent only our belief regarding future events, many of which, by their nature, are inherently uncertain and outside our control. These projections and statements may address, among other things, our strategy for growth, product development, financial results and reserves. Actual results and financial condition may differ, possibly materially, from these projections and statements and therefore you should not place undue reliance on them. Factors that could cause our actual results to differ, possibly materially, from those in the specific projections and statements are discussed throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations and in “Risk Factors” in Item 1A. of Part II of the Form 10-Q and Part I of our 2013 Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”) on February 18, 2014 (the “2013 Form 10-K”). We are under no obligation (and expressly disclaim any such obligation) to update or revise any forward-looking statement that may be made from time to time, whether as a result of new information, future developments or otherwise.

Overview

Our Business

We write a diversified portfolio of property and casualty insurance and reinsurance internationally through our subsidiaries and branches based in Australia, Bermuda, Canada, Europe, Hong Kong, Singapore, and the United States as well as our Lloyd’s Syndicate 2232. We manage our business through three operating segments: U.S. insurance, international insurance and reinsurance. As of September 30, 2014, we had approximately $12.8 billion of total assets, $3.7 billion of total shareholders’ equity and $4.5 billion of total capital, which includes shareholders’ equity and senior notes.

During the three months ended September 30, 2014, we continued to grow our direct insurance business, in particular in the United States and Europe, as we entered new lines of business and added scale to our existing lines of business while our reinsurance segment grew its business by selectively writing accounts where pricing, terms and conditions met our underwriting requirements. During the quarter, we experienced positive rate improvements in certain lines of business, such as general casualty, primary casualty, healthcare and professional liability in our U.S. insurance segment. During the quarter, we also experienced negative rate changes in our general property line of business in both our U.S. insurance and international insurance segments, as well as negative rate changes in our professional liability, general casualty and aviation lines of business in the international insurance segment. We believe in the near-term, there will be pricing pressure across most lines of business, in particular in our international insurance segment.

Our consolidated gross premiums written increased by $127.0 million, or 21.9%, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013 due to growth in each of our operating segments. Overall our combined ratio is higher by 7.5 percentage points, driven by increased property loss activity during the quarter, including $18.5 million related to Hurricane Odile, $8.0 million related to Windstorm Ela and $3.3 million related to Property Claims Services ("PCS") designated storm #45 in the Midwestern U.S. ("PCS storm #45").

Our net income decreased by $91.9 million to $30.9 million compared to the three months ended September 30, 2013. The decrease was primarily due to recording net realized losses on our investments of $35.1 million during the three months ended

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Table of Contents

September 30, 2014 compared to recording net realized gains of $27.5 million during the three months ended September 30, 2013 as a result of higher interest rates and widening credit spreads during the current quarter and recording $29.8 million in catastrophe losses.

Recent Developments

On May 1, 2014, the shareholders approved a 3-for-1 stock split of the our common shares. All historical share and per share amounts reflect the effect of the stock split.

In August 2014, we reached definitive agreements to acquire the Hong Kong and Singapore operations of Royal & Sun Alliance Insurance plc ("RSA") for approximately $211.0 million, at current exchange rates, subject to adjustments at closing. In addition to the purchase price, we expect to contribute an additional $90.0 million to capitalize the business on an ongoing basis. Subject to regulatory approvals in both Hong Kong and Singapore, as well as court approval in Singapore, the acquisition is expected to be completed in the first half of 2015. We believe the acquisition of the Hong Kong and Singapore branches of RSA complements our global specialist insurance strategy by providing meaningful additional scale in the region.

In October 2014, we acquired, through our subsidiary Allied World Financial Services, Inc., a minority interest in Blue Vista Capital Management, LLC ("Blue Vista"). Blue Vista invests across real estate asset classes and capital structures through limited partnerships and separate accounts. As part of the acquisition, we have agreed to invest $225.0 million to various funds managed by Blue Vista over the next several years.

Effective December 31, 2014, we will reorganize how we manage our business, and as a result we will realign our executive management team and change our reportable segments to correspond to the reorganization. Our Bermuda direct insurance operations, which had previously been included in the international insurance segment, will now be combined with the U.S. insurance segment and renamed North American Insurance. The remaining direct insurance operations of the international insurance segment will be renamed Global Markets Insurance. The reinsurance segment will remain unchanged. The newly created segments will be presented in our financial statements beginning with the period ended December 31, 2014 and prior periods will be recast to conform to the new presentation.




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Financial Highlights
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
 
($ in millions except share, per share and percentage data)
Gross premiums written
$
707.9

 
$
580.9

 
$
2,369.7

 
$
2,183.2

Net income
30.9

 
122.8

 
359.8

 
280.0

Operating income
60.6

 
101.8

 
266.5

 
289.5

Basic earnings per share:
 
 
 
 
 
 
 
Net income
$
0.32

 
$
1.20

 
$
3.67

 
$
2.72

Operating income
$
0.62

 
$
0.99

 
$
2.72

 
$
2.81

Diluted earnings per share:
 
 
 
 
 
 
 
Net income
$
0.31

 
$
1.18

 
$
3.60

 
$
2.66

Operating income
$
0.61

 
$
0.98

 
$
2.67

 
$
2.75

Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
96,458,231

 
101,974,077

 
97,926,378

 
103,020,681

Diluted
98,444,238

 
104,184,579

 
99,965,296

 
105,393,276

Basic book value per common share
$
38.11

 
$
33.95

 
$
38.11

 
$
33.95

Diluted book value per common share
$
37.12

 
$
33.05

 
$
37.12

 
$
33.05

Annualized return on average equity (ROAE), net income
3.4
%
 
14.4
%
 
13.2
%
 
11.0
%
Annualized ROAE, operating income
6.6
%
 
11.9
%
 
9.7
%
 
11.4
%

Non-GAAP Financial Measures

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

Operating income and operating income per share

Operating income is an internal performance measure used in the management of our operations and represents after-tax operational results excluding, as applicable, net realized investment gains or losses, net foreign exchange gain or loss, and other non-recurring items. We exclude net realized investment gains or losses, net foreign exchange gain or loss and any other non-recurring items from our calculation of operating income because these amounts are heavily influenced by and fluctuate in part according to the availability of market opportunities and other factors. In addition to presenting net income determined in accordance with U.S. GAAP, we believe that showing operating income enables investors, analysts, rating agencies and other users of our financial information to more easily analyze our results of operations and our underlying business performance. Operating income should not be viewed as a substitute for U.S. GAAP net income.










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Table of Contents

The following is a reconciliation of operating income to its most closely related U.S. GAAP measure, net income.
 
Three Months Ended 
 September 30,
 
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
 
2014
 
2013
 
($ in millions, except share, per share and percentage data)
Net income
$
30.9

 
$
122.8

 
 
$
359.8

 
$
280.0

Add after tax effect of:
 
 
 
 
 
 
 
 
Net realized investment losses (gains)
29.4

 
(25.4
)
 
 
(94.2
)
 
2.2

Foreign exchange loss
0.3

 
4.4

 
 
1.0

 
7.3

Operating income
$
60.6

 
$
101.8

 
 
$
266.5

 
$
289.5

Basic per share data:
 
 
 
 
 
 
 
 
Net income
$
0.32

 
$
1.20

 
 
$
3.67

 
$
2.72

Add after tax effect of:
 
 
 
 
 
 
 
 
Net realized investment losses (gains)
0.30

 
(0.25
)
 
 
(0.96
)
 
0.02

Foreign exchange loss
0.00

 
0.04

 
 
0.01

 
0.07

Operating income
$
0.62

 
$
0.99

 
 
$
2.72

 
$
2.81

Diluted per share data:
 
 
 
 
 
 
 
 
Net income
$
0.31

 
$
1.18

 
 
$
3.60

 
$
2.66

Add after tax effect of:
 
 
 
 
 
 
 
 
Net realized investment losses (gains)
0.30

 
(0.24
)
 
 
(0.94
)
 
0.02

Foreign exchange loss
0.00

 
0.04

 
 
0.01

 
0.07

Operating income
$
0.61

 
$
0.98

 
 
$
2.67

 
$
2.75


Diluted book value per share

We have included diluted book value per share because it takes into account the effect of dilutive securities; therefore, we believe it is an important measure of calculating shareholder returns. 
 
As of September 30,
 
2014
 
2013
 
($ in millions, except share and
per share data)
Price per share at period end
$
36.84

 
$
33.13

Total shareholders’ equity
$
3,673.6

 
$
3,443.9

Basic common shares outstanding
96,382,238

 
101,444,760

Add:
 
 
 
Unvested restricted stock units
512,112

 
249,720

Performance-based equity awards
619,428

 
812,559

Employee share purchase plan
28,381

 
45,960

Dilutive stock options outstanding
2,532,918

 
3,152,496

Weighted average exercise price per share
$
16.30

 
$
15.92

Deduct:
 
 
 
Options bought back via treasury method
(1,120,699
)
 
(1,515,171
)
Common shares and common share equivalents outstanding
98,954,378

 
104,190,324

Basic book value per common share
$
38.11

 
$
33.95

Diluted book value per common share
$
37.12

 
$
33.05







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Table of Contents

Annualized return on average equity

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

Annualized operating return on average shareholders’ equity is calculated using operating income and average shareholders’ equity.
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
 
($ in millions except percentage data)
Opening shareholders’ equity
$
3,682.8

 
$
3,373.2

 
$
3,616.7

 
$
3,326.3

 
 
 
 
 
 
 
 
Closing shareholders’ equity
$
3,673.6

 
$
3,443.9

 
$
3,673.6

 
$
3,443.9

 
 
 
 
 
 
 
 
Average shareholders’ equity
$
3,678.2

 
$
3,408.6

 
$
3,645.1

 
$
3,385.1

 
 
 
 
 
 
 
 
Net income available to shareholders
$
30.9

 
$
122.8

 
$
359.8

 
$
280.0

Annualized return on average shareholders’ equity —
net income available to shareholders
3.4
%
 
14.4
%
 
13.2
%
 
11.0
%
Operating income available to shareholders
$
60.6

 
$
101.8

 
$
266.5

 
$
289.5

Annualized return on average shareholders’ equity —
operating income available to shareholders
6.6
%
 
11.9
%
 
9.7
%
 
11.4
%


Relevant Factors

Revenues

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

Expenses

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

•
losses paid, which are actual cash payments to insureds and reinsureds, net of recoveries from reinsurers;
•
outstanding loss or case reserves, which represent management’s best estimate of the likely settlement amount for known claims, less the portion that can be recovered from reinsurers; and
•
reserves for losses incurred but not reported, or “IBNR”, which are reserves (in addition to case reserves) established by us that we believe are needed for the future settlement of claims. The portion recoverable from reinsurers is deducted from the gross estimated loss.

Acquisition costs are comprised of commissions, brokerage fees, insurance taxes and other acquisition related costs such as profit commissions. Commissions and brokerage fees are usually calculated as a percentage of premiums and depend on the market and line of business. Acquisition costs are reported after (1) deducting commissions received on ceded reinsurance,

37
Table of Contents

(2) deducting the part of deferred acquisition costs relating to the successful acquisition of new and renewal insurance and reinsurance contracts and (3) including the amortization of previously deferred acquisition costs.

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

Ratios

The Company measures its segment results as underwriting income or loss plus other insurance-related revenue and expenses, which may include the net earnings from our claims administration services operations and other income or expense that is not directly related to our underwriting operations. Management measures results for each segment's underwriting income or loss on the basis of the “loss and loss expense ratio,” “acquisition cost ratio,” “general and administrative expense ratio,” “expense ratio” and the “combined ratio.” Because we do not manage our assets by segment, investment income, interest expense and total assets are not allocated to individual reportable segments. General and administrative expenses are allocated to segments based on various factors, including staff count and each segment’s proportional share of gross premiums written. The loss and loss expense ratio is derived by dividing net losses and loss expenses by net premiums earned. The acquisition cost ratio is derived by dividing acquisition costs by net premiums earned. The general and administrative expense ratio is derived by dividing general and administrative expenses by net premiums earned. The expense ratio is the sum of the acquisition cost ratio and the general and administrative expense ratio. The combined ratio is the sum of the loss and loss expense ratio, the acquisition cost ratio and the general and administrative expense ratio.

Critical Accounting Policies
It is important to understand our accounting policies in order to understand our financial position and results of operations. Our unaudited condensed consolidated financial statements reflect determinations that are inherently subjective in nature and require management to make assumptions and best estimates to determine the reported values. If events or other factors cause actual results to differ materially from management’s underlying assumptions or estimates, there could be a material adverse effect on our financial condition or results of operations. We believe that some of the more critical judgments in the areas of accounting estimates and assumptions that affect our financial condition and results of operations are related to reserves for losses and loss expenses, reinsurance recoverables, premiums and acquisition costs, valuation of financial instruments and goodwill and other intangible asset impairment valuation. For a detailed discussion of our critical accounting policies, please refer to our 2013 Form 10-K. There were no material changes in the application of our critical accounting estimates subsequent to that report.


























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Table of Contents

Results of Operations

The following table sets forth our selected consolidated statement of operations data for each of the periods indicated.
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
 
($ in millions)
Revenues
 
 
 
 
 
 
 
Gross premiums written
$
707.9

 
$
580.9

 
$
2,369.7

 
$
2,183.2

Net premiums written
$
568.7

 
$
453.1

 
$
1,894.3

 
$
1,729.4

Net premiums earned
$
541.7

 
$
510.8

 
$
1,609.3

 
$
1,481.3

Net investment income
43.4

 
39.3

 
127.8

 
110.3

Net realized investment (losses) gains
(35.1
)
 
27.5

 
104.3

 
(8.1
)
Other income
1.0

 
—

 
1.0

 
—

 
$
551.0

 
$
577.6

 
$
1,842.4

 
$
1,583.5

Expenses
 
 
 
 
 
 
 
Net losses and loss expenses
$
336.1

 
$
277.0

 
$
926.2

 
$
807.3

Acquisition costs
72.4

 
65.1

 
214.4

 
186.4

General and administrative expenses
88.3

 
88.6

 
264.8

 
251.8

Other expense
6.6

 
—

 
6.6

 
—

Amortization of intangible assets
0.6

 
0.7

 
1.9

 
1.9

Interest expense
14.3

 
14.1

 
43.5

 
42.4

Foreign exchange loss
0.3

 
4.4

 
1.0

 
7.4

 
$
518.6

 
$
449.9

 
$
1,458.4

 
$
1,297.2

Income before income taxes
32.4

 
127.7

 
384.0

 
286.3

Income tax expense
1.5

 
4.9

 
24.3

 
6.3

Net income
$
30.9

 
$
122.8

 
$
359.7

 
$
280.0

Ratios
 
 
 
 
 
 
 
Loss and loss expense ratio
62.0
%
 
54.2
%
 
57.6
%
 
54.5
%
Acquisition cost ratio
13.4
%
 
12.7
%
 
13.3
%
 
12.6
%
General and administrative expense ratio
16.3
%
 
17.3
%
 
16.5
%
 
17.0
%
Expense ratio
29.7
%
 
30.0
%
 
29.8
%
 
29.6
%
Combined ratio
91.7
%
 
84.2
%
 
87.4
%
 
84.1
%

Comparison of Three Months Ended September 30, 2014 and 2013

Premiums

Gross premiums written increased by $127.0 million, or 21.9%, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The overall increase in gross premiums written was primarily the result of the following:
 
•
U.S. insurance: Gross premiums written increased by $78.0 million, or 25.3%. The increase in gross premiums written was primarily due to the growth in our general casualty line of business, in particular our primary casualty class of business which increased due to adding new business on existing accounts. We also continued to see growth in our newer lines of business such as our mergers and acquisitions, environmental and inland marine lines of business. This growth was partially offset by the non-renewal of business, particularly in certain classes within our healthcare line of business, that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions);

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Table of Contents

•
International insurance: Gross premiums written increased by $11.3 million, or 8.5%. The increase was primarily due to increased premiums on existing lines of business, particularly in our professional liability line of business. This was partially offset by lower premiums written in our aviation line of business. The decrease in our aviation line of business was due to $13.1 million of gross premiums written during the three months ended September 30, 2013 related to the renewal rights agreement we entered into with Markel International that did not occur during the three months ended September 30, 2014 partially offset by new business written during the current quarter; and
•
Reinsurance: Gross premiums written increased by $37.7 million, or 27.1%. The increase was from one new treaty in our casualty reinsurance line of business that resulted in $21.9 million of gross premiums written, and the timing of renewals primarily in our property reinsurance line of business. We had a large property treaty that renewed during the three months ended September 30, 2014 that was previously written during the second quarter of last year. This property reinsurance treaty included a fronting component which resulted in our retaining a small portion of the premiums written with the remainder being ceded.

The table below illustrates our consolidated gross premiums written by underwriter location for each of the periods indicated.
 
Three Months Ended 
 September 30,
 
Dollar
 
Percentage
 
2014
 
2013
 
Change
 
Change
 
($ in millions)  
 
 
 
 
 
United States
$
484.0

 
$
377.6

 
$
106.4

 
28.2
 %
Bermuda
109.5

 
111.1

 
(1.6
)
 
(1.4
)%
Europe
64.9

 
51.9

 
13.0

 
25.0
 %
Asia Pacific
45.1

 
40.3

 
4.8

 
11.9
 %
Canada
4.4

 
—

 
4.4

 
n/a

 
$
707.9

 
$
580.9

 
$
127.0

 
21.9
 %

Net premiums written increased by $115.6 million, or 25.5%, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The increase in net premiums written was primarily due to higher gross premiums written partially offset by higher premiums ceded. The increase in premiums ceded was due to higher ceded premiums related to our collateralized property catastrophe reinsurance protection as the premiums for the current treaty are recognized on a quarterly basis. This increase was partially offset by lower premiums ceded related to treaties that have contractual minimum premiums. The reduction in ceded premiums was due to recognizing annual ceded premiums at the inception of several reinsurance treaties rather than ratably over the contract period. This resulted in higher ceded premiums in previous quarters, as several reinsurance treaties incepted in those quarters, but lower ceded premiums in the current quarter. Previously, we recognized ceded premiums written on these agreements based on the actual premiums ceded each quarter. The difference between gross and net premiums written is the cost to us of purchasing reinsurance coverage, including the cost of property catastrophe reinsurance coverage. We ceded 19.7% of gross premiums written for the three months ended September 30, 2014 compared to 22.0% for the same period in 2013. The reduction was primarily due to the timing of the recognition of premiums ceded that have contractual minimum premiums.

Net premiums earned increased by $30.9 million, or 6.0%, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013 as a result of higher premiums earned in each of our operating segments.

We evaluate our business by segment, distinguishing between U.S. insurance, international insurance and reinsurance. The following table illustrates the mix of our business on both a gross premiums written and net premiums earned basis.
 
Gross Premiums Written
 
Net Premiums Earned
 
Three Months Ended 
 September 30,
 
Three Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
U.S. insurance
54.6
%
 
53.1
%
 
41.4
%
 
40.7
%
International insurance
20.4
%
 
22.9
%
 
17.4
%
 
17.1
%
Reinsurance
25.0
%
 
24.0
%
 
41.2
%
 
42.2
%
Total
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%


40
Table of Contents


Net Investment Income

Net investment income increased by $4.1 million, or 10.4%, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The increase was primarily due to higher income related to our fixed maturity non-core investments, which carry higher yields than government-backed securities. The annualized period book yield of the investment portfolio for the three months ended September 30, 2014 and 2013 was 2.0% and 1.9%, respectively.

As of September 30, 2014, we held 10.3% of our total investments and cash equivalents in "other invested assets" compared to 9.9% as of September 30, 2013.

Investment management expenses of $5.2 million and $4.1 million were incurred during the three months ended September 30, 2014 and 2013, respectively. The increase of $1.1 million, or 26.8%, was primarily due to additional investment portfolio managers utilized in the current period as compared to the prior period.

As of September 30, 2014, approximately 88.0% of our fixed income investments consisted of investment grade securities. As of September 30, 2014 and December 31, 2013, the average Standard & Poor’s credit rating of our fixed income portfolio was A+ and AA-, respectively.

Realized Investment (Losses) Gains

Net realized investment (losses) gains were comprised of the following:
 
Three Months Ended 
 September 30,
 
2014
 
2013
 
($ in millions)
Net realized gains on sale:
 
 
 
Fixed maturity investments, trading
$
5.8

 
$
(4.8
)
Equity securities, trading
(0.6
)
 
13.9

Other invested assets: hedge funds and private equity, trading
13.6

 
2.1

Total net realized gains on sale
18.8

 
11.2

Net realized and unrealized gains (losses) on derivatives
2.2

 
(4.2
)
Mark-to-market (losses) gains:
 
 
 
Fixed maturity investments, trading
(40.8
)
 
30.4

Equity securities, trading
(8.5
)
 
(17.2
)
Other invested assets: hedge funds and private equity, trading
(6.8
)
 
7.3

Total mark-to-market (losses) gains
(56.1
)
 
20.5

Net realized investment (losses) gains
$
(35.1
)
 
$
27.5


The total return of our investment portfolio was 0.1% and 0.8% for the three months ended September 30, 2014 and 2013, respectively. The decrease in total return was primarily due to higher interest rates and widening credit spreads that caused mark-to-market losses on our fixed maturity investments during the current period compared to lower interest rates and tightening credit spreads during the prior period.

Other Income

Other income represents the revenue of our third-party claims administration services that we acquired in the current year.

Net Losses and Loss Expenses

Net losses and loss expenses increased by $59.1 million, or 21.3%, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The following is a breakdown of the loss and loss expense ratio for the three months ended September 30, 2014 and 2013: 

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Table of Contents

 
Three Months Ended 
 September 30, 2014
 
Three Months Ended 
 September 30, 2013
 
Dollar Change
 
Loss Ratio Percentage Point Change
 
Amount
 
% of NPE (1)
 
Amount
 
% of NPE (1)
 
 
 
 
 
 
 
($ in millions)
 
 
 
 
 
 
Non-catastrophe
$
353.2

 
65.2
 %
 
$
338.4

 
66.2
 %
 
$
14.8

 
(1.0
)
Property catastrophe
29.8

 
5.5

 
—

 
—

 
29.8

 
5.5

Current period
383.0

 
70.7

 
338.4

 
66.2

 
44.6

 
4.5

Prior period
(46.9
)
 
(8.7
)
 
(61.4
)
 
(12.0
)
 
14.5

 
3.3

Net losses and loss expenses
$
336.1

 
62.0
 %
 
$
277.0

 
54.2
 %
 
$
59.1

 
7.8

________________________ 
(1)
“NPE” means net premiums earned.

Current year non-catastrophe losses and loss expenses

The increase in the current year non-catastrophe losses and loss expenses was primarily due to the overall growth of our operations. The decrease in the current year non-catastrophe losses and loss expenses ratio was primarily due to lower reported large property losses during the three months ended September 30, 2014 compared to the three months ended September 30, 2013.

Current year property catastrophe losses and loss expenses

During the three months ended September 30, 2014, we incurred $18.5 million of property catastrophe losses and loss expenses related to Hurricane Odile, of which $15.0 million was recorded by our international insurance segment and $3.5 million by our reinsurance segment, $8.0 million related to Windstorm Ela, and $3.3 million related to PCS storm #45. The losses related to Windstorm Ela and PCS storm #45 were recorded in our reinsurance segment. The losses related to Windstorm Ela and PCS storm #45 were classified as catastrophes in the current period as the additional net losses recorded in this period made the aggregate net losses incurred for these events in excess of $10.0 million, which is our quantitative threshold for classifying property-related losses as catastrophes. We did not incur any property catastrophe losses during the three months ended September 30, 2013.

Prior year losses and loss expenses

We recorded net favorable reserve development related to prior years of $46.9 million during the three months ended September 30, 2014 compared to net favorable reserve development of $61.4 million for the three months ended September 30, 2013, as shown in the tables below.
 
 
(Favorable) and Unfavorable Loss Reserve Development by Loss Year
 
For the Three Months Ended September 30, 2014
 
2004 and
Prior
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
2013
 
Total
 
($ in millions)
U.S. insurance
$
(0.1
)
 
$
10.2

 
$
(16.6
)
 
$
8.1

 
$
(3.5
)
 
$
(15.4
)
 
$
(2.3
)
 
$
2.3

 
$
4.0

 
$
13.9

 
$
0.6

International insurance
(0.5
)
 
(1.3
)
 
(3.8
)
 
(8.5
)
 
(5.1
)
 
(7.1
)
 
(8.7
)
 
(7.4
)
 
11.4

 
1.8

 
(29.2
)
Reinsurance
0.2

 
5.3

 
(1.0
)
 
(1.6
)
 
(4.3
)
 
(0.9
)
 
(0.6
)
 
(3.1
)
 
1.9

 
(14.2
)
 
(18.3
)
 
$
(0.4
)
 
$
14.2

 
$
(21.4
)
 
$
(2.0
)
 
$
(12.9
)
 
$
(23.4
)
 
$
(11.6
)
 
$
(8.2
)
 
$
17.3

 
$
1.5

 
$
(46.9
)

For the three months ended September 30, 2014, the net unfavorable prior year reserve development for the 2011 through 2013 loss years in our U.S. insurance segment was primarily due to a higher level of reported claims in our healthcare line of business while the net unfavorable prior year reserve development for the 2005 loss year primarily relates to our professional liability line of business. The net favorable reserve development in our international insurance segment for the 2011 and prior loss years was due to lower than expected loss emergence across most lines of business and loss years. The unfavorable prior reserve development for the 2012 loss year related to adverse development on two reported claims in our professional liability line of business. The net favorable reserve development in our reinsurance segment for the 2013 loss year was due to lower than expected reported loss activity in our property reinsurance line of business.


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Table of Contents

The following table shows the net favorable reserve development by loss year for each of our segments for the three months ended September 30, 2013.

 
(Favorable) and Unfavorable Loss Reserve Development by Loss Year
 
For the Three Months Ended September 30, 2013
 
2003 and
Prior
 
2004
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
Total
 
($ in millions)
U.S. insurance
$
(3.0
)
 
$
(0.6
)
 
$
(1.1
)
 
$
(6.1
)
 
$
(5.5
)
 
$
(2.9
)
 
$
(3.5
)
 
$
(4.8
)
 
$
13.2

 
$
18.1

 
$
3.8

International insurance
0.2

 
(1.2
)
 
3.2

 
(4.0
)
 
(8.6
)
 
(4.7
)
 
(5.9
)
 
(4.1
)
 
(2.1
)
 
(2.5
)
 
(29.7
)
Reinsurance
(1.6
)
 
(2.4
)
 
1.5

 
—

 
0.2

 
(2.1
)
 
(2.0
)
 
(2.6
)
 
(12.1
)
 
(14.4
)
 
(35.5
)
 
$
(4.4
)
 
$
(4.2
)
 
$
3.6

 
$
(10.1
)
 
$
(13.9
)
 
$
(9.7
)
 
$
(11.4
)
 
$
(11.5
)
 
$
(1.0
)
 
$
1.2

 
$
(61.4
)

For the three months ended September 30, 2013, the unfavorable reserve development for the 2011 loss year for our U.S. insurance segment was primarily due to a higher level of reported claims in our healthcare and errors and omissions (“E&O”) lines of business. The unfavorable reserve development for the 2012 loss year for our U.S. insurance segment was primarily due to a higher level of reported claims in our healthcare, private/not for profit directors’ and officers’ (“D&O”) and lawyers E&O lines of business.
   
The favorable reserve development for the reinsurance segment was primarily related to our property reinsurance line of business, and included favorable reserve development related to recent catastrophic events that occurred in 2010 through 2012.

The following table shows the components of net losses and loss expenses for each of the periods indicated. 
 
Three Months Ended 
 September 30,
 
Dollar
 
2014
 
2013
 
Change
 
($ in millions)
Net losses paid
$
256.2

 
$
243.7

 
$
12.5

Net change in reported case reserves
40.3

 
(15.7
)
 
56.0

Net change in IBNR
39.6

 
49.0

 
(9.4
)
Net losses and loss expenses
$
336.1

 
$
277.0

 
$
59.1



43
Table of Contents

The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables.
 
Three Months Ended 
 September 30,
 
2014
 
2013
 
($ in millions)
Net reserves for losses and loss expenses, July 1
$
4,633.9

 
$
4,517.3

Incurred related to:
 
 
 
Current period non-catastrophe
353.2

 
338.4

Current period property catastrophe
29.8

 
—

Prior period
(46.9
)
 
(61.4
)
Total incurred
336.1

 
277.0

Paid related to:
 
 
 
Current period
53.6

 
30.5

Prior period
202.6

 
213.2

Total paid
256.2

 
243.7

Foreign exchange revaluation
(10.5
)
 
4.1

Net reserve for losses and loss expenses, September 30
4,703.3

 
4,554.7

Losses and loss expenses recoverable
1,349.0

 
1,226.1

Reserve for losses and loss expenses, September 30
$
6,052.3

 
$
5,780.8


Acquisition Costs

Acquisition costs increased by $7.3 million, or 11.2%, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The increase in acquisition costs was primarily due to the growth in premiums earned, higher profit commission accruals in our U.S. insurance segment and higher ceding commissions paid to cedents for certain lines of business in our reinsurance segment. Acquisition costs as a percentage of net premiums earned were 13.4% for the three months ended September 30, 2014 compared to 12.7% for the same period in 2013. The higher acquisition cost ratio was primarily due to the reasons noted above.

General and Administrative Expenses

General and administrative expenses decreased by $0.3 million, or 0.3%, for the three months ended September 30, 2014 compared to the same period in 2013. Our general and administrative expense ratio was 16.3% and 17.3% for the three months ended September 30, 2014 and 2013, respectively. The decrease in general and administrative expenses was primarily due to lower stock-based compensation partially offset by higher salary related costs due to higher headcount. We have granted cash equivalent restricted stock units and performance-based equity awards to certain key employees, and we measure the value of each of those awards at the period ending share price. Changes in our share price are recognized as increases or decreases in our compensation expense ratably over the service period. Our share price decreased 3% for the three months ended September 30, 2014 compared to a 9% increase for the same period in 2013.

Other Expense

Other expense represents the expenses of our third-party claims administration services that we acquired in the current year of $1.3 million and the transaction-related costs incurred for the acquisition of the Hong Kong and Singapore operations of RSA of $5.3 million.

Amortization of Intangible Assets

The amortization of intangible assets was virtually unchanged for the three months ended September 30, 2014 compared to the three months ended September 30, 2013.




44
Table of Contents

Interest Expense

Interest expense increased by $0.2 million, or 1.4%, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013.

Foreign Exchange Loss

The foreign exchange loss decreased by $4.1 million, or 93.2%, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The decrease was due to higher gains recorded on our foreign exchange derivative contracts due to the strengthening of the U.S. dollar relative to other major currencies and the timing of the tenor of the derivative contracts.

Net Income

Net income for the three months ended September 30, 2014 was $30.9 million compared to net income of $122.8 million for the three months ended September 30, 2013. The $91.9 million decrease was primarily the result of recording net realized losses on our investments of $35.1 million during the three months ended September 30, 2014 compared to net realized gains of $27.5 million during the three months ended September 30, 2013, and higher net loss and loss expenses, including losses from catastrophes of $29.8 million. Income tax expense for the three months ended September 30, 2014 decreased by $3.4 million compared to the three months ended September 30, 2013. The decrease in income tax expense was primarily due to lower taxable income in our U.S. operations.

Comparison of Nine Months Ended September 30, 2014 and 2013

Premiums

Gross premiums written increased by $186.5 million, or 8.5%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The overall increase in gross premiums written was primarily the result of the following:
 
•
U.S. insurance: Gross premiums written increased by $126.1 million, or 14.5%. The increase in gross premiums written was primarily due to $45.2 million of new business growth during the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013, increased premiums on renewed business as well as premium rate increases across most lines of business. This was particularly evident in our general casualty, mergers and acquisitions, inland marine and environmental lines of business. This growth was partially offset by the non-renewal of business, particularly in certain classes within our healthcare line of business, that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions);
•
International insurance: Gross premiums written increased by $29.1 million, or 6.4%. The increase was primarily due to continued growth from new initiatives and new lines of business. The professional liability line of business grew $17.1 million on new business writings in European E&O and mergers and acquisitions classes of business, and our aviation and marine cargo lines of business grew by $11.3 million. This growth was partially offset by the general casualty line of business, which decreased by $3.9 million compared to the prior period, due to non-recurring business written in 2013 and the non-renewal of certain policies during the current period, that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions); and
•
Reinsurance: Gross premiums written increased by $31.4 million, or 3.7%. The increase was driven primarily by new business and increased renewals across several major lines of business. In our property reinsurance lines of business, premiums increased by approximately $16.8 million, which included $3.9 million of increased premiums from our collateralized property catastrophe reinsurance program through Aeolus Re, Ltd. ("Aeolus Re"). We also experienced non-renewals of certain treaties, particularly in our casualty reinsurance line of business, either due to poor terms and conditions or the cedents not renewing their reinsurance.








45
Table of Contents

The table below illustrates our consolidated gross premiums written by underwriter location for each of the periods indicated.
 
Nine Months Ended 
 September 30,
 
Dollar
 
Percentage
 
2014
 
2013
 
Change
 
Change
 
($ in millions)  
 
 
 
 
 
United States
$
1,447.7

 
$
1,296.2

 
$
151.5

 
11.7
 %
Bermuda
525.0

 
550.8

 
(25.8
)
 
(4.7
)%
Europe
245.9

 
198.7

 
47.2

 
23.8
 %
Asia Pacific
142.8

 
137.5

 
5.3

 
3.9
 %
Canada
8.3

 
—

 
8.3

 
n/a

 
$
2,369.7

 
$
2,183.2

 
$
186.5

 
8.5
 %

Net premiums written increased by $164.9 million, or 9.5%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The increase in net premiums written was due to the increase in gross premiums written and a decrease in ceded premiums written related to our property catastrophe reinsurance protection. We ceded 20.1% of gross premiums written for the nine months ended September 30, 2014 compared to 20.8% for the same period in 2013.

Net premiums earned increased by $128.0 million, or 8.6%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013 as a result of higher premiums earned in each of our operating segments.

The following table illustrates the mix of our business on both a gross premiums written and net premiums earned basis.
 
Gross Premiums Written
 
Net Premiums Earned
 
Nine Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
U.S. insurance
42.1
%
 
39.9
%
 
40.5
%
 
40.0
%
International insurance
20.4
%
 
20.8
%
 
16.9
%
 
17.5
%
Reinsurance
37.5
%
 
39.3
%
 
42.6
%
 
42.5
%
Total
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%

Net Investment Income

Net investment income increased by $17.5 million, or 15.9%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The increase was due to higher income across most asset classes. The annualized period book yield of the investment portfolio for the nine months ended September 30, 2014 and 2013 was 2.0% and 1.8%, respectively.

Investment management expenses of $13.7 million and $12.2 million were incurred during the nine months ended September 30, 2014 and 2013, respectively. The increase of $1.5 million, or 12.3%, was primarily due to additional investment portfolio managers utilized in the current period as compared to the prior period.















46
Table of Contents

Realized Investment Gains (Losses)

Net realized investment gains (losses) were comprised of the following:
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
($ in millions)
Net realized gains on sale:
 
 
 
Fixed maturity investments, trading
$
23.6

 
$
24.7

Equity securities, trading
43.8

 
30.1

Other invested assets: hedge funds and private equity, trading
53.2

 
16.8

Total net realized gains on sale
120.6

 
71.6

Net realized and unrealized (losses) gains on derivatives
(24.5
)
 
3.4

Mark-to-market gains (losses):
 
 
 
Fixed maturity investments, trading
18.0

 
(101.2
)
Equity securities, trading
(8.8
)
 
(18.6
)
Other invested assets: hedge funds and private equity, trading
(1.1
)
 
36.7

Total mark-to-market gains (losses)
8.1

 
(83.1
)
Net realized investment gains (losses)
$
104.2

 
$
(8.1
)

The total return of our investment portfolio was 2.7% and 1.2% for the nine months ended September 30, 2014 and 2013, respectively. The increase in total return was primarily due mark-to-market gains on our fixed maturity investments due to lower interest rates and tighter credit spreads during the nine months ended September 30, 2014 compared to mark-to-market losses due to higher rates during the nine months ended September 30, 2013. Equity securities and other invested assets continued to have a positive impact on the total return for the both the nine months ended September 30, 2014 and 2013. The realized and unrealized losses on derivatives for the nine months ended September 30, 2014 were the result of selling interest rate future and swap contracts to reduce the duration of the investment portfolio. Given the decrease in interest rates during the year, we recorded a loss related to these interest rate future and swap contracts.

Other Income

Other income represents the revenue of our third-party claims administration services that we acquired in the current year.

Net Losses and Loss Expenses

Net losses and loss expenses increased by $118.9 million, or 14.7%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The following is a breakdown of the loss and loss expense ratio for the nine months ended September 30, 2014 and 2013: 
 
Nine Months Ended 
 September 30, 2014
 
Nine Months Ended 
 September 30, 2013
 
Dollar Change
 
Loss Ratio Percentage Point Change
 
Amount
 
% of NPE (1)
 
Amount
 
% of NPE (1)
 
 
 
 
 
 
 
($ in millions)
 
 
 
 
 
 
Non-catastrophe
$
1,024.1

 
63.7
 %
 
$
961.2

 
64.9
 %
 
$
62.9

 
(1.2
)
Property catastrophe
43.0

 
2.7

 
—

 
—

 
43.0

 
2.7

Current period
1,067.1

 
66.4

 
961.2

 
64.9

 
105.9

 
1.5

Prior period
(140.9
)
 
(8.8
)
 
(153.9
)
 
(10.4
)
 
13.0

 
1.6

Net losses and loss expenses
$
926.2

 
57.6
 %
 
$
807.3

 
54.5
 %
 
$
118.9

 
3.1

________________________ 
(1)
“NPE” means net premiums earned.





47
Table of Contents


Current year non-catastrophe losses and loss expenses

The increase in the current year non-catastrophe losses and loss expenses was primarily due to the overall growth of our operations partially offset by a reduction in IBNR loss reserves due to lower than expected property losses in our reinsurance segment. The decrease in the current non-catastrophe losses and loss expense ratio was primarily due to the reduction in IBNR loss reserves.

Current year property catastrophe losses and loss expenses

During the nine months ended September 30, 2014, we incurred $18.5 million of property catastrophe losses and loss expenses related to Hurricane Odile, of which $15.0 million was recorded by our international insurance segment and $3.5 million by our reinsurance segment, $12.5 million related to PCS storm #45, and $12.0 million related to Windstorm Ela. The losses related to Windstorm Ela and PCS storm #45 were recorded in our reinsurance segment. We did not incur any property catastrophe losses during the nine months ended September 30, 2013.

Prior year losses and loss expenses

We recorded net favorable reserve development related to prior years of $140.9 million during the nine months ended September 30, 2014 compared to net favorable reserve development of $153.9 million for the nine months ended September 30, 2013, as shown in the tables below.
 
 
(Favorable) and Unfavorable Loss Reserve Development by Loss Year
 
Nine Months Ended September 30, 2014
 
2004 and
Prior
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
2013
 
Total
 
($ in millions)
U.S. insurance
$
(4.8
)
 
$
9.7

 
$
(16.6
)
 
$
7.7

 
$
(8.0
)
 
$
(24.4
)
 
$
(1.3
)
 
$
15.0

 
$
3.5

 
$
21.6

 
$
2.4

International insurance
7.3

 
(5.1
)
 
(4.5
)
 
(36.9
)
 
4.2

 
(27.4
)
 
(25.0
)
 
(12.4
)
 
12.2

 
9.0

 
(78.6
)
Reinsurance
(0.4
)
 
5.0

 
(3.1
)
 
(4.0
)
 
(5.7
)
 
(1.3
)
 
1.7

 
(8.2
)
 
2.2

 
(50.9
)
 
(64.7
)
 
$
2.1

 
$
9.6

 
$
(24.2
)
 
$
(33.2
)
 
$
(9.5
)
 
$
(53.1
)
 
$
(24.6
)
 
$
(5.6
)
 
$
17.9

 
$
(20.3
)
 
$
(140.9
)

For the nine months ended September 30, 2014, the net unfavorable prior year reserve development in the U.S. insurance segment for the 2011 through 2013 loss years was in our healthcare lines of business and was due to higher than expected loss frequency and severity. The net favorable prior year reserve development in the international insurance segment was primarily due to favorable reserve development for the 2007 loss year in our professional liability line of business and the net favorable development for the 2009 to 2011 loss years was due to actual loss emergence being lower than anticipated across several lines of business. Net unfavorable development for the 2012 loss year was due to adverse development on two reported claims in our professional liability line of business and the unfavorable reserve development for the 2013 loss year resulted from an increase in severity in our healthcare line of business. The net favorable prior year reserve development in our reinsurance segment for the 2013 loss year was primarily due to benign property loss activity, and therefore reported losses were less than our expectations.

 
(Favorable) and Unfavorable Loss Reserve Development by Loss Year
 
For the Nine Months Ended September 30, 2013
 
2003 and
Prior
 
2004
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
Total
 
($ in millions)
U.S. insurance
$
(3.1
)
 
$
(2.7
)
 
$
(4.6
)
 
$
(7.2
)
 
$
(18.5
)
 
$
(17.1
)
 
$
(6.5
)
 
$
(12.1
)
 
$
30.9

 
$
52.3

 
$
11.4

International insurance
6.1

 
(4.1
)
 
(1.1
)
 
(14.9
)
 
(18.9
)
 
(14.6
)
 
(6.5
)
 
(9.6
)
 
(11.8
)
 
(9.7
)
 
(85.1
)
Reinsurance
(1.4
)
 
(3.8
)
 
(1.6
)
 
1.1

 
(2.0
)
 
(9.0
)
 
(1.6
)
 
(4.7
)
 
(15.0
)
 
(42.2
)
 
(80.2
)
 
$
1.6

 
$
(10.6
)
 
$
(7.3
)
 
$
(21.0
)
 
$
(39.4
)
 
$
(40.7
)
 
$
(14.6
)
 
$
(26.4
)
 
$
4.1

 
$
0.4

 
$
(153.9
)


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Table of Contents

For the nine months ended September 30, 2013, the unfavorable reserve development for the 2011 and 2012 loss years for our U.S. insurance segment was due to higher than expected loss emergence, primarily in our private/not for profit D&O, healthcare and E&O products.

The favorable reserve development for our reinsurance segment was due to lower than expected reported losses in our property reinsurance line of business, including favorable loss reserve development related to recent catastrophic events that occurred in 2010 through 2012.


The following table shows the components of net losses and loss expenses for each of the periods indicated. 
 
Nine Months Ended 
 September 30,
 
Dollar
 
2014
 
2013
 
Change
 
($ in millions)
Net losses paid
$
747.0

 
$
751.2

 
$
(4.2
)
Net change in reported case reserves
37.3

 
(24.9
)
 
62.2

Net change in IBNR
141.9

 
81.0

 
60.9

Net losses and loss expenses
$
926.2

 
$
807.3

 
$
118.9


The table below is a reconciliation of the beginning and ending reserves for losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables.
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
($ in millions)
Net reserves for losses and loss expenses, January 1
$
4,532.0

 
$
4,504.4

Incurred related to:
 
 
 
Current period non-catastrophe
1,024.1

 
961.2

Current period property catastrophe
43.0

 
—

Prior period
(140.9
)
 
(153.9
)
Total incurred
926.2

 
807.3

Paid related to:
 
 
 
Current period
80.4

 
55.0

Prior period
666.6

 
696.2

Total paid
747.0

 
751.2

Foreign exchange revaluation
(7.9
)
 
(5.8
)
Net reserve for losses and loss expenses, September 30
4,703.3

 
4,554.7

Losses and loss expenses recoverable
1,349.0

 
1,226.1

Reserve for losses and loss expenses, September 30
$
6,052.3

 
$
5,780.8


Acquisition Costs

Acquisition costs increased by $28.0 million, or 15.0%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The increase in acquisition costs was due to the growth in net premiums earned and higher profit commission accruals in our U.S. insurance segment and higher ceding commissions paid to cedents for certain lines of business in our reinsurance segment. Acquisition costs as a percentage of net premiums earned were 13.3% for the nine months ended September 30, 2014 compared to 12.6% for the same period in 2013.

General and Administrative Expenses

General and administrative expenses increased by $13.0 million, or 5.2%, for the nine months ended September 30, 2014 compared to the same period in 2013. Our general and administrative expense ratio was 16.5% and 17.0% for the nine months ended September 30, 2014 and 2013, respectively. The increase in general and administrative expenses was primarily due to

49
Table of Contents

higher salary related costs due to higher headcount as our average headcount increased by 12% partially offset by lower stock-based compensation due to changes in our share price. Our share price decreased 2% for the nine months ended September 30, 2014 compared to a 26% increase for the same period in 2013.

Other Expense

Other expense represents the expenses of our third-party claims administration services that we acquired in the current year and the transaction-related costs incurred for the acquisition of the Hong Kong and Singapore operations of RSA.

Amortization of Intangible Assets

The amortization of intangible assets was virtually unchanged for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013.

Interest Expense

Interest expense increased by $1.1 million, or 2.6%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013.

Foreign Exchange Loss

The foreign exchange loss decreased by $6.4 million, or 86.5%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The decrease was the result of the strengthening of the U.S. dollar relative to other major currencies during the current period.

Net Income

Net income for the nine months ended September 30, 2014 was $359.7 million compared to net income of $280.0 million for the nine months ended September 30, 2013. The $79.7 million increase was primarily the result of recording net realized gains on our investments of $104.3 million during the nine months ended September 30, 2014 compared to net realized losses of $8.1 million during the nine months ended September 30, 2013 partially offset by lower underwriting income from our operating segment, which included $43.0 million in catastrophe-related losses. Income tax expense for the nine months ended September 30, 2014 increased by $18.0 million compared to the nine months ended September 30, 2013. The increase in income tax expense was primarily due to higher taxable income in our U.S. operations.

Underwriting Results by Operating Segments

Our company is organized into three operating segments:

U.S. Insurance Segment. The U.S. insurance segment includes our direct specialty insurance operations in the United States and Canada, as well as our claims administration services operations. This segment provides both direct property and specialty casualty insurance primarily to non-Fortune 1000 North American domiciled accounts, as well as third-party claims administration services.

International Insurance Segment. The international insurance segment includes our direct insurance operations in Bermuda, Europe and Asia Pacific, which includes offices in Australia, Singapore and Hong Kong. This segment provides both direct property and casualty insurance primarily to Fortune 1000 North American domiciled accounts from our Bermuda office and direct property and specialty casualty to our non-North American domiciled accounts from our European and Asia Pacific offices.

Reinsurance Segment. Our reinsurance segment has operations in Bermuda, Europe, Singapore and the United States. This segment includes the reinsurance of property, general casualty, professional liability, specialty lines and property catastrophe coverages written by insurance companies. We presently write reinsurance on both a treaty and a facultative basis, targeting several niche reinsurance markets.

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Table of Contents

U.S. Insurance Segment

The following table summarizes the underwriting results and associated ratios for the U.S. insurance segment for each of the periods indicated.
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
 
($ in millions)
Revenues
 
 
 
 
 
 
 
Gross premiums written
$
386.7

 
$
308.7

 
$
998.1

 
$
872.0

Net premiums written
321.7

 
238.8

 
746.4

 
652.5

Net premiums earned
224.8

 
207.6

 
651.5

 
593.5

Expenses
 
 
 
 
 
 
 
Net losses and loss expenses
$
153.0

 
$
141.2

 
$
440.5

 
$
398.9

Acquisition costs
31.1

 
28.4

 
88.3

 
78.8

General and administrative expenses
41.7

 
41.7

 
125.8

 
119.5

Underwriting (loss) income
(1.0
)
 
(3.7
)
 
(3.1
)
 
(3.7
)
Other insurance-related income
1.0

 
—

 
1.0

 
—

Other insurance-related expenses
1.3

 
—

 
1.3

 
—

Segment (loss) income
$
(1.3
)
 
$
(3.7
)
 
$
(3.4
)
 
$
(3.7
)
Ratios
 
 
 
 
 
 
 
Loss and loss expense ratio
68.1
%
 
68.0
%
 
67.6
%
 
67.2
%
Acquisition cost ratio
13.9
%
 
13.7
%
 
13.6
%
 
13.3
%
General and administrative expense ratio
18.6
%
 
20.0
%
 
19.3
%
 
20.1
%
Expense ratio
32.5
%
 
33.7
%
 
32.9
%
 
33.4
%
Combined ratio
100.6
%
 
101.7
%
 
100.5
%
 
100.6
%

Comparison of Three Months Ended September 30, 2014 and 2013

Premiums. Gross premiums written increased by $78.0 million, or 25.3%, for the three months ended September 30, 2014 compared to the same period in 2013. The increase in gross premiums written was primarily due to the growth in our general casualty line of business, in particular our primary casualty class of business which increased due to adding new business on existing accounts. We also continued to see growth in our newer lines of business such as mergers and acquisitions, environmental and inland marine. This growth was partially offset by the non-renewal of business, particularly in certain classes within our healthcare line of business, which did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions).



















51
Table of Contents

The table below illustrates our gross premiums written by line of business for each of the periods indicated.
 
Three Months Ended 
 September 30,
 
Dollar
 
Percentage
 
2014
 
2013
 
Change
 
Change
 
 
 
($ in millions)  

 
 
 
 
General casualty
$
153.0

 
$
107.2

 
$
45.8

 
42.7
 %
Professional liability
66.0

 
66.2

 
(0.2
)
 
(0.3
)%
Programs
46.7

 
41.1

 
5.6

 
13.6
 %
Healthcare
38.9

 
43.4

 
(4.5
)
 
(10.4
)%
General property
22.4

 
18.7

 
3.7

 
19.8
 %
Inland marine
17.4

 
12.1

 
5.3

 
43.8
 %
Environmental
15.8

 
8.4

 
7.4

 
88.1
 %
Other*
26.5

 
11.6

 
14.9

 
128.4
 %
 
$
386.7

 
$
308.7

 
$
78.0

 
25.3
 %
________________________
*
Includes our primary construction, mergers and acquisitions and surety lines of business.

Net premiums written increased by $82.9 million, or 34.7%, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The increase was primarily due to higher gross premiums written and lower ceded premiums. The reduction in ceded premiums was due to recognizing annual ceded premiums at the inception of several reinsurance treaties rather than ratably over the contract period as these reinsurance treaties had contractual minimum premiums. This resulted in higher ceded premiums in previous quarters, as several reinsurance treaties incepted in those quarters, but lower ceded premiums in the current quarter. Partially offsetting this decrease in ceded premiums was higher premiums ceded related to our collateralized property catastrophe reinsurance protection as the premiums for the current treaty are recognized on a quarterly basis. We ceded 16.8% of gross premiums written for the three months ended September 30, 2014 compared to 22.6% for the three months ended September 30, 2013. The reduction was primarily due to the timing of the recognition of premiums ceded that have contractual minimum premiums and the growth in our general casualty line of business which has lower premiums ceded relative to other lines of business.

Net premiums earned increased by $17.2 million, or 8.3%, for the three months ended September 30, 2014 compared to the same period in 2013. The increase was due to the continued growth of our U.S. insurance operations.

Net losses and loss expenses. Net losses and loss expenses increased by $11.8 million, or 8.4%, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The following is a breakdown of the loss and loss expense ratio for the three months ended September 30, 2014 and 2013: 
 
Three Months Ended 
 September 30, 2014
 
Three Months Ended 
 September 30, 2013
 
Dollar Change
 
Loss Ratio Percentage Point Change
 
Amount
 
% of NPE
 
Amount
 
% of NPE
 
 
 
 
 
 
 
($ in millions)
 
 
 
 
 
 
Non-catastrophe
$
152.4

 
67.8
%
 
$
137.4

 
66.2
%
 
$
15.0

 
1.6 Pts

Property catastrophe
—

 
—

 
—

 
—

 
—

 
—

Current period
152.4

 
67.8

 
137.4

 
66.2

 
15.0

 
1.6

Prior period
0.6

 
0.3

 
3.8

 
1.8

 
(3.2
)
 
(1.5
)
Net losses and loss expenses
$
153.0

 
68.1
%
 
$
141.2

 
68.0
%
 
$
11.8

 
0.1 Pts


Current year non-catastrophe losses and loss expenses

The increase in the current year non-catastrophe losses and loss expenses and the related ratio was primarily due to growth of the business and a loss related to our surety line of business in the current period.

Current year property catastrophe losses and loss expenses

During the three months ended September 30, 2014 and September 30, 2013, we did not incur any property catastrophe losses.

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Table of Contents


Prior year losses and loss expenses

Overall, our U.S. insurance segment recorded net unfavorable reserve development of $0.6 million during the three months ended September 30, 2014 compared to net unfavorable reserve development of $3.8 million for the three months ended September 30, 2013, as shown in the tables below.
 
 
(Favorable) and Unfavorable Loss Reserve Development by Loss Year
 
For the Three Months Ended September 30, 2014
 
2004 and
Prior
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
2013
 
Total
 
($ in millions)
General casualty
$
(0.1
)
 
$
0.7

 
$
—

 
$
(0.1
)
 
$
—

 
$
—

 
$
1.9

 
$
0.8

 
$
2.1

 
$
—

 
$
5.3

Programs
—

 
—

 
(0.2
)
 
(0.6
)
 
(0.8
)
 
(1.1
)
 
(1.4
)
 
(2.3
)
 
1.1

 
0.2

 
(5.1
)
General property
—

 
0.5

 
—

 
—

 
—

 
—

 
(0.2
)
 
3.0

 
(0.6
)
 
—

 
2.7

Healthcare
0.4

 
(1.1
)
 
(0.6
)
 
0.1

 
—

 
(0.1
)
 
—

 
1.9

 
4.1

 
7.6

 
12.3

Professional liability
(0.4
)
 
10.1

 
(15.8
)
 
8.7

 
(2.7
)
 
(14.2
)
 
(2.6
)
 
(1.1
)
 
(2.1
)
 
7.3

 
(12.8
)
Inland marine
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(0.7
)
 
(1.2
)
 
(1.9
)
Environmental
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
0.1

 
—

 
0.1

 
$
(0.1
)
 
$
10.2

 
$
(16.6
)
 
$
8.1

 
$
(3.5
)
 
$
(15.4
)
 
$
(2.3
)
 
$
2.3

 
$
4.0

 
$
13.9

 
$
0.6


For the three months ended September 30, 2014, the net unfavorable prior year reserve development primarily related to our healthcare and professional liability lines of business. The unfavorable prior year reserve development in our healthcare line of business for the 2011 through 2013 loss years was primarily due to higher than expected loss emergence in our medical malpractice line of business. The net favorable development in our professional liability line of business was primarily related to our public D&O line of business due to favorable development on several claims in the 2006 and 2009 loss years partially offset by higher than expected loss emergence, driven primarily from several claims, in the 2005 loss year.

 
(Favorable) and Unfavorable Loss Reserve Development by Loss Year
 
For the Three Months Ended September 30, 2013
 
2003 and
Prior
 
2004
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
Total
 
($ in millions)
General casualty
$
—

 
$
—

 
$
—

 
$
—

 
$
(4.6
)
 
$
—

 
$
(0.3
)
 
$
—

 
$
0.6

 
$
3.0

 
$
(1.3
)
Programs
—

 
—

 
—

 
—

 
(0.2
)
 
(1.7
)
 
(1.2
)
 
(1.4
)
 
0.5

 
0.5

 
(3.5
)
General property
—

 
0.6

 
(0.2
)
 
3.2

 
—

 
—

 
—

 
0.2

 
(0.2
)
 
(1.0
)
 
2.6

Healthcare
(3.0
)
 
(0.8
)
 
0.2

 
—

 
—

 
(2.1
)
 
(2.3
)
 
—

 
10.1

 
5.1

 
7.2

Professional liability
—

 
(0.4
)
 
(1.1
)
 
(9.3
)
 
(0.7
)
 
0.9

 
0.3

 
(3.6
)
 
2.4

 
10.5

 
(1.0
)
Other
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(0.2
)
 
—

 
(0.2
)
 
$
(3.0
)
 
$
(0.6
)
 
$
(1.1
)
 
$
(6.1
)
 
$
(5.5
)
 
$
(2.9
)
 
$
(3.5
)
 
$
(4.8
)
 
$
13.2

 
$
18.1

 
$
3.8


For the three months ended September 30, 2013, the unfavorable reserve development for the 2011 loss year was primarily due to higher than expected loss emergence in our healthcare and E&O lines of business. The unfavorable reserve development for the 2012 loss year was primarily due to higher than expected loss emergence in our healthcare, private/not for profit D&O and lawyers E&O lines of business. We also recorded unfavorable loss reserve development in our general property line of business for the 2006 loss year due to unfavorable development on a reported claim.

Acquisition costs. Acquisition costs increased by $2.7 million, or 9.5%, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The increase was primarily driven by the growth in net premiums earned and increased profit commissions in our programs line of business. The acquisition cost ratio was 13.9% for the three months ended September 30, 2014 compared to 13.7% for the three months ended September 30, 2013.


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Table of Contents

General and administrative expenses. General and administrative expenses remained constant for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. While the general and administrative expenses remained constant, we did incur higher salary related costs as we continued to grow our U.S. operations offset by lower stock-based compensation expense. The general and administrative expense ratio decreased to 18.6% for the three months ended September 30, 2014 from 20.0% for the same period in 2013.

Other insurance-related income and expense. The other insurance-related income and expense represents the revenue and related expenses of our third-party claims administration services that we acquired in the current year.

Comparison of Nine Months Ended September 30, 2014 and 2013

Premiums. Gross premiums written increased by $126.1 million, or 14.5%, for the nine months ended September 30, 2014 compared to the same period in 2013. The increase in gross premiums written was primarily due to $45.2 million of new business growth during the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013, increased premiums on renewed business as well as premium rate increases across most lines of business. This was particularly evident in our general casualty, mergers and acquisitions, inland marine and environmental lines of business. This growth was partially offset by the non-renewal of business, particularly in certain classes within our healthcare line of business, which did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions).

The table below illustrates our gross premiums written by line of business for each of the periods indicated.
 
Nine Months Ended 
 September 30,
 
Dollar
 
Percentage
 
2014
 
2013
 
Change
 
Change
 
 
 
($ in millions)  

 
 
 
 
General casualty
$
352.0

 
$
271.5

 
$
80.5

 
29.7
 %
Professional liability
190.2

 
193.7

 
(3.5
)
 
(1.8
)%
Programs
119.9

 
107.7

 
12.2

 
11.3
 %
Healthcare
111.0

 
143.4

 
(32.4
)
 
(22.6
)%
General property
76.1

 
74.0

 
2.1

 
2.8
 %
Inland marine
50.2

 
32.8

 
17.4

 
53.0
 %
Environmental
37.6

 
24.7

 
12.9

 
52.2
 %
Other*
61.1

 
24.2

 
36.9

 
152.5
 %
 
$
998.1

 
$
872.0

 
$
126.1

 
14.5
 %
________________________
*
Includes our primary construction, mergers and acquisitions and surety lines of business.

Net premiums written increased by $93.9 million, or 14.4%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The increase in net premiums written was primarily due to higher gross premiums written. We ceded 25.2% of gross premiums written for both the nine months ended September 30, 2014 and 2013.

Net premiums earned increased by $58.0 million, or 9.8%, for the nine months ended September 30, 2014 compared to the same period in 2013. The increase was due to the continued growth of our U.S. insurance operations.

Net losses and loss expenses. Net losses and loss expenses increased by $41.6 million, or 10.4%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The following is a breakdown of the loss and loss expense ratio for the nine months ended September 30, 2014 and 2013: 

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Table of Contents

 
Nine Months Ended 
 September 30, 2014
 
Nine Months Ended 
 September 30, 2013
 
Dollar Change
 
Loss Ratio Percentage Point Change
 
Amount
 
% of NPE
 
Amount
 
% of NPE
 
 
 
 
 
 
 
($ in millions)
 
 
 
 
 
 
Non-catastrophe
$
438.1

 
67.2
%
 
$
387.5

 
65.3
%
 
$
50.6

 
1.9 Pts

Property catastrophe
—

 
—

 
—

 
—

 
—

 
—

Current period
438.1

 
67.2

 
387.5

 
65.3

 
50.6

 
1.9

Prior period
2.4

 
0.4

 
11.4

 
1.9

 
(9.0
)
 
(1.5
)
Net losses and loss expenses
$
440.5

 
67.6
%
 
$
398.9

 
67.2
%
 
$
41.6

 
0.4 Pts


Current year non-catastrophe losses and loss expenses

The increase in the current year non-catastrophe losses and loss expenses and the related ratio was primarily due to growth and mix of the business, higher non-catastrophe property losses in the current period compared to the same period last year, a loss related to our surety line of business in the current period and increased loss adjustment expenses across several lines of business.

Current year property catastrophe losses and loss expenses

During the nine months ended September 30, 2014 and September 30, 2013, we did not incur any property catastrophe losses.

Prior year losses and loss expenses

Overall, our U.S. insurance segment recorded net unfavorable reserve development of $2.4 million during the nine months ended September 30, 2014 compared to net unfavorable reserve development of $11.4 million for the nine months ended September 30, 2013, as shown in the tables below.
 
 
(Favorable) and Unfavorable Loss Reserve Development by Loss Year
 
For the Nine Months Ended September 30, 2014
 
2004 and
Prior
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
2013
 
Total
 
($ in millions)
General casualty
$
(3.1
)
 
$
0.7

 
$
—

 
$
(0.8
)
 
$
(4.8
)
 
$
0.3

 
$
3.2

 
$
2.8

 
$
0.2

 
$
4.2

 
$
2.7

Programs
—

 
—

 
(0.2
)
 
0.3

 
0.5

 
(4.4
)
 
(1.1
)
 
(4.1
)
 
0.3

 
(1.2
)
 
(9.9
)
General property
—

 
0.5

 
—

 
—

 
—

 
—

 
0.3

 
1.4

 
(0.9
)
 
3.2

 
4.5

Healthcare
(1.3
)
 
(1.6
)
 
(0.6
)
 
(0.2
)
 
(0.6
)
 
3.0

 
0.1

 
16.1

 
7.9

 
9.7

 
32.5

Professional liability
(0.4
)
 
10.1

 
(15.8
)
 
8.4

 
(3.1
)
 
(23.3
)
 
(3.6
)
 
0.1

 
(1.7
)
 
7.3

 
(22.0
)
Inland marine
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(0.3
)
 
(1.2
)
 
(1.6
)
 
(3.1
)
Environmental
—

 
—

 
—

 
—

 
—

 
—

 
(0.2
)
 
(1.0
)
 
(1.1
)
 
—

 
(2.3
)
 
$
(4.8
)
 
$
9.7

 
$
(16.6
)
 
$
7.7

 
$
(8.0
)
 
$
(24.4
)
 
$
(1.3
)
 
$
15.0

 
$
3.5

 
$
21.6

 
$
2.4


For the nine months ended September 30, 2014, the net unfavorable prior year reserve development primarily related to our healthcare and professional liability lines of business. The unfavorable prior year reserve development in our healthcare line of business for the 2011 through 2013 loss years was primarily due to higher than expected loss frequency and severity. The net favorable development in our professional liability line of business was primarily related to our public D&O class of business due to favorable development on several claims in the 2006 and 2009 loss year partially offset by adverse development on reported claims in the 2005 loss year.


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Table of Contents

 
(Favorable) and Unfavorable Loss Reserve Development by Loss Year
 
For the Nine Months Ended September 30, 2013
 
2003 and
Prior
 
2004
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
Total
 
($ in millions)
General casualty
$
—

 
$
(0.7
)
 
$
(0.5
)
 
$
—

 
$
(9.1
)
 
$
(3.1
)
 
$
(0.2
)
 
$
—

 
$
2.6

 
$
3.5

 
$
(7.5
)
Programs
—

 
—

 
—

 
(1.4
)
 
(3.5
)
 
(1.5
)
 
(1.9
)
 
(4.1
)
 
(0.1
)
 
3.3

 
(9.2
)
General property
—

 
0.7

 
(0.2
)
 
3.5

 
(0.2
)
 
(1.3
)
 
(1.3
)
 
—

 
1.3

 
1.0

 
3.5

Healthcare
(3.1
)
 
(1.8
)
 
(1.4
)
 
(2.7
)
 
(2.3
)
 
(8.3
)
 
(3.5
)
 
(1.6
)
 
23.2

 
14.1

 
12.6

Professional liability
—

 
(0.9
)
 
(2.5
)
 
(6.6
)
 
(3.4
)
 
(2.9
)
 
0.4

 
(6.3
)
 
4.5

 
28.8

 
11.1

Other
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(0.1
)
 
(0.6
)
 
1.6

 
0.9

 
$
(3.1
)
 
$
(2.7
)
 
$
(4.6
)
 
$
(7.2
)
 
$
(18.5
)
 
$
(17.1
)
 
$
(6.5
)
 
$
(12.1
)
 
$
30.9

 
$
52.3

 
$
11.4


For the nine months ended September 30, 2013, the unfavorable reserve development for the 2011 and 2012 loss years was due to higher than expected loss emergence, primarily in our healthcare, private/not for profit D&O and E&O lines of business.

Acquisition costs. Acquisition costs increased by $9.5 million, or 12.1%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The increase was driven by the growth in net premiums earned, higher commission and brokerage rates compared to last year due to changes in the mix of business and higher rates charged by brokers, and an increase in other acquisition related costs. The acquisition cost ratio was 13.6% and 13.3% for the nine months ended September 30, 2014 and 2013.

General and administrative expenses. General and administrative expenses increased by $6.3 million, or 5.3%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The increase was primarily due to higher salary-related costs as we continue to grow our U.S. insurance operations partially offset by lower stock-based compensation. The general and administrative expense ratio decreased to 19.3% for the nine months ended September 30, 2014 from 20.1% for the same period in 2013.

Other insurance-related income and expense. The other insurance-related income and expense represents the revenue and related expenses of our third-party claims administration services that we acquired in the current year.



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Table of Contents


International Insurance Segment

The following table summarizes the underwriting results and associated ratios for the international insurance segment for each of the periods indicated.
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
 
($ in millions)
Revenues
 
 
 
 
 
 
 
Gross premiums written
$
144.2

 
$
132.9

 
$
483.1

 
$
454.0

Net premiums written
87.8

 
75.7

 
285.5

 
259.8

Net premiums earned
94.0

 
87.6

 
271.6

 
258.8

Expenses
 
 
 
 
 
 
 
Net losses and loss expenses
$
55.8

 
$
31.1

 
$
115.3

 
$
91.0

Acquisition costs
1.2

 
(0.3
)
 
0.8

 
(1.5
)
General and administrative expenses
28.0

 
26.5

 
82.2

 
75.4

Underwriting income
9.0

 
30.3

 
73.3

 
93.9

Other insurance-related income
—

 
—

 
—

 
—

Other insurance-related expenses
5.3

 
—

 
5.3

 
—

Segment income
$
3.7

 
$
30.3

 
$
68.0

 
$
93.9

Ratios
 
 
 
 
 
 
 
Loss and loss expense ratio
59.4
%
 
35.5
 %
 
42.5
%
 
35.2
 %
Acquisition cost ratio
1.3
%
 
(0.3
)%
 
0.3
%
 
(0.6
)%
General and administrative expense ratio
29.8
%
 
30.2
 %
 
30.3
%
 
29.1
 %
Expense ratio
31.1
%
 
29.9
 %
 
30.6
%
 
28.5
 %
Combined ratio
90.5
%
 
65.4
 %
 
73.1
%
 
63.7
 %

Comparison of Three Months Ended September 30, 2014 and 2013

Premiums. Gross premiums written increased by $11.3 million, or 8.5%, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The increase was primarily due to increased premiums on existing lines of business, particularly in our professional liability line of business. This was partially offset by lower premiums written in our aviation line of business. The decrease in our aviation line of business was due to $13.1 million of gross premiums written during the three months ended September 30, 2013 related to the renewal rights agreement we entered into with Markel International that did not occur during the three months ended September 30, 2014 partially offset by new business written during the current quarter.
The table below illustrates our gross premiums written by underwriter location for our international insurance operations.
 
Three Months Ended 
 September 30,
 
Dollar
 
Percentage
 
2014
 
2013
 
Change        
 
Change        
 
 
 
($ in millions)
 
 
 
 
Bermuda
$
84.2

 
$
83.9

 
$
0.3

 
0.4
%
Europe
51.2

 
42.7

 
8.5

 
19.9
%
Asia Pacific
8.8

 
6.3

 
2.5

 
39.7
%
 
$
144.2

 
$
132.9

 
$
11.3

 
8.5
%


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Table of Contents

The table below illustrates our gross premiums written by line of business for each of the periods indicated.
 
Three Months Ended 
 September 30,
 
Dollar
 
Percentage
 
2014
 
2013
 
Change
 
Change
 
($ in millions)  
 
 
 
 
 
Professional liability
$
51.5

 
$
43.8

 
$
7.7

 
17.6
 %
General casualty
32.4

 
28.7

 
3.7

 
12.9
 %
General property
23.3

 
22.6

 
0.7

 
3.1
 %
Healthcare
19.2

 
18.6

 
0.6

 
3.2
 %
Aviation
8.7

 
13.1

 
(4.4
)
 
(33.6
)%
Trade credit
6.9

 
6.1

 
0.8

 
13.1
 %
Other*
2.2

 
—

 
2.2

 
n/a

 
$
144.2

 
$
132.9

 
$
11.3

 
8.5
 %
________________________
*
Includes our marine cargo and onshore construction lines of business.

Net premiums written increased by $12.1 million, or 16.0%, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The increase in net premiums written was primarily due to higher gross premiums written and lower ceded premiums due to lower cessions in our professional liability reinsurance treaty. This was partially offset by higher premiums ceded during the quarter related to our collateralized property catastrophe reinsurance protection as the premiums for the current treaty are recognized on a quarterly basis. We ceded 39.1% of gross premiums written for the three months ended September 30, 2014 compared to 43.0% for the three months ended September 30, 2013.

Net premiums earned increased by $6.4 million, or 7.3%, primarily due to higher net premiums written as we continued to expand our European and Asia Pacific operations.

Net losses and loss expenses. Net losses and loss expenses increased by $24.7 million, or 79.4%, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The following is a breakdown of the loss and loss expense ratio for the three months ended September 30, 2014 and 2013: 
 
Three Months Ended 
 September 30, 2014
 
Three Months Ended 
 September 30, 2013
 
Dollar Change
 
Loss Ratio Percentage Point Change
 
Amount
 
% of NPE
 
Amount
 
% of NPE
 
 
 
 
 
 
 
($ in millions)
 
 
 
 
 
 
Non-catastrophe
$
70.0

 
74.5
 %
 
$
60.8

 
69.4
 %
 
$
9.2

 
5.1 Pts
Property catastrophe
15.0

 
16.0

 
—

 
—

 
15.0

 
16.0
Current period
85.0

 
90.5

 
60.8

 
69.4

 
24.2

 
21.1
Prior period
(29.2
)
 
(31.1
)
 
(29.7
)
 
(33.9
)
 
0.5

 
2.8
Net losses and loss expenses
$
55.8

 
59.4
 %
 
$
31.1

 
35.5
 %
 
$
24.7

 
23.9 Pts

Current year non-catastrophe losses and loss expenses

The increase in the current year non-catastrophe losses and loss expenses and related ratio was primarily due to higher reported non-catastrophe property loss activity during the three months ended September 30, 2014 compared to the three months ended September 30, 2013.

Current year property catastrophe losses and loss expenses

During the three months ended September 30, 2014, we incurred $15.0 million of property catastrophe losses and loss expenses related to Hurricane Odile, whereas we did not incur any property catastrophe losses during the three months ended September 30, 2013.





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Table of Contents


Prior year losses and loss expenses

Overall, our international insurance segment recorded net favorable reserve development of $29.2 million during the three months ended September 30, 2014 compared to net favorable reserve development of $29.7 million for the three months ended September 30, 2013, as shown in the tables below.
 
 
(Favorable) and Unfavorable Loss Reserve Development by Loss Year
 
For the Three Months Ended September 30, 2014
 
2004 and
Prior
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
2013
 
Total
 
($ in millions)
General casualty
$
0.8

 
$
(0.6
)
 
$
(1.0
)
 
$
(1.1
)
 
$
(3.7
)
 
$
(5.0
)
 
$
(0.3
)
 
$
(2.5
)
 
$
(0.1
)
 
$
—

 
$
(13.5
)
General property
0.1

 
0.6

 
(0.4
)
 
—

 
(0.4
)
 
—

 
(0.5
)
 
(3.5
)
 
(0.2
)
 
(1.3
)
 
(5.6
)
Professional liability
(0.2
)
 
(0.4
)
 
(1.3
)
 
(7.2
)
 
(0.8
)
 
(2.0
)
 
(3.9
)
 
(1.5
)
 
14.9

 
—

 
(2.4
)
Healthcare
(1.2
)
 
(0.9
)
 
(1.1
)
 
(0.2
)
 
(0.2
)
 
(0.1
)
 
(4.0
)
 
0.1

 
(1.2
)
 
1.2

 
(7.6
)
Trade credit
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(2.0
)
 
1.9

 
(0.1
)
 
$
(0.5
)
 
$
(1.3
)
 
$
(3.8
)
 
$
(8.5
)
 
$
(5.1
)
 
$
(7.1
)
 
$
(8.7
)
 
$
(7.4
)
 
$
11.4

 
$
1.8

 
$
(29.2
)

For the three months ended September 30, 2014, we recorded unfavorable prior year reserve development in our professional liability line of business for the 2012 loss year primarily due to higher than expected loss emergence.
 
(Favorable) and Unfavorable Loss Reserve Development by Loss Year
 
For the Three Months Ended September 30, 2013
 
2003 and
Prior
 
2004
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
Total
 
($ in millions)
 
 
General casualty
$
0.7

 
$
(0.6
)
 
$
(1.4
)
 
$
(2.3
)
 
$
(1.8
)
 
$
(4.1
)
 
$
(0.6
)
 
$
(2.9
)
 
$
(0.1
)
 
$
—

 
$
(13.1
)
General property
—

 
—

 
3.4

 
(0.1
)
 
(0.1
)
 
(0.1
)
 
(0.1
)
 
(0.8
)
 
(1.3
)
 
(2.5
)
 
(1.6
)
Professional liability
0.2

 
(0.4
)
 
1.4

 
(1.1
)
 
(3.6
)
 
(0.2
)
 
(0.3
)
 
(0.2
)
 
(0.4
)
 
—

 
(4.6
)
Healthcare
(0.7
)
 
(0.2
)
 
(0.2
)
 
(0.5
)
 
(3.1
)
 
(0.3
)
 
(4.9
)
 
(0.2
)
 
(0.3
)
 
—

 
(10.4
)
 
$
0.2

 
$
(1.2
)
 
$
3.2

 
$
(4.0
)
 
$
(8.6
)
 
$
(4.7
)
 
$
(5.9
)
 
$
(4.1
)
 
$
(2.1
)
 
$
(2.5
)
 
$
(29.7
)

For the three months ended September 30, 2013, we recorded unfavorable loss reserve development in our general property line of business for the 2005 loss year due to higher than expected loss emergence on an energy claim.

Acquisition costs. Acquisition costs increased by $1.5 million, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The acquisition cost ratio was 1.3% for the three months ended September 30, 2014 and negative 0.3% for the three months ended September 30, 2013. The negative cost represents ceding commissions received on ceded premiums, that have been earned, in excess of the brokerage fees and commissions paid on gross premiums written, that have been amortized. The ceding commission income also covers costs that are expensed as incurred. The increase in the acquisition costs and related ratio was due to lower ceding commission income earned from our outward reinsurance treaties due to lower ceded premiums, combined with higher acquisition-related costs during the three months ended September 30, 2014 compared to the three months ended September 30, 2013.

General and administrative expenses. General and administrative expenses increased by $1.5 million, or 5.7%, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The increase was primarily due to higher salary-related costs as we continue to grow our international insurance operations by adding specialty underwriting teams partially offset by lower stock-based compensation expense. The general and administrative expense ratio was 29.8% and 30.2% for the three months ended September 30, 2014 and 2013, respectively.

Other insurance-related income and expense. The other insurance-related expenses incurred for the current quarter represent the transaction-related costs incurred for our acquisition of RSA's Hong Kong and Singapore operations. Upon closing of the acquisition in 2015, RSA's Hong Kong and Singapore operations will be combined into our current branch

59
Table of Contents

operations in these jurisdictions and will be included in the international insurance segment. As such, the transaction-related costs have been reflected in this segment.

Comparison of Nine Months Ended September 30, 2014 and 2013

Premiums. Gross premiums written increased by $29.1 million, or 6.4%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The increase was primarily due to continued growth from new initiatives and new lines of business. The professional liability line of business grew $17.1 million on new business writings in European E&O and mergers and acquisitions classes of business, and our aviation and marine cargo lines of business grew by $11.3 million. This growth was partially offset by the general casualty line of business, which decreased by $3.9 million compared to the prior period, due to non-recurring business written in 2013 and the non-renewal of certain policies during the current period, that did not meet our underwriting requirements (which included inadequate pricing and/or terms and conditions).
The table below illustrates our gross premiums written by underwriter location for our international insurance operations.
 
Nine Months Ended 
 September 30,
 
Dollar
 
Percentage
 
2014
 
2013
 
Change        
 
Change        
 
 
 
($ in millions)
 
 
 
 
Bermuda
$
299.1

 
$
305.4

 
$
(6.3
)
 
(2.1
)%
Europe
162.1

 
129.5

 
32.6

 
25.2
 %
Asia Pacific
21.9

 
19.1

 
2.8

 
14.7
 %
 
$
483.1

 
$
454.0

 
$
29.1

 
6.4
 %

The table below illustrates our gross premiums written by line of business for each of the periods indicated.
 
Nine Months Ended 
 September 30,
 
Dollar
 
Percentage
 
2014
 
2013
 
Change
 
Change
 
($ in millions)  
 
 
 
 
 
Professional liability
$
151.3

 
$
134.2

 
$
17.1

 
12.7
 %
General property
125.4

 
126.5

 
(1.1
)
 
(0.9
)%
General casualty
93.1

 
97.0

 
(3.9
)
 
(4.0
)%
Healthcare
66.3

 
66.3

 
—

 
—
 %
Trade credit
22.4

 
16.9

 
5.5

 
32.5
 %
Aviation
18.2

 
13.1

 
5.1

 
38.9
 %
Other*
6.4

 
—

 
6.4

 
n/a

 
$
483.1

 
$
454.0

 
$
29.1

 
6.4
 %
________________________
*
Includes our marine cargo and onshore construction lines of business.

Net premiums written increased by $25.7 million, or 9.9%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The increase in net premiums written was primarily due to higher gross premiums written, lower ceded premiums related to our property catastrophe reinsurance protection for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013, and lower cessions in our professional liability reinsurance treaty. This was partially offset by higher premiums ceded for new reinsurance contracts for our aviation, marine cargo and small- to medium-sized enterprise lines of business. We ceded 40.9% of gross premiums written for the nine months ended September 30, 2014 compared to 42.8% for the nine months ended September 30, 2013.

Net premiums earned increased by $12.9 million, or 5.0%, primarily due to higher net premiums written as we continued to expand our European and Asia Pacific operations.

Net losses and loss expenses. Net losses and loss expenses increased by $24.3 million, or 26.7%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The following is a breakdown of the loss and loss expense ratio for the nine months ended September 30, 2014 and 2013: 

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Table of Contents

 
Nine Months Ended 
 September 30, 2014
 
Nine Months Ended 
 September 30, 2013
 
Dollar Change
 
Loss Ratio Percentage Point Change
 
Amount
 
% of NPE
 
Amount
 
% of NPE
 
 
 
 
 
 
 
($ in millions)
 
 
 
 
 
 
Non-catastrophe
$
178.9

 
65.9
 %
 
$
176.1

 
68.1
 %
 
$
2.8

 
(2.2) Pts

Property catastrophe
15.0

 
5.5

 
—

 
—

 
15.0

 
5.5

Current period
193.9

 
71.4

 
176.1

 
68.1

 
17.8

 
3.3

Prior period
(78.6
)
 
(28.9
)
 
(85.1
)
 
(32.9
)
 
6.5

 
4.0

Net losses and loss expenses
$
115.3

 
42.5
 %
 
$
91.0

 
35.2
 %
 
$
24.3

 
7.3 Pts


Current year non-catastrophe losses and loss expenses

The increase in the current year non-catastrophe losses and loss expenses was primarily due to the growth in international insurance operations partially offset by an increase to the loss adjustment expense reserve during the nine months ended September 30, 2013 that did not occur during the nine months ended September 30, 2014.

Current year property catastrophe losses and loss expenses

During the nine months ended September 30, 2014 we incurred $15.0 million of property catastrophe losses and loss expenses related to Hurricane Odile, whereas we did not incur any property catastrophe losses during the nine months ended September 30, 2013.

Prior year losses and loss expenses

Overall, our international insurance segment recorded net favorable reserve development of $78.6 million during the nine months ended September 30, 2014 compared to net favorable reserve development of $85.1 million for the nine months ended September 30, 2013, as shown in the tables below.
 
 
(Favorable) and Unfavorable Loss Reserve Development by Loss Year
 
For the Nine Months Ended September 30, 2014
 
2004 and
Prior
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
2013
 
Total
 
($ in millions)
General casualty
$
10.4

 
$
(2.0
)
 
$
(3.5
)
 
$
(4.6
)
 
$
7.7

 
$
(14.3
)
 
$
(9.1
)
 
$
(0.6
)
 
$
(0.2
)
 
$
—

 
$
(16.2
)
General property
(0.2
)
 
0.7

 
(0.9
)
 
(1.1
)
 
(0.7
)
 
(0.7
)
 
(0.4
)
 
(8.1
)
 
(4.8
)
 
(11.4
)
 
(27.6
)
Professional liability
(1.6
)
 
(2.0
)
 
1.9

 
(30.0
)
 
(1.8
)
 
(12.3
)
 
(7.5
)
 
(2.3
)
 
20.8

 
—

 
(34.8
)
Healthcare
(1.3
)
 
(1.8
)
 
(2.0
)
 
(1.2
)
 
(1.0
)
 
(0.1
)
 
(7.9
)
 
(0.4
)
 
(1.4
)
 
17.2

 
0.1

Trade credit
—

 
—

 
—

 
—

 
—

 
—

 
(0.1
)
 
(1.0
)
 
(2.2
)
 
3.2

 
(0.1
)
 
$
7.3

 
$
(5.1
)
 
$
(4.5
)
 
$
(36.9
)
 
$
4.2

 
$
(27.4
)
 
$
(25.0
)
 
$
(12.4
)
 
$
12.2

 
$
9.0

 
$
(78.6
)

For the nine months ended September 30, 2014, the unfavorable prior year reserve development in the healthcare line of business for the 2013 loss year and for the general casualty line of business for the 2008 loss year related to individual claims within each of those lines of business. The favorable prior year reserve development in the professional liability line of business for the 2007 loss year was primarily due to favorable reserve development on an individual claim while the unfavorable development for the 2012 loss year was primarily due to adverse development on two reported claims. The favorable development in the 2009 and 2010 loss years was primarily due to actual loss emergence being lower than anticipated across several lines of business.


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(Favorable) and Unfavorable Loss Reserve Development by Loss Year
 
For the Nine Months Ended September 30, 2013
 
2003 and
Prior
 
2004
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
Total
 
($ in millions)
 
 
General casualty
$
7.0

 
$
1.8

 
$
(8.4
)
 
$
(9.0
)
 
$
(10.5
)
 
$
(8.8
)
 
$
(1.8
)
 
$
(3.1
)
 
$
(0.1
)
 
$
0.9

 
$
(32.0
)
General property
—

 
—

 
3.3

 
(0.3
)
 
1.0

 
(1.1
)
 
(3.6
)
 
(4.8
)
 
(10.8
)
 
(10.6
)
 
(26.9
)
Professional liability
(0.1
)
 
(5.4
)
 
4.7

 
(4.0
)
 
(14.5
)
 
0.1

 
(6.8
)
 
(0.6
)
 
(0.5
)
 
—

 
(27.1
)
Healthcare
(0.8
)
 
(0.5
)
 
(0.7
)
 
(1.6
)
 
5.1

 
(4.8
)
 
5.7

 
(1.1
)
 
(0.4
)
 
—

 
0.9

 
$
6.1

 
$
(4.1
)
 
$
(1.1
)
 
$
(14.9
)
 
$
(18.9
)
 
$
(14.6
)
 
$
(6.5
)
 
$
(9.6
)
 
$
(11.8
)
 
$
(9.7
)
 
$
(85.1
)

For the nine months ended September 30, 2013, the net favorable reserve development for loss years 2004 to 2012 is a result of actual loss emergence being lower than anticipated, in particular for our general property line of business for the 2011 and 2012 loss years. The unfavorable reserve development in our healthcare line in the 2007 and 2009 loss years was due to adverse development on individual claims.

Acquisition costs. Acquisition costs increased by $2.3 million, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The acquisition cost ratio was 0.3% for the nine months ended September 30, 2014 and negative 0.6% for the nine months ended September 30, 2013. The higher acquisition cost ratio is primarily due to higher acquisition related costs during the current year as compared to the prior year.

General and administrative expenses. General and administrative expenses increased by $6.8 million, or 9.0%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The increase in general and administrative expenses was due to increased salary and related costs partially offset by lower stock-based compensation expense. The general and administrative expense ratio was 30.3% and 29.1% for the nine months ended September 30, 2014 and 2013, respectively.

Other insurance-related income and expense. The other insurance-related expenses incurred for the current period represent the transaction-related costs incurred for our acquisition of RSA's Hong Kong and Singapore operations.



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Table of Contents

Reinsurance Segment

The following table summarizes the underwriting results and associated ratios for the reinsurance segment for each of the periods indicated.
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
 
($ in millions)
Revenues
 
 
 
 
 
 
 
Gross premiums written
$
177.0

 
$
139.3

 
$
888.6

 
$
857.2

Net premiums written
159.2

 
138.6

 
862.4

 
817.1

Net premiums earned
223.0

 
215.6

 
686.2

 
629.0

Expenses
 
 
 
 
 
 
 
Net losses and loss expenses
$
127.3

 
$
104.7

 
$
370.4

 
$
317.4

Acquisition costs
40.1

 
37.0

 
125.3

 
109.1

General and administrative expenses
18.6

 
20.4

 
56.9

 
56.9

Underwriting income
37.0

 
53.5

 
133.6

 
145.6

Other insurance-related income
—

 
—

 
—

 
—

Other insurance-related expenses
—

 
—

 
—

 
—

Segment income
$
37.0

 
$
53.5

 
$
133.6

 
$
145.6

Ratios
 
 
 
 
 
 
 
Loss and loss expense ratio
57.1
%
 
48.5
%
 
54.0
%
 
50.5
%
Acquisition cost ratio
18.0
%
 
17.1
%
 
18.3
%
 
17.3
%
General and administrative expense ratio
8.3
%
 
9.5
%
 
8.3
%
 
9.1
%
Expense ratio
26.3
%
 
26.6
%
 
26.6
%
 
26.4
%
Combined ratio
83.4
%
 
75.1
%
 
80.6
%
 
76.9
%

Comparison of Three Months Ended September 30, 2014 and 2013

Premiums. Gross premiums written increased by $37.7 million, or 27.1%, for the three months ended September 30, 2014 compared to the same period in 2013. The increase was from one new treaty in our casualty reinsurance line of business that resulted in $21.9 million of gross premiums written, and the timing of renewals primarily in our property reinsurance line of business. We had a large property treaty that renewed during the three months ended September 30, 2014 that was previously written during the second quarter of last year. This property reinsurance treaty included a fronting component which resulted in our retaining a small portion of the premiums written with the remainder being ceded.

The table below illustrates our gross premiums written by underwriter location for our reinsurance operations.
 
Three Months Ended 
 September 30,
 
Dollar
 
Percentage
 
2014
 
2013
 
Change        
 
Change        
 
 
 
($ in millions)
 
 
 
 
United States
$
101.8

 
$
68.9

 
$
32.9

 
47.8
 %
Bermuda
25.3

 
27.2

 
(1.9
)
 
(7.0
)%
Asia
36.2

 
33.9

 
2.3

 
6.8
 %
Europe
13.7

 
9.3

 
4.4

 
47.3
 %
 
$
177.0

 
$
139.3

 
$
37.7

 
27.1
 %







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The table below illustrates our gross premiums written by line of business for each of the periods indicated.

 
Three Months Ended 
 September 30,
 
Dollar
 
Percentage
 
2014
 
2013
 
Change        
 
Change        
 
 
 
($ in millions)
 
 
 
 
Casualty
$
86.7

 
$
56.0

 
$
30.7

 
54.8
 %
Property
83.1

 
$
72.6

 
10.5

 
14.5
 %
Specialty
7.2

 
10.7

 
(3.5
)
 
(32.7
)%
 
$
177.0

 
$
139.3

 
$
37.7

 
27.1
 %

Net premiums written increased by $20.6 million, or 14.9%, due to the increase in gross premiums written partially offset by higher premiums ceded during the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The increase in premiums ceded was due to the timing of ceded premiums related to the large property reinsurance treaty that had a fronting component, as well as premiums ceded for our current year collateralized property catastrophe reinsurance protection as the premiums for the current treaty are recognized on a quarterly basis.
  
Net premiums earned increased by $7.4 million, or 3.4%, as a result of the increase in net premiums written during the previous quarters.

Net losses and loss expenses. Net losses and loss expenses increased by $22.6 million, or 21.6%, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The following is a breakdown of the loss and loss expense ratio for the three months ended September 30, 2014 and 2013: 
 
Three Months Ended 
 September 30, 2014
 
Three Months Ended 
 September 30, 2013
 
Dollar Change
 
Loss Ratio Percentage Point Change
 
Amount
 
% of NPE
 
Amount
 
% of NPE
 
 
 
 
 
 
 
($ in millions)
 
 
 
 
 
 
Non-catastrophe
$
130.8

 
58.7
 %
 
$
140.2

 
65.0
 %
 
$
(9.4
)
 
(6.3
)
Property catastrophe
14.8

 
6.6

 
—

 
—

 
14.8

 
6.6

Current period
145.6

 
65.3

 
140.2

 
65.0

 
5.4

 
0.3

Prior period
(18.3
)
 
(8.2
)
 
(35.5
)
 
(16.5
)
 
17.2

 
8.3

Net losses and loss expenses
$
127.3

 
57.1
 %
 
$
104.7

 
48.5
 %
 
$
22.6

 
8.6


Current year non-catastrophe losses and loss expenses

The decrease in the current year non-catastrophe losses and loss expenses and related ratio was primarily due to lower incurred large property losses during the three months ended September 30, 2014 compared to the same period in 2013, as well as a reduction in IBNR loss reserves due to lower than expected property losses. The large non-catastrophe property losses during the three months ended September 30, 2014 were approximately $6.1 million which primarily related to additional development for several storm events in the United States that occurred during the previous quarter. This compares to $14.9 million in reported large non-catastrophe property losses for the three months ended September 30, 2014.

Current year property catastrophe losses and loss expenses

During the three months ended September 30, 2014, we incurred property catastrophe losses and loss expenses of $8.0 million related to Windstorm Ela, $3.5 million related to Hurricane Odile and $3.3 million related to PCS storm #45, whereas we did not incur any property catastrophe losses during the three months ended September 30, 2013.

Prior year losses and loss expenses

Overall, our reinsurance segment recorded net favorable reserve development of $18.3 million during the three months ended September 30, 2014 compared to net favorable reserve development of $35.5 million for the three months ended September 30, 2013, as shown in the tables below.

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Table of Contents

 
(Favorable) and Unfavorable Loss Reserve Development by Loss Year
 
For the Three Months Ended September 30, 2014
 
2004 and
Prior
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
2013
 
Total
 
($ in millions)
Property
$
(0.1
)
 
$
0.9

 
$
—

 
$
0.1

 
$
(0.1
)
 
$
—

 
$
0.6

 
$
0.6

 
$
1.1

 
$
(14.8
)
 
$
(11.7
)
Casualty
0.1

 
4.6

 
(1.0
)
 
(1.6
)
 
(4.1
)
 
(0.8
)
 
(0.6
)
 
(3.1
)
 
(0.1
)
 
(0.1
)
 
(6.7
)
Specialty
0.2

 
(0.2
)
 
—

 
(0.1
)
 
(0.1
)
 
(0.1
)
 
(0.6
)
 
(0.6
)
 
0.9

 
0.7

 
0.1

 
$
0.2

 
$
5.3

 
$
(1.0
)
 
$
(1.6
)
 
$
(4.3
)
 
$
(0.9
)
 
$
(0.6
)
 
$
(3.1
)
 
$
1.9

 
$
(14.2
)
 
$
(18.3
)

For the three months ended September 30, 2014, the net favorable reserve development in the property line of business for the 2013 loss year was due to lower than expected reported loss activity.

 
(Favorable) and Unfavorable Loss Reserve Development by Loss Year
 
For the Three Months Ended September 30, 2013
 
2003 and
Prior
 
2004
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
Total
 
($ in millions)
Property
$
—

 
$
0.1

 
$
1.0

 
$
—

 
$
—

 
$
—

 
$
(0.4
)
 
$
(2.2
)
 
$
(6.0
)
 
$
(14.2
)
 
$
(21.7
)
Casualty
(1.6
)
 
(2.4
)
 
0.6

 
0.1

 
0.3

 
(2.0
)
 
(1.4
)
 
(0.7
)
 
(0.2
)
 
0.4

 
(6.9
)
Specialty
—

 
(0.1
)
 
(0.1
)
 
(0.1
)
 
(0.1
)
 
(0.1
)
 
(0.2
)
 
0.3

 
(5.9
)
 
(0.6
)
 
(6.9
)
 
$
(1.6
)
 
$
(2.4
)
 
$
1.5

 
$
—

 
$
0.2

 
$
(2.1
)
 
$
(2.0
)
 
$
(2.6
)
 
$
(12.1
)
 
$
(14.4
)
 
$
(35.5
)

For the three months ended September 30, 2013, the favorable reserve development for the 2011 and 2012 loss years for our reinsurance segment was largely due to lower than expected reported losses in our property line of business.

Acquisition costs. Acquisition costs increased by $3.1 million, or 8.4%, for the three months ended September 30, 2014 compared to the three months ended September 30, 2013. The increase was due to higher ceding commissions paid to cedents in certain lines of business. The acquisition cost ratio was 18.0% for the three months ended September 30, 2014 compared to 17.1% for the three months ended September 30, 2013. The increase in the acquisition cost ratio was due to higher ceding commissions paid to cedents in certain lines of business.

General and administrative expenses. General and administrative expenses decreased by $1.8 million, or 8.8%, for the three months ended September 30, 2014 compared to the same period in 2013. The decrease in general and administrative expenses was primarily due to lower stock-based compensation expense. The general and administrative expense ratios for the three months ended September 30, 2014 and 2013 were 8.3% and 9.5%, respectively.

Comparison of Nine Months Ended September 30, 2014 and 2013

Premiums. Gross premiums written increased by $31.4 million, or 3.7%, for the nine months ended September 30, 2014 compared to the same period in 2013. The increase was driven primarily by new business and increased renewals across several major lines of business. In our property reinsurance lines of business, premiums increased by approximately $16.8 million, which included $3.9 million of increased premiums from our collateralized property catastrophe reinsurance program through Aeolus Re. We also experienced non-renewals of certain treaties, particularly in our casualty reinsurance line of business, either due to poor terms and conditions or the cedents not renewing their reinsurance.
   










65
Table of Contents

The table below illustrates our gross premiums written by underwriter location for our reinsurance operations.
 
Nine Months Ended 
 September 30,
 
Dollar
 
Percentage
 
2014
 
2013
 
Change        
 
Change        
 
 
 
($ in millions)
 
 
 
 
United States
$
458.0

 
$
424.2

 
$
33.8

 
8.0
 %
Bermuda
225.9

 
245.4

 
(19.5
)
 
(7.9
)%
Asia
120.9

 
118.3

 
2.6

 
2.2
 %
Europe
83.8

 
69.3

 
14.5

 
20.9
 %
 
$
888.6

 
$
857.2

 
$
31.4

 
3.7
 %

The table below illustrates our gross premiums written by line of business for each of the periods indicated.
 
Nine Months Ended 
 September 30,
 
Dollar
 
Percentage
 
2014
 
2013
 
Change        
 
Change        
 
 
 
($ in millions)
 
 
 
 
Property
$
453.4

 
$
436.6

 
$
16.8

 
3.8
%
Casualty
236.2

 
230.3

 
5.9

 
2.6
%
Specialty
199.0

 
190.3

 
8.7

 
4.6
%
 
$
888.6

 
$
857.2

 
$
31.4

 
3.7
%

Net premiums written increased by $45.3 million, or 5.5%, primarily due to the increase in gross premiums written and not renewing the collateralized retrocessional catastrophe cover partially offset by ceded premiums written for the current year collateralized property catastrophe reinsurance protection.

Net premiums earned increased by $57.2 million, or 9.1%, as a result of the increase in net premiums written during 2013 and into 2014, as well as the reduction in ceded earned premium related to the non-renewal of the prior year collateralized retrocessional catastrophe cover partially offset by the current year collateralized property catastrophe reinsurance protection.

Net losses and loss expenses. Net losses and loss expenses increased by $53.0 million, or 16.7%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The following is a breakdown of the loss and loss expense ratio for the nine months ended September 30, 2014 and 2013: 
 
Nine Months Ended 
 September 30, 2014
 
Nine Months Ended 
 September 30, 2013
 
Dollar Change
 
Loss Ratio Percentage Point Change
 
Amount
 
% of NPE
 
Amount
 
% of NPE
 
 
 
 
 
 
 
($ in millions)
 
 
 
 
 
 
Non-catastrophe
$
407.1

 
59.3
 %
 
$
397.6

 
63.3
 %
 
$
9.5

 
(4.0
)
Property catastrophe
28.0

 
4.1

 
—

 
—

 
28.0

 
4.1

Current period
435.1

 
63.4

 
397.6

 
63.3

 
37.5

 
0.1

Prior period
(64.7
)
 
(9.4
)
 
(80.2
)
 
(12.8
)
 
15.5

 
3.4

Net losses and loss expenses
$
370.4

 
54.0
 %
 
$
317.4

 
50.5
 %
 
$
53.0

 
3.5


Current year non-catastrophe losses and loss expenses

The increase in the current year non-catastrophe losses and loss expenses was primarily due to growth in the reinsurance operations partially offset by lower incurred large property losses during the nine months ended September 30, 2014 compared to the same period in 2013, as well as a reduction in IBNR loss reserves due to lower than expected property losses. The decrease in the current year non-catastrophe losses and loss expenses ratio was primarily due to the reduction in IBNR loss reserves and lower reported large non-catastrophe property losses during the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The large non-catastrophe property losses during the nine months ended September 30, 2014 were 18.9 million and were primarily related to several storm events in the United States that occurred during the second quarter of 2014. This compares to $26.5 million in large reported non-catastrophe property losses for the nine months ended September 30, 2013.

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Table of Contents

Current year property catastrophe losses and loss expenses

During the nine months ended September 30, 2014, we incurred property catastrophe losses and loss expenses of $12.5 million related to PCS storm #45, $12.0 million related to Windstorm Ela and $3.5 million related to Hurricane Odile, whereas we did not incur any property catastrophe losses during the nine months ended September 30, 2013.

Prior year losses and loss expenses

Overall, our reinsurance segment recorded net favorable reserve development of $64.7 million during the nine months ended September 30, 2014 compared to net favorable reserve development of $80.2 million for the nine months ended September 30, 2013, as shown in the tables below.
 
(Favorable) and Unfavorable Loss Reserve Development by Loss Year
 
For the Nine Months Ended September 30, 2014
 
2004 and
Prior
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
2013
 
Total
 
($ in millions)
Property
$
0.4

 
$
0.9

 
$
(0.2
)
 
$
(0.1
)
 
$
(0.3
)
 
$
0.3

 
$
1.6

 
$
(5.2
)
 
$
(3.2
)
 
$
(44.4
)
 
$
(50.2
)
Casualty
(0.6
)
 
4.6

 
(2.8
)
 
(3.7
)
 
(5.3
)
 
(1.8
)
 
0.4

 
(2.0
)
 
(0.3
)
 
1.3

 
(10.2
)
Specialty
(0.2
)
 
(0.5
)
 
(0.1
)
 
(0.2
)
 
(0.1
)
 
0.2

 
(0.3
)
 
(1.0
)
 
5.7

 
(7.8
)
 
(4.3
)
 
$
(0.4
)
 
$
5.0

 
$
(3.1
)
 
$
(4.0
)
 
$
(5.7
)
 
$
(1.3
)
 
$
1.7

 
$
(8.2
)
 
$
2.2

 
$
(50.9
)
 
$
(64.7
)

For the nine months ended September 30, 2014, the net favorable reserve development in the property line of business for the 2013 loss year is due to lower than expected reported loss activity.

 
(Favorable) and Unfavorable Loss Reserve Development by Loss Year
 
For the Nine Months Ended September 30, 2013
 
2003 and
Prior
 
2004
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
Total
 
($ in millions)
Property
$
—

 
$
0.2

 
$
(1.3
)
 
$
0.1

 
$
—

 
$
(0.2
)
 
$
(0.5
)
 
$
(5.1
)
 
$
(14.5
)
 
$
(49.7
)
 
$
(71.0
)
Casualty
(1.4
)
 
(3.6
)
 
0.3

 
0.8

 
(1.9
)
 
(5.6
)
 
(1.8
)
 
0.2

 
3.1

 
5.7

 
(4.2
)
Specialty
—

 
(0.4
)
 
(0.6
)
 
0.2

 
(0.1
)
 
(3.2
)
 
0.7

 
0.2

 
(3.6
)
 
1.8

 
(5.0
)
 
$
(1.4
)
 
$
(3.8
)
 
$
(1.6
)
 
$
1.1

 
$
(2.0
)
 
$
(9.0
)
 
$
(1.6
)
 
$
(4.7
)
 
$
(15.0
)
 
$
(42.2
)
 
$
(80.2
)

For the nine months ended September 30, 2013, the favorable loss reserve development for the 2011 and 2012 loss years for our reinsurance segment was largely due to lower than expected reported losses in our property line of business. The unfavorable loss reserve development in our casualty reinsurance line of business for the 2011 and 2012 loss years was primarily due to the frequency of claims being greater than anticipated.

Acquisition costs. Acquisition costs increased by $16.2 million, or 14.8%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The increase was due to the increase in net premiums earned and increased ceding commission paid to cedents in certain lines of business. The acquisition cost ratio was 18.3% for the nine months ended September 30, 2014 compared to 17.3% for the nine months ended September 30, 2013. The increase in the acquisition cost ratio was due to higher ceding commission paid to cedents.

General and administrative expenses. General and administrative expenses remained constant for the nine months ended September 30, 2014 compared to the same period in 2013. The general and administrative expense ratios for the nine months ended September 30, 2014 and 2013 were 8.3% and 9.1%, respectively.


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Table of Contents

Reserves for Losses and Loss Expenses

Reserves for losses and loss expenses by segment were comprised of the following:
 
U.S. Insurance
 
International Insurance
 
Reinsurance
 
Total
 
Sep 30,
2014
 
Dec 31,
2013
 
Sep 30,
2014
 
Dec 31,
2013
 
Sep 30,
2014
 
Dec 31,
2013
 
Sep 30,
2014
 
Dec 31,
2013
 
($ in millions)
Case reserves
$
605.5

 
$
609.8

 
$
503.8

 
$
441.0

 
$
476.7

 
$
470.1

 
$
1,586.0

 
$
1,520.9

IBNR
1,642.7

 
1,509.2

 
1,702.5

 
1,710.4

 
1,121.1

 
1,026.0

 
4,466.3

 
4,245.6

Reserve for losses and loss expenses
2,248.2

 
2,119.0

 
2,206.3

 
2,151.4

 
1,597.8

 
1,496.1

 
6,052.3

 
5,766.5

Reinsurance recoverables
(587.7
)
 
(558.7
)
 
(754.0
)
 
(669.6
)
 
(7.3
)
 
(6.2
)
 
(1,349.0
)
 
(1,234.5
)
Net reserve for losses and loss expenses
$
1,660.5

 
$
1,560.3

 
$
1,452.3

 
$
1,481.8

 
$
1,590.5

 
$
1,489.9

 
$
4,703.3

 
$
4,532.0


We participate in certain lines of business where claims may not be reported for many years. Accordingly, management does not solely rely upon reported claims on these lines for estimating ultimate liabilities. We also use statistical and actuarial methods to estimate expected ultimate losses and loss expenses. Loss reserves do not represent an exact calculation of liability. Rather, loss reserves are estimates of what we expect the ultimate resolution and administration of claims will cost. These estimates are based on various factors including underwriters’ expectations about loss experience, actuarial analysis, comparisons with the results of industry benchmarks and loss experience to date. Loss reserve estimates are refined as experience develops and as claims are reported and resolved. Establishing an appropriate level of loss reserves is an inherently uncertain process. Ultimate losses and loss expenses may differ from our reserves, possibly by material amounts.

The following tables provide our ranges of loss and loss expense reserve estimates by business segment as of September 30, 2014:
 
Reserve for Losses and Loss Expenses
Gross of Reinsurance Recoverable
 
Carried
Reserves    
 
Low
Estimate    
 
High
Estimate    
 
($ in millions)
U.S. insurance
$
2,248.2

 
$
1,779.3

 
$
2,530.8

International insurance
2,206.3

 
1,770.2

 
2,425.9

Reinsurance
1,597.8

 
1,306.3

 
1,776.5

Consolidated (1)
6,052.3

 
4,948.2

 
6,640.8

 
Reserve for Losses and Loss Expenses
Net of Reinsurance Recoverable
 
Carried
Reserves    
 
Low
Estimate    
 
High
Estimate    
 
($ in millions)
U.S. insurance
$
1,660.5

 
$
1,313.5

 
$
1,909.6

International insurance
1,452.3

 
1,162.9

 
1,611.5

Reinsurance
1,590.5

 
1,301.2

 
1,768.7

Consolidated (1)
4,703.3

 
3,859.2

 
5,208.3

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

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

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

Reinsurance Recoverable

The following table illustrates our reinsurance recoverable as of September 30, 2014 and December 31, 2013:
 
 
September 30,
2014
 
December 31,
2013
 
($ in millions)
Ceded case reserves
$
261.5

 
$
225.8

Ceded IBNR reserves
1,087.5

 
1,008.7

Reinsurance recoverable
$
1,349.0

 
$
1,234.5


We remain obligated for amounts ceded in the event our reinsurers do not meet their obligations. Accordingly, we have evaluated the reinsurers that are providing reinsurance protection to us and will continue to monitor their credit ratings and financial stability. We generally have the right to terminate our treaty reinsurance contracts at any time, upon prior written notice to the reinsurer, under specified circumstances, including the assignment to the reinsurer by A.M. Best of a financial strength rating of less than “A-.” Approximately 99% of ceded reserves as of September 30, 2014 were recoverable from reinsurers who had an A.M. Best rating of “A-” or higher.

Liquidity and Capital Resources

Liquidity

Liquidity is a measure of our ability to access sufficient cash flows to meet the short-term and long-term cash requirements of our business operations. The company believes that its cash flows from operations and investments will provide sufficient liquidity for the foreseeable future.

Holdings is a holding company and transacts no business of its own. Cash flows to Holdings may comprise dividends, advances and loans from its subsidiary companies. Holdings is therefore reliant on receiving dividends and other permitted distributions from its subsidiaries to make dividend payments on its common shares.

Our operating subsidiaries depend upon cash inflows from premium receipts, net of commissions, investment income and proceeds from sales and redemptions of investments. Cash outflows for our operating subsidiaries are in the form of claims payments, net of reinsurance recoveries, reinsurance premium payments, purchase of investments, operating expenses and income tax payments as well as dividend payments to the holding company.

Historically, our operating subsidiaries have generated sufficient cash flows to meet all of their obligations. Because of the inherent volatility of our business, the seasonality in the timing of payments by insureds and cedents, the irregular timing of loss payments, and the impact of a change in interest rates and credit spreads on the investment income as well as seasonality in coupon payment dates for fixed income securities, cash flows from operating activities may vary between periods. In the unlikely event that paid losses exceed operating cash flows in any given period, we would use our cash balances available, liquidate a portion of our investment portfolio or borrow under our revolving loan facility (see "Credit Facilities" below) in order to meet our short-term liquidity needs.

Our total investments and cash and cash equivalents totaled $9.0 billion as of September 30, 2014, the main components of which were investment grade fixed income securities and cash and cash equivalents. As of September 30, 2014, we held $831.3 million of unrestricted cash and cash equivalents and $358.5 million of fixed income securities with a maturity of less than one year to meet short-term liquidity needs. Our remaining fixed income securities, equity securities and "other invested assets" are available to meet our long-term liquidity needs.


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As of September 30, 2014, we had $150 million available under our revolving loan facility.

Dividend Restrictions

The jurisdictions in which our operating subsidiaries are licensed to write business impose regulations requiring companies to maintain or meet various defined statutory ratios, including solvency and liquidity requirements. Some jurisdictions also place restrictions on the declaration and payment of dividends and other distributions. See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources” in the Company’s 2013 Form 10-K.

Cash Flows 
 
 
Nine Months Ended 
 September 30,
 
 
2014
 
2013
 
 
($ in millions)
Cash flows provided by operating activities
 
$
669.7

 
$
338.2

Cash flows (used in) provided by investing activities
 
(154.1
)
 
80.9

Cash flows used in financing activities
 
(213.6
)
 
(141.8
)
Effect of exchange rate changes on foreign currency cash
 
(2.6
)
 
(6.2
)
Net increase in cash and cash equivalents
 
299.4

 
271.1

Cash and cash equivalents, beginning of period
 
531.9

 
681.9

Cash and cash equivalents, end of period
 
$
831.3

 
$
953.0


The primary sources of cash inflows from operating activities are premiums received, loss payments from reinsurers, return of funds held balances related to our collateralized property catastrophe reinsurance program through Aeolus Re, and investment income. The primary sources of cash outflows from operating activities are ceded premiums paid to reinsurers, claims paid, contributions of funds held balances, commissions paid, operating expenses, interest expense and income taxes. The primary factor in our ability to generate positive operating cash flow is underwriting profitability. We have generated positive operating cash flow for more than 10 consecutive years.

In our casualty lines of business, claims may be reported and settled many years after the coverage period has terminated. As a result, we expect that we will generate significant operating cash flow as we accumulate casualty loss reserves on our balance sheet. In our property lines of business, claims are generally reported and paid within a relatively short period of time and we expect volatility in our operating cash flows as losses are incurred. We expect increases in the amount of expected loss payments in future periods with a resulting decrease in operating cash flow; however, we do not expect loss payments to exceed the premiums generated. Actual premiums written and collected and losses and loss expenses paid in any period could vary materially from our expectations and could have a significant and adverse effect on operating cash flow.

The increase in cash flows from operations was primarily due to the net receipt of $232.0 million of our funds held balance from Aeolus Re, which is included in "funds held" on the unaudited condensed consolidated balance sheets, for the 2013 and prior underwriting years. The return of our funds held balance from Aeolus Re is a function of the performance of each underwriting year. The timing and the amounts received from Aeolus Re can vary significantly, and we could potentially not receive any amounts back.

Cash flows from investing activities consist primarily of proceeds on the sale of investments and payments for investments acquired in addition to changes in restricted cash. The change in cash flows used in investing activities reflects the higher net purchases of securities during the nine months ended September 30, 2014 compared to the same period in 2013 primarily due to the increase in operating cash flow.

Cash flows from financing activities consist primarily of capital raising activities, which include the issuance of common shares or debt, the repurchase of our common shares, the payment of dividends and the repayment of debt. The increase in cash flows used in financing activities was due to the $46.0 million increase in share repurchases for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. Dividends paid increased as we increased our quarterly dividend per share amount to $0.225 in 2014 from $0.125 in 2013.




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Investments

Our funds are primarily invested in liquid, high-grade fixed income securities. As of September 30, 2014 and December 31, 2013, 88.0% and 89.3%, respectively, of our fixed income portfolio consisted of investment grade securities. The maturity distribution of our fixed-maturity portfolio (on a fair value basis) as of September 30, 2014 and December 31, 2013 was as follows: 
 
 
September 30,
2014
 
December 31,
2013
 
 
($ in millions)
Due in one year or less
 
$
358.5

 
$
838.8

Due after one year through five years
 
2,935.5

 
2,698.8

Due after five years through ten years
 
792.5

 
697.8

Due after ten years
 
101.0

 
67.0

Mortgage-backed
 
1,240.4

 
1,292.5

Asset-backed
 
700.4

 
505.9

Total
 
$
6,128.3

 
$
6,100.8


We have investments in "other invested assets", comprising interests in hedge funds, private equity funds, other private securities and high yield loan funds, the carrying value of which was $929.2 million as of September 30, 2014. Some of these funds have redemption notice requirements. For each of our funds, liquidity is allowed after certain defined periods based on the terms of each fund. See Note 4(b) “Investments — Other Invested Assets” to our unaudited condensed consolidated financial statements for additional details on our other invested assets.

We do not believe that inflation has had a material effect on our consolidated results of operations. The potential exists, after a catastrophe loss, for the development of inflationary pressures in a local economy. The effects of inflation are considered implicitly in pricing. Loss reserves are established to recognize likely loss settlements at the date payment is made. Those reserves inherently recognize the effects of inflation. The actual effects of inflation on our results cannot be accurately known, however, until claims are ultimately resolved.

Credit Facilities

In the normal course of our operations, we enter into agreements with financial institutions to obtain secured and unsecured credit facilities.

Allied World Assurance Company, Ltd currently has access to up to $1.45 billion in letters of credit under two letter of credit facilities, a $1.0 billion uncommitted secured facility with Citibank Europe plc and a $450 million committed secured credit facility with a syndication of lenders (the “Amended Secured Credit Facility”). These credit facilities are primarily for the issuance of standby letters of credit to support obligations in connection with the insurance and reinsurance business.

The letters of credit issued under the credit facility with Citibank Europe plc are deemed to be automatically extended without amendment for twelve months from the expiry date, or any future expiration date unless at least 30 days prior to any expiration date Citibank Europe plc notifies us that they elect not to consider the letters of credit renewed for any such additional period.

A portion of the Amended Secured Credit Facility may also be used for revolving loans for general corporate and working capital purposes, up to a maximum of $150 million. We may request that existing lenders under the Amended Secured Credit Facility make additional commitments from time to time, up to $150 million, subject to approval by the lenders. The Amended Secured Credit Facility contains representations, warranties and covenants customary for similar bank loan facilities, including certain covenants that, among other things, require us to maintain a certain leverage ratio and financial strength rating. We are in compliance with all covenants under the Amended Secured Credit Facility as of September 30, 2014.

As of September 30, 2014, we had combined unused letters of credit capacity of $984.1 million from the Amended Secured Credit Facility and Citibank Europe plc. We believe that this remaining capacity is sufficient to meet our future letter of credit needs. During the nine months ended September 30, 2014, we did not utilize the revolving loan available under the Amended Secured Credit Facility.



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Pledged Assets

We use trust accounts primarily to meet security requirements for inter-company and certain reinsurance transactions. We also have cash and cash equivalents and investments on deposit with various state or government insurance departments or pledged in favor of ceding companies in order to comply with reinsurance contract provisions and relevant insurance regulations. In addition, our credit facilities are collateralized, at least to the extent of letters of credit outstanding at any given time.

Security arrangements with ceding insurers may subject our assets to security interests or require that a portion of our assets be pledged to, or otherwise held by, third parties. Both of our letter of credit facilities are fully collateralized by assets held in custodial accounts at the Bank of New York Mellon held for the benefit of the banks. Although the investment income derived from our assets while held in trust accrues to our benefit, the investment of these assets is governed by the terms of the letter of credit facilities or the investment regulations of the state or territory of domicile of the ceding insurer, which may be more restrictive than the investment regulations otherwise applicable to us. The restrictions may result in lower investment yields on these assets, which may adversely affect our profitability.

As of September 30, 2014 and December 31, 2013, $3,082.6 million and $2,894.4 million, respectively, of cash and cash equivalents and investments were deposited, pledged or held in escrow accounts in favor of ceding companies and other counterparties or government authorities to comply with reinsurance contract provisions, insurance laws and other contract provisions.

In addition, as of September 30, 2014 and December 31, 2013, a further $543.8 million and $1,053.6 million, respectively, of cash and cash equivalents and investments were pledged as collateral for our credit facilities. The decrease in the assets pledged as collateral for our credit facilities was primarily due to a reduction in funding to various cedents where we were overfunded and our establishment of a direct collateral arrangement for our Lloyd's operations and, as such, the pledged assets are included in the $3,082.6 million noted above, whereas previously they were included in the pledged assets for our credit facilities.

We do not currently anticipate that the restrictions on liquidity resulting from restrictions on the payment of dividends by our subsidiary companies or from assets committed in trust accounts or to collateralize the letter of credit facilities will have a material impact on our ability to carry out our normal business activities, including interest and dividend payments, respectively, on our senior notes (described below) and common shares.

Financial Strength Ratings

Financial strength ratings represent the opinions of rating agencies on our capacity to meet our obligations. In the event of a significant downgrade in ratings, our ability to write business and to access the capital markets could be impacted. Our financial strength ratings as of September 30, 2014 have not changed since December 31, 2013. See Item 1. “Business” in our 2013 Form 10-K.

Capital Resources

The table below sets forth the capital structure of the Company as of September 30, 2014 and December 31, 2013: 
 
 
September 30,
2014
 
December 31,
2013
 
 
($ in millions)
Senior notes
 
$
798.7

 
$
798.5

Shareholders’ equity
 
3,673.6

 
3,519.8

Total capitalization
 
$
4,472.3

 
$
4,318.3

Debt to total capitalization
 
17.9
%
 
18.5
%

On September 10, 2012, we filed a shelf registration statement on Form S-3 with the SEC in which we may offer from time to time common shares of Allied World Switzerland, senior or subordinated debt securities of Allied World Bermuda, guarantees of debt securities of Allied World Bermuda, warrants to purchase common shares of Allied World Switzerland, warrants to purchase debt securities of Allied World Bermuda or units which may consist of any combination of the securities listed above. The registration statement is intended to provide us with additional flexibility to access capital markets for general corporate purposes, subject to market conditions and our capital needs.

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Share Repurchases

On May 1, 2014, our shareholders approved a new share repurchase program in order for us to repurchase up to $500.0 million of our common shares. This new share repurchase program supersedes the 2012 share repurchase program and no further repurchases will be made under the 2012 share repurchase program. Under the terms of this new share repurchase program, the first three million of common shares repurchased will remain in treasury and will be used by us to satisfy share delivery obligations under our equity-based compensation plans. Any additional common shares will be designated for cancellation at acquisition and will be canceled upon shareholder approval. As of September 30, 2014 approximately $429.2 million remained under this share repurchase authorization. Effective in the third quarter of 2014, we temporarily suspended our share repurchase program so as to preserve capital for future obligations such as the purchase of the Hong Kong and Singapore operations of RSA and any catastrophic events that may occur during the remainder of the year. We continually monitor our capital levels and will restart the share repurchase program when we believe it is prudent to do so.

During the three month and nine months ended September 30, 2014, our share repurchases were as follows: 
 
Three Months Ended 
 September 30, 2014
 
Nine Months Ended 
 September 30, 2014
 
($ in millions)
Common shares repurchased
654,851

 
4,616,543

Total cost of shares repurchased
$
25.0

 
$
164.5

Average price per share
$
38.17

 
$
35.64


Shares repurchased by the Company and not designated for cancellation are classified as “Treasury shares, at cost” on the consolidated balance sheets. The Company will issue shares out of treasury principally related to the Company’s employee benefit plans. Shares repurchased and designated for cancellation are constructively retired and recorded as a share cancellation.

Long-Term Debt

In July 2006, Allied World Bermuda issued $500.0 million aggregate principal amount of 7.50% senior notes due August 1, 2016, with interest payable August 1 and February 1 each year. Allied World Bermuda can redeem the senior notes prior to maturity, subject to payment of a “make-whole” premium; however, Allied World Bermuda currently has no intention of redeeming the notes.

In November 2010, Allied World Bermuda issued $300.0 million aggregate principal amount of 5.50% senior notes due November 1, 2020, with interest payable May 15 and November 15 each year, commencing May 15, 2011. Allied World Bermuda can redeem the senior notes prior to maturity, subject to payment of a “make-whole” premium; however, Allied World Bermuda currently has no intention of redeeming the notes.

The senior notes issued in 2006 and 2010 have been unconditionally and irrevocably guaranteed for the payment of the principal and interest by Holdings.

Off-Balance Sheet Arrangements
As of September 30, 2014, we did not have any off-balance sheet arrangements.
Item 3.
Quantitative and Qualitative Disclosures About Market Risk.
We believe that we are principally exposed to three types of market risk: interest rate risk, credit risk and currency risk.
The fixed income securities in our investment portfolio are subject to interest rate risk and credit risk. Any changes in interest rates and credit spreads have a direct effect on the fair values of fixed income securities. As interest rates rise, the fair values fall, and vice versa. As credit spreads widen, the fair values fall, and vice versa.
In the table below changes in fair values as a result of changes in interest rates are determined by calculating hypothetical September 30, 2014 ending prices based on yields adjusted to reflect the hypothetical changes in interest rates, comparing such hypothetical ending prices to actual ending prices, and multiplying the difference by the principal amount of the security. The

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sensitivity analysis is based on estimates. The estimated changes of our fixed maturity investments and cash and cash equivalents are presented below and actual changes for interest rate shifts could differ significantly.
 
Interest Rate Shift in Basis Points
 
-200
 
-100
 
-50
 
—
 
+50
 
+100
 
+200
 
($ in millions)
Total fair value
$
7,406.7

 
$
7,276.9

 
$
7,208.4

 
$
7,138.5

 
$
7,068.5

 
$
6,999.3

 
$
6,863.7

Fair value change from base
268.2

 
138.4

 
69.9

 
—

 
(70.0
)
 
(139.2
)
 
(274.8
)
Change in unrealized appreciation/(depreciation)
3.8
%
 
1.9
%
 
1.0
%
 
—
%
 
(1.0
)%
 
(1.9
)%
 
(3.8
)%
In the table below changes in fair values as a result of changes in credit spreads are determined by calculating hypothetical September 30, 2014 ending prices adjusted to reflect the hypothetical changes in credit spreads, comparing such hypothetical ending prices to actual ending prices, and multiplying the difference by the principal amount of the security. The sensitivity analysis is based on estimates. The estimated changes of our non-cash, non-U.S. Treasury fixed maturity investments are presented below and actual changes in credit spreads could differ significantly.
 
Credit Spread Shift in Basis Points
 
-200
 
-100
 
-50
 
—
 
+50
 
+100
 
+200
 
($ in millions)
Total fair value
$
5,371.3

 
$
5,250.5

 
$
5,190.1

 
$
5,129.8

 
$
5,069.4

 
$
5,009.0

 
$
4,888.2

Fair value change from base
241.5

 
120.7

 
60.3

 
—

 
(60.4
)
 
(120.8
)
 
(241.6
)
Change in unrealized appreciation/(depreciation)
4.7
%
 
2.4
%
 
1.2
%
 
—
%
 
(1.2
)%
 
(2.4
)%
 
(4.7
)%
In addition to credit spread risk, our portfolio is also exposed to the risk of securities being downgraded or of issuers defaulting. In an effort to minimize this risk, our investment guidelines have been defined to ensure that the assets held are well diversified and are primarily high-quality securities.

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The following table shows the types of securities in our portfolio, their fair market values, average rating and portfolio percentage as of September 30, 2014.
 
Fair Value 
 September 30, 2014
 
Average  
Rating
 
Portfolio
Percentage  
 
($ in millions)
 
 
 
 
Cash and cash equivalents
$
1,010.2

 
AAA
 
11.2
%
U.S. government securities
998.5

 
AA+
 
11.0
%
U.S. government agencies
185.6

 
AA+
 
2.1
%
Non-U.S. government and government agencies
219.3

 
AA+
 
2.4
%
State, municipalities and political subdivisions
260.7

 
AA-
 
2.9
%
Mortgage-backed securities (“MBS”):
 
 
 
 
 
Agency MBS
593.2

 
AA+
 
6.6
%
Non-agency MBS
126.0

 
B+
 
1.4
%
Commercial MBS
521.2

 
BBB
 
5.8
%
Total mortgage-backed securities
1,240.4

 
 
 
13.8
%
Corporate securities:
 
 
 
 
 
Financials
1,194.9

 
A
 
13.3
%
Industrials
1,202.9

 
BBB
 
13.3
%
Utilities
125.5

 
BBB+
 
1.4
%
Total corporate securities
2,523.3

 
 
 
28.0
%
Asset-backed securities:
 
 
 
 
 
Credit cards
72.7

 
AAA
 
0.8
%
Auto receivables
27.3

 
AAA
 
0.3
%
Student Loans
164.1

 
AA+
 
1.8
%
Collateralized loan obligations
372.2

 
AA
 
4.1
%
Other
64.1

 
AAA
 
0.7
%
Total asset-backed securities
700.4

 
 
 
7.8
%
Other invested assets:
 
 
 
 
 
Private equity
303.1

 
N/A
 
3.4
%
Hedge funds
471.5

 
N/A
 
5.2
%
Other private securities
123.1

 
N/A
 
1.4
%
High yield loan fund
31.5

 
N/A
 
0.3
%
Total other invested assets
929.2

 
 
 
10.3
%
Equities
945.1

 
N/A
 
10.5
%
Total investment portfolio
$
9,012.7

 
 
 
100.0
%
As of September 30, 2014, we held $6.1 billion of fixed income securities. Of those assets, approximately 88.0% were rated investment grade (Baa3/BBB- or higher) with the remaining 12.0% rated in the below investment grade category. The average credit quality of the fixed maturity portfolios was A+ by Standard & Poor’s.
Our agency pass-through mortgage-backed securities are exposed to prepayment risk, which occurs when holders of individual mortgages increase the frequency with which they prepay the outstanding principal before the maturity date to refinance at a lower interest rate cost. Given the proportion that these securities comprise of the overall portfolio, and the current interest rate environment and condition of the credit market, prepayment risk is not considered significant at this time.
Our non-agency commercial mortgage-backed securities are subject to the risk of non-payment due to increased levels of delinquencies, defaults and losses on commercial loans that cumulatively create shortfalls beyond the level of subordination in our specific securities.
As of September 30, 2014, we held investments in "other invested assets" with a carrying value of $929.2 million. Included in other invested assets are private equity funds, hedge funds, other private securities and a high yield loan fund. Investments in

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these types of assets involve certain risks related to, among other things, the illiquid nature of the fund shares, the limited operating history of these investments, as well as risks associated with the strategies employed by the managers of these investments. The funds’ objectives are generally to seek attractive long-term returns with lower volatility by investing in a range of diversified investment strategies. As our reserves and capital continue to build, we may consider additional investments in these or other alternative investments.
As of September 30, 2014, our direct exposure to European credit across all of Europe was $774.3 million as outlined in the table below and is included within “fixed maturity investments trading, at fair value” and “equity securities trading, at fair value” in the consolidated balance sheets. As of September 30, 2014, we had no direct sovereign exposure to Greece, Ireland, Italy, Portugal, Spain or Ukraine.
 
September 30, 2014
 
Sovereign and 
Sovereign
Guaranteed
 
Structured   
Products
 
Corporate
Bonds and   
Equities
 
Total
Exposure     
 
($ in millions)
Austria
$
—

 
$
—

 
$
0.1

 
$
0.1

Belgium
—

 
—

 
15.5

 
15.5

Denmark
—

 
—

 
2.3

 
2.3

Finland
—

 
—

 
1.5

 
1.5

France
—

 
—

 
225.1

 
225.1

Germany
29.9

 
—

 
17.2

 
47.1

Greece
—

 
—

 
0.5

 
0.5

Hungary
—

 
—

 
0.3

 
0.3

Ireland
—

 
—

 
2.0

 
2.0

Italy
—

 
—

 
4.4

 
4.4

Luxembourg
—

 
3.6

 
15.5

 
19.1

Netherlands
34.1

 
—

 
87.4

 
121.5

Norway
—

 
—

 
28.2

 
28.2

Portugal
—

 
—

 
0.6

 
0.6

Spain
—

 
—

 
18.5

 
18.5

Sweden
—

 
—

 
44.6

 
44.6

Switzerland
2.2

 
—

 
49.8

 
52.0

United Kingdom
26.0

 
4.1

 
161.0

 
191.1

Total exposure
$
92.2

 
$
7.7

 
$
674.4

 
$
774.3

The U.S. dollar is our reporting currency and the functional currency of all of our operating subsidiaries. However, we enter into insurance and reinsurance contracts where the premiums receivable and losses payable are denominated in currencies other than the U.S. dollar. In addition, we maintain a portion of our investments and liabilities in currencies other than the U.S. dollar, primarily Euro, British Sterling, Swiss Franc and the Canadian dollar. Receivables in non-U.S. currencies are generally converted into U.S. dollars at the time of receipt. When we incur a liability in a non-U.S. currency, we carry such liability on our books in the original currency. These liabilities are converted from the non-U.S. currency to U.S. dollars at the time of payment. As a result, we have an exposure to foreign currency risk resulting from fluctuations in exchange rates. We utilize a hedging strategy to minimize the potential loss of value caused by currency fluctuations by using foreign currency forward contract derivatives that expire in 90 days from purchase.
As of September 30, 2014 and December 31, 2013, approximately 4.1% and 2.3%, respectively, of our total investments and cash and cash equivalents were denominated in currencies other than the U.S. dollar. Of our business written during the nine months ended September 30, 2014 and 2013, approximately 14% and 11%, respectively, was written in currencies other than the U.S. dollar.
Item 4.
Controls and Procedures.

In connection with the preparation of this quarterly report, our management has performed an evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and

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procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of September 30, 2014. Disclosure controls and procedures are designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by SEC rules and forms and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow for timely decisions regarding required disclosures. Based on their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2014, our Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed in our reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by SEC rules and forms and accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow for timely decisions regarding required disclosures.

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide an absolute assurance that all control issues and instances of fraud, if any, within our Company have been detected.

No changes were made in our internal controls over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f), during the quarter ended September 30, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II
OTHER INFORMATION
Item 1.
Legal Proceedings.
The Company, in common with the insurance industry in general, is subject to litigation and arbitration in the normal course of its business. These legal proceedings generally relate to claims asserted by or against the Company in the ordinary course of insurance or reinsurance operations. Estimated amounts payable under these proceedings are included in the reserve for losses and loss expenses in the Company’s consolidated balance sheets. As of September 30, 2014, the Company was not a party to any material legal proceedings arising outside the ordinary course of business that management believes will have a material adverse effect on the Company’s results of operations, financial position or cash flow.

Item 1A.
Risk Factors.
Our business is subject to a number of risks, including those identified in Item 1A. of Part I of our 2013 Form 10-K, that could have a material adverse effect on our business, results of operations, financial condition and/or liquidity and that could cause our operating results to vary significantly from period to period. The risks described in our 2013 Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also could have a material adverse effect on our business, results of operations, financial condition and/or liquidity.

On August 22, 2014, Allied World Assurance Company, Ltd entered into (i) a Sale of Business Agreement with RSA, with respect to RSA’s Hong Kong insurance operations (the “Hong Kong Purchase Agreement”); and (ii) a Sale of Business Agreement with RSA with respect to RSA’s Singapore insurance operations (the “Singapore Purchase Agreement” and together with the Hong Kong Purchase Agreement, collectively, the “Purchase Agreements”). The Purchase Agreements provide that Allied World Assurance Company, Ltd will acquire the in-force insurance portfolios and related assets and liabilities of RSA’s Hong Kong and Singapore insurance operations. The following are a number of risks that we face in connection with the proposed acquisitions.

The occurrence of any event, change or other circumstances that could give rise to the termination of the Purchase Agreements could adversely affect our future business.     

There are significant risks and uncertainties associated with the acquisitions. The occurrence of certain events, changes or any other circumstances could give rise to the termination of one or both of the Purchase Agreements and cause the acquisitions not to be completed. There is no assurance that we will receive the necessary regulatory approvals from the Office of the

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Commissioner of Insurance in Hong Kong and the Monetary Authority of Singapore as well as the High Court of Singapore. If we fail to obtain such approvals or meet other conditions necessary to complete the acquisitions set forth in the Purchase Agreements, we would not be able to close the transactions. Failure to complete the acquisition(s) would prevent us from realizing its anticipated benefits to our business.

We must obtain regulatory approvals to complete the acquisitions, which, if delayed, not granted or granted with unacceptable conditions may jeopardize or delay the acquisitions, result in additional expense or reduce the anticipated benefits of the acquisitions.

We must obtain regulatory approvals from the Office of the Commissioner of Insurance in Hong Kong and the Monetary Authority of Singapore as well as the High Court of Singapore prior to the completion of the acquisitions. The regulatory authorities from which we seek approvals have broad discretion in administering relevant laws and regulations. As a condition to the approval of the acquisitions, regulatory authorities may impose requirements or limitations that could negatively affect the way we conduct our Hong Kong and/or Singapore business operations post-acquisition. If we agree to any material conditions or restrictions in order to obtain any approvals required to complete the acquisitions, these conditions or restrictions could adversely affect our ability to integrate each company’s businesses or reduce the anticipated benefits of the acquisitions.

Our business could be adversely impacted by uncertainty related to the proposed acquisitions, whether or not the acquisitions are completed.     

Whether or not the acquisitions are completed, the announcement and pendency of the acquisitions could impact our business, which could have an adverse effect on our financial condition, results of operations and the success of the acquisitions, including:

•
that the proposed acquisitions disrupt our current business plans and operations;

•
our management's attention being directed toward the completion of the acquisitions and transaction-related considerations and being diverted away from our day-to-day business operations and the execution of our current business plans; and

•
we may incur significantly higher transaction costs than we currently anticipate, such as legal and accounting fees, and other costs, fees, expenses and charges related to the acquisitions, whether or not the acquisitions are completed.

The anticipated benefits of the acquisitions may not be realized fully or at all or may take longer to realize than expected.     

The acquisitions involve the integration of RSA's Hong Kong and Singapore operations with and into our current Hong Kong and Singapore branch operations, which have previously operated independently. We will devote significant management attention and resources integrating the Hong Kong and Singapore businesses. Delays in this process could adversely affect our business, results of operations, financial condition and share price after the completion of the acquisitions. Achieving the anticipated benefits of the acquisitions is subject to a number of uncertainties, including whether RSA's Hong Kong and Singapore businesses and our business are integrated in an efficient and effective manner, and general competitive factors in the marketplace. We may experience unanticipated difficulties or expenses in connection with integrating these businesses, including:

•
retaining existing employees, clients, brokers, agents and third-party service providers of RSA's Hong Kong and Singapore operations;

•
retaining and integrating management and other key employees of RSA's Hong Kong and Singapore operations;

•
unanticipated issues in integrating information, communications, marketing, administrative and other systems; and

•
potential charges to earnings resulting from the application of purchase accounting to the transaction.

Even if the business operations are integrated successfully, there can be no assurance that we will realize the full benefits of synergies that we currently expect from this integration or that these benefits will be achieved within the anticipated time frame. Failure to achieve these anticipated benefits could result in increased costs, decreases in the amount of expected

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revenues and diversion of management’s time and energy and could materially adversely affect our business, financial condition and results of operations.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds.
 
(c)
The following table summarizes our repurchases of our common shares during the three months ended September 30, 2014:
Period
 
Total Number  
of Shares
Purchased
 
Average
Price Paid
per Share
 
Total Number of
Shares Purchased   
as Part of Publicly
Announced Plans
or Programs  
 
Maximum Dollar Value
(or Approximate
Dollar Value) of
Shares that May Yet
be Purchased Under
the Plans or Programs
July 1 - 31, 2014
 
654,851

 
$
38.17

 
654,851

 
$
429.2
 million
  
August 1 - 31, 2014
 
—

 
—

 
—

 
429.2
 million
  
September 1 - 30, 2014
 
—

 
—

 
—

 
429.2
 million
  
Total
 
654,851

 
$
38.17

 
654,851

 
$
429.2
 million
(1)
________________________  
(1)
At the 2014 Annual Shareholder Meeting on May 1, 2014, Holdings’ shareholders approved a new, two-year $500 million share repurchase program. Please see Part I, Item 2 - “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Share Repurchases” for more information about our share repurchase program. Share repurchases may be effected from time to time through open market purchases, privately negotiated transactions, tender offers or otherwise.


Item 3.
Defaults Upon Senior Securities.
None.

Item 4.
Mine Safety Disclosures.
Not applicable.

Item 5.
Other Information.
None.

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Item 6.
Exhibits.

Exhibit
Number
 
Description
 
 
 
2.1(1)
 
Sale of Business Agreement by and between Royal & Sun Alliance Insurance plc and Allied World Assurance Company, Ltd related to Hong Kong operations, dated as of August 22, 2014.
 
 
 
2.2(2)
 
Sale of Business Agreement by and between Royal & Sun Alliance Insurance plc and Allied World Assurance Company, Ltd related to Singapore operations, dated as of August 22, 2014.
 
 
 
3.1(3)
 
Articles of Association of Allied World Assurance Company Holdings, AG, as amended and restated.
 
 
 
31.1
 
Certification by Chief Executive Officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
31.2
 
Certification by Chief Financial Officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.1*
 
Certification by Chief Executive Officer, as required by Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.2*
 
Certification by Chief Financial Officer, as required by Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
101.1
 
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets as of September 30, 2014 and December 31, 2013, (ii) the Consolidated Statements of Operations and Comprehensive Income for the three and nine months ended September 30, 2014 and 2013, (iii) the Consolidated Statements of Shareholders’ Equity for the nine months ended September 30, 2014 and 2013, (iv) the Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013 and (v) the Notes to the Consolidated Financial Statements.
________________________ 
 
 
(1)
Incorporated herein by reference to Exhibit 2.1 to the Current Report on Form 8-K of Allied World Assurance Company Holdings, AG filed with the SEC on August 25, 2014.

 
 
(2)
Incorporated herein by reference to Exhibit 2.2 to the Current Report on Form 8-K of Allied World Assurance Company Holdings, AG filed with the SEC on August 25, 2014.
 
 
(3)
Incorporated herein by reference to Exhibit 3.1 to the Current Report on Form 8-K of Allied World Assurance Company Holdings, AG filed with the SEC on July 29, 2014.
 
 
*
These certifications are being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, chapter 63 of title 18 United States Code) and are not being filed as part of this report.
 
 



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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG
Dated: October 22, 2014
 
 
 
 
 
 
By:
/s/ Scott A. Carmilani
 
Name:
 Scott A. Carmilani
 
Title:
President and Chief Executive Officer
Dated: October 22, 2014
 
 
 
 
 
 
By:
/s/ Thomas A. Bradley
 
Name:
Thomas A. Bradley
 
Title:
Executive Vice President and Chief Financial Officer
Dated: October 22, 2014
 
 
 
 
 
 
By:
/s/ Kent W. Ziegler
 
Name:
Kent W. Ziegler
 
Title:
Senior Vice President, Finance and Chief Accounting Officer

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EXHIBIT INDEX
Exhibit
Number
 
Description
 
 
 
2.1(1)
 
Sale of Business Agreement by and between Royal & Sun Alliance Insurance plc and Allied World Assurance Company, Ltd related to Hong Kong operations, dated as of August 22, 2014.
 
 
 
2.2(2)
 
Sale of Business Agreement by and between Royal & Sun Alliance Insurance plc and Allied World Assurance Company, Ltd related to Singapore operations, dated as of August 22, 2014.
 
 
 
3.1(3)
 
Articles of Association of Allied World Assurance Company Holdings, AG, as amended and restated.
 
 
 
31.1
 
Certification by Chief Executive Officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
31.2
 
Certification by Chief Financial Officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.1*
 
Certification by Chief Executive Officer, as required by Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.2*
 
Certification by Chief Financial Officer, as required by Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
101.1
 
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets as of September 30, 2014 and December 31, 2013, (ii) the Consolidated Statements of Operations and Comprehensive Income for the three and nine months ended September 30, 2014 and 2013, (iii) the Consolidated Statements of Shareholders’ Equity for the nine months ended September 30, 2014 and 2013, (iv) the Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013 and (v) the Notes to the Consolidated Financial Statements.
_______________________ 
(1)
Incorporated herein by reference to Exhibit 2.1 to the Current Report on Form 8-K of Allied World Assurance Company Holdings, AG filed with the SEC on August 25, 2014.
 
 
(2)
Incorporated herein by reference to Exhibit 2.2 to the Current Report on Form 8-K of Allied World Assurance Company Holdings, AG filed with the SEC on August 25, 2014.
 
 
(3)
Incorporated herein by reference to Exhibit 3.1 to the Current Report on Form 8-K of Allied World Assurance Company Holdings, AG filed with the SEC on July 29, 2014.
 
 
*
These certifications are being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, chapter 63 of title 18 United States Code) and are not being filed as part of this report.