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AGII > SEC Filings for AGII > Form 10-Q on 9-May-2013All Recent SEC Filings

Show all filings for ARGO GROUP INTERNATIONAL HOLDINGS, LTD. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for ARGO GROUP INTERNATIONAL HOLDINGS, LTD.


9-May-2013

Quarterly Report


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

The following is a discussion and analysis of our results of operations for the three months ended March 31, 2013 compared with the three months ended March 31, 2012, and also a discussion of our financial condition as of March 31, 2013. This discussion and analysis should be read in conjunction with the attached unaudited interim Consolidated Financial Statements and notes thereto and Argo Group's Annual Report on Form 10-K for the year ended December 31, 2012 filed with the Securities and Exchange Commission on February 28, 2013, including the audited Consolidated Financial Statements and notes thereto.

Forward Looking Statements

Management's Discussion and Analysis of Financial Condition and Results of Operations, Quantitative and Qualitative Disclosures About Market Risk and the accompanying Consolidated Financial Statements (including the notes thereto) may contain "forward looking statements," which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The forward looking statements are based on our current expectations and beliefs concerning future developments and their potential effects on us. There can be no assurance that actual developments will be those anticipated by us. Actual results may differ materially as a result of significant risks and uncertainties, including non-receipt of expected payments, the capital markets and their effect on investment income and the fair value of the investment portfolio, development of claims and the effect on loss reserves, accuracy in estimating loss reserves, changes in the demand for our products, the effect of general economic conditions, adverse state and federal legislation and regulations, government investigations into industry practices, developments relating to existing agreements, heightened competition, changes in pricing environments and changes in asset valuations. For a more detailed discussion of risks and uncertainties, see our public filings made with the Securities and Exchange Commission. We undertake no obligation to publicly update any forward-looking statements.

Generally, it is our policy to communicate events that may have a material adverse impact on our operations or financial position, including property and casualty catastrophic events and material losses in the investment portfolio, in a timely manner through a public announcement. It is also our policy not to make public announcements regarding events that are believed to have no material adverse impact on our results of operations or financial position based on management's current estimates and available information, other than through regularly scheduled calls, press releases or filings.

Results of Operations

The following is a comparison of selected data from our operations:



                                                         Three Months
                                                       Ended March 31,
           (in millions)                              2013         2012
           Gross written premiums                    $ 438.2      $ 396.3

           Earned premiums                           $ 304.2      $ 277.3
           Net investment income                        27.9         31.4
           Fee income, net                               0.0          1.3
           Net realized investment and other gains       9.5         13.1

           Total revenue                             $ 341.6      $ 323.1

           Income before income taxes                $  37.5      $  28.1
           Provision for income taxes                    4.8          8.5

           Net income                                $  32.7      $  19.6

           Loss ratio                                   57.0 %       61.3 %
           Expense ratio                                42.4 %       42.1 %

           Combined ratio                               99.4 %      103.4 %


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The increase in consolidated gross written and earned premiums was primarily attributable to growth in our segments, excluding Commercial Specialty, resulting from our introduction of new products, increased renewals and moderate rate increases. Partially offsetting these increases were declines in gross written and earned premiums in the Commercial Specialty segment due to the planned exits from select lines.

The decline in consolidated net investment income was primarily attributable to a reduction in invested asset balances due to the transfer of certain invested assets as a result of a whole account quota share contract for our Syndicate 1200 segment, which was effective in December 2012. Additionally, consolidated net investment income was adversely impacted by declining yields.

The decline in consolidated net realized investment gains for the three months ended March 31, 2013 was attributable to the recognition of $4.8 million of other-than-temporary impairments on select equity and strategic investments. Consolidated net realized investment gains for the three months ended March 31, 2013, excluding the other-than-temporary impairments, were $14.3 million primarily within our fixed maturity and other invested assets portfolio.

We have purchased foreign currency 90 day forward contracts to manage currency exposure on losses related to the New Zealand and Japan earthquakes and Australian floods. The terms of these contracts give us flexibility to adjust the notional amount of the contracts based on payments made and changes in estimates of future losses. We do not apply hedge accounting to these contracts, and as a result, all gains (losses) are recognized in net realized investment gains. For the three months ended March 31, 2013 we recognized $0.5 million in foreign currency exchange gains related to the loss reserves recorded for these events, which were offset by $0.7 million in realized losses from the currency forward contracts. For the three months ended March 31, 2012 we recognized $2.3 million in foreign currency exchange losses related to the loss reserves recorded for these events and an additional $0.1 million in realized losses from the currency forward contracts.

Consolidated losses and loss adjustment expenses were $170.5 million and $165.8 million for the three months ended March 31, 2013 and 2012, respectively. Included in losses and loss adjustment expenses for the three months ended March 31, 2013 and 2012 was $1.9 million and $4.1 million, respectively, in catastrophe losses resulting from storm activity in the United States. Included in losses and loss adjustment expenses for the three months ended March 31, 2013 was $4.5 million in net favorable loss reserve development on prior accident years compared to $3.3 million in net favorable loss reserve development on prior accident years for the same period in 2012. The following table summarizes the reserve development as respects prior year loss reserves by line of business for the three months ended March 31, 2013:

                                                                Net Reserve Development                 Percent of
(in millions)                     2012 Net Reserves             (Favorable)/Unfavorable              2012 Net Reserves
General liability                $             919.9           $                    (5.0 )                         -0.5 %
Workers compensation                           365.3                                 0.2                            0.1 %
Commercial multi-peril                         195.2                                (1.3 )                         -0.7 %
Commercial auto
liability                                      165.1                                 3.3                            2.0 %
Reinsurance -
nonproportional assumed
property                                       122.9                                 1.5                            1.2 %
Special property                                21.6                                (0.2 )                         -0.9 %
Syndicate 1200 property                        140.1                                (1.7 )                         -1.2 %
Syndicate 1200 liability                       122.5                                (0.1 )                         -0.1 %
All other lines                                 58.3                                (1.2 )                         -2.1 %

Total                            $           2,110.9           $                    (4.5 )                         -0.2 %

In determining appropriate reserve levels at March 31, 2013, we maintained the same general processes and disciplines that were used to set reserves at prior reporting dates. No significant changes in methodologies were made to estimate the reserves since the last reporting date; however, at each reporting date we reassess the actuarial estimate of the reserve for loss and loss adjustment expenses and record our best estimate. Consistent with prior reserve valuations, as claims data becomes more mature for prior accident years, actuarial estimates were refined to weigh


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certain actuarial methods more heavily in order to respond to any emerging trends in the paid and reported loss data. These modifications to the analysis varied depending on whether the line of business was short-tailed or long-tailed and also varied by accident year. While prior accident years' net reserves for losses and loss adjustment expenses for some lines of business have developed favorably in recent years, this does not infer that more recent accident years' reserves also will develop favorably; pricing, reinsurance costs, the legal environment, general economic conditions including changes in inflation and many other factors impact management's ultimate loss estimates.

When determining reserve levels, we recognize that there are several factors that present challenges and uncertainties to the estimation of loss reserves. Examples of these uncertainties include changes to the reinsurance structure and potential increases in inflation. Our net retained losses vary by product and they have generally increased over time. To properly recognize these uncertainties, actuarial reviews have given significant consideration to the paid and incurred Bornhuetter-Ferguson ("BF") methodologies. Compared with other actuarial methodologies, the paid and incurred BF methods assign smaller weight to actual reported loss experience, with the greatest weight assigned to an expected or planned loss ratio. The expected or planned loss ratio has typically been determined using various assumptions pertaining to prospective loss frequency and loss severity. In setting reserves at March 31, 2013, we continued to consider the paid and incurred BF methods for recent years.

Our loss reserve estimates gradually blend in the results from development and frequency/severity methodologies over time. For general liability estimates, more credibility is assigned to our own loss experience approximately 60 to 72 months after the beginning of an accident year. For property business, our loss reserve estimates also blend in the results from development and frequency/severity methodologies over time. For property lines, in contrast to general liability estimates, full credibility is assigned to our loss experience approximately 18 to 36 months after the beginning of an accident year, where loss reporting and claims closing patterns settle more quickly. Our loss experience receives partial weighting in the estimates 12 to 24 months after the beginning of the accident year.

Consolidated loss reserves were $3,205.0 million (including $132.0 million of reserves attributable to the Syndicate 1200 segment's trade capital providers), and $3,267.2 million (including $181.9 million of reserves attributable to the Syndicate 1200 segment's trade capital providers) as of March 31, 2013 and 2012, respectively. Management has recorded its best estimate of loss reserves as of March 31, 2013 based on current known facts and circumstances. Due to the significant uncertainties inherent in the estimation of loss reserves, there can be no assurance that future loss development, favorable or unfavorable, will not occur.

In 2011, we entered into two reinsurance transactions with a special purpose reinsurance company which provided coverage through the issuance of two catastrophe bond transactions. The reinsurance transactions provide coverage for selected events. The initial catastrophe bond cover expired on December 31, 2012. In accordance with generally accepted accounting principles in the United States, we are accounting for these covers as derivatives, and as such, present the financial statement impact in a separate line item - "Other reinsurance-related expenses" - in the Consolidated Statements of Income. Other reinsurance-related expenses totaled $5.1 million and $6.9 million for the three months ended March 31, 2013 and 2012, respectively. As management views these coverages as reinsurance protection, we treat the financial statement effects of these covers as ceded premium for the purposes of calculating our loss, expense and combined ratios.

Consolidated underwriting, insurance and acquisition expenses were $126.7 million and $113.7 million for the three months ended March 31, 2013 and 2012, respectively. The increase in the dollar value of the expense was primarily attributable to increased acquisition costs due to the growth in premiums, coupled with a $5.5 million increase in equity compensation expenses due to the impact of the increase in our stock price on our cash-settled stock appreciation rights.

Consolidated interest expense was $4.9 million for the three months ended March 31, 2013 compared to $5.7 million for the same period in 2012. The decline in consolidated interest expense was the result of redemption of two fixed-rate junior subordinated debentures with the proceeds of the senior fixed rate notes, which bear a lower interest rate.


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Consolidated foreign currency exchange gain for the three months ended March 31, 2013 was $3.1 million compared to a foreign currency exchange loss of $2.9 million for the same period ended 2012. The increase to a foreign currency exchange gain was due to the U.S Dollar strengthening against the currencies in which we transact our business.

The consolidated provision for income taxes was $4.8 million for the three months ended March 31, 2013 compared to $8.5 million consolidated income tax provision for the same period ended 2012. The consolidated income tax provision represents the income tax expense associated with our operations based on the tax laws of the jurisdictions in which they operate. Therefore, the consolidated provision for income taxes represents taxes on net income for our United States, United Kingdom, Belgium, Brazil, Ireland and Switzerland operations. For the three months ended March 31, 2013 our operations in the United States generated lower taxable income as compared to 2012, resulting in a lower effective tax rate. Additionally for the three months ended March 31, 2013, our Bermuda operations, which are not subject to income taxes, reported net income compared to a net loss for the same period ended 2012.

Segment Results

We are primarily engaged in writing property and casualty insurance and reinsurance. We have four ongoing reporting segments: Excess and Surplus Lines, Commercial Specialty, International Specialty and Syndicate 1200. Additionally, we have a Run-off Lines segment for products that we no longer underwrite.

In evaluating the operating performance of our segments, we focus on core underwriting and investing results before consideration of realized gains or losses from the sales of investments. Management excludes realized investment gains and losses from segment results, as decisions regarding the sales of investments are made at the corporate level. Although this measure of profit
(loss) does not replace net income (loss) computed in accordance with GAAP as a measure of profitability, management uses this measure of profit (loss) to focus its reporting segments on generating operating income.

Since we generally manage and monitor the investment portfolio and indebtedness on an aggregate basis, the overall performance of the investment portfolio, including the related net investment income and interest expense, are discussed above on a consolidated basis under consolidated net investment income and consolidated interest expense rather than within or by segment. We allocate net investment income and interest expense to each segment based on their allocated capital and reserves, while taking into consideration the anticipated duration of these reserves.

Excess and Surplus Lines. The following table summarizes the results of operations for the Excess and Surplus Lines segment for the three months ended March 31, 2013 and 2012:

                                                          Three Months Ended
                                                               March 31,
     (in millions)                                        2013           2012
     Gross written premiums                             $   127.6       $ 107.3

     Earned premiums                                    $   105.1       $  96.2
     Losses and loss adjustment expenses                     58.6          52.2
     Other reinsurance-related expenses                       1.2           0.0
     Underwriting, acquisition and insurance expenses        40.7          35.8

     Underwriting income                                      4.6           8.2
     Net investment income                                   10.9          13.0
     Interest expense                                        (1.6 )        (2.3 )

     Income before income taxes                         $    13.9       $  18.9

     Loss ratio                                              56.5 %        54.2 %
     Expense ratio                                           39.1 %        37.3 %

     Combined ratio                                          95.6 %        91.5 %


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The increase in gross written and earned premiums for the three months ended March 31, 2013 as compared to the same period in 2012 was primarily attributable to increased premium writings in our casualty, property and environmental business units. The Excess and Surplus Lines segment has introduced several new products during 2012 and into 2013 to focus on future growth and profitability.

The increase in the loss ratio to 56.5% for the three months ended March 31, 2013 from 54.2% for the same period in 2012 was primarily attributable to lower favorable development on prior year loss reserves and $0.8 million of catastrophe losses being recognized in 2013. Included in losses and loss adjustment expenses for the three months ended March 31, 2013 was $5.2 million favorable development in the Excess and Surplus Lines segment primarily caused by favorable development of $5.9 million in the general and products liability lines and $3.3 million in commercial multi-peril liability, partially offset with $4.0 million of unfavorable development in commercial automobile. Included in losses and loss adjustment expenses for the three months ended March 31, 2012 was $9.3 million of favorable reserve development resulting principally from $6.8 million of favorable development in the general and products liability lines of business and $1.9 million of favorable development in the automobile liability lines of business. Loss reserves were $1,208.7 million and $1,271.2 million at March 31, 2013 and 2012, respectively.

The increase in the expense ratio for the three months ended March 31, 2013 as compared to the same period in 2012 was primarily attributable increased equity compensation expense due to the increase in our stock price.

Commercial Specialty. The following table summarizes the results of operations for the Commercial Specialty segment for the three months ended March 31, 2013 and 2012:

                                                          Three Months Ended
                                                               March 31,
     (in millions)                                        2013           2012
     Gross written premiums                             $   106.1       $ 107.7

     Earned premiums                                    $    75.2       $  82.0
     Losses and loss adjustment expenses                     47.5          59.3
     Other reinsurance-related expenses                       0.3           0.0
     Underwriting, acquisition and insurance expenses        26.4          28.7

     Underwriting income (loss)                               1.0          (6.0 )
     Net investment income                                    5.9           6.9
     Interest expense                                        (0.9 )        (1.4 )
     Fee income, net                                         (0.3 )         0.2

     Income (loss) before income taxes                  $     5.7       $  (0.3 )

     Loss ratio                                              63.4 %        72.4 %
     Expense ratio                                           35.2 %        35.0 %

     Combined ratio                                          98.6 %       107.4 %

The decline in gross written and earned premiums for the three months ended March 31, 2013 as compared to the same period ended 2012 was primarily due to reduced writings in our retail business and public entity units due to a planned reduction in writings as we exited unprofitable accounts and implemented underwriting initiatives, partially offset by increasing rates. Additionally, gross written and earned premiums declined for our mining products due to reduced payrolls from our coal mining accounts. Partially offsetting these declines was increased gross written premiums in the surety products, as this business unit continues to expand.


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The decline in the loss ratio for the three months ended March 31, 2013 as compared to the same period in 2012 was primarily from decreased catastrophe losses due to storms in the United States and decreased unfavorable loss reserve development on prior accident years. Catastrophe losses for the three months ended March 31, 2013 were $1.1 million compared to $2.3 million for the same period in 2012. Losses and loss adjustment expenses for the three months ended March 31, 2013 included $1.1 million of net unfavorable development primarily driven by $2.2 million unfavorable development in general liability due to increases in claim severity, offset by $1.0 million favorable development in the surety line of business at Rockwood. Losses and loss adjustment expenses for the three months ended March 31, 2012 included $4.6 million of net unfavorable loss reserve development on prior accident years driven by $9.4 million of unfavorable development in general liability due to increases in claim severity and $0.9 million of unfavorable development in the automobile liability lines of business. Partially offsetting this unfavorable development was $4.5 million of favorable development in workers compensation and $1.2 million of favorable development in short-tail lines. Loss reserves were $648.3 million and $619.3 million at March 31, 2013 and 2012, respectively.

The decline in the dollar value of underwriting, acquisition and insurance expense was primarily attributable to decreased acquisition costs due to the decline in premiums. Increased expense associated with the equity compensation awards was partially offset by increased ceding commissions.

International Specialty: The following table summarizes the results of operations for the International Specialty segment for the three months ended March 31, 2013 and 2012:

                                                          Three Months Ended
                                                               March 31,
     (in millions)                                        2013            2012
     Gross written premiums                             $    78.2        $ 57.6

     Earned premiums                                    $    32.7        $ 28.0
     Losses and loss adjustment expenses                     15.6          13.2
     Other reinsurance-related expenses                       1.5           2.3
     Underwriting, acquisition and insurance expenses        12.3           9.8

     Underwriting income                                      3.3           2.7
     Net investment income                                    2.3           4.1
     Interest expense                                        (0.8 )        (1.0 )

     Income before income taxes                         $     4.8        $  5.8

     Loss ratio                                              50.1 %        51.4 %
     Expense ratio                                           39.5 %        38.2 %

     Combined ratio                                          89.6 %        89.6 %

Gross written and earned premiums increased for the quarter ended March 31, 2013 primarily as a result of the business unit in Brazil, and increases in our excess casualty and professional liability business. The increase was also due to continued growth from our excess casualty and professional liability business. Earned premiums for the property catastrophe reinsurance unit were $17.1 million for the quarter ended March 31, 2013, in-line with earned premiums for the same period in 2012. The excess casualty and professional lines business contributed earned premiums of $5.6 million for the quarter ended March 31, 2013 compared with $4.4 million for the same period in 2012. Earned premium for the business unit in Brazil was $10.0 million for the quarter ended March 31, 2013 compared with $6.5 million in 2012.

Losses and loss adjustment expenses for the quarter ended March 31, 2013 included $0.9 million of unfavorable prior year development. This was comprised of $1.3 million of unfavorable prior year development on the property catastrophe reinsurance unit, primarily due to crop loss, offset by $0.5 million of favorable prior year development on the professional liability business. There were no catastrophe losses reported in the quarter ended March 31, 2013. Included in losses and loss adjustment expenses for the three months ended March 31, 2012 were $1.7 million of losses resulting from tornadoes in the United States. Losses and loss adjustment expenses also included $0.2 million of favorable loss reserve development on prior accident years primarily within the long-tail professional liability lines. Loss reserves were $260.7 million and $253.6 million at March 31, 2013 and 2012, respectively.


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The increase in the expense ratio for 2013 as compared to 2012 was primarily attributable to $5.6 million in expenses for the business unit in Brazil and expansion of our excess casualty and professional liability franchises.

Syndicate 1200: The following table summarizes the results of operations for the Syndicate 1200 segment for the three months ended March 31, 2013 and 2012:

                                                          Three Months Ended
                                                               March 31,
     (in millions)                                        2013           2012
     Gross written premiums                             $   126.1       $ 123.1
. . .
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