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

Show all filings for ARGO GROUP INTERNATIONAL HOLDINGS, LTD.

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


9-Aug-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 and six months ended June 30, 2013 compared with the three and six months ended June 30, 2012, and also a discussion of our financial condition as of June 30, 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               Six Months
                                               Ended June 30,            Ended June 30,
  (in millions)                              2013         2012         2013         2012
  Gross written premiums                    $ 542.2      $ 474.2      $ 980.4      $ 870.5

  Earned premiums                           $ 327.5      $ 290.2      $ 631.7      $ 567.5
  Net investment income                        25.3         30.0         53.2         61.4
  Fee income, net                               0.2          0.5          0.2          1.8
  Net realized investment and other gains      11.0         (2.7 )       20.5         10.4

  Total revenue                             $ 364.0      $ 318.0      $ 705.6      $ 641.1

  Income before income taxes                $  42.8      $  25.0      $  80.3      $  53.1
  Provision for income taxes                   11.1          1.0         15.9          9.5

  Net income                                $  31.7      $  24.0      $  64.4      $  43.6

  Loss ratio                                   59.7 %       62.1 %       58.4 %       61.7 %
  Expense ratio                                38.6 %       40.4 %       40.4 %       41.2 %

  Combined ratio                               98.3 %      102.5 %       98.8 %      102.9 %


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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 reductions in 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, the continued decline in portfolio yield and a modest repositioning of the portfolio away from long durations assets and investments with higher yields.

The increase in consolidated net realized investment gains for the three and six months ended June 30, 2013 was primarily attributable to the recognition of gains of certain fixed maturity and equity securities due to repositioning of the investment portfolio coupled with the increase in value of investments accounted for under the equity method of accounting. Net realized gains from the sales of equity investments were $6.5 million and $7.0 million for the three and six months ended June, 2013. Net realized gains from the sales of fixed maturity securities were $8.3 million and $13.3 million for the three and six months ended June 30, 2013. Other investments reported a realized loss of $3.3 million for the three months ended June 30, 2013, primarily attributable to foreign currency impact on our Fund's at Lloyd's investments and our foreign currency future forward contracts. For the six months ended June 30, 2013, other investments reported a realized gain of $5.5 million. Offsetting these realized gains were the recognition of $0.4 million and $5.2 million for the three and six months ended June 30, 2013, respectively, in other-than-temporary impairments on our equity and strategic investment portfolios.

We have purchased foreign currency future forward contracts to manage currency exposure on losses related to the New Zealand and Japan earthquakes and Australian floods. The open contracts have a term of 90 days to match the anticipated payment pattern of the associated losses, and may be renewed at the end of each term. We do not apply hedge accounting to these contracts; as a result, all gains (losses) were recognized in net realized investment gains (losses). For the three months ended June 30, 2013 we recognized $2.9 million in foreign currency exchange gains related to the loss reserves recorded for these events which were offset by $3.9 million in realized losses from the currency forward contracts. For the six months ended June 30, 2013, we recognized foreign currency exchange gains of $3.3 million related to the loss reserves recorded for these events which were offset by $4.6 million in realized losses from the currency forward contracts. The foreign currency exchange (gains) losses related to these loss reserves and the realized gains (losses) from the currency forward contracts are reported under the Corporate and Other segment.

Consolidated losses and loss adjustment expenses were $192.7 million and $175.8 million for the three months ended June 30, 2013 and 2012, respectively. Included in losses and loss adjustment expenses for the three months ended June 30, 2013 were current accident year large losses of $9.3 million. Also included in losses and loss adjustment expense for the three months ended June 30, 2013 was $10.5 million in catastrophe losses resulting from the European floods and storm activity in the United States. Offsetting these current accident year losses was $12.8 million of net favorable development on prior accident year loss reserves, primarily attributable to favorable development in the general liability and property lines partially offset by unfavorable development in the commercial automobile and reinsurance lines. Included in losses and loss adjustment expense for the three months ended June 30, 2012 was $3.9 million in catastrophe losses resulting from various United States storms. Additionally, included in losses and loss adjustment expense for the three months ended June 30, 2012 was $4.1 million in net favorable development on prior accident year loss reserves primarily attributable to favorable development in the general liability, property and reinsurance lines, partially offset by unfavorable development in the commercial multi peril and commercial automobile lines.

Consolidated losses and loss adjustment expenses were $363.2 million and $341.6 million for the six months ended June 30, 2013 and 2012, respectively. Included in losses and loss adjustment expense for the six months ended June 30, 2013 was $12.4 million in catastrophe losses compared to $8.1 million in catastrophe losses for the same period ended 2012. Included in losses and loss adjustment expenses for the six months ended June 30, 2013 was $17.3


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million in net favorable loss reserve development on prior accident years compared to $7.4 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 to prior year loss reserves by line of business for the six months ended June 30, 2013:

                                                              Net Reserve  Development                Percent of
(in millions)                     2012 Net Reserves            (Favorable)/Unfavorable             2012 Net Reserves
General liability                $             919.9          $                   (17.0 )                        -1.8 %
Workers compensation                           365.3                               (0.3 )                        -0.1 %
Commercial multi-peril                         195.2                               (0.5 )                        -0.3 %
Commercial auto liability                      165.1                                6.0                           3.6 %
Reinsurance -
nonproportional assumed
property                                       122.9                                2.7                           2.2 %
Special property                                21.6                               (1.4 )                        -6.5 %
Syndicate 1200 property                        140.1                               (4.0 )                        -2.9 %
Syndicate 1200 liability                       122.5                                0.4                           0.3 %
All other lines                                 58.3                               (3.2 )                        -5.5 %

Total                            $           2,110.9          $                   (17.3 )                        -0.8 %

In determining appropriate reserve levels at June 30, 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 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 these retentions 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 June 30, 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 $3,233.9 million (including $129.9 million of reserves attributable to Syndicate 1200 segment's trade capital providers), and $3,223.1 million (including $173.2 million of reserves attributable to Syndicate 1200 segment's trade capital providers) as of June 30, 2013 and 2012, respectively. Management has recorded its best estimate of loss reserves as of June 30, 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.


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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 $4.7 million and $9.8 million for the three and six months ended June 30, 2013, compared to $6.9 million and $13.8 million for the three and six months ended June 30, 2012. 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 $124.6 million and $251.3 million for the three and six months ended June 30, 2013, respectively, compared to $114.6 million and $228.3 million for the same period in 2012. The increase in the dollar value of the expense was primarily attributable to increased acquisition costs due to the growth in premiums, coupled with increases in equity compensation expenses due to the impact of the increase in our stock price on our cash-settled stock appreciation rights. The decline in the expense ratio for the period in 2013 as compared to 2012 was attributable to the increase premium volumes without a corresponding increase in fixed costs.

Consolidated interest expense was $5.1 million and $10.0 million for the three and six months ended June 30, 2013 compared to $5.5 million and $11.2 million for the same periods in 2012. The decline in consolidated interest expense was the result of redemption in November 2012 of two fixed-rate junior subordinated debentures with the proceeds of the senior fixed rate notes, which bear a lower interest rate.

Consolidated foreign currency exchange gains for the three and six months ended June 30, 2013 were $5.9 million and $9.0 million, respectively, compared to $9.8 million and $6.9 million for the same periods ended 2012. The changes in the foreign currency exchange gains were due to fluctuations of the U.S Dollar, on a weighted average basis, against the currencies in which we transact our business.

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. The consolidated provision for income taxes was $11.1 million for the three months ended June 30, 2013 compared to $1.0 million consolidated income tax provision for the same period ended 2012. For the three months ended June 30, 2013 our operations in the United States and the United Kingdom generated higher taxable income as compared to 2012, resulting in a higher effective tax rate. Additionally for the three months ended June 30, 2013, our Bermuda operations, which are not subject to income taxes, reported lower net income compared to same period ended 2012. The consolidated provision for income taxes was $15.9 million and $9.5 million for the six months ended June 30, 2013 and 2012, respectively. The increased effective tax rate for 2013 as compared to 2012 was primarily attributable to higher taxable income in the United Kingdom.

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.


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Since we generally manage and monitor the investment portfolio and indebtedness on an aggregate basis, 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 and six months ended June 30, 2013 and 2012:

                                                       Three Months Ended             Six Months Ended
                                                           June  30,                     June  30,
(in millions)                                         2013            2012           2013          2012
Gross written premiums                              $   175.8        $ 143.9       $  303.4       $ 251.2

Earned premiums                                     $   108.7        $  98.5       $  213.8       $ 194.7
Losses and loss adjustment expenses                      62.5           52.6          121.1         104.8
Other reinsurance-related expenses                        1.3            0.0            2.5           0.0
Underwriting, acquisition and insurance expenses         37.6           34.6           78.3          70.4

Underwriting income                                       7.3           11.3           11.9          19.5
Net investment income                                    11.2           13.0           22.1          26.0
Interest expense                                         (1.8 )         (2.0 )         (3.4 )        (4.3 )

Income before income taxes                          $    16.7        $  22.3       $   30.6       $  41.2

Loss ratio                                               58.1 %         53.4 %         57.3 %        53.8 %
Expense ratio                                            35.1 %         35.2 %         37.1 %        36.2 %

Combined ratio                                           93.2 %         88.6 %         94.4 %        90.0 %

The increase in gross written and earned premiums for the three and six months ended June 30, 2013 as compared to the same periods in 2012 was primarily attributable to increased underwriting and rate increases in virtually all lines. 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 for the three months ended June 30, 2013 as compared to the same period ended 2012 was primarily attributable to increased catastrophe losses and lower net favorable development on prior accident year reserves. Catastrophe losses for the three months ended June 30, 2013 and 2012 were $2.6 million and $2.1 million, respectively, resulting from storms in the United States. Included in losses and loss adjustment expenses for the three months ended June 30, 2013 was $9.2 million in net favorable development on prior accident year loss reserves consisting of $10.7 million of favorable development in the general and product liability lines, partially offset by $0.8 million of unfavorable development in the commercial auto lines and $0.8 million in unfavorable development in the property lines. Included in losses and loss adjustment expenses for the three months ended June 30, 2012 was $12.4 million in net favorable development on prior accident year loss reserves consisting of $11.4 million of favorable development in the general and products liability lines, primarily in accident year 2009, and $1.3 million of favorable development in property lines, primarily in accident year 2010. This was partially offset by unfavorable development of $0.5 million in auto liability, primarily in accident years 2010 and 2011.

Catastrophe losses for the six months ended June 30, 2013 and 2012 were $3.4 million and $2.2 million, respectively, resulting from storms in the United States. Included in losses and loss adjustment expenses for the six months ended June 30, 2013 was $14.4 million in net favorable development on prior accident year loss reserves consisting of $19.9 million of favorable development in the general and product liability lines, partially offset by $4.7 million of unfavorable development in the commercial auto lines and $0.9 million in unfavorable development in the property


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lines. Included in losses and loss adjustment expenses for the six months ended June 30, 2012 was $21.7 million in favorable development in prior accident year loss reserves consisting of $18.1 million of favorable development in the general and products liability lines of business primarily in accident year 2009, $2.0 million of favorable development in the property lines, primarily in accident year 2010, and $1.4 million of favorable development in the automobile liability lines of business, primarily in accident year 2009. Loss reserves were $1,200.5 million and $1,260.3 million at June 30, 2013 and 2012, respectively.

The decline in the expense ratio for the three months ended June 30, 2013 as compared to the same period in 2012 was primarily attributable to increased premium volumes. The increase in the expense ratio for the six months ended June 30, 2013 as compared to the same period in 2012 was primarily attributable to 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 and six months ended June 30, 2013 and 2012:

                                                 Three Months Ended               Six Months Ended
                                                      June  30,                       June 30,
(in millions)                                   2013             2012            2013           2012
Gross written premiums                        $    85.6         $  92.7        $  191.7        $ 200.4

Earned premiums                               $    75.3         $  81.2        $  150.5        $ 163.2
Losses and loss adjustment expenses                50.9            67.1            98.4          126.4
Other reinsurance-related expenses                  0.1             0.0             0.4            0.0
Underwriting, acquisition and insurance
expenses                                           27.1            28.3            53.5           57.0

Underwriting income (loss)                         (2.8 )         (14.2 )          (1.8 )        (20.2 )
Net investment income                               6.1             7.0            12.0           13.9
Interest expense                                   (0.9 )          (1.4 )          (1.8 )         (2.8 )
Fee income, net                                    (0.9 )          (0.2 )          (1.2 )          0.0

Income (loss) before income taxes             $     1.5         $  (8.8 )      $    7.2        $  (9.1 )

Loss ratio                                         67.6 %          82.6 %          65.5 %         77.5 %
Expense ratio                                      36.2 %          34.8 %          35.7 %         34.9 %

Combined ratio                                    103.8 %         117.4 %         101.2 %        112.4 %

The decline in gross written and earned premiums for the three and six months ended June 30, 2013 as compared to the same periods ended 2012 was primarily due to reduced underwriting in our retail business and public entity units due to planned reductions as we exited unprofitable accounts and implemented underwriting initiatives, partially offset by increasing rates. Partially offsetting these declines was increased gross written premiums in our surety business, as this business unit continues to expand.

The decline in the loss ratio for the three months ended June 30, 2013 as compared to the same period in 2012 was attributable to net favorable development on prior accident year reserves during 2013 versus net unfavorable development in 2012, partially offset by an increase in the current accident . . .

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