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AHL > SEC Filings for AHL > Form 10-K on 20-Feb-2014All Recent SEC Filings




Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following is a discussion and analysis of our financial condition and results of operations for the twelve months ended December 31, 2013, 2012 and 2011. This discussion and analysis should be read in conjunction with our audited consolidated financial statements and related Notes contained in this report. This discussion contains forward-looking statements that involve risks and uncertainties and that are not historical facts, including statements about our beliefs and expectations. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and particularly under the headings "Risk Factors," "Business" and "Forward-Looking Statements" contained in Item 1A, Item 1, and Part I of this report, respectively. Aspen's Year in Review
Our overall results for 2013 were strong delivering a return on equity of 10.6% for 2013 compared to 8.5% for 2012. Our reinsurance segment contributed $253.1 million to our results with lower catastrophe and attritional losses than in the prior year and favorable reserve developments in all lines of business. Our insurance segment had an overall loss of $43.9 million, driven by significant losses in the marine, aviation, energy and construction line of business, partially offset by the remaining four lines of business being profitable. The losses in the marine, aviation, energy and construction line of business were due to adverse loss development in the M.E.C. liability account which had an increased frequency of mid-sized energy and construction losses. Please refer to "Reserves for Losses and Loss Adjustment Expenses" below for further discussion. Turning to our investments, in light of the continuing low interest rate environment, we took advantage of opportunities to further diversify our investment portfolio by investing in EMD, BB High Yield Bonds and BB Bank Loans as well as increasing our investments in equities. However, our net investment income for 2013 was $186.4 million, a decrease from $204.9 million in 2012. Insurance. In 2013, we made significant progress in executing our strategic objectives to increase our insurance operations both geographically and in the level of premiums written. We continued to build our U.S. insurance operations with the establishment of a U.S. based property-focused onshore marine, energy and construction team, complementing our product offering across our marine, aviation, energy and construction line of business. Gross written premium for the segment increased by 11.6% reflecting significant growth in the U.S. combined with increases in several of our international accounts. Our combined ratio was 103.9% in 2013 compared to 99.3% in 2012.
Reinsurance. In reinsurance, notwithstanding challenging market conditions in certain lines of business, we continued to focus on growth in regional areas and we established Aspen Capital Markets in April 2013 to expand Aspen Re's participation in the alternative reinsurance market. The focus of the team is to develop alternative reinsurance structures to leverage Aspen Re's existing underwriting franchise, increase its operational flexibility in the capital markets and provide investors direct access to its underwriting expertise. Silverton, our sidecar, was established in 2013 to provide quota share support to Aspen Re's global property catastrophe excess of loss reinsurance business in light of these objectives. Gross written premium, in line with expectations and prevailing market conditions, reduced by 7.7%. The reinsurance segment's combined ratio was 76.4% in 2013 compared to 85.4% in 2012.
Capital Management. In early 2013, we undertook a strategic review of the businesses we write that was exposed to catastrophe in the U.S. and we concluded that the earnings from our U.S. property insurance portfolio were excessively volatile as a result of inadequate original rates for catastrophe exposure that left insufficient margin for expenses and non-catastrophe attritional claims. Therefore, we implemented a controlled reduction of our U.S. wind and earthquake exposure within our U.S. property insurance account through purchasing additional reinsurance which resulted in a significant release of capital contributing to the surplus capital available for our share repurchases in 2013. In 2013, we continued our strategy to return excess capital to shareholders with the repurchase of 8,461,174 shares for a total consideration of $309.6 million. We redeemed our $250 million 6.00% Senior Notes due August 14, 2014 following the issuance of $300 million of Senior Notes due November 15, 2023 (the "2023 Senior Notes") at a favorable interest rate of 4.65%. We also opportunistically redeemed our 5.625% Perpetual PIERS ($230 million), which had an adverse impact on our dilutive shares with the proceeds from a new issuance of $275 million of 5.95% Perpetual Preference Shares. In the second quarter of 2013, we increased our quarterly dividend on our ordinary shares from $0.17 to $0.18 per ordinary share.

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Financial Overview
The following overview of our 2013, 2012 and 2011 operating results and financial condition is intended to identify important themes and should be read in conjunction with the more detailed discussion further below. Operating highlights
Annualized net income return on average equity of 10.6% for 2013 compared with 8.5% in 2012 and (4.8)% in 2011.

Gross written premiums of $2,646.7 million for 2013, an increase of 2.5% compared with 2012 and 19.9% compared to 2011.

Combined ratio for 2013 of 92.6%, including $101.9 million, or 4.6 percentage points of pre-tax catastrophe losses, net of reinsurance and reinstatements, compared with 94.3% for 2012, which included $205.0 million or 10.8 percentage points of pre-tax catastrophe losses, net of reinsurance and reinstatements and 115.9% for 2011, which included 31.5 percentage points of pre-tax catastrophe losses, net of reinsurance and reinstatements.

Net favorable development on prior year loss reserves of $107.7 million, or 5.0 combined ratio points, for 2013 compared with $137.4 million, or 6.6 combined ratio points, for 2012, or $92.3 million, or 4.9 combined ratio points, for 2011.

Gross written premiums. The changes in our segments' gross written premiums for the twelve months ended December 31, 2013, 2012 and 2011 are as follows:

                                        Gross Written Premiums for the Twelve Months Ended December 31,
Business Segment                          2013                              2012                       2011
                              ($ in millions)     % change       ($ in millions)     % change      (in millions)
Reinsurance                  $       1,133.9         (7.7 )%   $         1,227.9         3.4 %   $       1,187.5
Insurance                            1,512.8         11.6  %             1,355.4        32.8 %           1,020.3
Total                        $       2,646.7          2.5  %   $         2,583.3        17.0 %   $       2,207.8

Gross written premium increased 2.5% in 2013 compared to 2012 due to increases from our insurance lines, mainly in the U.S. This has been partially offset by reductions across our reinsurance lines of business. The increase in gross written premiums in the insurance segment is mainly attributable to our casualty, financial and professional lines and programs business in the U.S., with casualty also benefiting from growth in our U.K.-based business. The decrease in gross written premiums in the reinsurance segment was across all lines and reflects challenging market conditions particularly in property catastrophe lines, higher commutations in casualty and specialty lines and adverse prior year premium adjustments in other property lines as well as rate pressures.
Gross written premiums increased by 17.0% in 2012 compared to 2011 due predominantly to the continued development of our U.S. insurance platform. The increase in gross written premiums in the insurance segment was across all lines, but was mainly attributable to our property and programs business. Increases in gross written premiums in our marine, aviation, energy and construction insurance lines were mainly due to increased premiums for marine, energy and liability business which achieved significant rate increases following a series of industry losses in recent years. The increase in gross written premiums in the reinsurance segment arose from other property and casualty reinsurance business. The increase in other property was due to strong production from our proportional treaty and facultative business as we benefited from positive pricing momentum in catastrophe-exposed accounts while casualty benefited from favorable prior year premium adjustments. In 2013, we recognized $6.8 million of reinstatements premiums associated with German hailstorms and Central European and Canadian floods, while in 2012, we recognized a total of $23.3 million of reinstatement premiums associated with catastrophe events, $22.1 million of which were associated with Superstorm Sandy.

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Combined ratio. We monitor the ratio of losses and expenses to net earned premium (the "combined ratio") as a measure of relative performance where a lower ratio represents a better result than a higher ratio. The combined ratios for our two business segments for the twelve months ended December 31, 2013, 2012 and 2011 were as follows:

Combined Ratios for the Twelve Months Ended December 31,

Business Segment          2013                   2012                  2011
Reinsurance                   76.4 %               85.4 %                 125.6 %
Insurance                    103.9 %               99.3 %                  96.1 %
Total                         92.6 %               94.3 %                 115.9 %

The combined ratio for 2013 decreased by 1.7 percentage points compared to 2012, primarily due to a reduction in pre-tax catastrophe losses, net of reinsurance and reinstatements of $205.0 million in 2012 to $101.9 million in 2013, partially offset by reduction of $29.7 million in prior year reserve releases and a $23.0 million increase in expenses.
The combined ratio for 2012 decreased by 21.6 percentage points compared to 2011. The decrease was primarily due to a $329.3 million reduction in pre-tax catastrophe losses, net of reinsurance and reinstatements from major natural catastrophes from $534.3 million in 2011 to $205.0 million in 2012 but was partially offset by an increase in the expense ratio.
In each of the years ended December 31, 2013, 2012 and 2011, we recorded a reduction in the level of reserves for prior years. In 2013, we reported net favorable development on prior year loss reserves of $107.7 million, or 5.0 combined ratio points, compared with $137.4 million, or 6.6 combined ratio points, for 2012, and $92.3 million, or 4.9 combined ratio points, for 2011. Reserve releases decreased by $29.7 million in 2013 due to a net reserve strengthening in our insurance segment of $14.9 million in 2013 principally in the marine, aviation, energy and construction line, compared to a $35.2 million reserve release in 2012. The reinsurance segment had a reserve release of $122.6 million compared to $102.2 million in 2012.
Reserve releases increased by $45.1 million in 2012 due mainly to a net reserve release of $102.2 million for our reinsurance segment compared to net reserve release of $72.3 million for our reinsurance segment in 2011. Reserve releases were lower in 2011 due to less favorable developments impacting our reinsurance segment, particularly property lines, while our insurance segment strengthened reserves in our financial and professional lines.
Further information relating to the release of reserves can be found below under "- Reserves for Losses and Loss Adjustment Expenses - Prior Year Loss Reserves." Amortization of deferred policy acquisition costs increased in 2013 compared to 2012, and in 2012 compared to 2011, in line with premium growth in our U.S. insurance operations and due mainly to adjustments in profit-related commission accruals. General, administrative and corporate expenses have increased to $368.1 million in 2013 from $345.1 million in 2012 and $284.5 million in 2011. The increase in 2013 is due to an increase in staff costs, performance-related accruals and other costs associated with the continued build out of our U.S. insurance. General, administrative and corporate expense increased in 2012 compared to 2011 due to increases in costs associated mainly with the continued build out of our U.S. insurance and U.K. regional platforms.
Net investment income. In 2013, we generated net investment income of $186.4 million, a decrease of 9.0% on the prior year (2012 - $204.9 million; 2011 - $225.6 million). Net investment income has steadily declined over the years from 2011 to 2013, due to the continuing decline in our reinvestment rate reflecting lower yields on investment grade fixed income securities. Lower reinvestment rates and declining book yields from fixed income securities were partially offset by $12.6 million of dividend income from our global equity securities portfolio in 2013 compared with $6.2 million in 2012 and $6.1 million in 2011. As mentioned above, we have invested in EMD, BB Bank Loans and BB High Yield Bonds and have increased our investments in equities.
Taxes. We recognized a tax expense in 2013 of $13.4 million (2012 - $15.0 million expense; 2011 - $37.2 million credit), equivalent to a consolidated rate on income before tax of 3.9% in 2013 compared to 5.1% in 2012 and 25.3% tax credit in 2011. The effective tax rate has reduced in 2013 due to the reduction in U.K. corporate tax rate from 24% to 23%. The tax in each of the years is representative of the geographic spread of our business between taxable and non-taxable jurisdictions in such years. The tax credit in 2011 was due to a greater proportion of losses having been incurred by Operating Subsidiaries in tax paying jurisdictions, adjustments to prior years' tax provisions as well as reductions in the U.K. corporation tax rates.
Net income. For 2013, we reported income after taxes of $329.3 million, compared to income after taxes of $280.4 million in 2012, and a loss after taxes of $110.1 million in 2011. The increase in net income in 2013 over 2012 was due to the $39.3

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million increase in underwriting income resulting from higher earned premiums, and lower catastrophe losses combined with a $9.6 million increase in realized and unrealized investment gains and losses and a $29.7 million increase in fair value of derivatives compensating for an $18.5 million reduction in investment income. The increase in net income after tax in 2012 over 2011 was due primarily to the $417.7 million increase in underwriting income, principally due to a reduction in catastrophe losses of $298.7 million from 2011 to 2012. Other comprehensive income. Total other comprehensive income decreased by $206.8 million (2012 - loss of $106.1 million), net of taxes, for the twelve months ended December 31, 2013. This is comprised of a $161.3 million loss in the net unrealized available for sale investment portfolio (2012 - $7.8 million unrealized gain) largely attributable to the impact of rising interest rates on our bond portfolios, $23.4 million reclassification of net realized losses to net income (2012 - $2.0 million reclassified realized losses) and an unrealized loss in foreign currency translation of $24.1 million (2012 - $11.5 million unrealized loss).
Dividends. In April 2013, the Board approved an increase in the quarterly dividend on our ordinary shares from $0.17 per ordinary share to $0.18 per ordinary share (2012 - $0.17 quarterly dividend; 2011 - $0.15 quarterly dividend). Dividends paid on the preference shares in 2013 were $35.5 million (2012 - $31.1 million; 2011 - $22.8 million). The increase from 2011 was due to the issuance in April 2012 of an additional series of $160.0 million of preference shares. The increase in the dividends paid in 2013 was due to the additional issuance of a series of preference shares on May 2, 2013 for $275.0 million and issue expenses of $4.4 million, offset by the redemption of the 5.625% Perpetual PIERS on May 30, 2013 for which dividends are no longer paid. Shareholders' equity and financial leverage. Total shareholders' equity reduced by $188.8 million from $3,488.4 million as at December 31, 2012 to $3,299.6 million at December 31, 2013. The most significant movements were:
the net proceeds of $270.6 million from the issuance of the 5.95% Perpetual Preference Shares;

a $239.3 million increase in retained earnings for the period;

the redemption of all of our 5.625% Perpetual PIERS with a liquidation preference of $50.00 for an aggregate amount of $230.0 million;

a reduction in accumulated other comprehensive income of $208.3 million;

the repurchase of 4,407,898 ordinary shares for $159.6 million through open market and other repurchases; and

the repurchase of 4,053,276 ordinary shares for $150.0 million through an accelerated share repurchase.

As at December 31, 2013, our total shareholders' equity included preference shares with a total value as measured by their respective liquidation preferences of $568.2 million (2012 - $523.2 million) less issue costs of $12.4 million (2012 - $15.1 million).

On May 2, 2013, we issued 11.0 million shares of 5.95% Perpetual Preference Shares. The 5.95% Perpetual Preference Shares have a liquidation preference of $25.00 per share and net proceeds were $270.6 million (comprising $275.0 million of total liquidation preference less $4.4 million of issue expenses). On May 30, 2013, we redeemed all of our 5.625% Perpetual PIERS with a liquidation preference of $50.00 for an aggregate amount of $230.0 million. We also issued a total of 1,835,860 ordinary shares in connection with the redemption of the 5.625% Perpetual PIERS.
Our senior notes were the only material debt issued by Aspen Holdings as of December 31, 2013 and 2012 of $549.0 million and $499.1 million, respectively. Management monitors the ratio of debt to total capital, with total capital being defined as shareholders' equity plus outstanding debt. As at December 31, 2013, this ratio was 15.4% (2012 - 12.5%).
In addition to the senior debt issued by Aspen Holdings, we have also reported $50.0 million of debt issued by Silverton. For further information relating to Silverton, refer to Note 19(c) of our consolidated financial statements, "Commitments and Contingencies."
Our preference shares are classified in our balance sheet as equity but may receive a different treatment in some cases under the capital adequacy assessments made by certain rating agencies. We also monitor the ratio of the total debt and the liquidation preference of our preference shares to total capital which was 29.6% as of December 31, 2013 (2012 - 25.3%). Diluted book value per ordinary share at December 31, 2013 was $40.90, an increase of 0.6% compared to $40.65 at December 31, 2012.
Book value per ordinary share is based on total shareholders' equity, less preference shares (liquidation preference less issue expenses), divided by the number of ordinary shares in issue at the end of the period.

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Balances as at December 31, 2013 and 2012 were:
                                                     As at December 31, 2013        As at December 31, 2012
                                                            ($ in millions, except for share amounts)
Total shareholders' equity                          $              3,299.6         $              3,488.4
Preference shares less issue expenses                               (555.8 )                       (508.1 )
Non-controlling interests                                              0.3                           (0.2 )
Net assets attributable to ordinary shareholders    $              2,744.1         $              2,980.1
Issued ordinary shares                                          65,546,976                     70,753,723
Issued and potentially dilutive ordinary shares                 67,089,572                     73,312,340

Market Conditions, Rate Trends and Developments in 2013 and Early 2014 Overall. The overall pricing environment in which we operate continues to be varied and highly dynamic.
Reinsurance. Currently in the reinsurance market the rate dynamics are evolving rapidly. The January 1 renewal season, which is a significant renewal date in the reinsurance market, again saw an influx of new capital. We view the increased amount of capital in the reinsurance market less as a developing story and more as the new norm. This renewal season saw a further increase in the level of supply in the market which was coupled with a decrease in demand. Companies reassessed their reinsurance needs to take advantage of both higher levels of capital on their balance sheets and the declining rate environment. Nevertheless, we were able to grow our premiums while maintaining the same amount of net exposure by utilizing our relationships with third party capital as well as taking advantage of less expensive retrocession.
In casualty reinsurance and the less catastrophe-exposed property lines, the January 1 renewal rates were broadly stable to slight reductions of approximately 2 to 3%. In property catastrophe however, the influx of new capital was most pronounced. This resulted in the most intense competition during the January renewals and rates are under significant pressure. At January 1, for the property catastrophe market as a whole, rates were down approximately 15%, with European property catastrophe experiencing rate decreases of approximately 10% to 15% whereas U.S. property catastrophe was more pressured with rate decreases between 15% and 20%. Within our property catastrophe account, we limited the overall rate reduction to approximately 12% for the January renewals. In the case of retrocession, where we are a buyer of reinsurance and not a seller, we benefited from rates declining in the range of 25 to 35%.
Insurance. January 1 is not a major renewal date for insurance overall. For the U.S. primary insurance market overall at the January renewals, rates increased yet at a more modest pace than a year ago. For the majority of international lines, the rates are holding firm. There are a few lines which previously experienced loss activity and are now showing rate increases. Conversely, a few specialized areas such as aviation and offshore energy property in the Gulf of Mexico are experiencing downward pressure. Recent Developments
From January 1, 2014 to February 14, 2014, we repurchased 715,505 ordinary shares at an average price of $40.16 per share for a total cost of $28.7 million.

Critical Accounting Policies
Our consolidated financial statements contain certain amounts that are inherently subjective in nature and require management to make assumptions and best estimates to determine the reported values. We believe that the following critical accounting policies affect the more significant estimates used in the preparation of our consolidated financial statements. A statement of all the significant accounting policies we use to prepare our financial statements is included in the Notes to the consolidated financial statements. If factors such as those described in Part I, Item 1A, "Risk Factors" cause actual events to differ from the assumptions used in applying the accounting policy and calculating financial results, there could be a material adverse effect on our operating results, financial condition and liquidity.

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Written Premiums
Written premiums are comprised of the estimated premiums on contracts of insurance and reinsurance entered into in the reporting period, except in the case of proportional reinsurance contracts, where written premium relates only to our estimated proportional share of premiums due on contracts entered into by the ceding company prior to the end of the reporting period.
All premium estimates are reviewed regularly, comparing actual reported premiums to expected ultimate premiums along with a review of the collectability of premiums receivable. Based on management's review, the appropriateness of the premium estimates is evaluated, and any adjustments to these estimates are recorded in the periods in which they become known. Adjustments to original premium estimates could be material and these adjustments may directly and significantly impact earnings in the period they are determined because the subject premium may be fully or substantially earned.
We refer to premiums receivable which are not fixed at the inception of the contract as adjustment premiums. The proportion of adjustment premiums included in the premium estimates varies between business lines with the largest adjustment premiums associated with property and casualty reinsurance business and the smallest with property and liability insurance lines.
Adjustment premiums are most significant in relation to reinsurance contracts. Different considerations apply to non-proportional and proportional treaties as follows:
Non-proportional treaties. A large number of the reinsurance contracts we write are written on a non-proportional or excess of loss treaty basis. As the ultimate level of business written by each cedant can only be estimated at the time the reinsurance is placed, the reinsurance contracts generally stipulate a minimum and deposit premium payable under the contract with an adjustable premium determined by variables such as the number of contracts covered by the reinsurance, the total premium received by the cedant and the nature of the exposures assumed. Minimum and deposit premiums generally cover the majority of premiums due under such treaty reinsurance contracts and the adjustable portion of the premium is usually a small portion of the total premium receivable. For excess of loss contracts, the minimum and deposit premium, as defined in the contract, is generally considered to be the best estimate of the contract's written premium at inception. Accordingly, this is the amount we generally record as written premium in the period the underlying risks incept. During the life of a contract, notifications from cedants and brokers may affect the estimate of ultimate premium and result in either increases or reductions in reported revenue. Changes in estimated adjustable premiums do not generally have a significant impact on short-term liquidity as the payment of adjustment premiums generally occurs after the expiration of a contract.
Many non-proportional treaties also include a provision for the payment to us by the cedant of reinstatement premiums based on loss experience under such contracts. Reinstatement premiums are the premiums charged for the restoration of the reinsurance limit of an excess of loss contract to its full amount after payment by the reinsurer of losses as a result of an occurrence. These premiums relate to the future coverage obtained during the remainder of the initial policy term and are included in revenue in the same period as the corresponding losses.
Proportional treaties ("treaty pro rata"). Estimates of premiums assumed under treaty pro rata reinsurance contracts are recorded in the period in which the underlying risks are expected to incept and are based on information provided by brokers and ceding companies and estimates of the underlying economic conditions at the time the risk is underwritten. We estimate premium receivable initially and update our estimates regularly throughout the contract term based on treaty . . .

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