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AGII > SEC Filings for AGII > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for ARGO GROUP INTERNATIONAL HOLDINGS, LTD.

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


28-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the consolidated financial statements and related notes beginning on page F-1. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward looking statements as a result of various factors described in this report.

Consolidated Results of Operations

For the year ended December 31, 2013, we reported net income of $143.2 million, or $5.14 per fully diluted share. For the year ended December 31, 2012, we reported net income of $52.3 million, or $1.83 per fully diluted share. For the year ended December 31, 2011, we reported net loss of $81.9 million, or ($2.74) per fully diluted share.


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

                                                     Years Ended December 31,
    (in millions)                               2013           2012           2011
    Gross written premiums                    $ 1,888.4      $ 1,745.7      $ 1,544.8

    Earned premiums                           $ 1,303.8      $ 1,186.5      $ 1,082.0
    Net investment income                         100.0          118.8          125.8
    Fee (expense) income, net                      (4.9 )          5.3            1.4
    Net realized investment and other gains        71.3           25.7           49.2

    Total revenue                             $ 1,470.2      $ 1,336.3      $ 1,258.4

    Income (loss) before income taxes         $   179.7      $    66.7      $   (61.9 )
    Provision for income taxes                     36.5           14.4           20.0

    Net income (loss)                         $   143.2      $    52.3      $   (81.9 )

    Loss ratio                                     57.8 %         64.5 %         80.2 %
    Expense ratio                                  39.7 %         40.1 %         39.6 %

    Combined ratio                                 97.5 %        104.6 %        119.8 %

The increase in gross written and earned premiums for the year ended December 31, 2013 as compared to the same periods ended 2012 and 2011 was primarily attributable to growth in our United States and Syndicate 1200 segments, coupled with the start up of our Brazil operations. Earned premiums for our United States segments increased to $759.9 million (on gross written premiums of 1,016.8 million) for the year ended December 31, 2013 compared to $718.4 million (on gross written premiums of $957.3 million) and $721.2 million (on gross written premiums of $913.3 million) for the same periods in 2012 and 2011, respectively. The increase in earned premiums was primarily attributable to growth in our Excess and Surplus Lines segment. Partially offsetting these increases were declines in our Commercial Specialty segment due to planned reduction in our retail and public entity units. Earned premiums for our Syndicate 1200 segment increased to $401.7 million (on gross written premiums of $583.9 million) from $320.8 million (on gross written premiums of $533.4 million) and $259.3 million (on gross written premiums of $438.5 million) for the same periods ended 2012 and 2011, respectively. Growth was attributable to increases in our property and liability units, coupled with the introduction of the specialty and aerospace units in 2011, in addition to an increased participation on the Syndicate by the group during that period. Earned premiums for our Bermuda operations were $103.5 million (on gross written premiums of $222.1 million), $120.7 million (on gross written premiums of $208.2 million) and $101.5 million (on gross written premiums of $193.0 million) for the years ended December 31, 2013, 2012 and 2011, respectively. Declines in the property reinsurance market were offset by increased premium writings in our professional lines and excess casualty units. Our operations in Brazil, which began writing business in 2012, contributed $38.7 million of earned premiums (on gross written premiums of $65.6 million) for the year ended December 31, 2013 compared to $26.6 million (on gross written premiums of $46.8 million) for the same period ended 2012.

Consolidated net investment income decreased for the year ended December 31, 2013 as compared to the same periods ended 2012 and 2011 due primarily to the continued reinvestment at market yields below the portfolio's book yield, a shift in strategy towards slightly shorter duration investments and a movement of a portion of the portfolio out of traditional fixed income investments. Total invested assets at December 31, 2013 were $3,991.9 million, net of $87.3 million of invested assets attributable to Argo International's trade capital providers. Total invested assets at December 31, 2012 were $4,056.8 million, net of $143.9 million of invested assets attributable to such trade capital providers. Total invested assets at December 31, 2011 were $3,985.0 million, net of $162.5 million of invested assets attributable to such trade capital providers. The decline in total invested assets was primarily attributable to the transfer of assets as a result of our entering into a whole account quota share contract within our Syndicate 1200 segment.

Consolidated gross realized gains were $131.6 million for the year ended December 31, 2013, as compared to $54.4 million and $74.2 million in 2012 and 2011, respectively. The increase in the gross realized gains for the year ended December 31, 2013 was primarily attributable to $59.1 million in realized gains, from a target reduction in certain equity holdings. Consolidated gross realized losses were $60.3 million, $28.7 million and $25.0 million for the years ended December 31, 2013, 2012 and 2011, respectively. Included in gross realized losses for the year ended December 31, 2013 were $19.6 million and $30.8 million of losses on our fixed maturity and other invested assets portfolios, respectively, as we reduced our non-investment grade holdings. Included in consolidated gross realized losses for the years ended December 31, 2013, 2012 and 2011 were write downs of approximately $7.8 million, $3.7 million and $1.2 million, respectively, from the recognition of other-than-temporary impairments on certain investment securities.


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We have purchased foreign currency 90 day forward contracts to manage currency exposure on losses related to selected catastrophe events. The term of these contracts gives 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 and other gains. For the year ended December 31, 2013, we recognized $2.6 million in realized losses from the currency forward contracts. Foreign currency exchange losses related to the loss reserves recorded for these events were negligible for the year ended December 31, 2013. For the years ended December 31, 2012 and 2011, we recognized $0.5 million and $4.6 million, respectively, in realized gains from the currency forward contracts, which were offset by $0.6 million and $4.3 million, respectively, in foreign currency exchange losses related to the loss reserves recorded for these events. The foreign currency exchange 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 $742.0 million for the year ended December 31, 2013, compared to $747.6 million and $863.1 million for the same periods in 2012 and 2011, respectively. Included in losses and loss adjustment expense was $24.6 million in catastrophe losses primarily attributable to storm activity in the United States and Germany and to flooding in Europe and Canada. Included in losses and loss adjustment expense for the year ended December 31, 2013 were current accident year large losses of $16.8 million in our Excess and Surplus Lines, Commercial Specialty and International Specialty segments. Offsetting these 2013 accident year losses was $33.6 million in net favorable loss reserve development on prior accident years, primarily within our general liability lines of business.

Included in losses and loss adjustment expenses for the year ended December 31, 2012 was $75.2 million in catastrophe losses from storm activity in the United States, including Hurricane Sandy and Hurricane Isaac. Partially offsetting these catastrophe losses was $32.9 million in net favorable loss reserve development on prior accident years. The net favorable development was primarily attributable to our general liability, workers compensation and Syndicate 1200 property lines, partially offset by unfavorable development in our commercial multi-peril lines.

Included in losses and loss adjustment expenses for the year ended December 31, 2011 was $208.6 million in catastrophe losses resulting from the Japan and New Zealand earthquakes, storm activity in the United States and flooding in Australia and Thailand. Additionally, we recognized $9.3 million in losses under aggregate reinsurance covers. Partially offsetting these 2011 accident year losses was $3.4 million in net favorable loss reserve development on prior accident years. The net favorable development was primarily attributable to our general liability and workers compensation lines, partially offset by unfavorable development in our Syndicate 1200 property and liability lines, as well as our commercial multi-peril lines.

The following table summarizes the above referenced loss reserve development as respects to prior year loss reserves by line of business for the year ended December 31, 2013:

                                                                  Net Reserve
                                                                  Development          Percent of
                                                 2012 Net        (Favorable)/           2012 Net
(in millions)                                    Reserves         Unfavorable           Reserves
General liability                                $   919.9       $       (33.4 )              -3.6 %
Workers compensation                                 365.3                (6.5 )              -1.8 %
Commercial multi-peril                               195.2                 2.7                 1.4 %
Commercial auto liability                            165.1                12.8                 7.8 %
Reinsurance-nonproportional assumed property         122.9                 3.7                 3.0 %
Special property                                      21.6                (2.6 )             -12.0 %
Syndicate 1200 property                              140.1                (4.3 )              -3.1 %
Syndicate 1200 liability                             122.5                (0.3 )              -0.2 %
All other lines                                       58.3                (5.7 )              -9.8 %

Total                                            $ 2,110.9       $       (33.6 )              -1.6 %

In determining appropriate reserve levels for the year ended December 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 certain actuarial methods more heavily in order to respond to any emerging trends in the paid and reported loss data. 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 imply that more recent accident years' reserves also will develop favorably; pricing, reinsurance costs, legal environment, general economic conditions including changes in inflation and many other factors impact management's ultimate loss estimates.


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When determining reserve levels, we recognize that there are several factors that present challenges and uncertainties to the estimation of net 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 December 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, our own loss experience is not deemed fully credible for several years after the end of an accident year. We rely primarily on the BF methods during that period. 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, we give greater weight to development methods starting at the end of the accident year where loss reporting and claims closing patterns settle more quickly.

For the Run-off Lines segment, in determining appropriate reserve levels, we maintained the same general processes and disciplines that were used to set reserves at prior reporting dates. No changes in key assumptions were made to estimate the reserves since the last reporting date.

Consolidated gross reserves for loss and loss adjustment expense were $3,230.3 million (including $128.6 million of reserves attributable to Argo International's trade capital providers), $3,223.5 million (including $161.6 million of reserves attributable to the trade capital providers) and $3,291.1 million (including $196.6 million of reserves attributable to the trade capital providers) as of December 31, 2013, 2012 and 2011, respectively. Management has recorded its best estimate of loss reserves at each date 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. The second catastrophe bond cover expired on December 31, 2013. In accordance with generally accepted accounting principles in the United States ("GAAP"), 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 our Consolidated Statements of Income (Loss). Other reinsurance-related expenses totaled $19.2 million, $27.3 million and $5.9 million for the years ended December 31, 2013, 2012 and 2011, 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, acquisition and insurance expenses were $510.8 million, $464.5 million and $425.7 million for the years ended December 31, 2013, 2012 and 2011, respectively. The decrease in the consolidated expense ratio for 2013 as compared to 2012 was primarily attributable to reduced fixed costs as a percentage of earned premiums, partially offset by increased equity compensation expense due to the impact of the increase in our stock price on cash-settled equity awards. The increase in the consolidated expense ratio for 2012 as compared to 2011 reflects approximately $13.1 million of increased expense related to our investments in start-up operations abroad.

Consolidated interest expense was $20.2 million, $23.7 million and $22.1 million for the years ended December 31, 2013, 2012 and 2011, respectively. The decline in consolidated interest expense for the year ended December 31, 2013 as compared to 2012 was due to the redemption in November 2012 of the $118.6 million Capital Trust Securities with proceeds from the senior fixed rate notes, which bear a lower interest rate. The increase in interest expense for the year ended December 31, 2012 as compared to the same period in 2011 was primarily attributable to interest being accrued for both the Senior Notes (issued in September 2012) and $118.6 million of Capital Trust Securities prior to their redemption in November 2012.

Consolidated foreign currency exchange gains were $1.7 million for the year ended December 31, 2013 compared to foreign currency exchange losses of $4.3 million and $3.5 million for the years ended December 31, 2012 and 2011, respectively. 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.


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The consolidated provisions for income taxes were $36.5 million, $14.4 million and $20.0 million for the years ended December 31, 2013, 2012 and 2011, respectively. 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, Ireland, Belgium, Brazil, Switzerland and the United Kingdom operations. The consolidated tax provision for the year ended December 31, 2013 was primarily attributable to our United States operations and was primarily the result of the realized investment gains. The consolidated tax provision for the year ended December 31, 2012 primarily represents taxes on net income from our operations in the United States and United Kingdom. For the year ended December 31, 2011, the tax provision generated by our operations based in the United States was partially offset by tax benefits for our operations based 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.

We consider many factors, including the nature of each segment's insurance and reinsurance products, production sources, distribution strategies and regulatory environment, in determining how to aggregate reporting segments.

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. Intersegment transactions are allocated to the segment that initiated the transaction. Realized investment gains and losses are reported as a component of the Corporate and Other segment, as decisions regarding the acquisition and disposal of securities reside with the corporate investment function and are not under the control of the individual business segments. 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 our reporting segments on generating operating income.

Since we generally manage and monitor the investment portfolio on an aggregate basis, the overall performance of the investment portfolio, and related net investment income, is discussed above on a combined basis under consolidated net investment income rather than within or by segment.

Excess and Surplus Lines.

The following table summarizes the results of operations for the Excess and
Surplus Lines segment:



                                                              Years Ended December 31,
(in millions)                                          2013             2012             2011
Gross written premiums                               $   594.2        $   513.5        $   478.9

Earned premiums                                      $   460.2        $   399.3        $   405.3
Losses and loss adjustment expenses                      244.0            223.3            247.1
Other reinsurance-related expenses                         4.9              0.0              0.0
Underwriting, acquisition and insurance expenses         157.2            143.9            139.8

Underwriting income                                       54.1             32.1             18.4
Net investment income                                     42.2             51.1             56.0
Interest expense                                          (6.9 )           (9.1 )           (8.5 )

Income before income taxes                           $    89.4        $    74.1        $    65.9

Loss ratio                                                53.6 %           55.9 %           61.0 %
Expense ratio                                             34.5 %           36.0 %           34.5 %

Combined ratio                                            88.1 %           91.9 %           95.5 %

Loss reserves at December 31                         $ 1,171.8        $ 1,209.0        $ 1,271.8


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The increase in gross written and earned premiums for the year ended December 31, 2013 as compared to the same periods in 2012 and 2011 was primarily attributable to increased underwriting activity and rate increases in virtually all lines. Gross written premiums for our casualty unit increased to $199.2 million for the year ended December 31, 2013 from $158.9 million for 2012 and $149.1 million for 2011. Gross written premiums for our contract unit increased to $138.0 million for the year ended December 31, 2013 from $121.7 million for 2012 and $116.7 million for 2011. Gross written premiums for our property unit increased to $67.8 million for the year ended December 31, 2013 from $48.6 million for 2012 and $35.7 million for 2011. Partially offsetting these increases were reduced writings in the transportation unit, as we continued to exit unprofitable accounts.

Included in losses and loss adjustment expense for the year ended December 31, 2013 was $4.1 million in catastrophe losses from storm activity in the United States. Included in losses and loss adjustment expense for the year ended December 31, 2013 was $5.0 million related to current accident year large property losses. Offsetting these catastrophe losses was $43.9 million of net favorable loss reserve development on prior accident years primarily due to $55.8 million of favorable development in the general and products liability lines of business. Partially offsetting this net favorable development was $11.9 million of unfavorable development in commercial automobile lines.

Included in losses and loss adjustment expenses for the year ended December 31, 2012 was $12.6 million in catastrophe losses from storm activity in the United States, including $8.2 million from Hurricane Isaac and $2.6 million from Superstorm Sandy. Offsetting these catastrophe losses was $48.0 million of net favorable loss reserve development on prior accident years primarily attributable to $39.2 million of favorable development in the general and products liability lines of business.

Included in losses and loss adjustment expenses for the year ended December 31, 2011 was $7.6 million in catastrophe losses from storm activity in the United States, including the Alabama and Joplin, Missouri tornados and Hurricane Irene. Offsetting these catastrophe losses was $33.8 million of net favorable loss reserve development on prior accident years primarily resulting from $30.2 million of favorable development in the general and products liability lines of business.

The decline in the expense ratio for the year ended December 31, 2013 as compared to the same period in 2012 was primarily attributable to the increase in earned premiums, without a corresponding increase in fixed costs. The increase in the expense ratio for the year ended December 31, 2012 as compared to the same period in 2011 was primarily attributable to declining earned premiums.

Commercial Specialty

The following table summarizes the results of operations for the Commercial
Specialty segment:



                                                         Years Ended December 31,
  (in millions)                                       2013         2012         2011
  Gross written premiums                             $ 419.1      $ 437.0      $ 428.8

  Earned premiums                                    $ 299.0      $ 317.5      $ 316.7
  Losses and loss adjustment expenses                  194.0        257.0        236.4
  Other reinsurance-related expenses                     0.9          0.0          0.0
  Underwriting, acquisition and insurance expenses      97.4        108.3        106.7

  Underwriting income (loss)                             6.7        (47.8 )      (26.4 )
  Net investment income                                 22.8         27.6         27.7
  Interest expense                                      (3.8 )       (5.9 )       (5.0 )
  Fee (expense) income, net                             (4.3 )        1.3          0.1

  Income (loss) before income taxes                  $  21.4      $ (24.8 )    $  (3.6 )

  Loss ratio                                            65.1 %       81.0 %       74.6 %
  Expense ratio                                         32.7 %       34.1 %       33.7 %

  Combined ratio                                        97.8 %      115.1 %      108.3 %

  Loss reserves at December 31                       $ 653.4      $ 660.0      $ 622.8

The decline in gross written and earned premiums for the year ended December 31, 2013 as compared to the same periods ended 2012 and 2011 was primarily due to reduced writings 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. Gross written premiums for our retail business declined to $75.6 million for the year ended December 31, 2013 compared to $98.7 million for the same period ended 2012. Gross written premiums for our public entity unit declined to $99.9 million for the year ended December 31, 2013 compared to $124.4 million for the same period in 2012. Partially offsetting these declines was increased gross written premiums in our surety business and commercial programs units, as these business units continue to expand.


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