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TWGP > SEC Filings for TWGP > Form 10-Q on 19-Jun-2014All Recent SEC Filings

Show all filings for TOWER GROUP INTERNATIONAL, LTD.

Form 10-Q for TOWER GROUP INTERNATIONAL, LTD.


19-Jun-2014

Quarterly Report


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

Note on Forward-Looking Statements

Some of the statements under "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business" and elsewhere in this Form 10-Q may include forward-looking statements that reflect our current views with respect to future events and financial performance. These statements include forward-looking statements both with respect to us specifically and to the insurance sector in general. Statements that include the words "expect," "intend," "plan," "believe," "project," "estimate," "may," "should," "anticipate," "will" and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the Federal securities laws or otherwise.

All forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are, or will be, important factors that could cause our actual results to differ materially from those indicated in these statements. We believe that these factors include, but are not limited to, those described under "Risk Factors" and the following:

changes in our financial strength or credit ratings could impact our ability to write new business, the cost of, and our ability to obtain, capital or our ability to attract and retain brokers, agents and customers;

further decreases in the capital and surplus of our insurance subsidiaries and their ability to meet minimum capital and surplus requirements;

changes in our ability to access our credit facilities or raise additional capital;

the implementation and effectiveness of our capital improvement strategy;

Tower's ability to continue operating as a going concern;

changes in our ability to meet ongoing cash requirements and pay dividends;

greater frequency or severity of claims and loss activity, including as a result of natural or man-made catastrophic events, than our underwriting, reserving or investment practices anticipate based on historical experience or industry data;

changes in the availability, cost or quality of reinsurance and failure of our reinsurers to pay claims timely or at all;

changes in the availability, cost or quality of reinsurance or retrocessional coverage;

decreased demand for our insurance or reinsurance products;

increased competition on the basis of pricing, capacity, coverage terms or other factors;

ineffectiveness or obsolescence of our business strategy due to changes in current or future market conditions;

currently pending or future litigation or governmental proceedings;

developments that may delay or limit our ability to enter new markets as quickly as we anticipate;

loss of the services of any of our executive officers or other key personnel;

changes in acceptance of our products and services, including new products and services;

developments in the world's financial and capital markets that could adversely affect the performance of our investments;

the effects of acts of terrorism or war;

changes in general economic conditions, including inflation, interest rates and other factors which could impact our performance and the performance of our investment portfolio;

changes in accounting policies or practices;

changes in legal theories of liability under our insurance policies;

changes in rating agency policies or practices;

declining demand for reinsurance due to increased retentions by cedents and other factors;

a lack of opportunities to increase writings in Tower's reinsurance lines of business and in specific areas of the reinsurance market;

changes in the percentage of our premiums written that we cede to reinsurers;

changes in regulations or laws applicable to us, our subsidiaries, brokers or customers, including regulatory limitations and restrictions on the declaration and payment of dividends and capital adequacy standards;

the Bermudian regulatory system, and potential changes thereto;

risks and uncertainties associated with technology, data security or outsourced services that could negatively impact our ability to conduct our business or adversely impact our reputation;


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the effects of mergers, acquisitions or divestitures;

disruptions in Tower's business arising from the integration of acquired businesses into Tower and the anticipation of potential or pending acquisitions or mergers; and

any changes concerning the conditions, terms, termination, or closing of the merger with ACP Re.

The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in this Form 10-Q. We undertake no obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.

If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary materially from what we project. Any forward-looking statements you read in this Form 10-Q reflect our views as of the date of this Form 10-Q with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. All subsequent written and oral forward-looking statements attributable to us or individuals acting on our behalf are expressly qualified in their entirety by this paragraph. Before making an investment decision, you should specifically consider all of the factors identified in this Form 10-Q that could cause actual results to differ.

Overview

The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to assist readers in understanding the interim consolidated results of operations and financial condition of Tower Group International, Ltd. and its subsidiaries (the "Company" or "Tower") and should be read in conjunction with the interim consolidated financial statements and notes thereto included under Part I, Item 1 of this Form 10-Q, as well as the MD&A contained in Tower's Annual Report on Form 10-K for the year ended December 31, 2013 (the "2013 Form 10-K"). References to "we," "our," "us" or similar terms refer to the business of Tower.

Tower, through its subsidiaries, offers a range of general commercial, specialty commercial and personal property and casualty insurance products and services to businesses in various industries and to individuals throughout the United States. We provide these products on both an admitted and an excess and surplus ("E&S") lines basis. Insurance companies writing on an admitted basis are licensed by the states in which they sell policies and are required to offer policies using premium rates and forms that are filed with state insurance regulators. Non-admitted carriers writing in the E&S market are not bound by most of the rate and form regulations imposed on standard market companies, allowing them the flexibility to change the coverage offered and the rate charged without the time constraints and financial costs associated with the filing process.

See "Note 1 - Nature of Business, Significant Business Developments and Risks and Uncertainties" in the Notes to the Consolidated Financial Statements for discussion on significant events impacting Tower's results of operations.

Critical Accounting Estimates

As of March 31, 2014, there were no material changes to our accounting policies on critical accounting estimates; refer to the Company's 2013 Annual Report on Form 10-K for a complete discussion of critical accounting estimates.

Critical Accounting Policies and New Accounting Standards Not Yet Adopted

See "Note 2 - Accounting Policies and Basis of Presentation" for information related to our significant accounting policies, including details of policies that were adopted during the three months ended March 31, 2014.


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Consolidating Supplemental Information

The following tables present the consolidating financial statements as of
March 31, 2014 and December 31, 2013 and for three months ended March 31, 2014
and 2013:



                                                                     March 31, 2014
                                                             Reciprocal
($ in thousands)                              Tower          Exchanges         Eliminations          Total
Assets
Investments
Available-for-sale investments, at fair
value:
Fixed-maturity securities                  $ 1,244,495      $    206,906      $            -      $ 1,451,401
Equity securities                               60,483             2,724                   -           63,207
Short-term investments                           2,000                 -                   -            2,000
Other invested assets                          131,807                 -             (77,200 )         54,607
Total investments                            1,438,785           209,630             (77,200 )      1,571,215
Cash and cash equivalents                      410,586            44,290                   -          454,876
Investment income receivable                    35,330             1,826             (25,050 )         12,106
Premiums receivable                            229,859            46,321              (2,029 )        274,151
Reinsurance recoverable on paid losses          36,319             1,674              (1,160 )         36,833
Reinsurance recoverable on unpaid losses       373,614            24,137              (9,112 )        388,639
Prepaid reinsurance premiums                   459,488            25,590              (3,906 )        481,172
Deferred acquisition costs, net                 13,855             8,312                   -           22,167
Intangible assets                               73,463             6,221                   -           79,684
Funds held by reinsured companies               88,349                 -                   -           88,349
Other assets                                   318,785             2,088             (11,452 )        309,421
Total assets                               $ 3,478,433      $    370,089      $     (129,909 )    $ 3,718,613
Liabilities
Loss and loss adjustment expenses          $ 1,943,782      $    109,617      $       (9,112 )    $ 2,044,287
Unearned premium                               580,619           108,906              (3,906 )        685,619
Reinsurance balances payable                   197,969             7,785              (3,190 )        202,564
Funds held under reinsurance agreements         81,347                23                   -           81,370
Other liabilities                              240,029            54,148             (36,701 )        257,476
Deferred income taxes                           10,507            19,181                   -           29,688
Debt                                           383,564            77,000             (77,000 )        383,564
Total liabilities                            3,437,817           376,660            (129,909 )      3,684,568
Shareholders' equity
Common stock                                       574                 -                   -              574
Treasury stock                                     (88 )               -                   -              (88 )
Paid-in-capital                                814,899             9,400              (9,400 )        814,899
Accumulated other comprehensive income         (32,198 )           2,617              (2,617 )        (32,198 )
Retained earnings (accumulated deficit)       (747,074 )         (18,588 )            18,588         (747,074 )
Noncontrolling interests                         4,503                 -              (6,571 )         (2,068 )
Total shareholders' equity                      40,616            (6,571 )                 -           34,045
Total liabilities and shareholders'
equity                                     $ 3,478,433      $    370,089      $     (129,909 )    $ 3,718,613


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                                                                   December 31, 2013
                                                             Reciprocal
($ in thousands)                              Tower          Exchanges         Eliminations          Total
Assets
Investments
Available-for-sale investments, at fair
value:
Fixed-maturity securities                  $ 1,390,146      $    252,549      $            -      $ 1,642,695
Equity securities                              104,107             2,523                   -          106,630
Short-term investments                           5,897                 -                   -            5,897
Other invested assets                          173,355                 -             (77,200 )         96,155
Total investments                            1,673,505           255,072             (77,200 )      1,851,377
Cash and cash equivalents                      288,214             5,684                   -          293,898
Investment income receivable                    38,564             2,325             (23,396 )         17,493
Premiums receivable                            267,151            44,878              (2,530 )        309,499
Reinsurance recoverable on paid losses          66,974             3,028              (1,039 )         68,963
Reinsurance recoverable on unpaid losses       555,468            25,208              (9,816 )        570,860
Prepaid reinsurance premiums                   164,250            26,514              (4,288 )        186,476
Deferred acquisition costs, net                 85,485             9,611                   -           95,096
Intangible assets                               73,599             6,337                   -           79,936
Goodwill                                             -                 -                   -                -
Funds held by reinsured companies               98,816                 -                   -           98,816
Other assets                                   391,258             1,395              (9,522 )        383,131
Total assets                               $ 3,703,284      $    380,052      $     (127,791 )    $ 3,955,545
Liabilities
Loss and loss adjustment expenses          $ 1,973,970      $    117,131      $       (9,816 )    $ 2,081,285
Unearned premium                               657,045           110,355              (4,288 )        763,112
Reinsurance balances payable                    84,948             8,441              (3,569 )         89,820
Funds held under reinsurance agreements        222,137                22                   -          222,159
Other liabilities                              268,937            50,352             (33,118 )        286,171
Deferred income taxes                           10,327            19,181                   -           29,508
Debt                                           382,770            77,000             (77,000 )        382,770
Total liabilities                            3,600,134           382,482            (127,791 )      3,854,825
Shareholders' equity
Common stock                                       574                 -                   -              574
Treasury stock                                     (39 )               -                   -              (39 )
Paid-in-capital                                815,119             9,400              (9,400 )        815,119
Accumulated other comprehensive (loss)
income                                         (19,507 )           1,338              (1,338 )        (19,507 )
Retained earnings (accumulated deficit)       (700,596 )         (13,168 )            13,168         (700,596 )
Noncontrolling interests                         7,599                 -              (2,430 )          5,169
Total shareholders' equity                     103,150            (2,430 )                 -          100,720
Total liabilities and shareholders'
equity                                     $ 3,703,284      $    380,052      $     (127,791 )    $ 3,955,545


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                                                                                          Three Months Ended March 31,
                                                                      2014                                                            2013
                                                            Reciprocal       Elimina-                                       Reciprocal       Elimina-
($ in thousands)                             Tower          Exchanges          tions          Total           Tower         Exchanges          tions          Total
Net premiums written                       $ (298,996 )    $     38,351      $       -      $ (260,645 )    $ 416,071      $     37,126      $       -      $ 453,197
Revenues
Net premiums earned                        $   72,669      $     38,875      $       -      $  111,544      $ 380,884      $     41,002      $       -      $ 421,886
Ceding commission revenue                       8,722             2,478           (398 )        10,802          4,516             2,216         (1,293 )        5,439
Insurance services revenue                      7,918                 -         (7,353 )           565          7,289                 -         (7,161 )          128
Policy billing fees                             2,572               104              -           2,676          2,847               303              -          3,150
Net investment income                          14,697             2,315         (1,654 )        15,358         29,584             2,380         (1,647 )       30,317
Total net realized investment gains
(losses)                                       18,800             3,463              -          22,263          6,233               618              -          6,851
Total revenues                                125,378            47,235         (9,405 )       163,208        431,353            46,519        (10,101 )      467,771
Expenses
Loss and loss adjustment expenses              72,628            29,933              -         102,561        240,334            35,398              -        275,732
Commission expense                             17,500             7,947           (398 )        25,049         76,123             7,691         (1,293 )       82,521
Other operating expenses                       72,736            13,494         (7,353 )        78,877         76,838            13,059         (7,161 )       82,736
Acquisition-related transaction costs             646                 -              -             646         19,056                 -              -         19,056
Interest expense                                7,010             1,654         (1,654 )         7,010          7,803             1,652         (1,647 )        7,808
Total expenses                                170,520            53,028         (9,405 )       214,143        420,154            57,800        (10,101 )      467,853
Equity in income (loss) of
unconsolidated affiliate                            -                 -              -               -            128                 -              -            128
Income (loss) before income taxes             (45,142 )          (5,793 )            -         (50,935 )       11,327           (11,281 )            -             46
Income tax expense (benefit)                      963                 -              -             963         (1,590 )               -              -         (1,590 )
Net income (loss)                          $  (46,105 )    $     (5,793 )    $       -      $  (51,898 )    $  12,917      $    (11,281 )    $       -      $   1,636
Less: Net income (loss) attributable to
Noncontrolling interests                          373            (5,793 )            -          (5,420 )            -           (11,281 )            -        (11,281 )
Net income (loss) attributable to Tower
Group, International, Ltd.                 $  (46,478 )    $          -      $       -      $  (46,478 )    $  12,917      $          -      $       -      $  12,917

Ratios
Net loss and LAE                                 99.9 %            77.0 %                         91.9 %         63.1 %            86.3 %                        65.4 %
Net underwriting expenses                        81.4 %            48.5 %                         69.9 %         35.5 %            44.5 %                        36.4 %
Net Combined                                    181.3 %           125.5 %                        161.8 %         98.6 %           130.8 %                       101.8 %

Return on Average Equity                        -44.6 %                                                           5.0 %

Insurance Ratios

Net loss ratio. The net loss ratio is the ratio of losses and LAE incurred to net premiums earned and measures the underwriting results of a company's insurance business. Our net loss ratio is meaningful in evaluating our financial results, which are net of ceded reinsurance, as reflected in our consolidated financial statements. In addition, we use accident year and calendar year loss ratios to measure our underwriting performance. An accident year loss ratio measures losses and LAE for insured events occurring in a particular year, regardless of when they are reported, as a percentage of premiums earned during that particular accident year. A calendar year loss ratio measures losses and LAE for insured events occurring during a particular year and the changes in estimates in loss and LAE reserves from prior accident years as a percentage of premiums earned during that particular calendar year.

Net underwriting expense ratio. We calculate our net underwriting expense ratio after the effect of ceded reinsurance and policy billing fees. Ceding commission revenue and policy billing fees are applied to reduce our underwriting expenses in our insurance company operation. As discussed below, this is a non-GAAP measure.

Net combined ratio. We use the net combined ratio to measure our underwriting performance. The net combined ratio is the sum of the net loss ratio and the net underwriting expense ratio. If the net combined ratio is at or above 100%, an insurance company is not underwriting profitably and may not be profitable unless investment income is sufficient to offset underwriting losses. As discussed below, this is a non-GAAP measure.

Non-GAAP measures. The net underwriting expense ratio and net combined ratio are considered non-GAAP financial measures under applicable SEC rules because a component of those ratios, net underwriting expense, is calculated by reducing our underwriting expenses in our insurance companies' operations with ceding commission revenues and policy billing fees. As discussed above, the Company uses these ratios to evaluate financial performance against historical results and establish targets on a consolidated basis. Other companies may calculate these measures differently, and, therefore, their measures may not be comparable to those used by the Company.

Consolidated Results of Operations

Our results of operations are discussed below in two parts, consolidated results of operations and the results of each of our three segments.

Consolidated Results of Operations for the Three Months Ended March 31, 2014 and 2013

Total revenues. Total revenues decreased by 65.1% for the three months ended March 31, 2014 compared to the same period in 2013. This decrease is primarily attributable to the significant decline in net premiums earned offset by an increase in ceding commission revenues. Tower has reinsured the majority of its business to AmTrust and NGHC through the Cut-Through Reinsurance Agreements.

Premiums earned. Net premiums earned for the three months ended March 31, 2014 and 2013 were $111.5 million and $421.9 million, respectively. The decrease of 73.6% for the three months ended March 31, 2014 compared to the same period in 2013 is directly attributable to $162.9 million of earned premiums ceded to AmTrust and NGHC as a result of the Cut-Through Reinsurance Agreement and to $42.2 million of earned premiums ceded relating to the quota share reinsurance agreements executed in the third and fourth quarters of 2013 with other unaffiliated entities. In addition, as a result of the rating agency downgrades, Tower's premiums written have declined in the fourth quarter 2013 and first quarter 2014, resulting in a reduction in gross premiums earned.

Commission and fee income. Commission and fee income, comprised of ceding commission revenue, insurance services revenue and policy billing fees, increased by $5.3 million in the three months ended March 31, 2014 compared to the same period in 2013. The increase is due primarily to ceding commission revenue earned on the Cut-Through Reinsurance Agreements.

Net investment income and net realized gains (losses). For the three months ended March 31, 2014, net investment income decreased $15.0 million compared to the same period in 2013, primarily due to lower investment balances in 2014 compared to


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2013. Investment balances have declined due to the previously discussed significant events that impacted Tower in 2013. In addition, the Company has disposed of certain of its invested assets in the first quarter of 2014, generating net realized gains but reducing net investment income.

For the three months ended March 31, 2014, $0.9 million of OTTI losses were recorded in net income compared to $0.7 million in 2013. The OTTI for the three months ended March 31, 2014 is related mostly to securities in the Company's equity security portfolio.

Net realized investment gains (losses) for the three months ended March 31, 2014 and 2013 were $22.3 million and $6.8 million, respectively. These gains are a function of the invested assets selected for sale when cash needs arise in the ordinary course of business or when market dictates disposals pursuant to our investment policy.

Loss and loss adjustment expenses. The consolidated net loss ratio, which includes the Reciprocal Exchanges, was 91.9% and 65.4 % for the three months ended March 31, 2014 and 2013, respectively. Excluding the Reciprocal Exchanges, the net loss ratio was 99.9% and 63.1% for the three months ended March 31, 2014 and 2013, respectively. The Reciprocal Exchanges' net loss ratio was 77.0% and 86.3% for the three months ended March 30, 2014 and 2013, respectively. The current accident year net loss ratio excluding the Reciprocal Exchanges for the period ending March 31, 2014 increased as compared to the same period in 2013 due to a significant increase in the unallocated loss expense ratio. This was caused by the substantial reduction in net earned premium due to increased cessions to quota share reinsurance including the Cut-Through Reinsurance Agreements. A portion of this increase was offset by ceding commission revenue.

Incurred losses and LAE for the three months ended March 31, 2014 attributable to insured events of prior years were $7.0 million. Excluding the Reciprocal Exchanges, the incurred losses and LAE from prior accident years were $8.0 million and increased the calendar year loss ratio by 11 points. Excluding the Reciprocal Exchanges there was adverse loss development of $11.4 million in the Commercial Insurance segment, favorable loss development of $3.6 million in the . . .

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