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XL > SEC Filings for XL > Form 10-Q on 7-Aug-2014All Recent SEC Filings

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Form 10-Q for XL GROUP PLC


7-Aug-2014

Quarterly Report


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND ITEM 2. RESULTS OF OPERATIONS

GENERAL
The following is a discussion of our financial condition and liquidity and results of operations. Certain aspects of our business have loss experience characterized as low frequency and high severity. This may result in volatility from period to period in both the Company's and an individual segment's results of operations and financial condition. Unless the context otherwise indicates, references herein to "the Company," "we," "us," or "our" are to XL Group plc, an Irish public limited company ("XL-Ireland"), and its consolidated subsidiaries. This "Management's Discussion and Analysis of Financial Condition and Results of Operations" contains forward-looking statements that involve inherent risks and uncertainties. Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements. These statements are based upon current plans, estimates and expectations. Actual results may differ materially from those projected in such forward-looking statements and, therefore, undue reliance should not be placed on them. See "Cautionary Note Regarding Forward-Looking Statements" for a list of additional factors that could cause actual results to differ materially from those contained in any forward-looking statement, as well as Item 1A, "Risk Factors," included in our Annual Report on Form 10-K for the year ended December 31, 2013. This discussion and analysis should be read in conjunction with the "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the audited Consolidated Financial Statements and Notes thereto, presented under Item 7 and Item 8, respectively, of our Annual Report on Form 10-K for the year ended December 31, 2013.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS The Private Securities Litigation Reform Act of 1995 ("PSLRA") provides a "safe harbor" for forward-looking statements. Any prospectus, prospectus supplement, Annual Report to ordinary shareholders, proxy statement, Form 10-K, Form 10-Q or Form 8-K or any other written or oral statements made by us or on our behalf may include forward-looking statements that reflect our current views with respect to future events and financial performance. Such statements include forward-looking statements both with respect to us in particular, and to the insurance and reinsurance sectors in general (both as to underwriting and investment matters). Statements that include the words "expect," "intend," "plan," "believe," "project," "anticipate," "may" and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the PSLRA or otherwise.
All forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause actual results to differ materially from those indicated in such statements. We believe that these factors include, but are not limited to, the following:
? changes in the size of our claims relating to natural or man-made catastrophe losses due to the preliminary nature of some reports and estimates of loss and damage to date;

? trends in rates for property and casualty insurance and reinsurance;

? the timely and full recoverability of reinsurance placed by us with third parties, or other amounts due to us;

? changes in ratings or rating agency policies or practices;

? changes in the projected amount of ceded reinsurance recoverables and the ratings and creditworthiness of reinsurers;

? the timing of claims payments being faster or the receipt of reinsurance recoverables being slower than we anticipated;

? our ability to successfully implement our business strategy;

? our ability to realize the value or benefits expected as a result of the Life Retro Arrangements, as defined herein;

? increased competition on the basis of pricing, capacity, coverage terms or other factors, which could harm our ability to maintain or increase our business volumes or profitability;

? greater frequency or severity of claims and loss activity than our underwriting, reserving or investment practices anticipate based on historical experience or industry data;

? changes in general economic conditions, including the effects of inflation on our business, including on pricing and reserving, and changes in interest rates, credit spreads, foreign currency exchange rates and future volatility in the world's credit, financial and capital markets that adversely affect the performance and valuation of our investments or access to such markets;

? developments, including uncertainties related to the future of the Euro-zone, the ability of Euro-zone countries to service existing debt obligations and the strength of the Euro as a currency and to the financial condition of counterparties, reinsurers and other companies that are at risk of bankruptcy;

? the potential impact on us from government-mandated insurance coverage for acts of terrorism;

? the potential for changes to methodologies, estimations and assumptions that underlie the valuation of our financial instruments that could result in changes to investment valuations;


? changes to our assessment as to whether it is more likely than not that we will be required to sell, or have the intent to sell, available for sale debt securities before their anticipated recovery;

? the availability of borrowings and letters of credit under our credit facilities;

? the ability of our subsidiaries to pay dividends to XL-Ireland and XLIT Ltd., an exempted company organized under the laws of the Cayman Islands ("XL-Cayman");

? the potential effect of regulatory developments in the jurisdictions in which we operate, including those which could impact the financial markets or increase our business costs and required capital levels;

? changes in regulations or laws applicable to us or our subsidiaries, brokers or customers;

? acceptance of our products and services, including new products and services;

? changes in the availability, cost or quality of reinsurance;

? changes in the distribution or placement of risks due to increased consolidation of insurance and reinsurance brokers;

? loss of key personnel;

? changes in accounting standards, policies or practices or the application thereof;

? legislative or regulatory developments including, but not limited to, changes in regulatory capital balances that must be maintained by our operating subsidiaries and governmental actions for the purpose of stabilizing the financial markets;

? the effects of mergers, acquisitions and divestitures;

? developments related to bankruptcies of companies insofar as they affect property and casualty insurance and reinsurance coverages or claims that we may have as a counterparty;

? changes in applicable tax laws, tax treaties or tax regulations or the interpretation or enforcement thereof;

? the effects of business disruption or economic contraction due to war, terrorism or other hostilities; and

? the other factors set forth in Item 1A, "Risk Factors," included in our Annual Report on Form 10-K for the year ended December 31, 2013 and our other documents on file with the SEC.

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 herein or elsewhere. We undertake no obligation to update publicly or revise any forward-looking statement, whether as a result of new information, future developments or otherwise, except as required by the federal securities laws.
EXECUTIVE OVERVIEW
See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Executive Overview," included in our Annual Report on Form 10-K for the year ended December 31, 2013. That discussion is updated with the disclosures set forth below.

RESULTS OF OPERATIONS AND KEY FINANCIAL MEASURES
Results of Operations
The following table presents an analysis of our net income (loss) attributable
to ordinary shareholders and other financial measures (described below) for the
three and six months ended June 30, 2014 and 2013:
                                              Three Months Ended           Six Months Ended
(U.S. dollars in thousands, except per             June 30,                    June 30,
share amounts)                                2014          2013          2014          2013
Net income (loss) attributable to
ordinary shareholders                     $ (279,261 )   $ 272,698     $ (23,544 )   $ 623,488
Earnings (loss) per ordinary share -
basic                                     $    (1.03 )   $    0.94     $   (0.09 )   $    2.13
Earnings (loss) per ordinary share -
diluted                                   $    (1.03 )   $    0.93     $   (0.09 )   $    2.10
Weighted average number of ordinary
shares and ordinary share equivalents, in
thousands - basic                            270,924       289,513       273,616       292,277
Weighted average number of ordinary
shares and ordinary share equivalents, in
thousands - diluted                          270,924       294,333       273,616       297,044

Sale of Life Reinsurance Subsidiary
Our net income (loss) attributable to ordinary shareholders and other financial measures as shown above for the three and six months ended June 30, 2014 have been affected primarily by the sale of our life reinsurance subsidiary that was completed during the second quarter of 2014. For further information on this transaction and its impact on our net income (loss) attributable to ordinary shareholders and other financial measures for the three and six months ended June 30, 2014 and 2013 see "Significant Items Affecting the Results of Operations" below and Item 1, Note 3, "Sale of Life Reinsurance Subsidiary," to the Unaudited Consolidated Financial Statements included herein.


Key Financial Measures
The following are some of the financial measures management considers important
in evaluating our operating performance:
                                    Three Months Ended                                       Six Months Ended
                               June 30,                      Change                     June 30,                    Change
(U.S. dollars in
thousands, except
ratios and per
share amounts)          2014               2013           2014 to 2013            2014             2013          2014 to 2013
Underwriting
profit (loss) -
P&C operations    $     167,946      $       92,124               82.3  %   $     312,820      $   272,712            14.7  %
Combined ratio -
P&C operations             88.3  %             93.8 %         (5.5)pts               89.0  %          90.8 %      (1.8)pts
Net investment
income (1)        $     213,608      $      232,546               (8.1 )%   $     446,797      $   479,014            (6.7 )%
Operating net
income (2)        $     279,576      $      221,591               26.2  %   $     518,225      $   501,459             3.3  %
Operating net
income per share
(2)               $        1.02      $         0.75     $         0.27      $        1.86      $      1.69     $      0.17
Annualized return
on average
ordinary
shareholders'
equity (2)                (11.0 )%             10.7 %        (21.7)pts               (0.5 )%          12.2 %     (12.7)pts
Annualized
operating return
on average
ordinary
shareholders'
equity (2)                 11.0  %              8.7 %           2.3pts               10.3  %           9.8 %        0.5pts
Annualized
operating return
on average
ordinary
shareholders'
equity excluding
unrealized gains
and losses on
investments (2)            12.3  %              9.7 %           2.6pts               11.5  %          11.0 %        0.5pts

                                                             Change                            December 31,         Change
(U.S. dollars)     June 30, 2014      March 31, 2014     (Three Months)      June 30, 2014         2013          (Six Months)
Book value per
ordinary share
(2)               $       37.39      $        37.45     $        (0.06 )    $       37.39      $     35.92     $      1.47
Fully diluted
tangible book
value per
ordinary share
(2)               $       35.09      $        35.30     $        (0.21 )    $       35.09      $     33.86     $      1.23


____________


(1) Represents Net investment income - excluding Life Funds Withheld Assets.

(2) Represents a non-GAAP financial measure as discussed further below.

The following are descriptions of these key financial measures and a brief discussion of the factors influencing them:
Underwriting profit - property and casualty insurance and reinsurance ("P&C") operations
One way that we evaluate the performance of our P&C operations is by underwriting profit or loss. We do not measure performance based on the amount of gross premiums written. Underwriting profit or loss is calculated from premiums earned less net losses incurred and expenses related to underwriting activities.
In the following discussion as well as in the "Income Statement Analysis" section, the following ratios are used to explain the underwriting profit (loss) from our P&C operations:
? The combined ratio related to the P&C operations is the sum of the loss and loss expense ratio and the underwriting expense ratio. A combined ratio under 100% represents an underwriting profit and over 100% represents an underwriting loss. In the P&C industry, the combined ratio is a widely used measure of underwriting profitability.

? The loss and loss expense ratio related to the P&C operations is calculated by dividing the losses and loss expenses incurred by the net premiums earned for the Insurance and Reinsurance segments.

? The underwriting expense ratio related to the P&C operations is the sum of acquisition costs and operating expenses for the Insurance and Reinsurance segments divided by net premiums earned for the Insurance and Reinsurance segments.

? The acquisition expense ratio related to the P&C operations is calculated by dividing the acquisition costs incurred by the net premiums earned for the Insurance and Reinsurance segments.

? The operating expense ratio related to the P&C operations is calculated by dividing the operating expenses incurred by the net premiums earned for the Insurance and Reinsurance segments.

Our underwriting profit (loss) in the three and six months ended June 30, 2014 and 2013 was consistent with the combined ratio, discussed below.


Combined ratio - P&C operations
The following table presents the ratios for our P&C operations for the three and six months ended June 30, 2014 and 2013:

                                   Three Months Ended                 Six Months Ended
                                June 30,          Change          June 30,          Change
                             2014      2013    2014 to 2013     2014     2013    2014 to 2013
Loss and loss expense ratio  57.6 %   63.0 %         (5.4 )    58.2 %   60.3 %         (2.1 )
Acquisition expense ratio    12.6 %   15.1 %         (2.5 )    13.1 %   14.9 %         (1.8 )
Operating expense ratio      18.1 %   15.7 %          2.4      17.7 %   15.6 %          2.1
Underwriting expense ratio   30.7 %   30.8 %         (0.1 )    30.8 %   30.5 %          0.3
Combined ratio               88.3 %   93.8 %         (5.5 )    89.0 %   90.8 %         (1.8 )

Three months ended June 30, 2014 vs. 2013: The combined ratio decrease was the result of a lower loss ratio mainly due to lower levels of natural catastrophe losses in 2014, partially offset by lower favorable prior year reserve development in 2014 compared to 2013. The underwriting expense ratio decrease was mainly driven by a decrease in acquisition expenses due to a change in the reinsurance structure in the Professional business group in our Insurance segment, partially offset by an increase in operating expenses as a result of higher compensation costs from increased headcount as a result of business expansion.
Six months ended June 30, 2014 vs. 2013: The combined ratio decrease was the result of a lower loss ratio mainly due to lower levels of natural catastrophe losses in 2014, partially offset by lower favorable prior year reserve development in 2014 compared to 2013. The underwriting expense ratio increase was driven by an increase in operating expenses primarily due to higher compensation costs from increased headcount as a result of business expansion, partially offset by a decrease in acquisition expenses due to a change in the reinsurance structure in the Professional business group in our Insurance segment and lower profit commissions within the Reinsurance segment in 2014. For further information on our combined ratio, see "Income Statement Analysis" below.
Net investment income
Net investment income - excluding Life Funds Withheld Assets, which includes interest and dividend income together with the amortization of premium and discount on fixed maturities and short-term investments, net of related investment expenses, is an important measure that affects our overall profitability. Our largest liability relates to our unpaid loss reserves, and our investment portfolio provides liquidity for claims settlements of these reserves as they become due. As a result, a significant part of the investment portfolio is invested in fixed income securities. Net investment income is influenced by a number of factors, including the amounts and timing of inward and outward cash flows, the level of interest rates and credit spreads, foreign exchange rates and changes in overall asset allocation. See the segment results under "Investment Activities" below for a discussion of our net investment income for the three and six months ended June 30, 2014. Operating net income and Operating net income per share Operating net income is a non-GAAP financial measure defined as net income
(loss) attributable to ordinary shareholders excluding: (1) our net investment income attributable to the Life Retro Arrangements, (2) our net realized gains and losses on investments, net of tax, (3) our net realized and unrealized gains and losses on derivatives, net of tax, (4) our net realized and unrealized gains and losses on life retrocession embedded derivative, net of tax, (5) our share of items (2) and (3) for our insurance company affiliates for the periods presented, (6) our loss on the sale of the life reinsurance subsidiary, XLLR, net of tax, and (7) our foreign exchange gains and losses, net of tax. We evaluate the performance of and manage our business to produce an underwriting profit. In addition to presenting net income (loss), we believe that showing operating net income (loss) enables investors and other users of our financial information to analyze our performance in a manner similar to how we analyze our performance. In this regard, we believe that providing only a GAAP presentation of net income (loss) would make it more difficult for users of our financial information to evaluate our underlying business. We also believe that equity analysts and certain rating agencies that follow us (and the insurance industry as a whole) exclude these items from their analyses for the same reasons, and they request that we provide this non-GAAP financial information on a regular basis. A reconciliation of our net income (loss) attributable to ordinary shareholders to operating net income (loss) is provided at "Reconciliation of Non-GAAP Measures" below.


Operating net income per share is calculated by dividing non-GAAP operating net income by the weighted average number of ordinary shares and ordinary share equivalents outstanding for each period combined with the impact from dilution of share-based compensation and certain conversion features where dilutive. Annualized return on average ordinary shareholders' equity ("ROE") ROE is another non-GAAP financial measure that we consider important in evaluating our operating performance and view as a key measure of return generated for ordinary shareholders. ROE is calculated by dividing the net income (loss) attributable to ordinary shareholders for any period by the average of the opening and closing Shareholders' equity attributable to XL-Ireland. We establish minimum target ROEs for our total operations, segments and lines of business. If our minimum ROE targets over the longer term are not met with respect to any line of business, we seek to modify and/or exit this line. In addition, among other factors, compensation of our senior officers is dependent on the achievement of our performance goals to enhance ordinary shareholder value as measured by ROE (adjusted for certain items considered to be "non-operating" in nature).
The following table presents our ROE for the three and six months ended June 30, 2014 and 2013:

           Three Months Ended                   Six Months Ended
        June 30,           Change           June 30,          Change
      2014      2013    2014 to 2013     2014      2013    2014 to 2013
ROE (11.0 )%   10.7 %      (21.7)pts    (0.5 )%   12.2 %      (12.7)pts

Three and six months ended June 30, 2014 vs. 2013: The decrease in our ROE for the three and six months ended June 30, 2014 as compared to the three and six months ended June 30, 2013 was primarily due to the after-tax net loss on sale of our life reinsurance subsidiary, XLLR, of $621.3 million. In addition, foreign exchange losses were recorded during the three and six months ended June 30, 2014 as compared to the foreign exchange gains recorded during the comparative periods of 2013. These items were offset by the favorable impact of the improvement in our P&C operations' combined ratio for the three and six months ended June 30, 2014 as compared to the three and six months ended June 30, 2013.
Annualized operating return on average ordinary shareholders' equity ("Operating ROE")
Operating ROE is another non-GAAP financial measure that we consider important in evaluating our operating performance. Operating ROE is derived by dividing non-GAAP operating net income for any period by the average of the opening and closing ordinary shareholders' equity.
The following table presents our Operating ROE for the three and six months ended June 30, 2014 and 2013:
Three Months Ended Six Months Ended June 30, Change June 30, Change 2014 2013 2014 to 2013 2014 2013 2014 to 2013 Operating ROE 11.0 % 8.7 % 2.3pts 10.3 % 9.8 % 0.5pts

Three and six months ended June 30, 2014 vs. 2013: The increase in our Operating ROE was the result of higher operating net income in 2014 due to the favorable impact of the improvement in our P&C combined ratio for the three and six months ended June 30, 2014 as compared to the three and six months ended June 30, 2013. A detailed discussion of our individual segment operating results is included below under "Income Statement Analysis".
A reconciliation of Net income (loss) attributable to ordinary shareholders to operating net income (loss) is provided under "Reconciliation of Non-GAAP Measures" below.
Annualized operating return on average ordinary shareholders' equity excluding unrealized gains and losses on investments ("Operating ROE ex-UGL") Operating ROE ex-UGL is an additional measure of our profitability that eliminates the impacts of mark to market fluctuations on our investment portfolio that have not been realized through sales, which we believe provides a consistent measure of our performance. Operating ROE ex-UGL is derived from the non-GAAP operating net income measure by dividing non-GAAP operating net income for any period by the average of the opening and closing ordinary shareholders'


equity excluding unrealized gains and losses on investments. A reconciliation of the opening and closing ordinary shareholders' equity to the opening and closing ordinary shareholders' equity excluding unrealized gains and losses on investments is provided under "Reconciliation of Non-GAAP Measures" below. The following table presents our Operating ROE ex-UGL for the three months ending June 30:

                          Three Months Ended                Six Months Ended
                        June 30,         Change         June 30,          Change
                      2014    2013    2014 to 2013    2014     2013    2014 to 2013
Operating ROE ex-UGL 12.3 %   9.7 %         2.6pts   11.5 %   11.0 %         0.5pts

Three and six months ended June 30, 2014 vs. 2013: The increase in our Operating ROE ex-UGL was the result of the higher operating net income in 2014 due to the factors discussed above as part of Operating ROE. Book value per ordinary share
We view the change in our book value per ordinary share as an additional measure of our performance, representing the value generated for our ordinary shareholders each period, and we believe that this measure (along with the diluted measures described below) is a key driver of our share price over time. Book value per ordinary share, a non-GAAP financial measure, is calculated by dividing ordinary shareholders' equity (total shareholders' equity less non-controlling interest in equity of consolidated subsidiaries) by the number of outstanding ordinary shares at the applicable period end. Book value per ordinary share is affected primarily by net income (loss), by any changes in the net unrealized gains and losses on our investment portfolio, by currency translation adjustments and by the impact of any share buyback or issuance activity. Ordinary shareholders' equity was $10.0 billion and $10.0 billion and the number of ordinary shares outstanding was 268.4 million and 278.3 million at June 30, 2014 and December 31, 2013, respectively. Ordinary shares outstanding include all ordinary shares legally issued and outstanding (as disclosed on the face of the balance sheets) as well as all director share units outstanding. The following table presents our book value per ordinary share at June 30, 2014, March 31, 2014 and December 31, 2013:
March 31, Change December 31, Change
(U.S. dollars) June 30, 2014 2014 (Three Months) June 30, 2014 2013 (Six Months)
Book value per ordinary share $ 37.39 $ 37.45 $ (0.06 ) $ 37.39 $ 35.92 $ 1.47

Three months ended June 30, 2014: Book value per ordinary share at June 30, 2014 marginally decreased in the quarter. The decrease reflects the after-tax net loss on sale of our life reinsurance subsidiary of $621.3 million, partially offset by the benefit of a $268.2 million increase in net unrealized gains on investments, net of tax, and by underwriting income generated from our P&C operations. Further detail regarding the impact of the life reinsurance transaction is included at "Significant Items Affecting Results of Operations" below, and at Item 1, Note 3, "Sale of Life Reinsurance Subsidiary," to the Unaudited Consolidated Financial Statements included herein. . . .

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