Global Indemnity plc — 2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014. The filing is for Global Indemnity plc, not an entity identified as Global Indemnity Group, LLC, and is an annual report rather than a standalone fourth-quarter filing. Unless noted, financial amounts are U.S. dollars.
Business context and reporting period
The company writes specialty property and casualty insurance, primarily in U.S. excess and surplus lines, and treaty reinsurance through its Bermuda-based reinsurance operation. Its reporting segments are Insurance Operations and Reinsurance Operations.
On January 1, 2015, after the reporting period, the company acquired American Reliable. The stated cash payment at closing was approximately $113.7 million, and the company assumed approximately $322.9 million of insurance-related liabilities and obligations. The latest estimated purchase price was approximately $117.9 million and remained subject to adjustment. American Reliable’s results are not included in 2014 results.
Financial performance and position
- Revenue and earnings: Total revenue was $333.8 million, up 4.6% from $319.1 million in 2013. Net income was $62.9 million, compared with $61.7 million; diluted EPS was $2.48 versus $2.45.
- Premiums: Gross premiums written were $291.3 million, up 0.2%; net premiums written were $273.2 million, up 0.4%; and net premiums earned were $268.5 million, up 8.0%.
- Underwriting: The consolidated combined ratio improved to 92.0% from 96.0% (below 100% indicates underwriting profit). Insurance Operations’ combined ratio was 97.8%, improving from 104.0%; Reinsurance Operations’ was 70.8%, compared with 65.7%. Favorable prior-year reserve development reduced 2014 losses by $16.4 million, versus $7.9 million in 2013.
- Investment results: Net investment income fell 22.5% to $28.8 million, largely due to lower reinvestment yields and the exit from the corporate loan portfolio. Net realized investment gains rose to $35.9 million from $27.4 million, largely reflecting equity-security gains, partly offset by $20.8 million of derivative losses. Total investment return was $18.8 million, down from $71.9 million.
- Cash flow: Cash used in operating activities was $12.0 million, compared with $4.9 million used in 2013. Investing activities used $109.2 million; financing activities provided $74.6 million. Year-end cash and cash equivalents were $58.8 million, down from $105.5 million.
- Balance sheet and liquidity: Total assets were $1.93 billion, shareholders’ equity $908.3 million, and investments plus cash and cash equivalents $1.50 billion. Restricted cash included $113.7 million held in escrow for the American Reliable acquisition. Management said operating companies and holding companies had sufficient liquidity; however, holding-company resources depend substantially on subsidiary distributions, which are subject to regulatory limits.
- Debt: Margin borrowing facilities totaled $174.7 million at year-end, versus $100.0 million a year earlier. The facilities are due on demand, carry rates tied to LIBOR (approximately 1% at the filing date), and are secured by securities; approximately $222.8 million of collateral supported the borrowings. The company also reported $200 million notional of interest-rate swaps, with a $13.7 million fair-value liability at year-end.
- Reserves: Unpaid losses and loss adjustment expenses were $675.5 million gross and $552.3 million net of reinsurance, compared with $779.5 million gross at year-end 2013. Net asbestos and environmental reserves were $31.2 million combined; net construction-defect reserves were $69.8 million.
Material changes versus comparable periods
- Insurance Operations’ earned premiums increased 7.6%, while gross written premiums declined 1.0%; management attributed the written-premium decline mainly to culling unprofitable commercial auto business, partly offset by small-business growth and rate increases.
- Insurance underwriting returned to segment profit of $5.2 million from a $2.1 million loss. The improvement included a lower expense ratio and favorable reserve development.
- Reinsurance segment income declined 7.2% to $16.7 million. Its current-accident-year loss ratio rose to 41.7% from 31.3%, mainly from higher property losses.
- Corporate and other operating expenses increased 25.4% to $14.6 million, including approximately $3.4 million of American Reliable acquisition costs. Income tax expense rose to $8.3 million from $1.0 million, including $6.3 million of U.S. withholding tax associated with a $125 million dividend to a Luxembourg affiliate.
- Investment portfolio fair value declined to $1.50 billion from $1.57 billion. Equity securities fell to $122.0 million from $254.1 million, while fixed maturities increased to $1.28 billion from $1.20 billion. The fixed-maturity book yield was 2.18%, down from 3.00%.
- For fourth-quarter context, unaudited 2014 Q4 net income was $11.1 million versus $33.7 million in 2013 Q4; 2014 Q4 included a $4.4 million net realized investment loss, while 2013 Q4 included $17.2 million of net realized investment gains.
Outlook, risks, contingencies, and unusual items
- Outlook: Management gave no quantified earnings or premium guidance. It described cautious deployment of reinsurance capital amid competitive pricing and expected American Reliable to materially affect future results. Integration, purchase-price finalization, and reserve development remained uncertain.
- Control weakness: Management and the auditor reported ineffective internal control over financial reporting as of December 31, 2014. The material weakness concerned the design and documentation of controls over management’s final loss-reserve selections when they differed from internal and external actuarial estimates. Management planned remediation in Q1 2015; additional procedures did not result in material changes to the financial statements.
- Reserve and claims exposure: Estimates are judgmental and may change as claims develop. Long-tail liability, construction-defect, asbestos and environmental claims, changing legal interpretations, and claim severity are key uncertainties. Net A&E reserves increased to $31.2 million from $23.0 million.
- Investment and financing risk: Risks include low reinvestment yields, interest-rate and credit movements, equity-price volatility, limited liquidity in partnership investments, and potential collateral calls on margin borrowing and swaps. A 100-basis-point rate increase was estimated to reduce bond market value by approximately $25.1 million.
- Other material risks: Catastrophe losses, reinsurer nonpayment, competition and pricing pressure, dependence on agencies and brokers, regulatory limits on subsidiary dividends, and the controlling shareholder’s approximately 92.9% of voting power. The company had an A.M. Best financial strength rating of “A” for its insurance and reinsurance operations.
- Legal and unusual items: The company said ordinary-course legal proceedings were not expected to have a material adverse effect. A court issued a final order in September 2014 approving a settlement concerning approximately 3,900 existing and future asbestos-related claims. The filing also disclosed $22.5 million of unfunded limited-partnership commitments and $11.4 million of operating-lease commitments.
Important facts for investors to verify
- Whether the reserve-control weakness was remediated and operated effectively after Q1 2015, and whether subsequent filings report new control issues or reserve revisions.
- The final American Reliable purchase price, acquired reserve adequacy, integration costs, and the acquired business’s contribution to post-acquisition results.
- The drivers and sustainability of favorable prior-year reserve development, particularly long-tail, construction-defect, and A&E exposures.
- Current margin-facility balances, collateral requirements, LIBOR sensitivity, and liquidity available after the acquisition and regulatory restrictions.
- Whether investment income and underwriting results can offset lower fixed-income yields and elevated catastrophe or reinsurance losses.
- Current statutory capital, dividend capacity, and any changes in ratings, reinsurer collectability, or material litigation.