Notes to Consolidated Financial Statements
(Unaudited)
Note 1Nature of Business
Tower Group International, Ltd. (TGIL, the Company or Tower) offers a range of commercial, assumed
reinsurance and personal property and casualty insurance products and services through its subsidiaries to businesses and to individuals. The Companys common stock is publicly traded on the NASDAQ Global Select Market under the symbol
TWGP.
Significant Business Developments and Risks and Uncertainties
Proposed Merger with ACP Re
On
January 3, 2014, Tower entered into an Agreement and Plan of Merger (the Original ACP Re Merger Agreement) with ACP Re Ltd. (ACP Re), and a wholly-owned subsidiary of ACP Re (Merger Sub). Subject to the
satisfaction or waiver of the conditions therein, it is expected Merger Sub would merge with and into Tower (the Merger), with Tower as the surviving corporation in the Merger and a wholly owned subsidiary of ACP Re. ACP Re is a Bermuda
based reinsurance company. The controlling shareholder of ACP Re is a trust established by the founder of AmTrust Financial Services, Inc. (AmTrust), National General Holdings Corporation (NGHC) and Maiden Holdings, Ltd.
On May 8, 2014, Tower entered into Amendment No. 1 to the Agreement and Plan of Merger (the ACP Re Amendment, and,
together with the Original ACP Re Merger Agreement, the ACP Re Merger Agreement) with ACP Re and Merger Sub. The ACP Re Amendment, among other things, (1) reduces the per share consideration to be received by holders of Towers
common shares in the Merger from $3.00 per share to $2.50 per share, (2) reduces the termination fee that Tower would, under certain circumstances, be required to pay to ACP Re in the event of a termination of the merger agreement,
(3) extends to November 15, 2014 both the date by which Tower must hold its shareholders meeting to vote on the Merger and the deadline for completing the merger before either party can terminate the ACP Re Merger Agreement,
(4) excludes from the material adverse effect closing condition any continued adverse results of Towers operations or deterioration of its financial condition resulting from (a) losses and loss adjustment expenses incurred under new,
renewal or in-force insurance and reinsurance related policies, insurance and reinsurance related contracts, and insurance and reinsurance related binders, (b) operating expenses, including acquisition expenses, associated with the maintenance
by Tower of its agency relationships, employees and facilities to operate its business in the ordinary course or (c) the insufficiency of Towers loss reserves (including IBNR reserves), (5) also excludes from the material adverse
effect closing condition any effect resulting from facts or circumstances disclosed in any of Towers previous SEC filings, (6) eliminates the condition in the Original ACP Re Merger Agreement that holders of shares representing more than
15% of Towers share capital shall not have exercised dissenters rights, (7) provides that the closing condition in the Original ACP Re Merger Agreement requiring that each of Towers U.S. insurance subsidiaries shall have risk
based capital that is equal to or exceeds its relevant company action level risk based capital will be deemed to have been satisfied if Tower and its subsidiaries have, on a consolidated basis, sufficient capital that could be reallocated among
Towers insurance subsidiaries so that such condition could be satisfied and (8) provides that all of Towers representations and warranties in the ACP Re Merger Agreement will be qualified by disclosures made in Towers previous
SEC filings.
Notwithstanding any other statement in this Form 10-Q/A or any other document, many of the conditions for closing the ACP Re
Merger Agreement remain outstanding and there can be no assurance that they will be satisfied or that the transaction will be consummated or when it may close.
Pursuant to the terms of the ACP Re Merger Agreement, at the effective time of the merger, each outstanding share of Tower's common stock, par value $0.01 per share (the Common Shares),
following the settlement of all outstanding equity awards, will be converted into the right to receive $2.50 in cash, with an aggregate value of approximately $143.3 million.
Each of the parties has made representations and warranties in the ACP Re Merger Agreement. Tower has agreed to certain covenants and agreements, including, among others, (i) to conduct its business
in the ordinary course of business, consistent with past practice, during the period between the execution of the ACP Re Merger Agreement and the closing of the merger, (ii) not to solicit alternate transactions, subject to a customary
"fiduciary out" provision which allows Tower under certain circumstances to provide information to and participate in discussions with third parties with respect to unsolicited alternative acquisition proposals that Tower's Board of Directors has
determined, in its good faith judgment, is appropriate in furtherance of the best interests of Tower, and (iii) to call and hold a special shareholders' meeting and recommend adoption of the ACP Re Merger Agreement.
On the same day as the execution of the Original ACP Re Merger Agreement, the controlling shareholder of ACP Re provided to Tower a guarantee for the
payment of the merger consideration, effective upon the closing of the merger.
The ACP Re Merger Agreement was unanimously approved by the
respective Boards of Directors of ACP Re and Tower, and is conditioned, among other things, on: (i) the approval of Tower's shareholders, (ii) receipt of governmental approvals, including antitrust and insurance regulatory approvals (on
January 30, 2014, the Company was granted early termination of the Hart-Scott-Rodino waiting period which requires persons contemplating certain mergers or acquisitions to give the Federal Trade
6
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
Commission and the Assistant Attorney General advanced notice and to wait designated periods before consummation of such plans), (iii) the absence of any law, order or injunction prohibiting
the merger, (iv) the accuracy of each party's representations and warranties (subject to customary materiality qualifiers), and (v) each party's compliance with its covenants and agreements contained in the ACP Re Merger Agreement. In
addition, ACP Re's obligation to consummate the merger is subject to the non-occurrence of any material adverse effect on Tower, as well as the absence of any insolvency-related event affecting Tower.
There is no financing condition to consummation of the transactions contemplated by the ACP Re Merger Agreement.
The ACP Re Merger Agreement provides certain termination rights for each of Tower and ACP Re, and further provides that upon termination of the ACP Re
Merger Agreement, under certain circumstances, Tower will be obligated to reimburse ACP Re for certain of its transaction expenses, subject to a cap of $2 million, and to pay ACP Re a termination fee of $6.8 million, net of any transaction expenses
it has reimbursed.
Cut-Through Reinsurance Agreements
On the same day as the execution of the Original ACP Re Merger Agreement, several subsidiaries of Tower entered into two Cut-Through Reinsurance Agreements, pursuant to which a subsidiary of AmTrust and a
subsidiary of NGHC provide 100% quota share reinsurance and a cut-through endorsement to cover all eligible new and renewal commercial and personal lines business, respectively, and at their option, losses incurred on or after January 1, 2014
on not less than 60% of the in-force business. Tower received confirmation on January 16, 2014 from AmTrust and NGHC that they would exercise such option to reinsure on a cut-through basis losses incurred on or after January 1, 2014 under
in-force policies with respect to (1) in the case of AmTrust, approximately 65.7% of Towers unearned premium reserves as of December 31, 2013 with respect to its ongoing commercial lines business, and (2) in the case of NGHC,
100% of Towers unearned premium reserves as of December 31, 2013 with respect to its personal lines segment business. Tower receives a 20% ceding commission from AmTrust or NGHC on all Tower unearned premiums that are subject to the
Cut-Through Reinsurance Agreements and a 22% ceding commission on 2014 ceded premiums.
As a result of the Cut-Through Reinsurance Agreements,
unearned premiums net of reinsurance aggregating $327.7 million at December 31, 2013 (of which $194.0 million and $133.7 million were from the commercial insurance and personal insurance segments, respectively) were transferred to AmTrust and
NGHC. The transfer of the unearned premium reserves at December 31, 2013 are recorded as negative written premiums in the first quarter 2014. In the first quarter 2014, net written premiums of $168.1 million were transferred to AmTrust and NGHC
for renewal business and new policies issued with policy effective dates in 2014 (of which $114.6 million and $53.5 million were from the commercial insurance and personal insurance segments, respectively).
The accompanying financial statements for 2014 reflect the impact of the Cut-Through Reinsurance Agreements, and therefore the trends and relationships
of net premiums written, premiums earned, acquisition expenses and losses incurred will differ materially from the same period in 2013.
Managing General Agent Agreements
On
April 1, 2014, a wholly-owned subsidiary of the Company, Tower Risk Management (TRM), entered into managing general agent agreements (the MGA Agreements), dated as of January 3, 2014, with AmTrust and NGHC pursuant
to which TRM serves as underwriting manager on behalf of AmTrust and NGHC with respect to the commercial lines business and personal lines business covered by the Cut-Through Reinsurance Agreements.
Under the MGA Agreements, TRM solicits, receives, underwrites, accepts, non-renews and cancels insurance risks for certain commercial lines business and
personal lines business of AmTrust and NGHC in return for commissions.
The MGA Agreements will terminate on January 2, 2015 unless
terminated earlier by TRM, AmTrust or NGHC by mutual agreement or by either of the parties under certain circumstances. With respect to AmTrust and NGHC, they may terminate their respective MGA Agreements if, among other things, the merger as
contemplated by the merger agreement is consummated, if TRM or any of its affiliates, including the Company, becomes insolvent or if all or a controlling portion of TRMs capital stock or all or any portion of its business is sold, transferred
or merged into a third party and AmTrust or NGHC believes that such sale, transfer or merger has, or could have, a material adverse impact on AmTrusts or NGHCs interests.
Other Reinsurance Agreements
In the third quarter of 2013, Tower entered into agreements
with three reinsurers, Arch Reinsurance Ltd. (Arch), Hannover Re (Ireland) Plc. (Hannover) and Southport Re (Cayman), Ltd. (Southport Re). These agreements provided for surplus enhancement and improved certain
financial leverage ratios, while increasing the Company's financial flexibility. The agreements with Arch and Hannover each consisted of one reinsurance agreement while the arrangement with Southport Re consisted of several agreements. The
agreements with Arch and Hannover covered business written from July 1, 2013 to December 31, 2013, as well as unearned premiums at June 30, 2013.
7
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
As a result of the announced merger agreement with ACP Re, it was decided that the Southport treaties
should be commuted. As a result of a negotiation between the Company and Southport, the treaties were commuted effective as of February 19, 2014, with the result of the commutation being that all premiums paid to Southport by the Company were
returned to the Company, and all liabilities assumed by Southport were cancelled, and such liabilities became the obligation of the Company.
A.M. Best, Fitch and Demotech Downgrade the Companys Financial Strength and Issuer Credit Ratings
On May 9, 2014, A.M. Best lowered the financial strength ratings of each of Towers insurance subsidiaries from B (Fair) to
C++ (Marginal), as well as the issuer credit ratings of each of Towers insurance subsidiaries from bb to b. In addition, on May 9, 2014, A.M. Best downgraded the issuer credit rating of Tower Group,
Inc. (TGI) as well as the debt rating on its $150 million 5.00% senior convertible notes due 2014 (the Notes) to cc from b-. On the same date, A.M. Best also downgraded the financial strength
rating of CastlePoint Reinsurance Company, Ltd. (Bermuda) to C++ (Marginal) from B- (Fair) and its issuer credit rating to b from bb and downgraded the issuer credit rating of Tower Group
International, Ltd. to cc from b-. TGI and each of its insurance subsidiaries currently are and will continue to be under review with developing implications. In downgrading Towers ratings, A.M. Best stated that its
actions took into consideration Towers most recent Securities and Exchange Commission 10K filing, which included an additional $63 million of prior year reserve development, further reductions in GAAP shareholders equity as well as
ongoing declines in statutory policyholders surplus and risk-adjusted capitalization, as measured by Bests Capital Adequacy Ratio (BCAR). These ratings factors are in addition to the diminished shareholders equity and reserves
actions already taken by Tower during the year. These rating actions also consider the material adverse impact these changes had on all of Towers entities in terms of their ability to operate as going concerns. This action also contemplates
the amended merger agreement announced by Tower.
On May 13, 2014, Fitch withdrew all ratings on Tower and its operating
subsidiaries due to a lack of robust data to maintain the ratings. Previously, on January 6, 2014, Fitch revised Towers rating watch status to evolving from negative following the ACP Re merger announcement, and
stated that [t]he Evolving Watch reflects that the ratings could go up if the merger closes; however, ratings could be lowered if the merger does not occur and [the Company] is unsuccessful in addressing upcoming debt maturity or if additional
reserve deficiencies develop. On January 2, 2014, Fitch downgraded Towers issuer default rating from B to CC and the insurer strength ratings of its insurance subsidiaries from BB to
B. On October 7, 2013, Fitch downgraded Towers issuer default rating to B (the sixth highest of 11 such ratings) from BBB and the insurer strength ratings of its insurance subsidiaries to B
(the fifth highest of Fitch Ratings nine such ratings) from A-. In downgrading such ratings, Fitch stated that it is concerned that Towers competitive position has been materially damaged, negatively impacting the
Companys financial flexibility and ability to write new business and that the magnitude of the second quarter charges was large enough to cause several key ratios to fall well outside of previously established ratings downgrade
triggers, which resulted in the multi-notch downgrade.
On December 24, 2013, Demotech, Inc.
(Demotech) announced the withdrawal of its Financial Stability Ratings
®
(FSRs) assigned to the
following insurance subsidiaries: Kodiak Insurance Company, Massachusetts Homeland Insurance Company, Tower Insurance Company of New York and York Insurance Company of Maine. Concurrently, Demotech advised that the FSRs assigned to Adirondack
Insurance Exchange, Mountain Valley Indemnity Company, New Jersey Skylands Insurance Association and New Jersey Skylands Insurance Company remain under review.
Previously, on October 7, 2013, Demotech had lowered its rating on Tower Insurance Company of New York (TICNY) and three other U.S. based insurance subsidiaries (Kodiak Insurance Company,
Massachusetts Homeland Insurance Company and York Insurance Company of Maine) from A (A prime) to A (A exceptional). In addition, Demotech removed its previous A (A prime) rating on six other U.S. based insurance subsidiaries
(CastlePoint Florida Insurance Company, CastlePoint Insurance Company, CastlePoint National Insurance Company, Hermitage Insurance Company, North East Insurance Company and Preserver Insurance Company). Demotech also affirmed its A ratings on
Adirondack Insurance Exchange, New Jersey Skylands Insurance Association, New Jersey Skylands Insurance Company and Mountain Valley Indemnity Company.
Management expects these rating actions, in combination with other items that have impacted the Company in 2013, to result in a significant decrease in the amount of premiums the insurance subsidiaries
are able to write. The Company had gross written premiums of $302.7 million and $551.2 million in the three months ended March 31, 2014 and 2013, respectively. The majority of the 2014 written premiums were transferred to AmTrust and NGHC
pursuant to the Cut-Through Reinsurance Agreements.
In January 2014, Towers Board of Directors approved the Merger with ACP Re. In
light of the adverse ratings actions, concurrent with entering into the Original ACP Re Merger Agreement Tower entered into cut-through reinsurance treaties with affiliates of ACP Re. As a result of the Merger, and the execution of the
cut-through reinsurance treaties, Tower believes its insurance subsidiaries will retain significant portions of their business.
8
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
Statutory Capital
The Company is required to maintain minimum capital and surplus for each of its insurance subsidiaries.
U.S. based insurance companies are required to maintain capital and surplus above Company Action Level, which is a calculated capital and surplus number using a risk-based formula adopted by the state
insurance regulators. The basis for this formula is the National Association of Insurance Commissioners (NAICs) risk-based capital (RBC) system and is designed to measure the adequacy of a U.S. regulated
insurers statutory capital and surplus compared to risks inherent in its business. If an insurance entity falls into Company Action Level, its management is required to submit a comprehensive financial plan that identifies the conditions that
contributed to the financial condition. This plan must contain proposals to correct the financial problems and provide projections of the financial condition, both with and without the proposed corrections. The plan must also outline the key
assumptions underlying the projections and identify the quality of, and problems associated with, the underlying business. Depending on the level of actual capital and surplus in comparison to the Company Action Level, the state insurance regulators
could increase their regulatory oversight, restrict the placement of new business, or place the company under regulatory control. Bermuda based insurance entities minimum capital and surplus requirements are calculated from a solvency formula
prescribed by the Bermuda Monetary Authority (the BMA).
Tower has in place several intercompany reinsurance transactions between
its U.S. based insurance subsidiaries and its Bermuda based insurance subsidiaries. The U.S. based insurance subsidiaries have historically reinsured on a quota share basis obligations to CastlePoint Reinsurance Company (CastlePoint Re),
one of its Bermuda based insurance subsidiaries. The obligations that CastlePoint Re assumes from the U.S. based insurance subsidiaries are then retroceded to Tower Reinsurance, Ltd. (TRL), Towers other Bermuda based insurance
subsidiary. On February 5, 2014, the BMA approved the transfer of $167.3 million in unencumbered liquid assets from TRL to CastlePoint Re, allowing CastlePoint Re to increase the funding in the reinsurance trust for the benefit of TICNY. As of
March 31, 2014, CastlePoint Re is required to collateralize $603.5 million of its assumed reserves in a reinsurance trust for the benefit of TICNY, the lead pool company of the U.S. insurance companies. As of March 31, 2014, CastlePoint Re
held $555.4 million in its reinsurance trust.
Based on RBC calculations as of December 31, 2013, six of Towers ten U.S. based
insurance subsidiaries had capital and surplus below Company Action Level and did not meet the minimum capital and surplus requirements of their respective state regulators. As a result, management has discussed the ACP Re Merger Agreement and the
Cut-Through Reinsurance Agreements and provided its 2014 RBC forecasts to the regulators to document the Companys business plan to bring two of these U.S based insurance subsidiaries capital and surplus levels above Company Action Level.
As a result of the recognition of the ceding commission relating to the Cut-Through Reinsurance Agreements executed with AmTrust and NGHC in
January 2014, the U.S. based insurance subsidiaries capital and surplus increased significantly from December 31, 2013 to January 1, 2014, as the U.S. based subsidiaries transferred a significant portion of their commercial lines
unearned premium to a subsidiary of AmTrust and all of their personal lines unearned premiums to a subsidiary of NGHC. Accordingly, as of January 1, 2014, the effect of the Cut-Through Reinsurance Agreements increased the surplus of two of the
U.S. based insurance subsidiaries such that their capital and surplus levels exceeded Company Action Level.
In 2013, the New York State
Department of Financial Services (NYDFS) issued orders for seven of Towers insurance subsidiaries, subjecting them to heightened regulatory oversight, which includes providing the NYDFS with increased information with respect to
the insurance subsidiaries business, operations and financial condition. In addition, the NYDFS has placed limitations on payments and transactions outside the ordinary course of business and material changes in the insurance
subsidiaries management and related matters. Towers management and Board of Directors have held discussions with the NYDFS, and Tower has been complying with the orders and oversight.
On April 21, 2014, the NYDFS issued additional orders for two of Towers insurance subsidiaries instructing them to provide plans to address
weaknesses in such insurance subsidiaries risk based capital levels as shown in their statutory annual financial statements, and imposing further enhanced reporting and prior approval requirements and limitations on writings of new
business. On the same date, the NYDFS issued a letter pertaining to one of Towers insurance subsidiaries requiring the submission of a plan to address weaknesses in risk based capital levels.
On May 7, 2014, the Illinois Department of Insurance (the IDI) sent a letter to the Companys Illinois insurance subsidiary instructing
such subsidiary to provide a plan to strengthen its risk based capital level as shown in its statutory annual financial statement. The subsidiary expects to submit such plan to the IDI by June 20, 2014 in accordance with the letter.
On May 20, 2014, the Massachusetts Department of Insurance (the MDOI) entered an amended order of administrative supervision with
respect to two of Towers insurance subsidiaries (collectively, the Massachusetts Insurers). Under the terms of the order, the Massachusetts Insurers are subject to enhanced reporting requirements to the MDOI and are restricted from
selling or encumbering assets or incurring debt, making material changes in management, entering into employment agreements, writing any new business other than policies that are 100% reinsured to affiliates of AmTrust and NGHC pursuant to the
Cut-Through Reinsurance Agreements that are currently in effect with such entities, declaring or paying dividends, making new investments or changing investment practices, entering into new reinsurance agreements and increasing the compensation of
officers or directors, in each case without the consent of the MDOI. Given that substantially all of the new business production of the Massachusetts Insurers is reinsured pursuant to the Cut-Through Reinsurance Agreements referenced above, the
Company believes that the order will not have a material impact on the ability of the Massachusetts Insurers to continue to write new
9
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
business. Also, under the terms of the order, the Company must prepare and submit to the MDOI a preliminary operations plan no later than June 1, 2014. The plan must include detailed
information describing the steps the Company is taking to enable it to repay its convertible senior debt holders and continue operations as a going concern in the event its pending merger with ACP Re does not occur. Accordingly, the Company has
engaged Greenhill & Co., LLC to advise it in connection with its 5.00% convertible senior notes due September 2014. The Company submitted such plan on May 29, 2014.
The Maine Bureau of Insurance entered a Corrective Order imposing certain conditions on Maine domestic insurers York Insurance Company of Maine (YICM) and North East Insurance Company
(NEIC). The Corrective Order imposes increased reporting obligations on YICM and NEIC with respect to business operations and financial condition and imposes restrictions on payments or other transfers of assets from YICM and NEIC
outside the ordinary course of business.
On April 11, 2014, the New Jersey Department of Banking and Insurance imposed an enhanced
reporting requirement on the intercompany transactions involving Towers two New Jersey domiciled insurance subsidiaries and Towers New Jersey managed insurer. Such companies are now required to submit for prior approval any
transactions with affiliates, even transactions that would otherwise not be reportable under the applicable holding company act.
On June 4,
2014, Tower National Insurance Company (TNIC), a Massachusetts domiciled insurance subsidiary of the Company, received notice from the Ohio Department of Insurance (ODOI) in respect of the decrease in TNICs statutory
capital below Ohios minimum capital requirements. Subsequently, TNIC agreed to enter into a consent order with the ODOI on June 11, 2014, the terms of which are still being finalized. The Company expects that the consent order will require
TNIC to cease writing any new or renewal insurance business in Ohio until TNICs statutory capital deficiency has been resolved to the satisfaction of the ODOI. For the year ended December 31, 2013, TNIC wrote $843 thousand of business in
Ohio. TICNY has a license to write business in Ohio, and there have been no restrictions placed against this license.
As of
December 31, 2013, TRL and CastlePoint Re had capital and surplus that did not meet the minimum solvency requirements of the BMA. Management has discussed the ACP Re Merger Agreement and provided 2014 solvency forecasts to the BMA.
The BMA has issued directives for TRL and CastlePoint Re, subjecting them to heightened regulatory oversight and requiring BMA approval before certain
transactions can be executed. Tower has been complying with the directives issued by the BMA.
Liquidity
TGI is the obligor under the $150 million Convertible Senior Notes due September 15, 2014. The indebtedness of TGI is guaranteed by TGIL.
The Companys plan to repay the Notes is related to the closing of the ACP Re Merger Agreement. The Company has engaged Greenhill &
Co., LLC to advise it in the event that the ACP Re Merger Agreement does not close. The Company would evaluate the use of proceeds from the potential sale of certain assets held at TGI to repay the Notes. The Company can provide no assurance that it
would be successful in finalizing the liquidation of the assets held at TGI or that, if it is successful, the proceeds of such liquidation would be sufficient to repay the Notes.
As of March 31, 2014, there were $235.1 million of subordinated debentures outstanding. The subordinated debentures do not have financial covenants that would cause an acceleration of their stated
maturities. The earliest stated maturity date is on a $10 million debenture, which matures in May 2033. If an event of default occurs and is continuing, the entire principal and the interest accrued on the affected subordinated indenture may be
declared to be due and payable immediately. Pursuant to a notice sent to the applicable holders of the subordinated debentures on June 18, 2014, four indirect wholly-owned non-insurance subsidiaries (the Issuers) of Tower Group
International, Ltd. exercised their respective contractual rights pursuant to an indenture, dated as of December 1, 2006, by and between CastlePoint Management Corp. and Wilmington Trust Company, an indenture, dated as of December 14, 2006, by and
between CastlePoint Management Corp. and Wilmington Trust Company, an indenture, dated as of September 27, 2007, by and between CastlePoint Bermuda Holdings, Ltd. and Wilmington Trust Company, an indenture, dated as of January 25, 2007, by and
between Tower Group, Inc. and Wilmington Trust Company, an indenture, dated as of May 15, 2003, by and between Tower Group, Inc. and U.S. Bank, an indenture, dated as of December 21, 2004, by and between Tower Group, Inc. and JPMorgan
Chase Bank, National Association, an indenture, dated as of December 15, 2004, by and between Tower Group, Inc. and Wilmington Trust Company, an indenture, dated as of March 31, 2006, by and between Tower Group, Inc. and Wells Fargo Bank,
National Association, and an indenture, dated as of May 26, 2004, by and between Preserver Group, Inc. and Wilmington Trust Company, to defer the payment of regularly scheduled interest payments on their outstanding junior subordinated
debentures issued in connection with outstanding trust preferred securities. Under the terms of such indentures, the Issuers may defer interest payments for twenty consecutive quarterly periods without default or penalty. The interest on these
debentures will continue to accrue.
The merger with ACP Re is expected to close in the summer of 2014, and there are contractual termination
rights available to each of Tower and ACP Re under various circumstances. There can be no assurance that the merger will close, or that it will close under the same terms and conditions contained in the ACP Re Merger Agreement, or as to when it may
close.
Dividends
U.S.
state insurance regulations restrict the ability of our insurance subsidiaries to pay dividends to Tower Group International, Ltd. as their ultimate parent (the Holding Company). Generally dividends may only be paid out of earned
surplus, and the amount of an insurers surplus following payment of any dividends must be reasonable in relation to the insurers outstanding liabilities and adequate to meet its financial needs. As of March 31, 2014, no dividends
may be paid to the Holding Company without the approval of the state regulators or BMA, as appropriate.
Going Concern
There can be no guarantee that the Company will be able to remedy current statutory capital deficiencies in certain of its insurance subsidiaries,
maintain adequate levels of statutory capital in the future, or generate sufficient liquidity to repay the Notes due in 2014. Consequently, there is substantial doubt about the Companys ability to continue as a going concern. Should the
Company be unable to successfully execute the merger with ACP Re or generate sufficient funds to repay the Notes and remedy the capital deficiencies, these conditions would have a material adverse effect on its business, results of operations and
financial position.
10
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
Resignation of Towers Chairman of the Board, President and Chief Executive Officer and
Appointment of new Chairman of the Board and new President and Chief Executive Officer
On February 6, 2014, Tower and Michael H. Lee
entered into a Separation and Release Agreement in connection with the resignation of Mr. Lee from his positions as Chairman of the Board of Directors, President and Chief Executive Officer, effective as of February 6, 2014.
Mr. Lees employment with the Company was terminated effective as of February 6, 2014. In connection with his resignation, Mr. Lee received on March 31, 2014 a severance payment of approximately $3.3 million calculated
pursuant to terms of his employment agreement.
Jan R. Van Gorder, who is the lead independent director of the Board and a member of the
Boards Audit Committee, Compensation Committee and Corporate Governance and Nominating Committee, was appointed on February 9, 2014 to succeed Mr. Lee as Chairman of the Board. William W. Fox, Jr., who had served as a member of the
Board and of the Boards Audit Committee and Corporate Governance and Nominating Committee until his resignation from the Board on December 31, 2013, succeeded Mr. Lee as President and Chief Executive Officer of Tower, effective as of
February 14, 2014.
Other
Tower received a document request from the U.S. Securities and Exchange Commission (the SEC) dated January 13, 2014, as part of an informal inquiry (the SEC Request). The
SEC Request asks for documents related to Towers financial statements, accounting policies, and analysis. Tower is cooperating with the SECs inquiry and has provided the requested information.
The Company and certain of its current and former senior officers have been named as defendants in several class action lawsuits instituted against them
by certain shareholders. In addition, the Company and certain of its current and former directors, along with certain other parties, have been named as defendants in a putative class action lawsuit instituted against them by another purported
shareholder. See Note 16 Contingencies for additional detail on such litigation.
Note 2Accounting Policies and Basis of Presentation
Basis of Presentation
The 2013 Canopius Merger Transaction (see Note 3 Canopius Merger Transaction in the Notes to the consolidated financial statements in
the Companys Annual Report on Form 10-K for the year ended December 31, 2013 filed on May 2, 2014 (the 2013 Form 10-K)) was accounted for as a reverse acquisition, under which TGI was identified and treated as the
accounting acquirer. As such, the Companys 2013 unaudited consolidated financial statements include the accounts and operations of TGI and its insurance subsidiaries, managing general agencies and management companies as its historical
financial statements, with the results of Tower Group International, Ltd., as accounting acquiree, being included from March 13, 2013, the effective date of the Canopius Merger Transaction. The unaudited consolidated financial statements also
include the accounts of Adirondack Insurance Exchange, a New York reciprocal insurer, and New Jersey Skylands Insurance Association, a New Jersey reciprocal insurer (together, the Reciprocal Exchanges). The Company does not own the
Reciprocal Exchanges but manages their business operations through its wholly-owned management companies.
The unaudited consolidated
financial statements included in this report have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and with the instructions to Securities
and Exchange Commission (SEC) Form 10-Q and Article 10 of SEC Regulation S-X. The principles for condensed interim financial information do not require the inclusion of all the information and footnotes required by GAAP for
complete financial statements. Therefore, these financial statements should be read in conjunction with the Companys consolidated financial statements as of and for the year ended December 31, 2013 and notes thereto included in the
Companys 2013 Form 10-K. The accompanying consolidated financial statements have not been audited by an independent registered public accounting firm in accordance with standards of the Public Company Accounting Oversight Board (United States)
but, in the opinion of management, such financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the Companys financial position, results of operations and cash flows. All
intercompany transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from
those estimates.
11
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
Reclassifications
Certain reclassifications have been made to prior years financial information to conform to the current year presentation.
Accounting Pronouncements
Accounting guidance adopted in 2014
In March 2013, the Financial Accounting Standards Board (FASB) issued an Accounting Standard Codification (ASC) update addressing whether consolidation guidance or foreign currency
guidance applies to the release of the cumulative translation adjustment into net income when a parent sells all or a part of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or net assets that
are a business (other than a sale of in-substance real estate) within a foreign entity. The guidance also resolves the diversity in practice for the cumulative translation adjustment treatment in business combinations achieved in stages involving
foreign entities.
Under this standard, the entire amount of the cumulative translation adjustment associated with the foreign entity should
be released into earnings when there has been: (i) a sale of a subsidiary or group of net assets within a foreign entity and the sale represents a complete or substantially complete liquidation of the foreign entity in which the subsidiary or
the net assets had resided; (ii) a loss of a controlling financial interest in an investment in a foreign entity; or (iii) a change in accounting method from applying the equity method to an investment in a foreign entity to consolidating
the foreign entity. The standard is effective for fiscal years and interim periods beginning after December 15, 2013, and will be applied prospectively. We adopted the standard effective January 1, 2014 with no material effect on our
consolidated financial condition, results of operations or cash flows.
In July 2013, the FASB clarified the applicable guidance for the
presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the
financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward as long as it is available, at the reporting date under the tax law of the applicable jurisdiction,
to settle any additional income taxes that would result from the disallowance of a tax position (with certain exceptions). The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset
that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. This ASC update is effective for annual and interim periods beginning after December 15, 2013, with early adoption permitted,
and is to be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. We adopted the standard effective January 1, 2014 with no material effect on our consolidated
financial condition, results of operations or cash flows.
In July 2013, the FASB issued an accounting standard that permits the Federal Funds
Effective Swap Rate (or Overnight Index Swap Rate) to be used as a U.S. benchmark interest rate for hedge accounting purposes in addition to U.S. Treasury rates and LIBOR. The standard also removes the prohibition on the use of differing benchmark
rates when entering into similar hedging relationships. The standard became effective on a prospective basis for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013 to the extent the Federal Funds
Effective Swap Rate is used as a U.S. benchmark interest rate for hedge accounting purposes. The Company will apply this guidance if and when it enters into any new hedging relationships.
Accounting guidance not yet effective
In April 2014, the FASB issued updated guidance on
reporting discontinued operations. Under this updated guidance, a discontinued operation will include a disposal of a major part of an entitys operations and financial results such as a separate major line of business or a separate major
geographical area of operations. The guidance raises the threshold to be a major operation but no longer precludes discontinued operations presentation where there is significant continuing involvement or cash flows with a disposed component of an
entity. The guidance expands disclosures to include cash flows where there is significant continuing involvement with a discontinued operation and the pre-tax profit or loss of disposal transactions not reported as discontinued operations. The
updated guidance is effective prospectively for years beginning on or after December 15, 2014, with early application permitted. The Company will apply this new guidance in any future disposals and the impacts, if any, on the Companys
consolidated financial condition, results of operations or cash flows will be dependent on the nature of such disposals.
In May 2014, the
FASB issued accounting guidance on the recognition of revenue from customers. The FASB notes that the core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an
amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
12
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
The guidance sets out five steps an entity should undertake to fulfill the core principle of the
guidance as follows:
|
|
|
Identify the contract(s) with a customer.
|
|
|
|
Identify the performance obligations in the contract.
|
|
|
|
Determine the transaction price.
|
|
|
|
Allocate the transaction price to the performance obligations in the contract.
|
|
|
|
Recognize revenue when (or as) the entity satisfies a performance obligation.
|
For a public entity, the amendments in this Update are effective for annual reporting periods beginning after December 15, 2016, including interim
periods within that reporting period. Early application is not permitted. While the guidance specifically excludes revenues from insurance contracts, investments and financial instruments from the scope of the new guidance, the guidance will be
applicable to the Companys other forms of revenue not specifically exempted from the guidance. The Company is currently evaluating the impact this guidance will have on its consolidated financial condition, results of operations, cash flows
and disclosures and is currently unable to estimate the impact of adopting this guidance.
Note 3Investment in Canopius Group Limited (Canopius Group)
See Note 3 Canopius Merger Transaction in the Notes to the consolidated financial statements in the Companys
2013 Form 10-K for further discussion on the March 13, 2013 Canopius Merger transaction.
On December 13, 2013, Tower closed a sale
to an investment fund managed by Bregal Capital LLP (Bregal) of all of the shares of the capital stock of Canopius Group owned by Tower. The initial purchase price for the Canopius shares was $69.7 million (£42.5 million),
which has been paid in full to Tower. In addition, if Bregal subsequently entered into a legally binding contract for the sale or other transfer of shares representing a majority of the voting power of Canopius Group within six months after the date
of Towers sale of such stock to Bregal, a further cash payment would be made by Bregal to Tower. This additional cash payment would be equivalent to the excess, if any, of (1) one-third of the difference between the amount in British
pound sterling paid for the shares previously owned by Tower in such sale and £40.6 million (plus Towers share of expenses of such sale), minus (2) £1.95 million (the Additional Payment). On
May 1, 2014, NKSJ Holdings closed on its acquisition, through its insurance subsidiary Sompo Japan Insurance, Inc. of 100% of the shares of Canopius Group from Bregal. The Additional Payment meets the definition of a derivative. As of
March 31, 2014 and December 31, 2013, the fair value of this derivative recorded in other assets was $7.8 million and $9.3 million, respectively. The change in fair value has been recorded in net realized losses on the statement of
operations for the three months ended March 31, 2014. In May 2014, Tower received $5.8 million of the estimated $7.8 million. Tower expects to receive additional consideration in the second or third quarter of 2014, as the closing balance
sheet associated with the sale transaction is completed.
Note 4Variable Interest Entities (VIEs)
Through its management companies, Tower is the attorney-in-fact for the Reciprocal Exchanges and has the ability to direct their
activities. The Reciprocal Exchanges are policyholder-owned insurance carriers organized as unincorporated associations. Each policyholder insured by the Reciprocal Exchanges shares risk with the other policyholders.
In the event of dissolution, policyholders would share any residual unassigned surplus in the same proportion as the amount of insurance purchased but
are not subject to assessment for any deficit in unassigned surplus of the Reciprocal Exchanges. Tower receives management fee income for the services provided to the Reciprocal Exchanges. The assets of the Reciprocal Exchanges can be used only to
settle the obligations of the Reciprocal Exchanges and general creditors to their liabilities have no recourse to Tower as the primary beneficiary.
In addition, Tower holds the surplus notes issued by the Reciprocal Exchanges when they were originally capitalized. The obligation to repay principal and interest on the surplus notes is subordinated to
the Reciprocal Exchanges other liabilities including obligations to policyholders and claimants for benefits under insurance policies. Principal and interest on the surplus notes are payable only with regulatory approval. The Company has no
ownership interest in the Reciprocal Exchanges.
The Company determined that each of the Reciprocal Exchanges qualifies as a VIE and that the
Company is the primary beneficiary as it has both the power to direct the activities of the Reciprocal Exchanges that most significantly impact their economic performance and the risk of economic loss through its ownership of the surplus notes.
Accordingly, the Company consolidates these Reciprocal Exchanges and eliminates all intercompany balances and transactions with Tower.
For
the three months ended March 31, 2014, the Reciprocal Exchanges recognized total revenues, total expenses and net income (loss) of $49.2 million, $55.0 million and $(5.8) million, respectively. For the three months ended March 31, 2013,
the Reciprocal Exchanges recognized total revenues, total expenses and net income (loss) of $47.3 million, $58.6 million and $(11.3) million, respectively.
13
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
Note 5Investments
The cost or amortized cost and fair value of the Companys investments in fixed maturity and equity securities, gross unrealized
gains and losses, and other-than-temporary impairment losses (OTTI) as of March 31, 2014 and December 31, 2013 are summarized as follows:
14
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in thousands)
|
|
Cost or
Amortized
Cost
|
|
|
Gross
Unrealized
Gains
|
|
|
Gross
Unrealized
Losses
|
|
|
Fair Value
|
|
|
Unrealized
OTTI
Losses (1)
|
|
March 31, 2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities
|
|
$
|
474,654
|
|
|
$
|
723
|
|
|
$
|
(6,272
|
)
|
|
$
|
469,105
|
|
|
$
|
-
|
|
U.S. Agency securities
|
|
|
107,940
|
|
|
|
1,557
|
|
|
|
(258
|
)
|
|
|
109,239
|
|
|
|
-
|
|
Municipal bonds
|
|
|
255,653
|
|
|
|
10,035
|
|
|
|
(2,083
|
)
|
|
|
263,605
|
|
|
|
1
|
|
Corporate and other bonds
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Finance
|
|
|
102,801
|
|
|
|
4,532
|
|
|
|
(439
|
)
|
|
|
106,894
|
|
|
|
-
|
|
Industrial
|
|
|
191,901
|
|
|
|
4,585
|
|
|
|
(1,023
|
)
|
|
|
195,463
|
|
|
|
-
|
|
Utilities
|
|
|
30,321
|
|
|
|
325
|
|
|
|
(736
|
)
|
|
|
29,910
|
|
|
|
(1
|
)
|
Commercial mortgage-backed securities
|
|
|
100,807
|
|
|
|
6,245
|
|
|
|
(948
|
)
|
|
|
106,104
|
|
|
|
(351
|
)
|
Residential mortgage-backed securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency backed securities
|
|
|
70,033
|
|
|
|
376
|
|
|
|
(681
|
)
|
|
|
69,728
|
|
|
|
-
|
|
Non-agency backed securities
|
|
|
18,325
|
|
|
|
1,989
|
|
|
|
(28
|
)
|
|
|
20,286
|
|
|
|
(3
|
)
|
Asset-backed securities
|
|
|
81,239
|
|
|
|
20
|
|
|
|
(192
|
)
|
|
|
81,067
|
|
|
|
-
|
|
Total fixed-maturity securities
|
|
|
1,433,674
|
|
|
|
30,387
|
|
|
|
(12,660
|
)
|
|
|
1,451,401
|
|
|
|
(354
|
)
|
Preferred stocks, principally financial sector
|
|
|
16,120
|
|
|
|
211
|
|
|
|
(1,192
|
)
|
|
|
15,139
|
|
|
|
-
|
|
Common stocks, principally financial and industrial sectors
|
|
|
38,771
|
|
|
|
9,537
|
|
|
|
(240
|
)
|
|
|
48,068
|
|
|
|
-
|
|
Short-term investments
|
|
|
2,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,000
|
|
|
|
-
|
|
Total, March 31, 2014
|
|
$
|
1,490,565
|
|
|
$
|
40,135
|
|
|
$
|
(14,092
|
)
|
|
$
|
1,516,608
|
|
|
$
|
(354
|
)
|
Tower
|
|
$
|
1,284,708
|
|
|
$
|
34,181
|
|
|
$
|
(11,911
|
)
|
|
$
|
1,306,978
|
|
|
$
|
(353
|
)
|
Reciprocal Exchanges
|
|
|
205,857
|
|
|
|
5,954
|
|
|
|
(2,181
|
)
|
|
|
209,630
|
|
|
|
(1
|
)
|
Total, March 31, 2014
|
|
$
|
1,490,565
|
|
|
$
|
40,135
|
|
|
$
|
(14,092
|
)
|
|
$
|
1,516,608
|
|
|
$
|
(354
|
)
|
|
|
|
|
|
|
December 31, 2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities
|
|
$
|
370,959
|
|
|
$
|
729
|
|
|
$
|
(7,726
|
)
|
|
$
|
363,962
|
|
|
$
|
-
|
|
U.S. Agency securities
|
|
|
110,362
|
|
|
|
1,420
|
|
|
|
(561
|
)
|
|
|
111,221
|
|
|
|
-
|
|
Municipal bonds
|
|
|
277,382
|
|
|
|
7,981
|
|
|
|
(6,257
|
)
|
|
|
279,106
|
|
|
|
-
|
|
Corporate and other bonds
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Finance
|
|
|
148,132
|
|
|
|
9,797
|
|
|
|
(1,028
|
)
|
|
|
156,901
|
|
|
|
-
|
|
Industrial
|
|
|
316,474
|
|
|
|
8,286
|
|
|
|
(3,008
|
)
|
|
|
321,752
|
|
|
|
-
|
|
Utilities
|
|
|
47,838
|
|
|
|
1,341
|
|
|
|
(1,890
|
)
|
|
|
47,289
|
|
|
|
(17
|
)
|
Commercial mortgage-backed securities
|
|
|
189,808
|
|
|
|
16,852
|
|
|
|
(1,754
|
)
|
|
|
204,906
|
|
|
|
(634
|
)
|
Residential mortgage-backed securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency backed securities
|
|
|
63,668
|
|
|
|
891
|
|
|
|
(1,218
|
)
|
|
|
63,341
|
|
|
|
-
|
|
Non-agency backed securities
|
|
|
30,228
|
|
|
|
4,659
|
|
|
|
(31
|
)
|
|
|
34,856
|
|
|
|
(13
|
)
|
Asset-backed securities
|
|
|
58,783
|
|
|
|
681
|
|
|
|
(103
|
)
|
|
|
59,361
|
|
|
|
-
|
|
Total fixed-maturity securities
|
|
|
1,613,634
|
|
|
|
52,637
|
|
|
|
(23,576
|
)
|
|
|
1,642,695
|
|
|
|
(664
|
)
|
Preferred stocks, principally financial sector
|
|
|
21,330
|
|
|
|
54
|
|
|
|
(2,536
|
)
|
|
|
18,848
|
|
|
|
-
|
|
Common stocks, principally industrial and financial sectors
|
|
|
76,378
|
|
|
|
11,432
|
|
|
|
(28
|
)
|
|
|
87,782
|
|
|
|
-
|
|
Short-term investments
|
|
|
5,925
|
|
|
|
-
|
|
|
|
(28
|
)
|
|
|
5,897
|
|
|
|
-
|
|
Total, December 31, 2013
|
|
$
|
1,717,267
|
|
|
$
|
64,123
|
|
|
$
|
(26,168
|
)
|
|
$
|
1,755,222
|
|
|
$
|
(664
|
)
|
Tower
|
|
$
|
1,465,039
|
|
|
$
|
56,480
|
|
|
$
|
(21,369
|
)
|
|
$
|
1,500,150
|
|
|
$
|
(664
|
)
|
Reciprocal Exchanges
|
|
|
252,228
|
|
|
|
7,643
|
|
|
|
(4,799
|
)
|
|
|
255,072
|
|
|
|
-
|
|
Total, December 31, 2013
|
|
$
|
1,717,267
|
|
|
$
|
64,123
|
|
|
$
|
(26,168
|
)
|
|
$
|
1,755,222
|
|
|
$
|
(664
|
)
|
(1)
|
Represents the gross unrealized loss on other-than-temporarily impaired securities recognized in accumulated other comprehensive income (loss).
|
In accordance with Lloyds operating guidelines, the Company deposits funds at Lloyds to support underwriting
operations. These funds are available only to fund claims obligations. These restricted assets consisted of approximately $ 106.6 million of cash and cash equivalents as of March 31, 2014 and December 31, 2013, respectively. In
addition, the Company had $203.9 million and $248.9 million of cash and cash equivalents and investments as of March 31, 2014 and December 31, 2013, respectively, held by counterparties as collateral or in trusts to support letters of
credit issued on the Companys behalf, reinsurance liabilities on certain assumed reinsurance treaties, collateral posted for certain leases and other purposes.
15
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
The Company also deposits funds with various state and governmental authorities in the U.S. For a
discussion of the Companys deposits with state and governmental authorities, see Note 5 Investments of the Notes to Consolidated Financial Statements in the Companys Annual Report on Form 10-K for the year ended
December 31, 2013.
Major categories of net investment income are summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
($ in thousands)
|
|
2014
|
|
|
2013
|
|
Income
|
|
|
|
|
|
|
|
|
Fixed-maturity securities
|
|
$
|
12,577
|
|
|
$
|
20,973
|
|
Equity securities
|
|
|
1,311
|
|
|
|
6,484
|
|
Cash and cash equivalents
|
|
|
50
|
|
|
|
51
|
|
Other invested assets
|
|
|
2,382
|
|
|
|
4,256
|
|
Other
|
|
|
81
|
|
|
|
327
|
|
Total
|
|
|
16,401
|
|
|
|
32,091
|
|
Expenses
|
|
|
|
|
|
|
|
|
Investment expenses
|
|
|
(1,043
|
)
|
|
|
(1,774
|
)
|
Net investment income
|
|
$
|
15,358
|
|
|
$
|
30,317
|
|
Tower
|
|
|
14,697
|
|
|
|
29,980
|
|
Reciprocal Exchanges
|
|
|
2,315
|
|
|
|
2,380
|
|
Elimination of interest on Reciprocal Exchange surplus notes
|
|
|
(1,654
|
)
|
|
|
(2,043
|
)
|
Net investment income
|
|
$
|
15,358
|
|
|
$
|
30,317
|
|
Proceeds from the sale of fixed-maturity securities were $635.1 million and $123.7 million for the three months ended
March 31, 2014 and 2013, respectively. Proceeds from the sale of equity securities were $100.9 million and $375.2 million for the three months ended March 31, 2014 and 2013, respectively.
Gross realized gains, losses and impairment write-downs on investments are summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
($ in thousands)
|
|
2014
|
|
|
2013
|
|
Fixed-maturity securities
|
|
|
|
|
|
|
|
|
Gross realized gains
|
|
$
|
28,568
|
|
|
$
|
7,364
|
|
Gross realized losses
|
|
|
(1,564
|
)
|
|
|
(190
|
)
|
|
|
|
27,004
|
|
|
|
7,174
|
|
Equity securities
|
|
|
|
|
|
|
|
|
Gross realized gains
|
|
|
3,318
|
|
|
|
4,236
|
|
Gross realized losses
|
|
|
(3,033
|
)
|
|
|
(4,813
|
)
|
|
|
|
285
|
|
|
|
(577
|
)
|
Other
|
|
|
|
|
|
|
|
|
Gross realized gains
|
|
|
547
|
|
|
|
1,755
|
|
Gross realized losses
|
|
|
(4,666
|
)
|
|
|
(812
|
)
|
|
|
|
(4,119
|
)
|
|
|
943
|
|
Net realized gains (losses) on investments
|
|
|
23,170
|
|
|
|
7,540
|
|
Other-than-temporary impairment losses:
|
|
|
|
|
|
|
|
|
Fixed-maturity securities
|
|
|
(907
|
)
|
|
|
(164
|
)
|
Equity securities
|
|
|
-
|
|
|
|
(525
|
)
|
Total other-than-temporary impairment losses recognized in
earnings
|
|
|
(907
|
)
|
|
|
(689
|
)
|
Total net realized investment gains (losses)
|
|
$
|
22,263
|
|
|
$
|
6,851
|
|
Tower
|
|
$
|
18,800
|
|
|
$
|
6,233
|
|
Reciprocal Exchanges
|
|
|
3,463
|
|
|
|
618
|
|
Total net realized investment gains (losses)
|
|
$
|
22,263
|
|
|
$
|
6,851
|
|
16
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
Management may dispose of a particular security due to changes in facts and circumstances related to the
invested asset that have arisen since the last analysis supporting managements determination whether or not it intended to sell the security, and if not, whether it is more likely than not that the Company would be required to sell the
security before recovery of its amortized cost basis.
Impairment Review
Management regularly reviews the Companys fixed-maturity and equity portfolios to evaluate the necessity of recording impairment losses for OTTI in accordance with its impairment policy. The
determination of OTTI is a subjective process and different judgments and assumptions could affect the timing of loss realization.
Management, in conjunction with its outside portfolio managers, analyzes its non-agency residential mortgage-backed securities (RMBS) using
default loss models based on the performance of the underlying loans. Performance metrics include delinquencies, defaults, foreclosures, anticipated cash flow prepayments and cumulative losses incurred. The expected losses for a mortgage pool are
compared to the break-even loss, which represents the point at which the Companys tranche begins to experience losses.
The commercial
mortgage-backed securities (CMBS) holdings are evaluated using analytical techniques and various metrics including the level of subordination, debt-service-coverage ratios, loan-to-value ratios, delinquencies, defaults and foreclosures.
For the non-structured fixed-maturity securities (U.S. Treasury and Agency securities, municipal bonds, and corporate debt), unrealized
losses are reviewed to determine whether full recovery of principal and interest will be received. The estimate of expected cash flows is determined by projecting a recovery value and a recovery time frame and assessing whether further principal and
interest will be received. The determination of recovery value incorporates an issuer valuation assumption utilizing one or a combination of valuation methods as deemed appropriate by management. The present value of the cash flows is determined by
applying the effective yield of the security at the date of acquisition (or the most recent implied rate used to accrete the security if the implied rate has changed as a result of a previous impairment) and an estimated recovery time frame. For
securities for which the issuer is financially troubled but not in bankruptcy, that time frame is generally longer. Included in the present value calculation are expected principal and interest payments; however, for securities for which the issuer
is classified as bankrupt or in default, the present value calculation assumes no interest payments and a single recovery amount. In situations for which a present value of cash flows cannot be estimated, a write-down to fair value is recorded.
In estimating the recovery value, significant judgment is involved in the development of assumptions related to the issuer including, but not
limited to, revenue, margin and earnings projections, the likely market or liquidation values of assets, potential additional debt to be incurred pre- or post- bankruptcy/restructuring, the ability to shift existing or new debt to different priority
layers, the amount of restructuring/bankruptcy expenses, the size and priority of unfunded pension obligations, litigation or other contingent claims, the treatment of intercompany claims and the likely outcome with respect to inter-creditor
conflicts.
The evaluation of equity securities includes managements intent and ability to hold the security to recovery. Management
will record OTTI in situations where it does not intend to hold the security to recovery or if the security is not expected to recover in value in the near term.
The following table shows the fixed-maturity and equity securities OTTI amounts for the three months ended March 31, 2014 and 2013:
17
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
($ in thousands)
|
|
2014
|
|
|
2013
|
|
Municipal bonds
|
|
$
|
(672
|
)
|
|
$
|
-
|
|
Corporate and other bonds
|
|
|
(99
|
)
|
|
|
-
|
|
Commercial mortgage-backed securities
|
|
|
(364
|
)
|
|
|
(24
|
)
|
Residential mortgage-backed securities
|
|
|
(123
|
)
|
|
|
(140
|
)
|
Equities
|
|
|
-
|
|
|
|
(525
|
)
|
Other-than-temporary-impairments
|
|
|
(1,258
|
)
|
|
|
(689
|
)
|
Portion of loss recognized in accumulated other comprehensive income
(loss)
|
|
|
351
|
|
|
|
-
|
|
Impairment losses recognized in earnings
|
|
$
|
(907
|
)
|
|
$
|
(689
|
)
|
Tower
|
|
$
|
(662
|
)
|
|
$
|
(689
|
)
|
Reciprocal Exchanges
|
|
|
(245
|
)
|
|
|
-
|
|
Impairment losses recognized in earnings
|
|
$
|
(907
|
)
|
|
$
|
(689
|
)
|
The following table provides a rollforward of the cumulative amounts of credit OTTI for securities held as of
March 31, 2014 and 2013 showing the amounts that have been included in earnings on a pretax basis for the three months ended March 31, 2014 and 2013:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
($ in thousands)
|
|
2014
|
|
|
2013
|
|
Balance, January 1,
|
|
$
|
7,817
|
|
|
$
|
4,492
|
|
Additional credit losses recognized during the period, related to securities for which:
|
|
|
|
|
|
|
|
|
No OTTI has been previously recognized
|
|
|
772
|
|
|
|
164
|
|
OTTI has been previously recognized
|
|
|
135
|
|
|
|
-
|
|
Reductions due to:
|
|
|
|
|
|
|
|
|
Securities sold during the period (realized)
|
|
|
(1,209
|
)
|
|
|
(140
|
)
|
Balance, March 31,
|
|
$
|
7,515
|
|
|
$
|
4,516
|
|
Unrealized Losses
There are 313 securities at March 31, 2014, including fixed maturities and equity securities, which account for the gross unrealized loss, none of which is deemed by management to be OTTI. Temporary
losses on corporate and other bonds result from purchases made in a lower yield spread environment. In addition, there have been some ratings downgrades on certain of these securities. After analyzing the credit quality, balance sheet strength and
company outlook, management believes these securities will recover in value. To the extent projected cash flows on structured securities change adversely, they would be considered OTTI, and an impairment loss would be recognized in the current
period. Management considered all relevant factors, including expected recoverability of cash flows, in assessing whether a loss was other-than-temporary. The gross unrealized loss position associated with the fixed-maturity portfolio was $12.7
million as of March 31, 2014, consisting primarily of municipal bonds, corporate and other bonds and U.S. Treasury securities of $10.6 million. The total fixed-maturity portfolio of gross unrealized losses included 302 securities which were, in
aggregate, approximately 1.0% below amortized cost. Of the 302 fixed maturity investments identified, 37 have been in an unrealized loss position for more than 12 months. The total unrealized loss on these investments at March 31, 2014 was $2.0
million. Management does not consider these investments to be other-than-temporarily impaired.
In the equity portfolio, there were 11
securities in a loss position at March 31, 2014 totaling $1.4 million. Management evaluated the financial condition of the common stock issuers, the severity and duration of the impairment, and the Companys ability and intent to hold to
recovery. The evaluation consisted of a detailed review, including but not limited to some or all of the following factors for each security: the current S&P rating, analysts reports, past earnings trends and analysts earnings
expectations for the next 12 months, liquidity, near-term financing risk, and whether the company was currently paying dividends on its equity securities. Management does not consider these investments to be other-than-temporarily impaired.
18
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
The following table presents information regarding invested assets that were in an unrealized loss
position at March 31, 2014 and December 31, 2013 by amount of time in a continuous unrealized loss position:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than 12 Months
|
|
|
12 Months or Longer
|
|
|
Total
|
|
($ in thousands)
|
|
Fair
Value
|
|
|
Unrealized
Losses
|
|
|
Fair
Value
|
|
|
Unrealized
Losses
|
|
|
Aggregate
Fair Value
|
|
|
Unrealized
Losses
|
|
March 31, 2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities
|
|
$
|
343,335
|
|
|
$
|
(6,272
|
)
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
343,335
|
|
|
$
|
(6,272
|
)
|
U.S. Agency securities
|
|
|
51,843
|
|
|
|
(258
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
51,843
|
|
|
|
(258
|
)
|
Municipal bonds
|
|
|
61,758
|
|
|
|
(1,836
|
)
|
|
|
5,996
|
|
|
|
(247
|
)
|
|
|
67,754
|
|
|
|
(2,083
|
)
|
Corporate and other bonds
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Finance
|
|
|
28,227
|
|
|
|
(425
|
)
|
|
|
345
|
|
|
|
(14
|
)
|
|
|
28,572
|
|
|
|
(439
|
)
|
Industrial
|
|
|
72,945
|
|
|
|
(841
|
)
|
|
|
7,078
|
|
|
|
(182
|
)
|
|
|
80,023
|
|
|
|
(1,023
|
)
|
Utilities
|
|
|
13,983
|
|
|
|
(149
|
)
|
|
|
7,954
|
|
|
|
(587
|
)
|
|
|
21,937
|
|
|
|
(736
|
)
|
Commercial mortgage-backed securities
|
|
|
12,097
|
|
|
|
(238
|
)
|
|
|
24,744
|
|
|
|
(710
|
)
|
|
|
36,841
|
|
|
|
(948
|
)
|
Residential mortgage-backed securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency backed
|
|
|
48,130
|
|
|
|
(450
|
)
|
|
|
5,050
|
|
|
|
(231
|
)
|
|
|
53,180
|
|
|
|
(681
|
)
|
Non-agency backed
|
|
|
162
|
|
|
|
(28
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
162
|
|
|
|
(28
|
)
|
Asset-backed securities
|
|
|
71,452
|
|
|
|
(192
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
71,452
|
|
|
|
(192
|
)
|
Total fixed-maturity securities
|
|
|
703,932
|
|
|
|
(10,689
|
)
|
|
|
51,167
|
|
|
|
(1,971
|
)
|
|
|
755,099
|
|
|
|
(12,660
|
)
|
Preferred stocks
|
|
|
8,285
|
|
|
|
(1,007
|
)
|
|
|
2,219
|
|
|
|
(185
|
)
|
|
|
10,504
|
|
|
|
(1,192
|
)
|
Common stocks
|
|
|
6,661
|
|
|
|
(240
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
6,661
|
|
|
|
(240
|
)
|
Short-term investments
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Total, March 31, 2014
|
|
$
|
718,878
|
|
|
$
|
(11,936
|
)
|
|
$
|
53,386
|
|
|
$
|
(2,156
|
)
|
|
$
|
772,264
|
|
|
$
|
(14,092
|
)
|
Tower
|
|
$
|
676,838
|
|
|
$
|
(10,995
|
)
|
|
$
|
22,062
|
|
|
$
|
(916
|
)
|
|
$
|
698,900
|
|
|
$
|
(11,911
|
)
|
Reciprocal Exchanges
|
|
|
42,040
|
|
|
|
(941
|
)
|
|
|
31,324
|
|
|
|
(1,240
|
)
|
|
|
73,364
|
|
|
|
(2,181
|
)
|
Total, March 31, 2014
|
|
$
|
718,878
|
|
|
$
|
(11,936
|
)
|
|
$
|
53,386
|
|
|
$
|
(2,156
|
)
|
|
$
|
772,264
|
|
|
$
|
(14,092
|
)
|
|
|
|
|
|
|
|
December 31, 2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities
|
|
$
|
273,217
|
|
|
$
|
(7,726
|
)
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
273,217
|
|
|
$
|
(7,726
|
)
|
U.S. Agency securities
|
|
|
51,808
|
|
|
|
(561
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
51,808
|
|
|
|
(561
|
)
|
Municipal bonds
|
|
|
109,345
|
|
|
|
(5,056
|
)
|
|
|
4,268
|
|
|
|
(1,201
|
)
|
|
|
113,613
|
|
|
|
(6,257
|
)
|
Corporate and other bonds
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Finance
|
|
|
37,811
|
|
|
|
(1,005
|
)
|
|
|
335
|
|
|
|
(23
|
)
|
|
|
38,146
|
|
|
|
(1,028
|
)
|
Industrial
|
|
|
124,869
|
|
|
|
(2,550
|
)
|
|
|
10,023
|
|
|
|
(458
|
)
|
|
|
134,892
|
|
|
|
(3,008
|
)
|
Utilities
|
|
|
27,698
|
|
|
|
(805
|
)
|
|
|
7,292
|
|
|
|
(1,085
|
)
|
|
|
34,990
|
|
|
|
(1,890
|
)
|
Commercial mortgage-backed securities
|
|
|
26,469
|
|
|
|
(597
|
)
|
|
|
20,397
|
|
|
|
(1,157
|
)
|
|
|
46,866
|
|
|
|
(1,754
|
)
|
Residential mortgage-backed securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency backed
|
|
|
37,660
|
|
|
|
(925
|
)
|
|
|
5,166
|
|
|
|
(293
|
)
|
|
|
42,826
|
|
|
|
(1,218
|
)
|
Non-agency backed
|
|
|
1,027
|
|
|
|
(19
|
)
|
|
|
182
|
|
|
|
(12
|
)
|
|
|
1,209
|
|
|
|
(31
|
)
|
Asset-backed securities
|
|
|
32,461
|
|
|
|
(103
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
32,461
|
|
|
|
(103
|
)
|
Total fixed-maturity securities
|
|
|
722,365
|
|
|
|
(19,347
|
)
|
|
|
47,663
|
|
|
|
(4,229
|
)
|
|
|
770,028
|
|
|
|
(23,576
|
)
|
Preferred stocks
|
|
|
10,538
|
|
|
|
(2,285
|
)
|
|
|
6,154
|
|
|
|
(251
|
)
|
|
|
16,692
|
|
|
|
(2,536
|
)
|
Common stocks
|
|
|
7,125
|
|
|
|
(28
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
7,125
|
|
|
|
(28
|
)
|
Short-term investments
|
|
|
3,897
|
|
|
|
(28
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
3,897
|
|
|
|
(28
|
)
|
Total, December 31, 2013
|
|
$
|
743,925
|
|
|
$
|
(21,688
|
)
|
|
$
|
53,817
|
|
|
$
|
(4,480
|
)
|
|
$
|
797,742
|
|
|
$
|
(26,168
|
)
|
Tower
|
|
$
|
663,127
|
|
|
$
|
(19,335
|
)
|
|
$
|
23,096
|
|
|
$
|
(2,034
|
)
|
|
$
|
686,223
|
|
|
$
|
(21,369
|
)
|
Reciprocal Exchanges
|
|
|
80,798
|
|
|
|
(2,353
|
)
|
|
|
30,721
|
|
|
|
(2,446
|
)
|
|
|
111,519
|
|
|
|
(4,799
|
)
|
Total, December 31, 2013
|
|
$
|
743,925
|
|
|
$
|
(21,688
|
)
|
|
$
|
53,817
|
|
|
$
|
(4,480
|
)
|
|
$
|
797,742
|
|
|
$
|
(26,168
|
)
|
Management evaluated the severity of the impairment in relation to the carrying values for the securities referred to
above and considered all relevant factors in assessing whether the loss was other-than-temporary.
Fixed-Maturity InvestmentTime to
Maturity
The following table shows the amortized cost and fair value of the fixed-maturity portfolio by contractual time to maturity at
March 31, 2014 and December 31, 2013:
19
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Tower
|
|
|
Reciprocal Exchanges
|
|
|
Total
|
|
($ in thousands)
|
|
Amortized
Cost
|
|
|
Fair Value
|
|
|
Amortized
Cost
|
|
|
Fair Value
|
|
|
Amortized
Cost
|
|
|
Fair Value
|
|
March 31, 2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Remaining Time to Maturity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than one year
|
|
$
|
29,834
|
|
|
$
|
30,223
|
|
|
$
|
7,762
|
|
|
$
|
7,850
|
|
|
$
|
37,596
|
|
|
$
|
38,073
|
|
One to five years
|
|
|
587,613
|
|
|
|
591,857
|
|
|
|
24,245
|
|
|
|
24,615
|
|
|
|
611,858
|
|
|
|
616,472
|
|
Five to ten years
|
|
|
338,210
|
|
|
|
342,185
|
|
|
|
64,639
|
|
|
|
65,442
|
|
|
|
402,849
|
|
|
|
407,627
|
|
More than 10 years
|
|
|
72,583
|
|
|
|
73,697
|
|
|
|
38,384
|
|
|
|
38,347
|
|
|
|
110,967
|
|
|
|
112,044
|
|
Mortgage and asset-backed securities
|
|
|
202,328
|
|
|
|
206,533
|
|
|
|
68,076
|
|
|
|
70,652
|
|
|
|
270,404
|
|
|
|
277,185
|
|
Total, March 31, 2014
|
|
$
|
1,230,568
|
|
|
$
|
1,244,495
|
|
|
$
|
203,106
|
|
|
$
|
206,906
|
|
|
$
|
1,433,674
|
|
|
$
|
1,451,401
|
|
December 31, 2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Remaining Time to Maturity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than one year
|
|
$
|
33,305
|
|
|
$
|
33,727
|
|
|
$
|
7,866
|
|
|
$
|
8,021
|
|
|
$
|
41,171
|
|
|
$
|
41,748
|
|
One to five years
|
|
|
507,388
|
|
|
|
513,841
|
|
|
|
39,469
|
|
|
|
41,381
|
|
|
|
546,857
|
|
|
|
555,222
|
|
Five to ten years
|
|
|
459,070
|
|
|
|
459,251
|
|
|
|
82,003
|
|
|
|
81,515
|
|
|
|
541,073
|
|
|
|
540,766
|
|
More than 10 years
|
|
|
100,977
|
|
|
|
102,801
|
|
|
|
41,069
|
|
|
|
39,693
|
|
|
|
142,046
|
|
|
|
142,494
|
|
Mortgage and asset-backed securities
|
|
|
263,417
|
|
|
|
280,526
|
|
|
|
79,070
|
|
|
|
81,939
|
|
|
|
342,487
|
|
|
|
362,465
|
|
Total, December 31, 2013
|
|
$
|
1,364,157
|
|
|
$
|
1,390,146
|
|
|
$
|
249,477
|
|
|
$
|
252,549
|
|
|
$
|
1,613,634
|
|
|
$
|
1,642,695
|
|
Other Invested Assets
The following table shows the composition of the other invested assets as of March 31, 2014 and December 31, 2013:
|
|
|
|
|
|
|
|
|
($ in thousands)
|
|
March 31,
2014
|
|
|
December 31,
2013
|
|
Limited partnerships, equity method
|
|
$
|
35,829
|
|
|
$
|
46,521
|
|
Real estate, amortized cost
|
|
|
-
|
|
|
|
6,054
|
|
Securities reported under the fair value option
|
|
|
18,778
|
|
|
|
43,580
|
|
Other
|
|
|
-
|
|
|
|
-
|
|
Total
|
|
$
|
54,607
|
|
|
$
|
96,155
|
|
Other invested assets reported under the fair value option include six securities, which contain embedded derivatives and
other features. The significant inputs used to determine fair value are considered Level 3 pursuant to the fair value hierarchy. See Note 6 Fair Value Measurements below.
As of March 31, 2014, the Company and its insurance companies had future funding commitments of $44.6 million including but not limited to the limited partnerships.
Note 6Fair Value Measurements
GAAP establishes a three-level hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The fair
value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the assets or liabilities fall within
different levels of the hierarchy, the classification is based on the lowest level input that is significant to the fair value measurement of the asset or liability. Classification of assets and liabilities within the hierarchy considers the markets
in which the assets and liabilities are traded, including during periods of market disruption, and the reliability and transparency of the assumptions used to determine fair value. The hierarchy requires the use of observable market data when
available. The levels of the hierarchy are as follows:
Level 1
Inputs to the valuation methodology are quoted prices
(unadjusted) for identical assets or liabilities traded in active markets. Included are those equity securities that are traded on active exchanges, such as the NASDAQ Global Select Market.
Level 2
Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets
that are not active, inputs other than quoted prices that are observable for the asset or liability and market-corroborated inputs. Included are investments in U.S. Treasury and Agency securities and, together with municipal bonds, corporate debt
securities, commercial mortgages, residential mortgage-backed securities and asset-backed securities. Additionally, interest-rate swap contracts utilize Level 2 inputs in deriving fair values.
Level 3
Inputs to the valuation methodology are unobservable in the market for the asset or liability and are significant to the fair value
measurement. Material assumptions and factors considered in pricing investment securities may include projected cash flows, collateral performance including delinquencies, defaults and recoveries, and any market clearing activity or liquidity
circumstances in the security or similar securities that may have occurred since the prior pricing period.
20
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
The availability of observable inputs varies and is affected by a wide variety of factors. When the
valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires significantly more judgment. The degree of judgment exercised by management in determining fair value is greatest
for investments categorized as Level 3. For investments in this category, management considers prices and inputs that are current as of the measurement date. In periods of market dislocation, as characterized by current market conditions, the
ability to observe stable prices and inputs may be reduced for many instruments. This condition could cause a security to be reclassified between levels.
21
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
As at March 31, 2014 and December 31, 2013, the Companys financial instruments carried
at fair value are allocated among levels as follows:
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|
|
|
|
|
|
|
|
|
($ in thousands)
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
March 31, 2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed-maturity securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities
|
|
$
|
-
|
|
|
$
|
469,105
|
|
|
$
|
-
|
|
|
$
|
469,105
|
|
U.S. Agency securities
|
|
|
-
|
|
|
|
109,239
|
|
|
|
-
|
|
|
|
109,239
|
|
Municipal bonds
|
|
|
-
|
|
|
|
263,605
|
|
|
|
-
|
|
|
|
263,605
|
|
Corporate and other bonds
|
|
|
-
|
|
|
|
328,841
|
|
|
|
3,426
|
|
|
|
332,267
|
|
Commercial mortgage-backed securities
|
|
|
-
|
|
|
|
106,104
|
|
|
|
-
|
|
|
|
106,104
|
|
Residential mortgage-backed securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency
|
|
|
-
|
|
|
|
69,728
|
|
|
|
-
|
|
|
|
69,728
|
|
Non-agency
|
|
|
-
|
|
|
|
20,286
|
|
|
|
-
|
|
|
|
20,286
|
|
Asset-backed securities
|
|
|
-
|
|
|
|
81,067
|
|
|
|
-
|
|
|
|
81,067
|
|
Total fixed-maturities
|
|
|
-
|
|
|
|
1,447,975
|
|
|
|
3,426
|
|
|
|
1,451,401
|
|
Equity securities
|
|
|
63,207
|
|
|
|
-
|
|
|
|
-
|
|
|
|
63,207
|
|
Short-term investments
|
|
|
-
|
|
|
|
2,000
|
|
|
|
-
|
|
|
|
2,000
|
|
Total investments at fair value
|
|
|
63,207
|
|
|
|
1,449,975
|
|
|
|
3,426
|
|
|
|
1,516,608
|
|
Other invested assets (1)
|
|
|
-
|
|
|
|
-
|
|
|
|
18,778
|
|
|
|
18,778
|
|
Other assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-
|
|
Additional Payment derivative
|
|
|
-
|
|
|
|
-
|
|
|
|
7,843
|
|
|
|
7,843
|
|
Other liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
-
|
|
Interest rate swap contracts
|
|
|
-
|
|
|
|
(5,408
|
)
|
|
|
-
|
|
|
|
(5,408
|
)
|
Debt and equity securities sold, not yet purchased
|
|
|
-
|
|
|
|
(11,033
|
)
|
|
|
-
|
|
|
|
(11,033
|
)
|
Total, March 31, 2014
|
|
$
|
63,207
|
|
|
$
|
1,433,534
|
|
|
$
|
30,047
|
|
|
$
|
1,526,788
|
|
Tower
|
|
$
|
60,483
|
|
|
$
|
1,226,628
|
|
|
$
|
30,047
|
|
|
$
|
1,317,158
|
|
Reciprocal Exchanges
|
|
|
2,724
|
|
|
|
206,906
|
|
|
|
-
|
|
|
|
209,630
|
|
Total, March 31, 2014
|
|
$
|
63,207
|
|
|
$
|
1,433,534
|
|
|
$
|
30,047
|
|
|
$
|
1,526,788
|
|
December 31, 2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed-maturity securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities
|
|
$
|
-
|
|
|
$
|
363,962
|
|
|
$
|
-
|
|
|
$
|
363,962
|
|
U.S. Agency securities
|
|
|
-
|
|
|
|
111,221
|
|
|
|
-
|
|
|
|
111,221
|
|
Municipal bonds
|
|
|
-
|
|
|
|
279,106
|
|
|
|
-
|
|
|
|
279,106
|
|
Corporate and other bonds
|
|
|
-
|
|
|
|
522,516
|
|
|
|
3,426
|
|
|
|
525,942
|
|
Commercial mortgage-backed securities
|
|
|
-
|
|
|
|
204,906
|
|
|
|
-
|
|
|
|
204,906
|
|
Residential mortgage-backed securities
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Agency
|
|
|
-
|
|
|
|
63,341
|
|
|
|
-
|
|
|
|
63,341
|
|
Non-agency
|
|
|
-
|
|
|
|
34,856
|
|
|
|
-
|
|
|
|
34,856
|
|
Asset-backed securities
|
|
|
-
|
|
|
|
59,361
|
|
|
|
-
|
|
|
|
59,361
|
|
Total fixed-maturities
|
|
|
-
|
|
|
|
1,639,269
|
|
|
|
3,426
|
|
|
|
1,642,695
|
|
Equity securities
|
|
|
106,630
|
|
|
|
-
|
|
|
|
-
|
|
|
|
106,630
|
|
Short-term investments
|
|
|
-
|
|
|
|
5,897
|
|
|
|
-
|
|
|
|
5,897
|
|
Total investments at fair value
|
|
|
106,630
|
|
|
|
1,645,166
|
|
|
|
3,426
|
|
|
|
1,755,222
|
|
Other invested assets (2)
|
|
|
-
|
|
|
|
-
|
|
|
|
43,580
|
|
|
|
43,580
|
|
Other assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional Payment derivative
|
|
|
-
|
|
|
|
-
|
|
|
|
9,343
|
|
|
|
9,343
|
|
Other liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swap contracts
|
|
|
-
|
|
|
|
(6,066
|
)
|
|
|
-
|
|
|
|
(6,066
|
)
|
Debt and equity securities sold, not yet purchased
|
|
|
-
|
|
|
|
(11,099
|
)
|
|
|
-
|
|
|
|
(11,099
|
)
|
Total, December 31, 2013
|
|
$
|
106,630
|
|
|
$
|
1,628,001
|
|
|
$
|
56,349
|
|
|
$
|
1,790,980
|
|
Tower
|
|
$
|
104,107
|
|
|
$
|
1,375,452
|
|
|
$
|
56,349
|
|
|
$
|
1,535,908
|
|
Reciprocal Exchanges
|
|
|
2,523
|
|
|
|
252,549
|
|
|
|
-
|
|
|
|
255,072
|
|
Total, December 31, 2013
|
|
$
|
106,630
|
|
|
$
|
1,628,001
|
|
|
$
|
56,349
|
|
|
$
|
1,790,980
|
|
(1) $18.8 million of the $54.6 million Other invested assets reported on the consolidated balance sheet at March 31,
2014 is reported at fair value. The remaining $35.8 million of Other invested assets is reported under the equity method of accounting or at amortized cost.
(2) $43.6 million of the $96.2 million Other invested assets reported on the consolidated balance sheet at December 31, 2013 is reported at fair value. The remaining $52.6 million of Other invested
assets is reported under the equity method of accounting or at amortized cost.
22
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
As of March 31, 2014, substantially all of the investment portfolio recorded at fair value was
priced based upon quoted market prices or other observable inputs. For investments in active markets, the Company used the quoted market prices provided by the outside pricing services to determine fair value. In circumstances where quoted market
prices were unavailable, the Company used fair value estimates based upon other observable inputs including matrix pricing, benchmark interest rates, market comparables and other relevant inputs. When observable inputs were adjusted to reflect
managements best estimate of fair value, such fair value measurements are considered a lower level measurement in the GAAP fair value hierarchy.
The Companys process to validate the market prices obtained from the outside pricing sources includes, but is not limited to, periodic evaluation of model pricing methodologies and analytical
reviews of certain prices. The Company also periodically performs testing of the market to determine trading activity, or lack of trading activity, as well as market prices. Several securities sold during the quarter were back-tested
(i.e., the sales price is compared to the previous month end reported market price to determine reasonableness of the reported market price). If management believes that the price provided from the pricing source is distressed, management will use a
valuation method that reflects an orderly transaction between market participants, generally a discounted cash flow method that incorporates relevant interest rate, risk and liquidity factors.
The ability to observe stable prices and inputs may be reduced for highly-customized and illiquid instruments which had been the case for certain
non-agency residential and commercial mortgage-backed securities and asset-backed securities in previous periods.
Substantially all of the
portfolio valuations at March 31, 2014, classified as Level 1 or Level 2 in the above table are determined utilizing several independent pricing services that provide a price quote for each security. There were no adjustments made to the prices
obtained from the independent pricing sources and dealers on securities classified as Level 1 or Level 2.
In 2014 and 2013, there were no
transfers of investments between Level 1 and Level 2 or between Level 2 and Level 3.
The fair values of the interest rate swaps were derived
using an industry standard swap valuation model with market based inputs for swaps having similar characteristics.
The fair values of the
debt and equity securities sold, not yet purchased were derived using quoted prices for similar securities in active markets. These instruments resulted in gross realized gains and losses of $0.2 million and $0.1 million for the three months ended
March 31, 2014, respectively.
The Company holds six securities which are reported in other invested assets and have been classified as
Level 3 of the fair value hierarchy. Management utilizes a discounted cash flow analysis to derive the fair values. One of the six securities is an investment in a credit linked note which matures in 2017, and whose cash flows are supported by
underlying short-term loans. The significant unobservable inputs include the underlying short-term loans probability of default and loss severity, and a discount for the securitys lack of marketability. Increases in the probability of
default and loss severity assumptions (which generally move directionally with each other) would have the effect of decreasing the fair value of this security. The Company obtains credit ratings on the underlying short-term loans quarterly and
considers these ratings when updating its assumptions.
Four securities are preferred equity interests in limited partnerships that invest in
leisure hotels. The preferred interests pay a stated quarterly dividend with residual equity incentives payable after the General Partners minimum return thresholds are met. The significant unobservable inputs include the market discount rate
and the instruments lack of marketability. These four preferred equity interest investments are carried at fair value and are modeled quarterly using discounted market yields from similar hotel properties.
The Company has one fixed-maturity security classified as Level 3. This security, a privately placed corporate convertible bond, is valued by management
using a liquidation pricing methodology.
Management is responsible for the determination of the value of the investments carried at fair
value and the supporting methodologies and assumptions. Management has reviewed the pricing techniques and methodologies of the independent pricing sources and believes that their policies adequately consider market activity, either based on
specific transactions for the issue valued or based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. Management monitors security-specific valuation trends and discusses material changes
or the absence of expected changes with the portfolio managers to understand the underlying factors and inputs and to validate the reasonableness of pricing. Management also back-tests the prices on numerous sales of securities during the year to
validate the previous pricing provided as well as utilizes other pricing sources to validate the pricing provided by the Companys primary provider of the majority of the non-U.S. Treasury securities and non-agency securities included in Level
2.
23
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
The following table summarizes activity in Level 3 assets measured at fair value for the three months
ended March 31, 2014 and 2013 for Tower (the Reciprocal Exchanges have no Level 3 assets):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2014
|
|
|
2013
|
|
($ in thousands)
|
|
Other
Invested
Assets
|
|
|
Fixed
Maturity
Securities
(1)
|
|
|
Additional
Payment
Derivative
|
|
|
Total
|
|
|
Other
Invested
Assets
|
|
Beginning balance, January 1
|
|
$
|
43,580
|
|
|
$
|
3,426
|
|
|
$
|
9,343
|
|
|
$
|
56,349
|
|
|
$
|
25,000
|
|
Total gains (losses)-realized / unrealized
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Included in net income
|
|
|
58
|
|
|
|
-
|
|
|
|
(1,500
|
)
|
|
|
(1,442
|
)
|
|
|
-
|
|
Settlements
|
|
|
(24,860
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(24,860
|
)
|
|
|
-
|
|
Ending balance, March 31,
|
|
$
|
18,778
|
|
|
$
|
3,426
|
|
|
$
|
7,843
|
|
|
$
|
30,047
|
|
|
$
|
25,000
|
|
(1) Comprised of corporate and other bonds
Note 7Reinsurance
The Company utilizes various excess of loss, quota share and catastrophe reinsurance programs to limit its exposure to a maximum loss
on any one risk.
In addition, as disclosed in Note 1 Nature of the Business, as a result of the 2013 significant business
developments and the execution of the ACP Re Merger Agreement, Tower had entered into two Cut-Through Reinsurance Agreements, pursuant to which a subsidiary of AmTrust and a subsidiary of NGHC agreed to provide 100% quota share reinsurance and
a cut-through endorsement to cover all eligible new and renewal commercial and personal lines business, respectively, and at their option, losses incurred on or after January 1, 2014 of not less than 60% of the in-force business. Tower received
confirmation on January 16, 2014 from AmTrust and NGHC that they would exercise such option to reinsure on a cut -through basis losses incurred on or after January 1, 2014 under in-force policies with respect to (1) in the case of
AmTrust, 65.7% of Towers unearned premium reserves as of December 31, 2013 with respect to its ongoing commercial lines business, and (2) in the case of NGHC, 100% of Towers unearned premium reserves as of December 31,
2013 with respect to its personal lines segment business. Tower received a 20% ceding commission from AmTrust and NGHC on all Tower unearned premiums that were subject to the Cut-Through Reinsurance Agreements and a 22% ceding commission on
2014 ceded premiums.
Impact of Reinsurance on Premiums
The table below shows direct, assumed and ceded premiums for the three months ended March 31, 2014 and 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
($ in thousands)
|
|
Direct
|
|
|
Assumed
|
|
|
Ceded -
Other
|
|
|
Ceded - Cut-
Through
|
|
|
Net
|
|
2014
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums written
|
|
$
|
281,202
|
|
|
$
|
21,459
|
|
|
$
|
67,528
|
|
|
$
|
495,778
|
(1)
|
|
$
|
(260,645
|
)
|
Change in unearned premiums
|
|
|
82,946
|
|
|
|
(5,453
|
)
|
|
|
38,212
|
|
|
|
(332,908
|
)
|
|
|
372,189
|
|
Premiums earned
|
|
$
|
364,148
|
|
|
$
|
16,006
|
|
|
$
|
105,740
|
|
|
$
|
162,870
|
|
|
$
|
111,544
|
|
2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums written
|
|
$
|
445,715
|
|
|
$
|
105,514
|
|
|
$
|
98,032
|
|
|
$
|
-
|
|
|
$
|
453,197
|
|
Change in unearned premiums
|
|
|
(16,128
|
)
|
|
|
(44,389
|
)
|
|
|
(29,206
|
)
|
|
|
-
|
|
|
|
(31,311
|
)
|
Premiums earned
|
|
$
|
429,587
|
|
|
$
|
61,125
|
|
|
$
|
68,826
|
|
|
$
|
-
|
|
|
$
|
421,886
|
|
(1) Includes $327.7 million of unearned premiums transferred on January 1, 2014 under the Cut-Through Reinsurance
Agreements.
24
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
Note 8Loss and Loss Adjustment Expense
The following table provides a reconciliation of the beginning and ending consolidated balances for unpaid losses and loss adjustment
expense (LAE) for the three months ended March 31, 2014 and 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
Reciprocal
|
|
|
|
|
|
|
|
|
Reciprocal
|
|
|
|
|
($ in thousands)
|
|
Tower
|
|
|
Exchanges
|
|
|
Total
|
|
|
Tower
|
|
|
Exchanges
|
|
|
Total
|
|
Balance at January 1,
|
|
$
|
1,973,972
|
|
|
$
|
107,313
|
|
|
$
|
2,081,285
|
|
|
$
|
1,759,888
|
|
|
$
|
135,791
|
|
|
$
|
1,895,679
|
|
Less reinsurance recoverables on unpaid losses
|
|
|
(555,468
|
)
|
|
|
(15,392
|
)
|
|
|
(570,860
|
)
|
|
|
(407,068
|
)
|
|
|
(52,389
|
)
|
|
|
(459,457
|
)
|
|
|
|
1,418,504
|
|
|
|
91,921
|
|
|
|
1,510,425
|
|
|
|
1,352,820
|
|
|
|
83,402
|
|
|
|
1,436,222
|
|
Net reserves, at fair value, of acquired entities
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
161,886
|
|
|
|
-
|
|
|
|
161,886
|
|
Change in net reserves for ADC (i)
|
|
|
313,229
|
|
|
|
-
|
|
|
|
313,229
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Incurred related to:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current year
|
|
|
64,674
|
|
|
|
30,872
|
|
|
|
95,546
|
|
|
|
239,210
|
|
|
|
28,827
|
|
|
|
268,037
|
|
Prior years unfavorable/(favorable) development
|
|
|
7,955
|
|
|
|
(940
|
)
|
|
|
7,015
|
|
|
|
1,124
|
|
|
|
6,571
|
|
|
|
7,695
|
|
Total incurred
|
|
|
72,629
|
|
|
|
29,932
|
|
|
|
102,561
|
|
|
|
240,334
|
|
|
|
35,398
|
|
|
|
275,732
|
|
Paid related to:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current year
|
|
|
85,130
|
|
|
|
23,403
|
|
|
|
108,533
|
|
|
|
103,324
|
|
|
|
17,721
|
|
|
|
121,045
|
|
Prior years
|
|
|
149,064
|
|
|
|
12,970
|
|
|
|
162,034
|
|
|
|
171,026
|
|
|
|
707
|
|
|
|
171,733
|
|
Total paid
|
|
|
234,194
|
|
|
|
36,373
|
|
|
|
270,567
|
|
|
|
274,350
|
|
|
|
18,428
|
|
|
|
292,778
|
|
Net balance at end of period
|
|
|
1,570,168
|
|
|
|
85,480
|
|
|
|
1,655,648
|
|
|
|
1,480,690
|
|
|
|
100,372
|
|
|
|
1,581,062
|
|
Add reinsurance recoverables on unpaid losses
|
|
|
373,614
|
|
|
|
15,025
|
|
|
|
388,639
|
|
|
|
822,634
|
|
|
|
27,554
|
|
|
|
850,188
|
|
Balance at March 31,
|
|
$
|
1,943,782
|
|
|
$
|
100,505
|
|
|
$
|
2,044,287
|
|
|
$
|
2,303,324
|
|
|
$
|
127,926
|
|
|
$
|
2,431,250
|
|
(i) In the first quarter of 2014, Tower terminated the Southport Re ADCs (see "Note 1 -
Nature of the Business
" for further description). The termination of the Southport Re ADCs resulted in a direct increase to net loss reserves.
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.
Incurred losses and LAE for the
three months ended March 31, 2014 attributable to events of prior years were $7.0 million including the Reciprocal Exchanges and $8.0 million excluding the Reciprocal Exchanges.
Prior year development is based upon numerous estimates by line of business and accident year. The Companys management continually monitors claims activity to assess the appropriateness of carried
case and incurred but not reported (IBNR) reserves, giving consideration to Company and industry trends.
Note 9Shareholders Equity
Shares of Common Stock Issued
For the three months ended March 31, 2014 and 2013, 0 and 240,293 new common shares, respectively, were issued as the result of the Companys restricted stock grants. For the three months ended
March 31, 2014 and 2013, no new common shares were issued as the result of employee stock option exercises.
For the three months ended
March 31, 2014 and 2013, 17,364 and 340,707 shares, respectively, of common stock were purchased from employees in connection with the vesting of restricted stock issued under the Companys equity compensation plans. The shares were
withheld at the direction of employees as permitted under the equity compensation plans in order to pay the expected amount of tax liability owed by the employees from the vesting of those shares. In addition, for the three months ended
March 31, 2014 and 2013, 52,834 and 6,848 shares, respectively, of common stock were surrendered as a result of restricted stock forfeitures.
Share Repurchase Program
As part of Towers capital management strategy,
Towers Board of Directors approved a $50 million share repurchase program on May 7, 2013. Purchases under this program can be made from time to time in the open market or in privately negotiated transactions in accordance with applicable
laws and regulations. In the three months ended March 31, 2014 and 2013, no shares of common stock were purchased under this program.
25
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
Dividends Declared
On November 14, 2013, the Company announced that its Board of Directors determined that it would not declare and pay a dividend to shareholders beginning in the fourth quarter of 2013. For the three
months ended March 31, 2014, no dividends were declared or paid. There can be no assurance that we will resume paying dividends in the future even if the necessary financial conditions are met and if sufficient cash is available for
distribution.
Dividends on common stock and participating unvested restricted stock of $7.2 million for the three months ended March 31,
2013 were declared and paid.
Note 10Accumulated Other Comprehensive Income (Loss)
The following table provides a summary of changes in accumulated other comprehensive income, by component, for the three months ended
March 31, 2014 and 2013, with all amounts reflected net of income taxes and noncontrolling interest:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in thousands)
|
|
Unrealized
gains (losses)
on available for
sale securities
|
|
|
Gains
(losses) on
cash flow
hedges
|
|
|
Cumulative
translation
adjustments
|
|
|
Total
|
|
Balance at December 31, 2012
|
|
$
|
87,412
|
|
|
$
|
(5,860
|
)
|
|
$
|
1,204
|
|
|
$
|
82,756
|
|
Other comprehensive income before reclassifications, net of tax
|
|
|
906
|
|
|
|
514
|
|
|
|
(2,347
|
)
|
|
|
(927
|
)
|
Amounts reclassified from accumulated other comprehensive income, net of
tax
|
|
|
(4,051
|
)
|
|
|
533
|
|
|
|
-
|
|
|
|
(3,518
|
)
|
Net current period other comprehensive income
|
|
|
(3,145
|
)
|
|
|
1,047
|
|
|
|
(2,347
|
)
|
|
|
(4,445
|
)
|
Balance at March 31, 2013
|
|
$
|
84,267
|
|
|
$
|
(4,813
|
)
|
|
$
|
(1,143
|
)
|
|
$
|
78,311
|
|
Balance at December 31, 2013
|
|
$
|
(15,528
|
)
|
|
$
|
(3,979
|
)
|
|
$
|
-
|
|
|
$
|
(19,507
|
)
|
Other comprehensive income before reclassifications, net of tax
|
|
|
5,697
|
|
|
|
(425
|
)
|
|
|
-
|
|
|
|
5,272
|
|
Amounts reclassified from accumulated other comprehensive income, net of
tax
|
|
|
(18,816
|
)
|
|
|
853
|
|
|
|
-
|
|
|
|
(17,963
|
)
|
Net current period other comprehensive income
|
|
|
(13,119
|
)
|
|
|
428
|
|
|
|
-
|
|
|
|
(12,691
|
)
|
Balance at March 31, 2014
|
|
$
|
(28,647
|
)
|
|
$
|
(3,551
|
)
|
|
$
|
-
|
|
|
$
|
(32,198
|
)
|
The following provides a summary of the items that have been reclassified from accumulated other comprehensive income to
net income in their entirety during the three months ended March 31, 2014 and 2013, including the line item on the consolidated statement of operations on which the impact is reflected. Unrealized gains (losses) on available for sale securities
are reclassified from accumulated other comprehensive income when a security is sold or when a non-credit impairment is recorded. Gains (losses) on cash flow hedges are reclassified from accumulated other comprehensive income when the related hedged
item (subordinated debentures floating rate interest payments) are recorded in the statement of operations.
|
|
|
|
|
|
|
|
|
|
|
($ in thousands)
|
Accumulated other comprehensive income components
|
|
Amounts reclassified
from accumulated other
comprehensive income
|
|
|
Affected line item in the consolidated statement of
operations
|
|
|
Three Months Ended March 31,
|
|
|
|
|
|
2014
|
|
|
2013
|
|
|
|
Unrealized gains (losses) on available for sale securities
|
|
$
|
(18,816
|
)
|
|
$
|
(6,232
|
)
|
|
Other net realized investment gains
|
|
|
|
-
|
|
|
|
2,181
|
|
|
Income tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(18,816
|
)
|
|
$
|
(4,051
|
)
|
|
Total net of income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains (losses) on cash flow hedges interest rate swaps
|
|
$
|
853
|
|
|
$
|
820
|
|
|
Interest expense
|
|
|
|
-
|
|
|
|
(287)
|
|
|
Income tax expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
853
|
|
|
$
|
533
|
|
|
Total net of income taxes
|
|
|
|
|
|
|
|
|
|
|
|
26
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
Note 11Debt
The Companys borrowings consisted of the following at March 31, 2014 and December 31, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2014
|
|
|
December 31, 2013
|
|
|
|
Carrying
|
|
|
Fair
|
|
|
Carrying
|
|
|
Fair
|
|
($ in thousands)
|
|
Value
|
|
|
Value
|
|
|
Value
|
|
|
Value
|
|
Convertible senior notes
|
|
$
|
148,506
|
|
|
$
|
142,875
|
|
|
$
|
147,712
|
|
|
$
|
129,525
|
|
Subordinated debentures
|
|
|
235,058
|
|
|
|
116,991
|
|
|
|
235,058
|
|
|
|
114,900
|
|
Total
|
|
$
|
383,564
|
|
|
$
|
259,866
|
|
|
$
|
382,770
|
|
|
$
|
244,425
|
|
The fair value of the convertible senior notes is determined utilizing recent transaction prices for these securities
between third-party market participants. The fair value of the subordinated debentures is based on discounted cash flow analysis. The significant inputs used for fair value are considered Level 2 in the fair value hierarchy.
Total interest expense incurred, including interest expense on the funds held liabilities, was $7.0 million and $7.8 million for the three months ended
March 31, 2014 and 2013, respectively.
Subordinated Debentures
The Company and its wholly-owned subsidiaries have issued trust preferred securities through wholly-owned Delaware statutory business trusts. The trusts use the proceeds of the sale of the trust preferred
securities and common securities that the Company acquired from the trusts to purchase junior subordinated debentures from the Company with terms that match the terms of the trust preferred securities. Interest on the junior subordinated debentures
and the trust preferred securities is payable quarterly. In some cases, the interest rate is fixed for an initial period of five years after issuance and then floats with changes in the London Interbank Offered Rate (LIBOR) and in other
cases the interest rate floats with LIBOR without any initial fixed-rate period. As of March 31, 2014, the Company had outstanding par of $ 235.1million relating to the subordinated debentures.
Interest Rate Swaps
In October 2010,
the Company entered into interest rate swap contracts (the Swaps) with $190 million notional value to manage interest costs and cash flows associated with the floating rate subordinated debentures. The Swaps have terms of five years. The
Swaps convert the subordinated debentures to rates ranging from 5.1% to 5.9%. As of March 31, 2014 and December 31, 2013, the Swaps had a fair value of $5.4 million and $6.1million in a liability position, respectively, and are reported in
Other Liabilities.
The Company has designated and accounts for the Swaps as cash flow hedges. The Swaps are considered to have no
ineffectiveness and changes in their fair values are recorded in accumulated other comprehensive income (AOCI), net of tax. For the three months ended March 31, 2014 and 2013, $0.9 million and $0.5 million, respectively, were
reclassified from AOCI to interest expense for the effects of the hedges. As of March 31, 2014, the Company had collateral on deposit with the counterparty amounting to $5.5 million pursuant to a Credit Support Annex.
Convertible Senior Notes
In September
2010, TGI issued $150.0 million principal amount of 5.0% convertible senior notes (the Notes), which mature on September 15, 2014. Interest on the Notes is payable semi-annually in arrears on March 15 and September 15 of
each year, commencing March 15, 2011. The original terms of the Notes allowed Holders to convert their Notes into cash or common shares, at TGIs option, at any time on or after March 15, 2014 or earlier under certain circumstances
determined by: (i) the market price of TGIs stock, (ii) the trading price of the Notes, or (iii) the occurrence of specified corporate transactions. Upon conversion, TGI intends to settle its obligation either entirely or
partially in cash. Upon completion of the Canopius Merger Transaction, the change in control provision of the Indenture was triggered and the Holders were allowed, at their option, to convert their notes into cash or common shares of Tower Group
International, Ltd. at a make-whole exchange ratio. As required by the terms of the Indenture, TGI delivered a Fundamental Company Change Notice (Change Notice) to the Holders on March 23, 2013. The Change Notice provided Holders
the option to convert the Notes into cash or common shares of TGIL at a fundamental make-whole exchange ratio up to and including April 26, 2013. There were no bonds tendered or converted as a result of the Change Notice delivery.
The adjusted conversion rate at March 31, 2014 is 39.7769 shares of common stock per $1,000 principal amount of the Notes (equivalent to a
conversion price of $25.14 per share), subject to further adjustment upon the occurrence of certain events, including the following: if Tower issues shares of common stock as a dividend or distribution on shares of the common stock , or if Tower
effects a share split or share combination; if Tower issues to all or substantially all holders of common stock any rights, options or warrants entitling them, for a period of not more than 45 calendar days after the announcement date of such
issuance, to subscribe for or purchase shares of the common stock at a price per share that is less than the average of the last reported sales price of the common stock for the ten consecutive trading day period ending on the date of announcement
of such issuance; if Tower distributes shares of its capital stock, other indebtedness, other assets or property of Tower or rights, options or warrants to
27
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
acquire capital stock or other securities of Tower, to all or substantially all holders of capital stock; if any cash dividend or distribution is made to all or substantially all holders of the
common stock, other than a regular quarterly cash dividend that does not exceed $0.110 per share; if Tower makes a payment in respect of a tender offer or exchange offer for common stock, and the cash and value of any other consideration included in
the payment per share of common stock exceeds the last reported sale price of the common stock on the trading day next succeeding the last day on which the tenders or exchange may be made.
The proceeds from the issuance of the Notes were allocated to the liability component and the embedded conversion option, or equity component. The equity component was reported as an adjustment to
paid-in-capital, net of tax, and is reflected as an original issue discount (OID). After considering the contractual interest payments and amortization of the original issue discount, the Notes effective interest rate is 7.2%.
Transaction costs of $0.4 million associated with the equity component were netted with the equity component in paid-in-capital. Interest expense, including amortization of deferred origination costs, recognized on the Notes was $3.0 million for the
three months ended March 31, 2014.
The following table shows the amounts recorded for the Notes as of March 31, 2014 and
December 31, 2013:
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
($ in thousands)
|
|
2014
|
|
|
2013
|
|
Liability component
|
|
|
|
|
|
|
|
|
Outstanding principal
|
|
$
|
150,000
|
|
|
$
|
150,000
|
|
Unamortized OID
|
|
|
(1,494
|
)
|
|
|
(2,288
|
)
|
Liability component
|
|
|
148,506
|
|
|
|
147,712
|
|
Equity component, net of tax
|
|
$
|
7,469
|
|
|
$
|
7,469
|
|
To the extent the market value per share of the Companys common stock exceeds the conversion price, the Company
will use the treasury stock method in calculating the dilutive effect on earnings per share.
Convertible Senior Notes Hedge
and Warrant Transactions
In connection with the offering of the Notes, TGI also entered into convertible senior notes hedge transactions
(the Note Hedges or purchased call options) and warrant transactions (the Warrants) with respect to its common stock with financial institutions. The Note Hedges and Warrants were intended generally to reduce the
potential dilution of TGIs common stock and to offset potential cash payments in excess of the principal of the Notes upon conversion. The Note Hedges and Warrants were separate transactions, entered into by TGI with the financial
institutions, and were not part of the terms of the Notes.
In March 2013, as a result of the Canopius Merger Transaction, TGI terminated the
Note Hedges and Warrants. The Company received $2.4 million and paid $1.0 million to terminate the Note Hedges and Warrants, respectively. The effects of the terminations and an associated tax adjustment of $0.8 million were recorded
directly to paid-in-capital in shareholders equity.
Note 12Stock Based Compensation
2008 Long-Term Equity Compensation Plan (2008 LTEP)
In 2008, the Companys Board of Directors adopted and its shareholders approved the 2008 LTEP, which amended and revised the 2004 Long-Term Equity Compensation Plan.
The 2008 LTEP provides for the granting of non-qualified stock options, incentive stock options (within the meaning of Section 422 of the Internal
Revenue Code), stock appreciation rights (SARs), restricted stock and restricted stock unit awards, performance shares and other cash or share-based awards. The maximum amount of share-based awards authorized is 2,325,446 of which
126,275 are available for future grants as of March 31, 2014.
2013 Long-Term Incentive Plan (2013 LTIP)
The Compensation Committee of the Board of Directors established, beginning in 2013 a new Long Term Incentive Plan (the 2013 LTIP), to
replace the Companys existing 2008 LTEP. The 2013 LTIP was approved by the shareholders in May 2013. The maximum amount of share-based awards authorized is 2,150,000 of which 2,147,531 are available for future grants as of March 31, 2014.
28
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
Restricted Stock
The following table provides an analysis of restricted stock activity for the three months ended March 31, 2014 and 2013 (historical share counts and fair values have been adjusted for the 1.1330
share conversion ratio, as discussed more fully in Note 3 Canopius Merger Transaction in the 2013 Form 10-K):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
Average
|
|
|
|
Number of
|
|
|
Grant Date
|
|
|
Number of
|
|
|
Grant Date
|
|
|
|
Shares
|
|
|
Fair Value
|
|
|
Shares
|
|
|
Fair Value
|
|
Outstanding, January 1
|
|
|
235,586
|
|
|
$
|
17.98
|
|
|
|
1,015,902
|
|
|
$
|
20.19
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
240,293
|
|
|
|
18.08
|
|
Vested
|
|
|
(42,670
|
)
|
|
|
18.07
|
|
|
|
(950,773
|
)
|
|
|
20.44
|
|
Forfeitures
|
|
|
(52,834
|
)
|
|
|
18.12
|
|
|
|
(6,848
|
)
|
|
|
20.51
|
|
Outstanding, March 31,
|
|
|
140,082
|
|
|
$
|
17.89
|
|
|
|
298,574
|
|
|
$
|
17.67
|
|
On March 13, 2013, 525,548 shares vested as a result of the Canopius Merger Transaction.
Stock Options
The following table
provides an analysis of stock option activity for the three months ended March 31, 2014 and 2013 (historical share counts and fair values have been adjusted for the 1.1330 share conversion ratio, as discussed more fully in Note 3
Canopius Merger Transaction in the 2013 Form 10-K):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
Average
|
|
|
|
Number of
|
|
|
Exercise
|
|
|
Number of
|
|
|
Exercise
|
|
|
|
Shares
|
|
|
Price
|
|
|
Shares
|
|
|
Price
|
|
Outstanding, January 1
|
|
|
955,804
|
|
|
$
|
17.75
|
|
|
|
969,307
|
|
|
$
|
17.78
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeitures and expirations
|
|
|
(691,162
|
)
|
|
|
17.00
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding, March 31
|
|
|
264,642
|
|
|
$
|
19.73
|
|
|
|
969,307
|
|
|
$
|
17.78
|
|
Exercisable, March 31
|
|
|
264,642
|
|
|
$
|
19.73
|
|
|
|
969,307
|
|
|
$
|
17.78
|
|
Stock Based Compensation Expense
The following table provides an analysis of stock based compensation expense for the three months ended March 31, 2014 and 2013:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
($ in thousands)
|
|
2014
|
|
|
2013
|
|
Restricted stock
|
|
|
|
|
|
|
|
|
Expense, net of tax
|
|
$
|
8
|
|
|
$
|
7,982
|
|
Value of shares vested
|
|
|
959
|
|
|
|
9,485
|
|
Value of unvested shares
|
|
|
378
|
|
|
|
5,509
|
|
Stock options
|
|
|
|
|
|
|
|
|
Intrinsic value of outstanding options
|
|
|
-
|
|
|
|
1,149
|
|
Intrinsic value of vested outstanding options
|
|
|
-
|
|
|
|
1,149
|
|
Unrecognized compensation expense
|
|
|
|
|
|
|
|
|
Unvested restricted stock, net of tax
|
|
|
414
|
|
|
|
5,509
|
|
Weighted average years over which expense will be recognized (in years)
|
|
|
2.9
|
|
|
|
3.9
|
|
29
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
Note 13Income Taxes
Under current Bermuda Law the Company is not required to pay any taxes on Bermuda based income or capital gains. The Company has
received an undertaking from the Minister of Finance in Bermuda that in the event of such taxes being imposed, the Company will be exempted from taxation until the year 2035 pursuant to the Bermuda Exempted Undertakings Tax Protection Act of 1966.
The Companys United States-based subsidiaries are subject to federal, state and local taxes, as applicable, on income and capital gains earned by those subsidiaries.
The Company and TRL, its Bermuda reinsurance subsidiary, are deemed to have permanent establishments in Bermuda. The Bermuda companies have not and do not expect to conduct business that is through a
permanent establishment in the U.S. All transactions between Towers U.S.-based subsidiaries and the Bermuda companies are subject to transfer pricing rules. The Company has executed certain reinsurance treaties and service agreements
between its U.S.-based subsidiaries and TRL and management believes these arrangements to be conducted at current market rates and in accordance with transfer pricing rules.
During the three months ended March 31, 2014, Towers U.S. taxed subsidiaries (excluding the Reciprocal Exchanges) recognized pre-tax losses of approximately $(23.0) million. This resulted in
$187.7 million of net operating loss carryforwards in the deferred tax inventory and a net deferred tax asset, before any valuation allowance, of $277.7 million (excluding the Reciprocal Exchanges) as of March 31, 2014. Including the Reciprocal
Exchanges, the net deferred tax asset, before any valuation allowance, was $277.8 million.
At March 31, 2014, a full valuation
allowance was recorded against the deferred tax assets. For the three months ended March 31, 2014, $5.2 million of the valuation allowance was recorded in income tax expense (benefit) in the statement of operations.
In 2013, management in its judgment concluded that a full valuation allowance was required for Towers U.S. taxed subsidiaries after its
consideration of the cumulative three-year pre-tax loss in its U.S. taxed subsidiaries resulting from the 2013 and 2012 pre-tax losses. Management believed that the negative evidence associated with the realizability of its net deferred tax asset,
including a cumulative three-year pre-tax loss outweighed the positive evidence that the deferred tax assets, including the net operating loss carryforward, would be realized, and recorded the full valuation allowance.
The Companys effective tax rate of (1.9)% for the three months ended March 31, 2014 reflects the recording of the full valuation allowance in
the three months ended March 31, 2014. In the first quarter of 2013, Tower calculated an estimated annual effective tax rate on its U.S. taxed subsidiaries that differed from the U.S. statutory rate due to costs associated with tax exempt
interest and dividends received deductions.
Note 14Earnings (Loss) per Share
Undistributed net earnings (net income less dividends declared during the period) are allocated to both common stock and unvested
share-based payment awards (unvested restricted stock). Because the common shareholders and unvested restricted stock holders share in dividends on a 1:1 basis, the earnings per share on undistributed earnings is equivalent, however,
undistributed losses are allocated only to common stock holders. Undistributed earnings are allocated to all outstanding share-based payment awards, including those for which the requisite service period is not expected to be rendered.
The following table shows the computation of the earnings per share:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
(in thousands, except per share amounts)
|
|
2014
|
|
|
2013
|
|
Numerator
|
|
|
|
|
|
|
|
|
Net income (loss) attributable to Tower Group International, Ltd.
|
|
$
|
(46,478
|
)
|
|
$
|
12,917
|
|
Less: Allocation of income for unvested participating restricted stock
|
|
|
-
|
|
|
|
(37
|
)
|
Less: Dividends on unvested participating restricted stock
|
|
|
-
|
|
|
|
(166
|
)
|
Net income (loss) available to common shareholders - Basic
|
|
|
(46,478
|
)
|
|
|
12,714
|
|
Reallocation of income for unvested participating restricted stock
|
|
|
-
|
|
|
|
-
|
|
Net income (loss) available to common shareholders - Diluted
|
|
|
(46,478
|
)
|
|
|
12,714
|
|
Denominator
|
|
|
|
|
|
|
|
|
Basic earnings per share denominator
|
|
|
57,150
|
|
|
|
45,614
|
|
Effect of dilutive securities:
|
|
|
-
|
|
|
|
74
|
|
Diluted earnings per share denominator
|
|
|
57,150
|
|
|
|
45,688
|
|
Earnings (loss) per share attributable to Tower Group International, Ltd. - Basic
|
|
|
|
|
|
|
|
|
Common stock:
|
|
|
|
|
|
|
|
|
Distributed earnings
|
|
$
|
-
|
|
|
$
|
0.17
|
|
Undistributed earnings
|
|
|
(0.81
|
)
|
|
|
0.11
|
|
Total - basic
|
|
|
(0.81
|
)
|
|
|
0.28
|
|
Earnings (loss) per share attributable to Tower Group International, Ltd. -
Diluted
|
|
$
|
(0.81
|
)
|
|
$
|
0.28
|
|
30
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
The computation of diluted earnings (loss) per share excludes outstanding options and other common stock
equivalents in periods where inclusion of such potential common stock instruments would be anti-dilutive. For the three months ended March 31, 2014, 268,100 options to purchase Company shares were excluded from the computation of diluted
earnings (loss) per share because the exercise price of the options was greater than the average market price. For the three months ended March 31, 2013, 190,500 options to purchase Company shares were excluded from the computation of diluted
earnings (loss) per share because the exercise price of the options was greater than the average market price.
Note 15Segment Information
The accounting policies of the segments are the same as those described in TGILs summary of significant accounting policies in
the Annual Report on Form 10-K for the year ended December 31, 2013.
As disclosed in Note 1 Nature of Business, in
the third quarter of 2013, the Company revised its business segments to present Commercial Insurance, Assumed Reinsurance and Personal Insurance segments. The Company has restated prior period segments to be consistent with the current presentation.
Segment performance is evaluated based on segment profit, which excludes investment income, realized gains and losses, interest expense,
income taxes, goodwill and fixed asset impairments and corporate expenses. The Companys assets and liabilities are not allocated to segments because they are considered in total by management for decision-making purposes.
The Personal Insurance segment, which includes the Reciprocal Exchanges and the management companies, reports the management fees earned by Tower from
the Reciprocal Exchanges for underwriting, investment management and other services as a reduction to other underwriting expenses. The effects of these management fees between Tower and the Reciprocal Exchanges are eliminated in consolidation to
derive consolidated net income. However, the management fee income is reported in net income attributable to Tower Group International, Ltd. and included in basic and diluted earnings (loss) per share.
31
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
Business segment results are as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
($ in thousands)
|
|
2014
|
|
|
2013
|
|
Commercial Insurance Segment
|
|
|
|
|
|
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
Premiums earned
|
|
$
|
55,773
|
|
|
$
|
258,419
|
|
Ceding commission revenue
|
|
|
2,379
|
|
|
|
449
|
|
Policy billing fees
|
|
|
1,276
|
|
|
|
1,370
|
|
Total revenues
|
|
|
59,428
|
|
|
|
260,238
|
|
Expenses
|
|
|
|
|
|
|
|
|
Loss and loss adjustment expenses
|
|
|
63,971
|
|
|
|
177,003
|
|
Underwriting expenses
|
|
|
51,021
|
|
|
|
92,284
|
|
Total expenses
|
|
|
114,992
|
|
|
|
269,287
|
|
Underwriting profit (loss)
|
|
$
|
(55,564
|
)
|
|
$
|
(9,049
|
)
|
|
|
|
Assumed Reinsurance Segment
|
|
|
|
|
|
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
Premiums earned
|
|
$
|
16,033
|
|
|
$
|
49,365
|
|
Ceding commission revenue
|
|
|
-
|
|
|
|
-
|
|
Total revenues
|
|
|
16,033
|
|
|
|
49,365
|
|
Expenses
|
|
|
|
|
|
|
|
|
Loss and loss adjustment expenses
|
|
|
2,408
|
|
|
|
19,360
|
|
Underwriting expenses
|
|
|
872
|
|
|
|
17,793
|
|
Total expenses
|
|
|
3,280
|
|
|
|
37,153
|
|
Underwriting profit (loss)
|
|
$
|
12,753
|
|
|
$
|
12,212
|
|
|
|
|
Personal Insurance Segment
|
|
|
|
|
|
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
Premiums earned
|
|
$
|
39,738
|
|
|
$
|
114,102
|
|
Ceding commission revenue
|
|
|
8,423
|
|
|
|
4,990
|
|
Policy billing fees
|
|
|
1,400
|
|
|
|
1,780
|
|
Total revenues
|
|
|
49,561
|
|
|
|
120,872
|
|
Expenses
|
|
|
|
|
|
|
|
|
Loss and loss adjustment expenses
|
|
|
36,182
|
|
|
|
79,369
|
|
Underwriting expenses
|
|
|
39,579
|
|
|
|
52,112
|
|
Total expenses
|
|
|
75,761
|
|
|
|
131,481
|
|
Underwriting profit (loss)
|
|
$
|
(26,200
|
)
|
|
$
|
(10,609
|
)
|
Tower
|
|
$
|
(16,284
|
)
|
|
$
|
2,018
|
|
Reciprocal Exchanges
|
|
|
(9,916
|
)
|
|
|
(12,627
|
)
|
Total underwriting profit (loss)
|
|
$
|
(26,200
|
)
|
|
$
|
(10,609
|
)
|
32
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
The following table reconciles revenue by segment to consolidated revenues:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
($ in thousands)
|
|
2014
|
|
|
2013
|
|
Commercial Insurance segment
|
|
$
|
59,428
|
|
|
$
|
260,238
|
|
Assumed Reinsurance segment
|
|
|
16,033
|
|
|
|
49,365
|
|
Personal Insurance segment
|
|
|
49,561
|
|
|
|
120,872
|
|
Total segment revenues
|
|
|
125,022
|
|
|
|
430,475
|
|
Net investment income
|
|
|
15,358
|
|
|
|
30,317
|
|
Net realized gains (losses) on investments, including other-than-temporary impairments
|
|
|
22,263
|
|
|
|
6,851
|
|
Insurance services revenue
|
|
|
565
|
|
|
|
128
|
|
Consolidated revenues
|
|
$
|
163,208
|
|
|
$
|
467,771
|
|
The following table reconciles the results of the Company's individual segments to consolidated income before income
taxes:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
($ in thousands)
|
|
2014
|
|
|
2013
|
|
Commercial Insurance segment underwriting profit (loss)
|
|
$
|
(55,564
|
)
|
|
$
|
(9,049
|
)
|
Assumed Reinsurance segment underwriting profit (loss)
|
|
|
12,753
|
|
|
|
12,212
|
|
Personal Insurance segment underwriting profit (loss)
|
|
|
(26,200
|
)
|
|
|
(10,609
|
)
|
Net investment income
|
|
|
15,358
|
|
|
|
30,317
|
|
Net realized gains on investments, including other-than-temporary impairments
|
|
|
22,263
|
|
|
|
6,851
|
|
Corporate and other
|
|
|
(11,889
|
)
|
|
|
(2,940
|
)
|
Acquisition-related transaction costs
|
|
|
(646
|
)
|
|
|
(19,056
|
)
|
Interest expense
|
|
|
(7,010
|
)
|
|
|
(7,808
|
)
|
Equity income in unconsolidated affiliate
|
|
|
-
|
|
|
|
128
|
|
Income before income taxes
|
|
$
|
(50,935
|
)
|
|
$
|
46
|
|
Note 16Contingencies
Legal Proceedings
On August 20, 2013, Robert P. Lang, a purported shareholder of Tower Group International Ltd. (Tower), filed a purported class action complaint (the Lang Complaint) against
Tower and certain of its current and former officers in the United States District Court for the Southern District of New York. The Lang Complaint purports to be asserted on behalf of a class of persons who purchased Tower stock between
July 30, 2012 and August 8, 2013. The Lang Complaint alleges that Tower and certain of its current and former officers violated federal securities laws and seeks unspecified damages. On September 3, 2013, a second purported
shareholder class action complaint was filed by Dennis Feighay, another purported Tower shareholder, containing similar allegations to those set forth in the Lang Complaint (the Feighay Complaint). The Feighay Complaint purports to be
asserted on behalf of a class of persons who purchased Tower stock between May 9, 2011 and August 7, 2013. On October 4, 2013, a third complaint was filed by Sanju Sharma (the Sharma Complaint). The Sharma Complaint names
as defendants Tower and certain of its current and former officers, and purports to be asserted on behalf of a plaintiff class who purchased Tower stock between May 10, 2011 and September 17, 2013. On October 18, 2013, an amended
complaint was filed in the Sharma case (the Sharma Amended Complaint). The Sharma Amended Complaint alleges additional false and misleading statements, and purports to be asserted on behalf of a plaintiff class who purchased Tower stock
between March 1, 2011 and October 7, 2013. On October 21, 2013, a number of motions were filed seeking to consolidate the shareholder class actions into one matter and for appointment of a lead plaintiff. On June 17, 2014, the
United States District Court for the Southern District of New York issued an order consolidating the Lang, Feighay, and Sharma actions (hereinafter the Consolidated Securities Action) and appointing Adar Enhanced Investment Fund, Ltd.
and Adar Investment Fund, Ltd. (the Adar Funds) and Jacksonville Police and Fire Pension Fund, Oklahoma Firefighters Pension and Retirement System, and the Kansas City, Missouri Employees Retirement System (the Public Pension
Funds) as co-lead plaintiffs in the Consolidated Securities Action and Bernstein Liebhard LLP, Saxena White P.A., and Bernstein Litowitz Berger & Grossmann LLP as co-lead counsel. The Company believes that it is not probable that the
Consolidated Securities Action will result in a loss, and if it would result in a loss, that the amount of any such loss cannot reasonably be estimated.
On October 18, 2013, Cinium Financial Services Corporation (Cinium) and certain other affiliated parties (collectively, Plaintiffs) commenced an action against, among others,
Tower, CastlePoint Insurance Company (CastlePoint), an indirect wholly owned subsidiary of Tower, and certain officers of Tower (the New York Action) in New York State Supreme Court. CastlePoint is a party to a
Securityholders Agreement, dated as of June 14, 2012 (the Securityholders Agreement), among
33
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
certain parties including Plaintiffs, and is also the holder of a senior note issued by Cinium dated May 15, 2012 that is convertible into shares of Cinium common stock (the Senior
Note). On October 29, 2013, Plaintiffs filed a complaint which revised their initial pleading (the Complaint). Plaintiffs seek, among other things, (i) a declaratory judgment that CastlePoint has no right to exercise any
control over Cinium under the Securityholders Agreement or to convert the Senior Note without prior regulatory approval; (ii) rescission of the Senior Note and Securityholders Agreement based on alleged fraudulent misrepresentations
by Tower at the time these agreements were entered into; and (iii) damages of $150 million for alleged breach of fiduciary duties to Cinium and its shareholders by certain directors, and for alleged lender liability and fraudulent
misrepresentation by the Company.
On April 22, 2014, counsel for Plaintiffs notified counsel for defendants of its intent to file a
stipulation of discontinuance without prejudice of the New York Action within thirty days. On June 2, 2014, counsel for Plaintiffs filed a notice of discontinuance without prejudice against all defendants in the New York Action.
Tower received a document request from the U.S. Securities and Exchange Commission (the SEC) dated January 13, 2014, as part of an
informal inquiry (the SEC Request). The SEC Request asks for documents related to Towers financial statements, accounting policies, and analysis. Tower is cooperating with the SECs inquiry and has provided the
requested information.
On January 14, 2014, Derek Wilson, a purported shareholder of Tower, filed a purported class action complaint
(the Wilson Complaint) against Tower, certain of its current and former directors, ACP Re Ltd. (ACP Re), London Acquisition Company Limited (Merger Sub), and AmTrust Financial Services, Inc. (AmTrust)
in the United States District Court for the Southern District of New York. The Wilson Complaint alleges that the members of the Companys Board of Directors breached their fiduciary duties owed to the shareholders of Tower under Bermuda law by
approving Towers entry into the ACP Re Merger Agreement and failing to take steps to maximize the value of Tower to its public shareholders, and that Tower, ACP Re, Merger Sub, and AmTrust aided and abetted such breaches of fiduciary duties.
The Wilson Complaint also alleges, among other things, that the proposed transaction undervalues Tower, that the process leading up to the ACP Re Merger Agreement was flawed, and that certain provisions of the ACP Re Merger Agreement improperly
favor ACP Re and discourage competing offers for the Company. The Wilson Complaint further alleges oppressive conduct by the directors against Towers shareholders in violation of Bermuda law. The Wilson Complaint seeks, among other things,
declaratory and injunctive relief concerning the alleged fiduciary breaches, injunctive relief prohibiting the defendants from consummating the proposed transaction, rescission of the ACP Re Merger Agreement to the extent already implemented, and
other forms of equitable relief. On February 27, 2014, the same purported shareholder filed an amended complaint alleging, in addition, that the Company and the directors disseminated a materially false and misleading preliminary proxy
statement regarding the ACP Re Merger Agreement in violation of Sections 14(a) and 20(a) of the Exchange Act and Rule 14a-9 promulgated thereunder (the Wilson Amended Complaint).
On March 3, 2014, another purported shareholder filed a purported class action complaint against the Company, certain of its current and former officers and directors, ACP Re, Merger Sub, and
AmTrust, also in the United States District Court for the Southern District of New York (the Raul Complaint). The Raul Complaint alleges that the defendants disseminated a materially false and misleading preliminary proxy statement
regarding the ACP Re Merger Agreement in violation of sections 14(a) and 20(a) of the Exchange Act and Rule 14a-9.
On May 12, 2014, the
United States District Court for the Southern District of New York issued an order consolidating the Wilson and Raul actions (hereinafter the Consolidated Federal Action). On May 22, 2014, the Court issued an order appointing Wilson
and George Strum, another purported shareholder of the Company, as co-lead plaintiffs in the Consolidated Federal Action and appointing Robbins Arroyo LLP and WeissLaw LLP as co-lead counsel.
On March 24, 2014, two purported shareholders of the Company filed a purported class action and shareholder derivative complaint against the Company, certain of its current and former officers and
directors, and Tower Group, Inc., in the Supreme Court of the State of New York, County of New York (the Bekkerman Complaint and, together with the Wilson Amended Complaint and the Raul Complaint, the Merger
Complaints). The Bekkerman Complaint alleges, among other things, that the members of the Companys board of directors breached their fiduciary duties owed to the shareholders of the Company by failing to exercise appropriate
oversight over the conduct of the Companys business, awarding Michael Lee excessive compensation, approving the Companys entry into the ACP Re Merger Agreement, failing to take steps to maximize the value of the Company to its public
shareholders, and misrepresenting or omitting material information in connection with the proposed transaction, and that the Company and Tower Group, Inc. aided and abetted such breaches of fiduciary duties. The Bekkerman Complaint also
alleges, among other things, that Lee was unjustly enriched as a result of the compensation he received while allegedly breaching his fiduciary duties and by selling stock while in the possession of material, adverse, non-public
information. The Bekkerman Complaint seeks, among other things, an award of money damages, declaratory and injunctive relief concerning the alleged fiduciary breaches, injunctive relief prohibiting the defendants from consummating the proposed
transaction, rescission of the ACP Re Merger Agreement to the extent already implemented, and other forms of equitable relief. On May 16, 2014, the defendants removed the Bekkerman action to the United States District Court for the Southern
District of New York, and requested that it be designated as related to the Consolidated Federal Action. On June 3, 2014, the United States District Court for the Southern District of New York accepted the designation of the Bekkerman Complaint
as related to the Consolidated Federal Action.
34
Tower Group International, Ltd.
Notes to Consolidated Financial Statements
(Unaudited)
The Company believes that it is not probable that the Merger Complaints will result in a loss, and if
they would result in a loss, that the amount of any such loss cannot reasonably be estimated.
From time to time, the Company is involved in
other various legal proceedings in the ordinary course of business. The Company does not believe that the resolution of any currently pending legal proceedings, either individually or taken as a whole, will have a material adverse effect on its
business, results of operations or financial condition.
35