10-K 1 c72814_10k.htm 3B2 EDGAR HTML -- c72814_preflight.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

S ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2012
OR

£ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from   to  
Commission file number 1-10804

XL GROUP
Public Limited Company

(Exact name of registrant as specified in its charter)

 

 

 

Ireland
(State or other jurisdiction of
incorporation or organization)

 

98-0665416
(I.R.S. Employer Identification No.)

No. 1 Hatch Street Upper, 4th Floor,
Dublin 2, Ireland

(Address of principal executive offices and zip code)

 

+353 (1) 405-2033
(Registrant’s telephone number, including area code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 

 

 

Title of each class

 

Name of each exchange
on which registered

Ordinary Shares, Par Value $0.01 per Share
XLIT Ltd. 5.75% Senior Notes due 2021

 

New York Stock Exchange
New York Stock Exchange

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes S  No £

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes £  No S

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes S  No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files). Yes S  No £

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. S

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  S  Accelerated filer  £   Non-accelerated filer  £   Smaller reporting company £

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
     Yes
£  No S     

The aggregate market value of the voting common equity of the registrant held by non-affiliates of the registrant on June 30, 2012 was approximately $6.4 billion computed upon the basis of the closing sales price of the ordinary shares on June 30, 2012. For purposes of this computation, ordinary shares held by directors and officers of the registrant have been excluded. Such exclusion is not intended, nor shall it be deemed, to be an admission that such persons are affiliates of the registrant.

As of February 25, 2013, there were outstanding 294,958,080 Ordinary Shares, $0.01 par value per share, of the registrant.

Documents Incorporated By Reference

Portions of the Registrant’s Definitive Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report relating to the annual meeting of ordinary shareholders to be held on April 26, 2013 are incorporated by reference into Part III of this Form 10-K.




XL GROUP PLC
TABLE OF CONTENTS

 

 

 

 

 

 

 

 

 

Page

PART I

Item 1.

 

Business

 

 

 

1

 

Item 1A.

 

Risk Factors

 

 

 

28

 

Item 1B.

 

Unresolved Staff Comments

 

 

 

48

 

Item 2.

 

Properties

 

 

 

48

 

Item 3.

 

Legal Proceedings

 

 

 

49

 

Item 4.

 

Mine Safety Disclosures

 

 

 

50

 

PART II

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

 

 

53

 

Item 6.

 

Selected Financial Data

 

 

 

56

 

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

59

 

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

 

 

116

 

Item 8.

 

Financial Statements and Supplementary Data

 

 

 

126

 

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

 

 

 

221

 

Item 9A.

 

Controls and Procedures

 

 

 

221

 

Item 9B.

 

Other Information

 

 

 

221

 

PART III

Item 10.

 

Directors, Executive Officers and Corporate Governance

 

 

 

222

 

Item 11.

 

Executive Compensation

 

 

 

222

 

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

 

 

222

 

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

 

 

 

222

 

Item 14.

 

Principal Accounting Fees and Services

 

 

 

222

 

PART IV

Item 15.

 

Exhibits and Financial Statement Schedules

 

 

 

223

 

This Annual Report on Form 10-K contains “Forward-Looking Statements” as defined in the Private Securities Litigation Reform Act of 1995. Important factors that could cause actual results to differ materially from those in such Forward-Looking Statements are set forth herein under Item 1A, “Risk Factors,” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” under the caption “Cautionary Note Regarding Forward-Looking Statements.”


PART I

 

 

 

 

 

 

ITEM 1.

 

BUSINESS

 

 

 

History

XL Group plc, through its subsidiaries, is a global insurance and reinsurance company providing property, casualty and specialty products to industrial, commercial and professional firms, insurance companies and other enterprises on a worldwide basis. We were incorporated with limited liability under the Cayman Islands Companies Act on March 16, 1998, as EXEL Merger Company. XL Capital Ltd was formed as a result of the merger of EXEL Limited and Mid Ocean Limited on August 7, 1998, and the company was named EXEL Limited on that date. At a special general meeting held on February 1, 1999, the shareholders of EXEL Limited approved a resolution changing the name of the company to XL Capital Ltd.

EXEL Limited and Mid Ocean Limited were incorporated in the Cayman Islands with principal operations in Bermuda in 1986 and 1992, respectively. On June 18, 1999, XL Capital Ltd merged with NAC Re Corp. (“NAC”), a Delaware corporation organized in 1985, in a stock merger.

On July 25, 2001, we acquired certain Winterthur International insurance operations (“Winterthur International”) to extend its predominantly North American-based large corporate insurance business globally.

Effective January 1, 2002, we increased our shareholding in Le Mans Ré from 49% to 67% in order to expand our international reinsurance operations. On September 3, 2003, we exercised our option to buy the remaining 33% from Les Mutuelles du Mans Assurances (“MMA”) and changed the name of Le Mans Ré to XL Re Europe S.A. On October 18, 2006, we received approval to form a new European company, XL Re Europe Ltd, based in Dublin, Ireland, which is licensed to write all classes of reinsurance business. XL Re Europe Ltd is the headquarters of the company’s European reinsurance platform with branch offices in France and the United Kingdom (the “U.K.”).

On August 4, 2006, we completed the sale of approximately 37% of our then financial guarantee reinsurance and insurance businesses through an initial public offering of 23.4 million common shares of Syncora Holdings Ltd. (“Syncora”) (formerly Security Capital Assurance Ltd. or “SCA”). On June 6, 2007, we completed the sale of an additional portion of Syncora’s common shares still owned by the company through a secondary offering and thereby reduced its ownership of Syncora’s outstanding common shares further from approximately 63% to approximately 46%. On August 5, 2008, we closed an agreement (the “Master Agreement”) with Syncora and its subsidiaries, as well as certain counterparties to credit default swap agreements, in connection with the termination of certain reinsurance and other agreements. As part of the Master Agreement, we transferred all of the shares we owned in Syncora to a trust and, as a result, have no further ownership interest in the company.

On July 1, 2010, XL Group plc, a newly formed Irish public limited company (“XL-Ireland”) and XL Capital Ltd (now known as XLIT Ltd.), an exempted company organized under the laws of the Cayman Islands (“XL-Cayman”), completed a redomestication transaction in which all of the ordinary shares of XL-Cayman were exchanged for all of the ordinary shares of XL-Ireland (the “Redomestication”). As a result, XL-Cayman became a wholly-owned subsidiary of XL-Ireland. On July 23, 2010, the Irish High Court approved XL-Ireland’s creation of distributable reserves, subject to the completion of certain formalities under Irish Company law. These formalities were completed in early August 2010. For further detailed information on this transaction and its impacts on shareholder rights, shareholders’ equity, debt and notes then outstanding and employee stock plan awards, see the company’s Report on Form 8-K filed with the U.S. Securities and Exchange Commission on July 1, 2010.

For periods prior to July 1, 2010, unless the context otherwise indicates, references herein to the “Company”, “we”, “us” or “our” are to, and the Consolidated Financial Statements herein include the accounts of, XL-Cayman and its consolidated subsidiaries. For periods on and subsequent to July 1, 2010, unless the context otherwise indicates, references herein to the “Company”, “we”, “us” or “our” are to, and the Consolidated Financial Statements herein include, the accounts of, XL-Ireland and its consolidated subsidiaries.

1


See further information under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Segments

We are organized into three operating segments: Insurance, Reinsurance and Life operations. Our general investment and financing operations are reflected in Corporate.

We evaluate the performance of both the Insurance and Reinsurance segments based on underwriting profit and the performance of the Life operations segment based on its contribution to net income. Other items of our revenue and expenditure are not evaluated at the segment level for reporting purposes. In addition, we do not allocate investment assets of our property and casualty (“P&C”) operations to the other segments. Investment assets related to our Life operations and certain structured products included in the Insurance and Reinsurance segments are held in separately identified portfolios. As such, net investment income from these assets is included in the contribution from each of these operations.

The following table sets forth an analysis of gross premiums written by segment for the years ended December 31, 2012, 2011 and 2010. Additional financial information about our segments, including financial information about geographic areas, is included in Item 8, Note 4, “Segment Information,” to the Consolidated Financial Statements included herein.

 

 

 

 

 

 

 

 

 

 

 

(U.S. dollars in thousands)

 

Gross Premiums Written

 

Percentage Change

 

2012

 

2011

 

2010

 

2012 to 2011

 

2011 to 2010

Insurance

 

 

$

 

5,166,974

 

 

 

$

 

4,824,665

 

 

 

$

 

4,418,380

 

 

 

 

7.1

%

 

 

 

 

9.2

%

 

Reinsurance

 

 

 

2,008,156

 

 

 

 

2,073,619

 

 

 

 

1,842,951

 

 

 

 

(3.2

)%

 

 

 

 

12.5

%

 

Life operations

 

 

 

355,754

 

 

 

 

394,555

 

 

 

 

411,938

 

 

 

 

(9.8

)%

 

 

 

 

(4.2

)%

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

$

 

7,530,884

 

 

 

$

 

7,292,839

 

 

 

$

 

6,673,269

 

 

 

 

3.3

%

 

 

 

 

9.3

%

 

 

 

 

 

 

 

 

 

 

 

 

Insurance Segment

General

Our insurance operations are organized into four business groups: International Property and Casualty, North America Property and Casualty, Global Professional Lines and Global Specialty Lines.

Our insurance operations provide customized insurance policies for complex corporate risks that may require large limits and are marketed and distributed through a wide variety of local, national and international producers. Large deductibles and self-insured retentions are incorporated into these policies to further manage risk along with stringent underwriting guidelines. While our insurance operations are known for insuring large complex risk, certain of our products are targeted to small and midsize companies and organizations, such as our professional liability and program business. We focus on those lines of business that we believe will provide the best return on capital over time.

The Insurance segment’s most significant operating legal entities in 2012 based on revenues were as follows: XL Insurance (Bermuda) Ltd, XL Insurance Company Limited, XL Specialty Insurance Company, Indian Harbor Insurance Company, Greenwich Insurance Company and XL Insurance America, Inc., as well as certain Lloyd’s syndicates.

The excess nature of many of our insurance products, coupled with historically large policy limits, results in a book of business that can have losses characterized as low frequency and high severity. As a result, large losses, though infrequent, can have a significant impact on our results of operations, financial condition and liquidity. We attempt to mitigate this risk by, among other things, using strict underwriting guidelines, effective risk management practices (e.g., monitoring of aggregate exposures) and various reinsurance arrangements, as discussed below.

International Property and Casualty (“IPC”)

IPC includes the following lines of business: property, primary and excess casualty and environmental liability.

2


Property and casualty products are typically written as global insurance programs for large and medium sized multinational companies and institutions and include property and liability coverages. Property and casualty products generally provide large capacity on a primary, quota share or excess of loss basis. Global insurance programs are targeted to large multinational companies in major industry groups including aerospace, automotive, consumer products, pharmaceutical, pulp and paper, high technology, telecommunications, transportation and basic metals. The primary casualty programs generally require customers to take large deductibles or self-insured retentions. For the excess business, our liability attaches after large deductibles, including self insurance or insurance layers provided by other companies. Policies are written on an occurrence, claims-made and occurrence reported basis. Our property business, which also includes construction projects, is short-tail by nature and written on both a primary and excess of loss basis. Property business includes exposures to man-made and natural disasters, and generally, loss experience is characterized as low frequency and high severity.

Environmental liability products include pollution and remediation legal liability, general and project-specific pollution and professional liability, and commercial general property redevelopment and contractor’s pollution liability. Business is written for both single and multiple years on a primary or excess of loss, claims- made or, less frequently, occurrence basis. Targeted industries include environmental service firms, contractors, healthcare facilities, manufacturing facilities, real estate development, transportation and construction.

North America Property and Casualty (“NAPC”)

NAPC includes the following lines of business: property, primary and excess casualty, environmental liability, excess and surplus lines, construction, surety and program business.

In addition to the property, casualty and environmental products described under IPC, the NAPC business unit also includes 100% property products for the large account risk engineered markets and general liability, U.S. workers’ compensation and auto liability for the risk management accounts, which require customers to take large deductibles or self-insured retentions.

Excess and surplus lines products include general liability property, excess auto and excess liability coverages where most Insurance Services Office, Inc. (“ISO”) products are written. Targets include a variety of classes, including rail roads with focus on “one-off” risks generated by contracted wholesale brokers.

Construction products include property coverages (builders risk, contractors equipment, property and inland marine), general liability, U.S. workers compensation and commercial auto, as well as professional liability for contractors and owner, excess umbrella, subcontractor default insurance and primary casualty wrap ups.

Surety products include contract bonds, including bid, performance, payment and contractor qualification bonds, as well as commercial surety bonds, including appeal, court and qualification bonds. Products in general provide large capacity and are written on a sole surety, co-surety or shared surety basis.

Our program business specializes in insurance coverages for distinct market segments in North America, including program administrators and managing general agents who operate in a specialized market niche and have unique industry backgrounds or specialized underwriting capabilities. Products encompass mostly property and casualty coverages.

Global Professional Lines (“Professional”)

Professional includes directors’ and officers’ liability, errors and omissions liability, employment practices liability and technology and cyber liability coverages. Policies are written on both a primary and excess of loss basis. Directors’ and officers’ coverage includes primary and excess directors’ and officers’ liability, employment practices liability and company securities and private company directors’ and officers’ liability. Products are targeted at a variety of different sized companies, with a heavy concentration on small to medium-sized firms when written on a primary basis. Employment practices liability is written primarily for very large corporations on an excess of loss basis and covers those firms for legal liability in regard to the treatment of employees. Errors and omissions coverage is written on a primary and excess basis.

3


Errors and omissions insurance written on a primary basis is targeted to small and medium-sized firms and coverage is provided for various professional exposures, including, but not limited to, architects and engineers, insurance brokers, consultants, lawyers, public entities and real estate agents.

Global Specialty Lines (“Specialty”)

Specialty includes the following lines of business: aviation and satellite, marine and offshore energy, fine art and specie, equine, product recall, political risk and trade credit and North America inland marine.

Aviation and satellite products include comprehensive airline hull and liability, airport liability, aviation manufacturers’ product liability, aviation ground handler liability, large aircraft hull and liability, corporate non-owned aircraft liability, space third party liability and satellite risk including damage or malfunction during ascent to orbit and continual operation, and aviation war. Aviation liability and physical damage coverage is offered for large aviation risks on a proportional basis, while smaller general aviation risks are offered on a primary basis. Satellite risks are generally written on a proportional basis. The target markets for aviation and satellite products include airlines, aviation product manufacturers, aircraft service firms, general aviation operators and telecommunications firms.

Marine and offshore energy coverage includes marine hull and machinery, marine war, marine excess liability, cargo and offshore energy insurance. Fine art and specie coverages include fine art and other collections, jewelers block, cash in transit and related coverages for financial institutions. Equine products specialize in providing bloodstock and livestock insurance. Product recall coverages include product contamination for the food and beverage sector and end-product consumer goods and product guarantee aimed at component part manufacturers.

In 2011, we launched underwriting capabilities for political risk and trade credit as well as North America inland marine business.

Also included as part of the Insurance segment is XL Global Asset Protection Services (“XL GAPS”), a fee for service loss prevention consulting service that offers individually tailored risk management solutions to risk managers, insurance brokers and insurance company clients operating on a global basis. Services are offered on an “unbundled” (services not tied to an insurance contract) and “bundled” basis.

Underwriting

We underwrite and price most risks individually following a review of the exposure and in accordance with our underwriting guidelines. Most of our insurance operations have underwriting guidelines that are industry-specific. We seek to serve our clients while controlling our exposure on individual insurance contracts through terms and conditions, policy limits and sublimits, attachment points and facultative and treaty reinsurance arrangements on certain types of risks.

Our underwriters generally evaluate each industry category and subgroups within each category. Premiums are set and adjusted for an insured based, in large part, on the industry group in which the insured is placed and the perceived risk of the insured relative to the other risks in that group. Rates may vary significantly according to the industry group of the insured as well as the insured’s risk relative to the group. Our rating methodology for individual insureds seeks to set premiums in accordance with claims potential as measured by past experience and future expectations, the attachment point and amount of underlying insurance, the nature and scope of the insured’s operations, exposures to loss, including natural hazard exposures, risk management quality and other specific risk factors relevant in the judgment of our underwriters to the type of business being written.

Underwriting and loss experience is reviewed regularly for, among other things, loss trends, emerging exposures, changes in the regulatory or legal environment as well as the efficacy of policy terms and conditions.

As our insurance products are primarily specialized coverages, underwriting guidelines and policy forms differ by product offering as well as by legal jurisdiction. Liability insurance is written on both a primary and excess of loss basis, on occurrence, occurrence reported and claims-made policy forms. Occurrence reported policies typically cover occurrences causing unexpected and unintended personal injury or property damage to third parties arising from events or conditions that commence at or subsequent to an

4


inception date, or retroactive date, if applicable, and prior to the expiration of the policy provided that proper notice is given during the term of the policy or the discovery period. Claims-made policies typically cover only claims made during the policy period or extended reporting period and are generally associated with professional liability and environmental coverages. Traditional occurrence coverage is also available for restricted classes of risk and is generally written on a follow-form basis for excess of loss coverage, where the policy adopts the terms, conditions and exclusions of the underlying policy. Property insurance risks are written on a lead or follow-form basis that usually provides coverage for all risks of physical damage and business interruption. Maximum limits are generally subject to sublimits for coverage in critical earthquake and flood zones, where we seek to limit liability in these areas.

Engineering

Property engineering for our insurance operations includes conducting on-site inspections and consulting services related to loss prevention, reviews of building plans for fire protection design, Computer Assisted Drawings (diagrams) of facilities, recommendations on how to improve site protection, reviews of existing loss prevention reports/information for underwriters, summarizing multiple sources of information into an account summary, and providing underwriters an opinion on the risk to assist with risk selection, pricing and other underwriting decisions. The property engineering team consists of staff located in over 20 countries.

Other engineering resources support casualty, environmental, specialty and construction lines and serve as internal consultants to their respective underwriting teams, assisting them with making underwriting decisions, as well as helping their customers improve their local site or account protection.

Reinsurance Ceded

In certain cases, the risks assumed by us in the Insurance segment are partially reinsured by third party reinsurers. Reinsurance ceded varies by location and line of business based on a number of factors, including market conditions. The benefits of ceding risks to third party reinsurers include reducing exposure on individual risks, protecting against catastrophic risks, maintaining acceptable capital ratios and enabling the writing of additional business. Reinsurance ceded does not legally discharge us from our liabilities to the original policyholder in respect of the risk being reinsured.

We use reinsurance to support the underwriting and retention guidelines of each of our subsidiaries as well as to control our aggregate exposure to a particular risk or class of risks. Reinsurance is purchased at several levels ranging from reinsurance of risks assumed on individual contracts to reinsurance covering the aggregate exposure on a portfolio of policies issued by groups of companies. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for further information.

Premiums

Premium rates and underwriting terms and conditions for all lines of business written vary by jurisdiction principally due to local market conditions, competitor product offerings and legal requirements.

The following table provides an analysis of gross premiums written, net premiums written and net premiums earned for the Insurance segment for the years ended December 31, 2012, 2011 and 2010:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(U.S. dollars in thousands)

 

2012

 

2011 (1)

 

2010 (1)

 

Gross
Premiums
Written

 

Net
Premiums
Written

 

Net
Premiums
Earned

 

Gross
Premiums
Written

 

Net
Premiums
Written

 

Net
Premiums
Earned

 

Gross
Premiums
Written

 

Net
Premiums
Written

 

Net
Premiums
Earned

Professional

 

 

$

 

1,460,025

 

 

 

$

 

1,395,704

 

 

 

$

 

1,350,328

 

 

 

$

 

1,377,560

 

 

 

$

 

1,278,724

 

 

 

$

 

1,287,231

 

 

 

$

 

1,412,131

 

 

 

$

 

1,306,441

 

 

 

$

 

1,316,173

 

Casualty

 

 

 

1,726,226

 

 

 

 

1,238,280

 

 

 

 

1,157,909

 

 

 

 

1,504,203

 

 

 

 

1,035,458

 

 

 

 

998,326

 

 

 

 

1,317,203

 

 

 

 

888,045

 

 

 

 

879,287

 

Property

 

 

 

782,337

 

 

 

 

483,682

 

 

 

 

489,743

 

 

 

 

858,839

 

 

 

 

499,622

 

 

 

 

464,576

 

 

 

 

699,453

 

 

 

 

414,140

 

 

 

 

416,806

 

Specialty

 

 

 

892,086

 

 

 

 

738,650

 

 

 

 

708,564

 

 

 

 

871,562

 

 

 

 

723,048

 

 

 

 

702,604

 

 

 

 

828,101

 

 

 

 

709,793

 

 

 

 

682,518

 

Other (2)

 

 

 

306,300

 

 

 

 

216,197

 

 

 

 

218,096

 

 

 

 

212,501

 

 

 

 

170,812

 

 

 

 

210,990

 

 

 

 

161,492

 

 

 

 

142,731

 

 

 

 

234,354

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

$

 

5,166,974

 

 

 

$

 

4,072,513

 

 

 

$

 

3,924,640

 

 

 

$

 

4,824,665

 

 

 

$

 

3,707,664

 

 

 

$

 

3,663,727

 

 

 

$

 

4,418,380

 

 

 

$

 

3,461,150

 

 

 

$

 

3,529,138

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


 

 

(1)

 

 

 

Certain reclassifications have been made to conform to current year presentation.

 

(2)

 

 

 

Other includes excess and surplus, surety, structured indemnity and certain other discontinued lines.

5


Competition

We compete globally in the property and casualty insurance markets. Our competitors include the following companies and their affiliates: The ACE Group of Companies (“ACE”); Allianz SE (“Allianz”); American International Group, Inc. (“AIG”); Factory Mutual Global (“FMG”) for property only; The Hartford Financial Services Group, Inc. (“Hartford”); Lloyd’s of London Syndicates (“Lloyd’s”); The Chubb Corporation (“Chubb”); The Travelers Companies (“Travelers”); and Zurich Financial Services Group (“Zurich”).

Our major geographical markets for our property and casualty insurance operations are North America, Europe and Bermuda. Our main competitors in each of these markets include the following:

North America – AIG, ACE, Chubb, FMG, Zurich, Travelers, CNA Financial Corporation, Hartford, Liberty Mutual Group, Arch Capital Group Ltd (“Arch”), W.R. Berkley Corporation, Markel Corporation and Lloyd’s.

Europe – Allianz, AIG, FMG, Zurich, AXA Insurance Ltd. (“AXA”), ACE, Lloyd’s, Assicurazioni Generali, HDI-Gerling Industrie Versicherung AG and MAPFRE S.A.

Bermuda – ACE, Allied World Assurance Company, Axis Capital Group, Alterra Capital, Endurance Specialty Insurance Ltd and Arch.

Marketing and Distribution

The majority of business in our Insurance segment originates via a large number of international, national and regional producers, acting as the brokers and representatives of current and prospective policyholders. This channel is supported by our Global Distribution and Network Unit, which consists of sales and marketing representatives in key markets throughout the world, representing all of our products in collaboration with the four business groups. A portion of Insurance segment business is also marketed and underwritten by general agents and a portion by independent agents acting on our behalf. Typically, all such producers, general agents and independent agents receive commission payments from us for their services, which are calculated as a percentage of the gross premium paid by the policyholder on an account-by-account basis. A certain portion of business originating from producers is submitted on a fee basis under which the producer is compensated by a fee paid to it by its policyholder client. From time to time, we also consider requests for commissions from a producer, with disclosure by the producer to the policyholder-client, where the producer receives a fee from the policyholder-client. We evaluate such requests on a case-by-case basis.

We consider requests for contingent commission arrangements where such additional commissions are based upon the volume of bound business originated from a specific producer during a prior calendar year where legal and appropriate. Such arrangements are distinct from program business where additional commissions are generally based on profitability of business submitted to and bound by us.

With regard to excess and surplus lines business, we receive submissions from licensed wholesale surplus lines brokers.

We have no implied or explicit commitments to accept business from any particular broker, and neither producers nor any other third party have the authority to bind us, except in the case where underwriting authority may be delegated contractually to selected general agents. Such general agents are subject to a financial and operational due diligence review prior to any such delegation of authority and we conduct ongoing reviews and audits as deemed necessary with the goal of assuring the continuing integrity of underwriting and related business operations. See Item 8, Note 17(a), “Commitments and Contingencies – Concentrations of Credit Risk,” to the Consolidated Financial Statements included herein, for information on our major producers.

Apart from compensation arrangements established with producers in connection with insurance transactions, we also have engaged, and may in the future engage, certain producers or their affiliates in consulting roles pursuant to which such producers provide access to certain systems and information that may assist us with our marketing and distribution strategy. In instances where we engage producers in such consulting roles, we may compensate the relevant producers on a fixed fee basis, a variable fee basis based

6


upon our usage of the systems and information proffered, or through a combination of fixed and variable fees.

Claims Administration

Claims management for our insurance operations includes the review of initial loss reports, administration of claims databases, generation of appropriate responses to claims reports, identification and handling of coverage issues, determination of whether further investigation is required and, where appropriate, retention of claims counsel, establishment of case reserves, payment of claims and notification to reinsurers. With respect to the establishment of case reserves, when we are notified of insured losses, our claims personnel record a case reserve as appropriate for the estimated amount of the exposure at that time. The estimate reflects the judgment of claims personnel based on general reserving practices, the experience and knowledge of such personnel regarding the nature of the specific claim and, where appropriate, advice of counsel. Reserves are also established to provide for the estimated expense of settling claims, including legal and other fees and the general expenses of administering the claims adjustment process.

Claims in respect of business written by our Lloyd’s syndicates are primarily notified by various central market bureaus. Where a syndicate is a “leading” syndicate on a Lloyd’s policy, its underwriters and claims adjusters will work directly with the broker or insured on behalf of itself and the following market for any particular claim. This may involve appointing attorneys or loss adjusters. The claims bureaus and the leading syndicate advise movement in loss reserves to all syndicates participating on the risk. Our claims department may adjust the case reserves it records from those advised by the bureaus as deemed necessary.

Certain of our product lines have arrangements with third party administrators to provide claims handling services to us in respect of such product lines. These agreements set forth the duties of the third party administrators, limits of authority, protective indemnification language and various procedures that are required to meet statutory compliance. These arrangements are also subject to audit review by our relevant claim department.

Reinsurance Segment

General

Our Reinsurance segment is structured geographically into Bermuda operations, North American operations, European/Asia Pacific operations and Latin American operations.

This segment provides casualty, property risk, property catastrophe, marine, aviation, treaty and other specialty reinsurance on a global basis with business being written on both a proportional and non-proportional basis and also on a facultative basis. Our lines of business within the reinsurance segment continue to focus on those that provide the best return on capital. For our Reinsurance segment, given challenging market conditions and the changing economic environment experienced since 2008 this resulted, in certain instances, in a greater emphasis being placed on short-tail lines of business.

Business written on a non-proportional basis generally provides for an indemnification by us to the ceding company for a portion of losses, both individually and in the aggregate, on policies with limits in excess of a specified individual or aggregate loss deductible. For business written on a proportional basis, including on a “quota share” or “surplus” basis, we receive an agreed percentage of the premium and are liable for the same percentage of each and all incurred loss. For proportional business, the ceding company normally receives a ceding commission for the premiums ceded and may also, under certain circumstances, receive a profit commission based on performance of the contract. Occasionally this commission could be on a sliding scale depending on the loss ratio performance of the contract. Our casualty reinsurance includes general liability, professional liability, automobile and workers’ compensation. Professional liability includes directors’ and officers’, employment practices, medical malpractice and environmental liability. Casualty lines are written as treaties or programs and on both a proportional and a non-proportional basis. The treaty business includes clash programs, which cover a number of underlying policies involved in one occurrence or a judgment above an underlying policy’s limit, before suffering a loss.

7


Our property business, primarily short-tail in nature, is written on both a portfolio/treaty and individual/facultative basis and includes property catastrophe, property risk excess of loss and property proportional. A significant portion of the underwritten property business consists of large aggregate exposures to man-made and natural disasters and, generally, loss experience is characterized as low frequency and high severity. This may result in volatility in our results of operations, financial condition and liquidity. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

We seek to manage our reinsurance exposures to catastrophic events by limiting the amount of exposure written in each geographic or peril zone worldwide, underwriting in excess of varying attachment points and requiring that contracts exposed to catastrophe loss include aggregate limits. We also seek to protect our total aggregate exposures by peril and zone through the purchase of reinsurance programs.

Our property catastrophe reinsurance account is generally “all risk” in nature. As a result, we are exposed to losses from sources as diverse as hurricanes and other windstorms, earthquakes, freezing, riots, floods, industrial explosions, fires and many other potential natural or man-made disasters. In accordance with market practice, our policies generally exclude certain risks such as war, nuclear contamination or radiation. Following the terrorist attacks at the World Trade Center in New York City, Washington, D.C. and Pennsylvania on September 11, 2001 (collectively, “the September 11 event”), terrorism cover, including nuclear, biological, radiological and chemical has been restricted or excluded in many territories and classes. Some U.S. states require some cover for “Fire Following” terrorism and some countries make terrorism coverage mandatory. Our predominant exposure under such coverage is to property damage.

Property catastrophe reinsurance provides coverage on an excess of loss basis when aggregate losses and loss adjustment expenses from a single occurrence of a covered event exceed the attachment point specified in the policy. Some of our property catastrophe contracts limit coverage to one occurrence in any single policy year, but most contracts generally enable at least one reinstatement to be purchased by the reinsured.

We also write property risk excess of loss reinsurance. Property risk excess of loss reinsurance covers a loss to the reinsured on a single risk of the type reinsured rather than to aggregate losses for all covered risks on a specific peril, as is the case with catastrophe reinsurance. Our property proportional account includes reinsurance of direct property insurance. We seek to limit the catastrophe exposure from our proportional and per risk excess business through extensive use of occurrence and cession limits.

Other specialty reinsurance products include energy, marine, aviation, space, engineering, fidelity, surety, trade credit and political risk. We underwrite a small portfolio of contracts covering political risk and trade credit. Exposure is assumed from a limited number of trade credit contracts.

The segment’s most significant operating legal entities in 2012 based on revenues were as follows: XL Reinsurance America Inc., XL Re Europe Limited, XL Re Ltd and XL Re Latin America Ltd.

Underwriting

Underwriting risks for the reinsurance property and casualty business are evaluated using a number of factors including, but not limited to, the type and layer of risk to be assumed, the actuarial evaluation of premium adequacy, the cedant’s underwriting and claims experience, the cedant’s financial condition and claims paying rating, the exposure and/or experience with the cedant, and the line of business to be reinsured.

Other factors we assess include the reputation of the proposed cedant, the geographic area in which the cedant does business and its market share, a detailed evaluation of catastrophe and risk exposures, and historical loss data for the cedant, where available, and for the industry as a whole in the relevant regions in order to compare the cedant’s historical loss experience to industry averages. On-site underwriting and claim reviews are performed where it is deemed necessary to determine the quality of a current or prospective cedant’s underwriting operations, with particular emphasis on casualty proportional and working excess of loss placements.

For property catastrophe reinsurance business, our underwriting guidelines generally limit the amount of exposure we will directly underwrite for any one reinsured and the amount of the aggregate exposure to catastrophic losses in any one geographic zone. We believe that we have defined geographic and peril

8


zones such that a single occurrence, for example, an earthquake or hurricane, should not affect more than one peril zone. While the exposure to multiple zones is considered remote for events such as a hurricane, we do manage our aggregate exposures for such a scenario where we consider it appropriate to do so. The definition of our peril zones is subject to periodic review. We also generally seek an attachment point for our property catastrophe reinsurance at a level that is high enough to produce a low frequency of loss. We seek to limit our aggregate exposure in the proportional business through extensive use of occurrence and cession limits.

Reinsurance Retroceded

We use third party reinsurance to support the underwriting and retention guidelines of each reinsurance subsidiary as well as to seek to limit our aggregate exposure to a particular risk or class of risks. Reinsurance is purchased at several levels ranging from reinsurance of risks assumed on individual contracts to reinsurance covering aggregate exposures. The benefits of ceding risks to other reinsurers include reducing exposure on individual risks, protecting against catastrophic risks, maintaining acceptable capital ratios and enabling the writing of additional business. Reinsurance ceded does not legally discharge us from our liabilities in respect of the risk being reinsured. Reinsurance ceded varies by location and line of business based on factors including, among others, market conditions and the credit worthiness of the counterparty.

Our traditional catastrophe retrocession program was renewed in 2012 to cover certain of our exposures. These protections, in various layers and in excess of varying attachment points according to the territory exposed, assist in managing our net retention to an acceptable level. We have co-reinsurance retentions within this program.

We continue to buy additional protection for our marine and offshore energy exposures and in 2012 increased our retentions for these lines. We continue to buy specific reinsurance on our property and aviation portfolios to manage our net exposures in these classes.

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, Note 9, “Reinsurance,” to the Consolidated Financial Statements included herein, for further information.

Premiums

The following table provides an analysis of gross premiums written, net premiums written and net premiums earned for the Reinsurance segment for the last three years ended December 31:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(U.S. dollars in thousands)

 

2012

 

2011 (1)

 

2010 (1)

 

Gross
Premiums
Written

 

Net
Premiums
Written

 

Net
Premiums
Earned

 

Gross
Premiums
Written

 

Net
Premiums
Written

 

Net
Premiums
Earned

 

Gross
Premiums
Written

 

Net
Premiums
Written

 

Net
Premiums
Earned

Casualty - professional lines

 

 

$

 

221,357

 

 

 

$

 

221,357

 

 

 

$

 

213,322

 

 

 

$

 

217,389

 

 

 

$

 

217,389

 

 

 

$

 

213,949

 

 

 

$

 

218,301

 

 

 

$

 

222,133

 

 

 

$

 

222,720

 

Casualty - other lines

 

 

 

332,561

 

 

 

 

330,715

 

 

 

 

311,160

 

 

 

 

292,507

 

 

 

 

290,962

 

 

 

 

256,853

 

 

 

 

229,535

 

 

 

 

222,351

 

 

 

 

219,154

 

Property catastrophe

 

 

 

537,086

 

 

 

 

473,373

 

 

 

 

463,977

 

 

 

 

461,742

 

 

 

 

404,447

 

 

 

 

387,523

 

 

 

 

370,266

 

 

 

 

326,758

 

 

 

 

323,588

 

Other property

 

 

 

653,514

 

 

 

 

622,853

 

 

 

 

613,295

 

 

 

 

847,816

 

 

 

 

583,100

 

 

 

 

587,611

 

 

 

 

802,494

 

 

 

 

562,416

 

 

 

 

534,422

 

Marine, energy, aviation & satellite

 

 

 

169,889

 

 

 

 

153,954

 

 

 

 

147,370

 

 

 

 

156,161

 

 

 

 

141,924

 

 

 

 

130,855

 

 

 

 

117,438

 

 

 

 

103,926

 

 

 

 

88,855

 

Other (2)

 

 

 

93,749

 

 

 

 

82,256

 

 

 

 

92,218

 

 

 

 

98,004

 

 

 

 

87,902

 

 

 

 

86,594

 

 

 

 

104,917

 

 

 

 

100,854

 

 

 

 

113,260

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

$

 

2,008,156

 

 

 

$

 

1,884,508

 

 

 

$

 

1,841,342

 

 

 

$

 

2,073,619

 

 

 

$

 

1,725,724

 

 

 

$

 

1,663,385

 

 

 

$

 

1,842,951

 

 

 

$

 

1,538,438

 

 

 

$

 

1,501,999

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


 

 

(1)

 

 

 

Certain reclassifications have been made to conform to current year presentation.

 

(2)

 

 

 

Other includes whole account contracts, surety and other lines.

Additional discussion and financial information about the Reinsurance segment are set forth in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, Note 4, “Segment Information,” to the Consolidated Financial Statements included herein.

9


Competition

We compete globally in the property and casualty markets.

Our reinsurance operations are structured geographically into business groups: Bermuda, North America, International (Europe and Asia Pacific) and Latin America. The main competitors in each of these markets include the following:

Bermuda – ACE Tempest Reinsurance Ltd, AXIS Specialty Limited, Arch Reinsurance Limited, Renaissance Reinsurance Limited, Montpelier Reinsurance Ltd, Platinum Underwriters Bermuda Ltd, PartnerRe Ltd and Validus Reinsurance Ltd.

North America – Berkshire Hathaway Inc., Munich Re Group (“Munich Re”), Swiss Reinsurance America Corporation (“Swiss Re”), Alleghany Corporation, Everest Re Group Ltd, Hannover Re Group (“Hannover Re”) and PartnerRe Ltd.

Europe and the rest of world – Munich Re, Swiss Re, Lloyd’s, SCOR Reinsurance Company, Hannover Re and PartnerRe Ltd.

Latin America – Munich Re, Swiss Re, Mapfre Re and IRB-Brazil Re.

Marketing and Distribution

See “Insurance Segment – Marketing and Distribution” and Item 8, Note 17(a), “Commitments and Contingencies – Concentrations of Credit Risk,” to the Consolidated Financial Statements included herein, for information on our marketing and distribution procedures and information on our major brokers.

Claims Administration

Claims management for the reinsurance operations includes the receipt of loss notifications, review and approval of claims through a claims approval process, establishment of loss reserves for reported claims and approval of loss payments. Case reserves for reported claims are generally established based on reports received from ceding companies with additional case reserves being established when deemed appropriate. Additionally, claims audits are conducted for specific claims and claims procedures at the offices of selected ceding companies, particularly in the United States and the U.K.

Life Operations Segment

During 2009, we completed a strategic review of our life reinsurance business. In relation to this initiative, during 2009 we sold the renewal rights to certain of our businesses, sold our U.S. life reinsurance business and announced that we would run-off our existing book of U.K. and Irish traditional life and annuity business, and not accept new business. In addition, in 2010, we consummated various transactions to novate and recapture U.K. and Irish term assurance and critical illness treaties and U.S. mortality retrocession pools. In addition, during the fourth quarter of 2012, we entered into an agreement to recapture two small U.S. life reinsurance treaties.

The Life operations segment provided life reinsurance on business written by life insurance companies, principally to help them manage mortality, morbidity, survivorship, investment and lapse risks.

Prior to the decision to run-off the U.K. and Irish business, products offered included a broad range of underlying lines of life insurance business, including term assurances, group life, critical illness cover, immediate annuities and disability income. In addition, prior to selling the renewal rights, the products offered included short-term life, accident and health business. Notwithstanding these sales, the Life operations still covers a range of geographic markets, with an emphasis on the U.K., U.S., Ireland and Continental Europe.

The portfolio has three particularly significant components:

(1) The portfolio includes a small number of large contracts relating to closed blocks of U.K. and Irish fixed annuities in payment. In relation to certain of these contracts, we received cash and investment assets at the inception of the reinsurance contract, relating to the future policy benefit reserves assumed. These contracts are long-term in nature, and the expected claims payout period can span up to 30 or 40 years

10


with average duration of around 10 years. We are exposed to investment and survivorship risk over the life of these arrangements.

(2) The second component of the portfolio relates to life risks (in the U.S., the U.K. and Ireland)), income protection risks (in the U.S.) and critical illness risks (in the U.K. and Ireland) where we are exposed to the mortality, morbidity and lapse experience from the underlying business, over the medium to long-term.

(3) The third component relates to the annually renewable business covering life, accident and health risks written in Continental Europe. These contracts are short-term in nature and include both proportional and non-proportional reinsurance structures. While the renewal rights for this business have been sold, the existing business remains with us.

Underwriting & Claims Administration

While the Life operations segment was closed to new business in March 2009, the pricing information below reflects how new business was acquired prior to that date and hence is relevant to the in-force portfolio of business.

Life reinsurance transactions fall into two distinct forms. The first relates to the reinsurance of an existing and closed block of risks (“in-force deal”), where the nature of the underlying exposure is known at the date of execution. The second relates to the reinsurance of liabilities that are yet to be written by the ceding company (“new business treaty”) where, provided the subsequent risks are within the agreed treaty parameters, these risks may be added to the portfolio.

The underwriting of an in-force deal is highly actuarial in nature, requiring detailed analytical appraisal of the key parameters that drive the ultimate profitability of the deal. This includes analysis of historic experience (claims, lapses, etc.) as well as the projection of these assumptions into the future.

When new business was written, in addition to the actuarial analysis required to set the terms, there was also a requirement to establish medical underwriting criteria that will apply to the new risks that may be added to the treaty. Once a treaty was accepted, there was then an ongoing need to monitor the risk selection by the medical underwriters at the ceding company and to ensure that the criteria were being met.

The Life operations team includes many members with specialized actuarial knowledge. Claims administration also relies on experienced team members and specific medical expertise, supported where required by third party medical underwriters and claims managers.

Reinsurance Retroceded

We purchase limited retrocession capacity on a “per-life” basis in the United States in order to cap the maximum claim arising from the death of a single individual. Cover is purchased from professional retrocessionaires that meet our criteria for counterparty exposures. Limited retrocession of fixed annuity business has been arranged to manage aggregate longevity capacity on specific deals. Limited retrocession of life, accident and health business on specific treaties written in Continental Europe has also been arranged to manage mortality and morbidity risks.

Premiums

The following table is an analysis of the Life operations gross premiums written, net premiums written and net premiums earned for the year ended December 31, 2012.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(U.S. dollars
in thousands)

 

2012

 

2011

 

2010

 

Gross
Premiums
Written

 

Net
Premiums
Written

 

Net
Premiums
Earned

 

Gross
Premiums
Written

 

Net
Premiums
Written

 

Net
Premiums
Earned

 

Gross
Premiums
Written

 

Net
Premiums
Written

 

Net
Premiums
Earned

Annuity

 

 

$

 

155,255

 

 

 

$

 

126,912

 

 

 

$

 

126,912

 

 

 

$

 

161,800

 

 

 

$

 

132,232

 

 

 

$

 

132,232

 

 

 

$

 

155,235

 

 

 

$

 

127,019

 

 

 

$

 

127,019

 

Other Life

 

 

 

200,499

 

 

 

 

197,520

 

 

 

 

197,547

 

 

 

 

232,755

 

 

 

 

230,130

 

 

 

 

230,786

 

 

 

 

256,703

 

 

 

 

255,056

 

 

 

 

255,905

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

$

 

355,754

 

 

 

$

 

324,432

 

 

 

$

 

324,459

 

 

 

$

 

394,555

 

 

 

$

 

362,362

 

 

 

$

 

363,018

 

 

 

$

 

411,938

 

 

 

$

 

382,075

 

 

 

$

 

382,924

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional discussion and financial information about the Life operations is set forth in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, Note 4, “Segment Information,” to the Consolidated Financial Statements included herein.

11


Competition

In regards to the Life operations segment, the core activity is in the United States, the U.K., Ireland and Continental Europe. While we no longer compete for new business, we retain an in-force portfolio and hence view companies with similar portfolios as competitors.

For the fixed annuity business, market participants include less traditional reinsurance entities, such as Canada Life and Prudential (U.K.) together with Swiss Re, Partner Re Ltd., Scor Global Life and Pacific Life Re, among others, who have entered or re-entered this market.

Marketing and Distribution

We no longer market or distribute new products in this segment.

Life Operations – Collateral Requirements

For certain blocks of Life operations’ business, we are required, under the terms of the relevant treaties, to hold collateral in favor of the underlying cedants. The amount of the collateral is typically determined in relation to the level that would be necessary to satisfy requirements in either the U.K. or U.S. regulatory regimes. These requirements are higher than is required under U.S. GAAP accounting requirements and hence the amounts are generally higher than the reserves reported herein. For the closed blocks of U.K. and Irish fixed annuities, under which assets were transferred to us, those assets are maintained in segregated investment portfolios subject to security and account control agreements in favor of the cedant. For the U.S. term life and income protection business, collateral is provided through a combination of letters of credit and assets held in trust to the benefit of the client.

Unpaid Losses and Loss Expenses

Loss reserves are established due to the significant periods of time that may lapse between the occurrence, reporting and payment of a loss. To recognize liabilities for unpaid losses and loss expenses, we estimate future amounts needed to pay claims and related expenses with respect to insured events. Our reserving practices and the establishment of any particular reserve reflect our judgment concerning sound financial practice and do not represent any admission of liability with respect to any claim. Unpaid losses and loss expense reserves are established for reported claims (“case reserves”) and incurred but not reported (“IBNR”) claims.

The nature of our high excess of loss liability and catastrophe business can result in loss payments that are both irregular and significant. Similarly, adjustments to reserves for individual years can be irregular and significant. Such adjustments are part of the normal course of business for us. Certain aspects of our business have loss experience characterized as low frequency and high severity. This may result in volatility in our results of operations, financial condition and liquidity.

The tables below present the development of our unpaid losses and loss expense reserves on both a net and gross basis. The cumulative redundancy (deficiency) calculated on a net basis differs from that calculated on a gross basis. As different reinsurance programs cover different underwriting years, net and gross loss experience will not develop proportionately. The top lines of the tables show the estimated liability, net of reinsurance recoveries, as at the year end balance sheet date for each of the indicated years. This represents the estimated amounts of losses and loss expenses, including IBNR, arising in the current and all prior years that are unpaid at the year end balance sheet date of the indicated year. The tables show the re-estimated amount of the previously recorded reserve liability based on experience as of the year end balance sheet date of each succeeding year. The estimate changes as more information becomes known about the frequency and severity of claims for individual years. The cumulative redundancy (deficiency) represents the aggregate change with respect to that liability originally estimated. The lower portion of the first table also reflects the cumulative paid losses relating to these reserves. Conditions and trends that have affected development of liabilities in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate redundancies or deficiencies into the future, based on the tables below. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Cautionary Note Regarding Forward-Looking Statements.”

12


Analysis of P&C Losses and Loss Expenses Reserve Development
Net of Reinsurance Recoverables

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(U.S. dollars in millions)

 

2002

 

2003

 

2004

 

2005

 

2006

 

2007

 

2008

 

2009

 

2010

 

2011

 

2012

ESTIMATED LIABILITY FOR UNPAID LOSSES AND LOSS EXPENSES, NET OF REINSURANCE RECOVERABLES

 

 

$

 

8,313

 

 

 

$

 

10,532

 

 

 

$

 

12,671

 

 

 

$

 

17,200

 

 

 

$

 

17,900

 

 

 

$

 

18,191

 

 

 

$

 

17,686

 

 

 

$

 

17,266

 

 

 

$

 

16,882

 

 

 

$

 

16,984

 

 

 

$

 

17,122

 

LIABILITY RE-ESTIMATED AS OF:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One year later

 

 

 

9,250

 

 

 

 

10,800

 

 

 

 

13,785

 

 

 

 

17,090

 

 

 

 

17,475

 

 

 

 

17,580

 

 

 

 

17,401

 

 

 

 

16,893

 

 

 

 

16,597

 

 

 

 

16,668

 

 

 

Two years later

 

 

 

9,717

 

 

 

 

11,842

 

 

 

 

13,675

 

 

 

 

16,828

 

 

 

 

16,631

 

 

 

 

17,286

 

 

 

 

17,027

 

 

 

 

16,503

 

 

 

 

16,274

 

 

 

 

 

Three years later

 

 

 

10,723

 

 

 

 

11,849

 

 

 

 

13,607

 

 

 

 

16,155

 

 

 

 

16,441

 

 

 

 

16,956

 

 

 

 

16,639

 

 

 

 

16,261

 

 

 

 

 

 

 

Four years later

 

 

 

10,738

 

 

 

 

11,860

 

 

 

 

13,258

 

 

 

 

16,067

 

 

 

 

16,064

 

 

 

 

16,550

 

 

 

 

16,350

 

 

 

 

 

 

 

 

 

Five years later

 

 

 

10,710

 

 

 

 

11,680

 

 

 

 

13,236

 

 

 

 

15,796

 

 

 

 

15,667

 

 

 

 

16,287

 

 

 

 

 

 

 

 

 

 

 

Six years later

 

 

 

10,642

 

 

 

 

11,794

 

 

 

 

13,068

 

 

 

 

15,448

 

 

 

 

15,500

 

 

 

 

 

 

 

 

 

 

 

 

 

Seven years later

 

 

 

10,824

 

 

 

 

11,669

 

 

 

 

12,819

 

 

 

 

15,248

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Eight years later

 

 

 

10,775

 

 

 

 

11,464

 

 

 

 

12,702

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine years later

 

 

 

10,617

 

 

 

 

11,372

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ten years later

 

 

 

10,534

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CUMULATIVE REDUNDANCY (DEFICIENCY)

 

 

 

(2,221

)

 

 

 

 

(840

)

 

 

 

 

(31

)

 

 

 

 

1,952

 

 

 

 

2,400

 

 

 

 

1,904

 

 

 

 

1,336

 

 

 

 

1,005

 

 

 

 

608

 

 

 

 

316

 

 

 

CUMULATIVE PAID LOSSES, NET OF REINSURANCE RECOVERIES, AS OF:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One year later

 

 

$

 

2,521

 

 

 

$

 

1,985

 

 

 

$

 

2,008

 

 

 

$

 

3,437

 

 

 

$

 

3,188

 

 

 

$

 

3,207

 

 

 

$

 

3,436

 

 

 

$

 

3,028

 

 

 

$

 

3,256

 

 

 

$

 

3,366

 

 

 

Two years later

 

 

 

3,800

 

 

 

 

2,867

 

 

 

 

3,884

 

 

 

 

5,759

 

 

 

 

5,620

 

 

 

 

5,673

 

 

 

 

5,848

 

 

 

 

5,530

 

 

 

 

5,581

 

 

 

 

 

Three years later

 

 

 

4,163

 

 

 

 

4,380

 

 

 

 

5,181

 

 

 

 

7,590

 

 

 

 

7,528

 

 

 

 

7,471

 

 

 

 

7,860

 

 

 

 

7,283

 

 

 

 

 

 

 

Four years later

 

 

 

5,365

 

 

 

 

5,286

 

 

 

 

6,392

 

 

 

 

8,936

 

 

 

 

8,787

 

 

 

 

8,941

 

 

 

 

9,229

 

 

 

 

 

 

 

 

 

Five years later

 

 

 

6,018

 

 

 

 

6,225

 

 

 

 

7,386

 

 

 

 

9,882

 

 

 

 

9,763

 

 

 

 

9,896

 

 

 

 

 

 

 

 

 

 

 

Six years later

 

 

 

6,764

 

 

 

 

7,002

 

 

 

 

8,098

 

 

 

 

10,636

 

 

 

 

10,463

 

 

 

 

 

 

 

 

 

 

 

 

 

Seven years later

 

 

 

7,381

 

 

 

 

7,591

 

 

 

 

8,690

 

 

 

 

11,139

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Eight years later

 

 

 

7,797

 

 

 

 

8,106

 

 

 

 

9,115

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine years later

 

 

 

8,249

 

 

 

 

8,463

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ten years later

 

 

 

8,558

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Analysis of P&C Losses and Loss Expenses Reserve Development
Gross of Reinsurance Recoverables

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(U.S. dollars in millions)

 

2002

 

2003

 

2004

 

2005

 

2006

 

2007

 

2008

 

2009

 

2010

 

2011

 

2012

ESTIMATED GROSS LIABILITY FOR UNPAID LOSSES AND LOSS EXPENSES

 

 

$

 

13,333

 

 

 

$

 

16,553

 

 

 

$

 

19,616

 

 

 

$

 

23,598

 

 

 

$

 

22,895

 

 

 

$

 

22,857

 

 

 

$

 

21,650

 

 

 

$

 

20,824

 

 

 

$

 

20,532

 

 

 

$

 

20,614

 

 

 

$

 

20,484

 

LIABILITY RE-ESTIMATED AS OF:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One year later

 

 

$

 

15,204

 

 

 

$

 

18,189

 

 

 

$

 

19,987

 

 

 

$

 

23,209

 

 

 

$

 

22,458

 

 

 

$

 

21,803

 

 

 

$

 

21,348

 

 

 

$

 

20,509

 

 

 

$

 

20,258

 

 

 

$

 

20,200

 

 

 

Two years later

 

 

 

16,994

 

 

 

 

18,520

 

 

 

 

19,533

 

 

 

 

22,937

 

 

 

 

21,337

 

 

 

 

21,445

 

 

 

 

21,094

 

 

 

 

19,982

 

 

 

 

19,870

 

 

 

 

 

Three years later

 

 

 

17,210

 

 

 

 

18,324

 

 

 

 

19,525

 

 

 

 

22,139

 

 

 

 

21,057

 

 

 

 

21,305

 

 

 

 

20,605

 

 

 

 

19,689

 

 

 

 

 

 

 

Four years later

 

 

 

17,048

 

 

 

 

18,362

 

 

 

 

19,153

 

 

 

 

21,992

 

 

 

 

20,787

 

 

 

 

20,853

 

 

 

 

20,244

 

 

 

 

 

 

 

 

 

Five years later

 

 

 

17,106

 

 

 

 

18,236

 

 

 

 

19,099

 

 

 

 

21,835

 

 

 

 

20,350

 

 

 

 

20,509

 

 

 

 

 

 

 

 

 

 

 

Six years later

 

 

 

17,051

 

 

 

 

18,328

 

 

 

 

19,050

 

 

 

 

21,426

 

 

 

 

20,117

 

 

 

 

 

 

 

 

 

 

 

 

 

Seven years later

 

 

 

17,189

 

 

 

 

18,321

 

 

 

 

18,766

 

 

 

 

21,186

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Eight years later

 

 

 

17,253

 

 

 

 

18,083

 

 

 

 

18,605

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine years later

 

 

 

17,072

 

 

 

 

17,895

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ten years later

 

 

 

16,905

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CUMULATIVE REDUNDANCY (DEFICIENCY)

 

 

 

(3,572

)

 

 

 

 

(1,342

)

 

 

 

 

1,011

 

 

 

 

2,412

 

 

 

 

2,778

 

 

 

 

2,348

 

 

 

 

1,406

 

 

 

 

1,135

 

 

 

 

662

 

 

 

 

414

 

 

 

13


The following table presents an analysis of our paid, unpaid and incurred losses and loss expenses and a reconciliation of beginning and ending unpaid losses and loss expenses for the years indicated.

 

 

 

 

 

 

 

Year ended December 31,
(U.S. dollars in thousands)

 

2012

 

2011

 

2010

Unpaid losses and loss expenses at the beginning of the year

 

 

$

 

20,613,901

 

 

 

$

 

20,531,607

 

 

 

$

 

20,823,524

 

Unpaid losses and loss expenses recoverable

 

 

 

3,629,928

 

 

 

 

3,649,290

 

 

 

 

3,557,391

 

 

 

 

 

 

 

 

Net unpaid losses and loss expenses at the beginning of the year

 

 

 

16,983,973

 

 

 

 

16,882,317

 

 

 

 

17,266,133

 

 

 

 

 

 

 

 

Increase (decrease) in net losses and loss expenses incurred in respect of losses occurring in:

 

 

 

 

 

 

Current year

 

 

 

4,081,377

 

 

 

 

4,363,258

 

 

 

 

3,584,662

 

Prior years

 

 

 

(315,895

)

 

 

 

 

(284,867

)

 

 

 

 

(372,862

)

 

 

 

 

 

 

 

 

Total net incurred losses and loss expenses

 

 

 

3,765,482

 

 

 

 

4,078,391

 

 

 

 

3,211,800

 

Exchange rate effects

 

 

 

156,206

 

 

 

 

(130,533

)

 

 

 

 

(125,107

)

 

Less net losses and loss expenses paid in respect of losses occurring in:

 

 

 

 

 

 

Current year

 

 

 

416,844

 

 

 

 

589,870

 

 

 

 

442,262

 

Prior years

 

 

 

3,366,398

 

 

 

 

3,256,332

 

 

 

 

3,028,247

 

 

 

 

 

 

 

 

Total net paid losses

 

 

 

3,783,242

 

 

 

 

3,846,202

 

 

 

 

3,470,509

 

Net unpaid losses and loss expenses at the end of the year

 

 

 

17,122,419

 

 

 

 

16,983,973

 

 

 

 

16,882,317

 

Unpaid losses and loss expenses recoverable

 

 

 

3,361,702

 

 

 

 

3,629,928

 

 

 

 

3,649,290

 

 

 

 

 

 

 

 

Unpaid losses and loss expenses at the end of the year

 

 

$

 

20,484,121

 

 

 

$

 

20,613,901

 

 

 

$

 

20,531,607

 

 

 

 

 

 

 

 

Our net unpaid losses and loss expenses relating to our operating segments at December 31, 2012 and 2011 were as follows:

 

 

 

 

 

(U.S. dollars in thousands)

 

2012

 

2011

Insurance

 

 

$

 

11,384,855

 

 

 

$

 

11,374,315

 

Reinsurance

 

 

 

5,737,564

 

 

 

 

5,609,658

 

 

 

 

 

 

Net unpaid losses and loss expenses

 

 

$

 

17,122,419

 

 

 

$

 

16,983,973

 

 

 

 

 

 

Current year net losses incurred

Current year net losses incurred decreased by $281.9 million in 2012 as compared to 2011. This was mainly as a result of the current year loss ratio excluding prior year development decreasing by 11.1 loss percentage points due to lower losses from natural catastrophes as compared to 2011. In addition, the current year loss ratio excluding natural catastrophes improved in both the Insurance and Reinsurance segments due to lower large property risk losses, as well as business mix changes and other underwriting improvements.

Current year net losses incurred increased by $778.6 million in 2011 as compared to 2010. This was mainly as a result of the current year loss ratio excluding prior year development increasing by 10.7 loss percentage points due to higher losses from natural catastrophes as compared to 2010, but also from the following: (i) the Insurance segment in 2011 experienced higher large loss activity in the energy, property and marine businesses, as compared to 2010; and (ii) the Reinsurance segment in 2011 experienced higher levels of large loss events in U.S. property, including a deterioration in the performance of a large U.S. agricultural program, higher attritional losses as well as business mix changes, as compared to 2010.

See the Income Statement Analysis at Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for further information regarding the current year loss ratios for each of the years indicated within each of our operating segments.

Prior year net losses incurred

The following tables present the development of our gross and net losses and loss expense reserves. The tables also show the estimated reserves at the beginning of each fiscal year and the favorable or adverse development (prior year development) of those reserves during such fiscal year.

14


 

 

 

 

 

 

 

Gross
(U.S. dollars in thousands)

 

2012

 

2011

 

2010

Unpaid losses and loss expenses at January 1

 

 

$

 

20,613,901

 

 

 

$

 

20,531,607

 

 

 

$

 

20,823,524

 

Gross (favorable) adverse development of those reserves during the year

 

 

 

(413,764

)

 

 

 

 

(273,444

)

 

 

 

 

(314,809

)

 

 

 

 

 

 

 

 

Unpaid losses and loss expenses reserves re-estimated at December 31

 

 

$

 

20,200,137

 

 

 

$

 

20,258,163

 

 

 

$

 

20,508,715

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net
(U.S. dollars in thousands)

 

 

 

 

 

 

Unpaid losses and loss expenses at January 1

 

 

$

 

16,983,973

 

 

 

$

 

16,882,317

 

 

 

$

 

17,266,133

 

Net (favorable) adverse development of those reserves during the year

 

 

 

(315,895

)

 

 

 

 

(284,867

)

 

 

 

 

(372,862

)

 

 

 

 

 

 

 

 

Unpaid losses and loss expenses reserves re-estimated at December 31

 

 

$

 

16,668,078

 

 

 

$

 

16,597,450

 

 

 

$

 

16,893,271

 

 

 

 

 

 

 

 

As different reinsurance programs cover different underwriting years, contracts and lines of business, net and gross loss experience do not develop proportionately. In 2012, gross prior year favorable development exceeded net prior year favorable development in the Insurance segment due primarily to a significant reduction in a single large event in the International energy book that was heavily ceded. In 2011, gross prior year favorable development was in line with net prior year favorable development in total. However, during 2011, the Insurance segment experienced favorable net prior year development of $76.5 million compared to adverse gross prior year development of $23.1 million. The difference between net and gross development was driven primarily by adverse development related to large excess casualty claims associated with the Deepwater Horizon event in the 2010 accident year totaling $135.6 million on a gross basis, while the net impact was $33.4 million due to the offsetting impact of reinsurance protections. In addition, $150.0 million gross and $65.0 million net excess casualty IBNR reserves were reallocated to the 2010 accident year in respect of Deepwater Horizon exposures. These IBNR movements were entirely offset by reserve reductions in older accident years. This activity largely explains the difference between the gross and net prior year development for the Insurance segment in 2011 as well as the overall strengthening of the 2010 accident year reflected in the loss reserve development tables shown on the previous pages. During 2010, net prior year favorable development exceeded gross prior year favorable development due primarily to the Insurance segment from a single large claim in excess casualty that was heavily ceded.

The following table presents the gross and net (favorable) adverse prior year loss development of our loss and loss expense reserves by operating segment for each of the years indicated:

 

 

 

 

 

 

 

Gross:
(U.S. dollars in thousands)

 

2012

 

2011

 

2010

Insurance

 

 

 

(247,232

)

 

 

 

 

23,125

 

 

 

 

(31,387

)

 

Reinsurance

 

 

 

(166,532

)

 

 

 

 

(296,569

)

 

 

 

 

(283,422

)

 

 

 

 

 

 

 

 

Total

 

 

$

 

(413,764

)

 

 

 

$

 

(273,444

)

 

 

 

$

 

(314,809

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net:

 

 

 

 

 

 

Insurance

 

 

$

 

(140,067

)

 

 

 

$

 

(76,516

)

 

 

 

$

 

(127,411

)

 

Reinsurance

 

 

 

(175,828

)

 

 

 

 

(208,351

)

 

 

 

 

(245,451

)

 

 

 

 

 

 

 

 

Total

 

 

$

 

(315,895

)

 

 

 

$

 

(284,867

)

 

 

 

$

 

(372,862

)

 

 

 

 

 

 

 

 

We had net favorable prior year reserve development in property and casualty operations of $315.9 million, $284.9 million and $372.9 million for the years ended December 31, 2012, 2011 and 2010, respectively. See the Income Statement Analysis at Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, Note 10, “Losses and Loss Expenses,” to the Consolidated Financial Statements included herein, for further information regarding the developments in prior year loss reserve estimates for each of the years indicated within each of our operating segments.

15


Net loss reserves (disposed) acquired

We did not dispose of or acquire net loss reserves in the years ended December 31, 2012, 2011 and 2010.

Exchange rate effects

Exchange rate effects on net loss reserves in each of the three years ended December 31, 2012, 2011 and 2010 related to our global operations primarily where reporting units have a functional currency that is not the U.S. dollar. In 2012, the U.S. dollar was weaker against the major currencies to which we are exposed, including the U.K. sterling, the Euro and the Swiss franc. In 2011, the U.S. dollar was stronger against U.K. sterling, the Euro, the Brazilian real and the Swiss franc, which more than offset losses that were driven by a stronger Australian dollar. In 2010, the U.S. dollar was stronger against the Euro, while weaker against the Swiss franc, Canadian dollar and Brazilian real. These movements in the U.S. dollar gave rise to translation and revaluation exchange movements related to carried loss reserve balances of $156.2 million, $(130.5) million and $(125.1) million in the years ended December 31, 2012, 2011 and 2010, respectively.

Net paid losses

Total net paid losses were $3.8 billion, $3.8 billion and $3.5 billion in 2012, 2011 and 2010, respectively. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for further information.

Other loss related information

Our net incurred losses and loss expenses include actual and estimates of potential non-recoveries from reinsurers. At December 31, 2012 and 2011, the reserve for potential non-recoveries from reinsurers was $107.9 million and $99.2 million, respectively. For further information, see Item 8, Note 9, “Reinsurance,” to the Consolidated Financial Statements included herein.

Except for certain workers’ compensation (including long term disability) liabilities and certain U.K. motor liability claims, we do not discount our unpaid losses and loss expenses.

We utilize tabular reserving for workers’ compensation (including long-term disability) unpaid losses that are considered fixed and determinable, and discount such losses using an interest rate of 5% in 2012 and 2011. The interest rate approximates the average yield to maturity on specific fixed income investments that support these liabilities. The tabular reserving methodology results in applying uniform and consistent criteria for establishing expected future indemnity and medical payments (including an explicit factor for medical inflation) and the use of mortality tables to determine expected payment periods. Tabular unpaid losses and loss expenses, net of reinsurance, at December 31, 2012 and 2011 on an undiscounted basis were $645.2 million and $612.9 million, respectively. The related discounted unpaid losses and loss expenses were $343.0 million and $290.3 million at December 31, 2012 and 2011, respectively.

The Company records specific reserve allowance for Periodical Payment Orders (“PPO”) in the U.K. motor liabilities. This allowance includes the unpaid losses for claims already settled and notified as PPO at December 31, 2012, as well as the unpaid losses for claims to be settled in the future. The future care element of the unpaid losses were discounted using an interest rate of 1.5% at December 31, 2012 reduced from 2% at December 31, 2011 to reflect the increased reserve and the yields obtained on the additional purchase of assets. Unpaid losses and loss expenses, net of reinsurance, at December 31, 2012 and 2011 on an undiscounted basis were $240.0 million and $52.8 million, respectively. After discounting of the future care element the unpaid losses and loss expenses were $148.6 million and $29.6 million at December 31, 2012 and 2011, respectively. The increase in net undiscounted unpaid losses and loss expenses between December 31, 2011 and December 31, 2012 is explained in part by the identification of a proportion of the overall UK motor reserves that will settle as Periodical Payment claims in the future. This is in addition to a revision of the assumptions underlying the PPO reserve calculation and the worse than expected settlement of claims as PPOs during 2012.

16


Investments

Investment structure and strategy

Our investment operations are managed centrally by our Investment Group. The Risk and Finance Committee (the “RFC”) of the Board of Directors of XL-Ireland approves overall investment policy and guidelines, and reviews the implementation of the investment strategies on a regular basis.

Strategic Asset Allocation

The investment strategy for the investment portfolio is based on the strategic asset allocation (“SAA”) process, which establishes a benchmark for the aggregate investment portfolios supporting P&C investment operations and a separate benchmark for the aggregate investment portfolio supporting Life operations. These two benchmarks (“SAA Benchmarks”) are constructed to maximize company value subject to risk tolerance of management and various constraints, e.g., liability profile, local regulatory requirements, business needs, collateral management and insurance regulation. This process involves an integrated and stochastic model that includes our financial condition, reserve volatility and loss payout patterns, premium expense and loss ratio projections and correlations among asset, liabilities and economic variables.

As part of the implementation of our SAA Benchmarks, we employ a comprehensive framework of investment decision authorities (“Authorities Framework”). The objective of the Authorities Framework is to ensure that the risk profile of our investment portfolio is consistent with management’s risk tolerance as reflected in the SAA Benchmarks. The Authorities Framework controls active or tactical deviations from the SAA Benchmarks. As the magnitude of these deviations increases or the resulting impact on the risk profile of the investment portfolio reaches certain predetermined thresholds, additional levels of authority and approval are required, up to and including the RFC.

The RFC reviews and approves the SAA Benchmarks for P&C and Life operations and the Authorities Framework as part of the investment policy. Management approves further detailed investment authorities which integrate the Authorities Framework into our risk governance processes. We have an ongoing process that focuses on optimizing the composition of the P&C and Life portfolios relative to the SAA Benchmarks. See “Investment Portfolio Structure” for more details.

Investment Portfolio Structure

Our investment portfolio consists of fixed income securities, equities, alternative investments, private investments, derivatives and other investments and cash. These securities and investments are denominated in U.S. dollar, U.K. sterling, Euro, Swiss franc, Canadian dollar and other foreign currencies.

Our direct use of investment derivatives includes futures, forwards, swaps and options that derive their value from underlying assets, indices, reference rates or a combination of these factors. Our current investment policy allows derivatives to be used in the investment portfolio to reduce risk and enhance portfolio efficiency. Derivatives may not be used if they materially increase our investment risk.

At December 31, 2012 and 2011, total investments, cash and cash equivalents, accrued investment income, and net receivable (payable) for investments sold (purchased), were $36.9 billion and $35.9 billion, respectively.

Functionally, our investment portfolio is divided into two principal components:

1) P&C investment portfolio: The larger component is the P&C investment portfolio and its principal objective is to support our insurance and reinsurance operations, the liabilities of which have some uncertainty as to the timing and/or amount. In addition, a smaller portion of the P&C investment portfolio supports corporate operations as well as run-off financial lines business, in which the liabilities have a greater level of certainty and much longer durations than typical P&C business.

The investment strategy for the P&C investment portfolio is based on the SAA process with a constrained total return mandate. The primary performance objective is for the total return of the P&C portfolio to meet or exceed the return of the SAA Benchmark with realized loss constraints. The second performance objective is capital preservation through managing the risk profile of the investment portfolio within management’s risk tolerance. The third performance objective is achieving the budget for net investment income.

17


2) Life operations investment portfolio: The second component of the investment portfolio is the Life operations investment portfolio. The principal objective of the Life operations investment portfolio is to support our Life operations, which are now in run-off. The largest portion of the Life operations investment portfolio supports the policy benefit reserves associated with asset annuity transactions, with limited uncertainty as to the timing or amount of the liability cash flows. A smaller portion of the Life operations investment portfolio supports life annuity liabilities that were assumed without portfolio asset transfer.

As discussed above, the investment strategy for the Life operations investment portfolio is based on the SAA process. The Life operations investment portfolio SAA process incorporates an additional overlay of the regulatory capital model and a more extensive focus on asset-liability management, which is possible due to the lower volatility of life liabilities relative to P&C liabilities.

The primary performance objective for the investments supporting the asset annuity transactions is to achieve a steady credit-adjusted book yield of the Life operations investment portfolio in order to maximize the embedded value and minimize statutory capital needs (owing to unique technical requirements of the statutory capital model). For the investments supporting the other portions of the Life operations investment portfolio, which do not have this unique capital model, the performance objective is for the constrained total return to at least match the total return of the benchmark, similar to that used in the P&C investment portfolio.

Implementation of investment strategy

Although our management within the Investment Group is responsible for implementation of the investment strategy, the day-to-day management of our investment portfolio is outsourced to investment management service providers in accordance with detailed investment guidelines provided and monitored by us. This approach gives us access to top investment talent with specialized skills across a broad range of investment products and provides flexibility to actively manage the structure of the portfolio as dictated by our business needs. Investment management service providers are selected directly on the basis of various criteria including investment style, track record, performance, risk management capabilities, internal controls, operational risk management and diversification implications. The vast majority of our investment portfolio is managed by large, well-established asset management institutions, while a small portion of the portfolio is managed by asset management specialist firms or boutiques. Each investment management service provider may manage one or more portfolios, each of which is generally governed by a detailed set of investment guidelines, including overall objectives, risk limits (where appropriate) and diversification requirements that fall within our overall investment policies and guidelines, including but not limited to exposures to eligible securities, prohibited investments/transactions, credit quality and general concentration limits. The Investment Group has a surveillance program to manage the aggregation of individual manager portfolios relative to the SAA Benchmarks.

Investment performance

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Investment Performance,” for discussion of our investment performance.

Investment portfolio credit ratings, duration and maturity profile

It is our policy to operate the combined P&C and Life (“aggregate”) fixed income portfolio with a minimum weighted average credit rating of Aa3/AA-. See Item 1A, “Risk Factors,” for discussion on ratings downgrades. The aggregate credit rating is determined based on the weighted average rating of securities, where the average credit rating, where available, from Standard & Poor’s (“S&P”), Moody’s Investors Service (“Moody’s”) and Fitch Ratings (“Fitch”) is allocated to each security. The weighted average credit rating of the aggregate fixed income portfolio was Aa2/AA at December 31, 2012 and 2011. U.S. agencies and Agency RMBS paper, whether with implicit or explicit government support, reflect the credit quality rating of the U.S. government for the purpose of these calculations.

We did not have an aggregate direct investment in a single corporate issuer in excess of 5% of shareholders’ equity at December 31, 2012 or 2011. Corporate issuers represent our direct exposure to fixed maturities and short-term investments of the parent issuer and its subsidiaries. These exposures exclude

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asset and mortgage-backed securities that were issued, sponsored or serviced by the parent and government-guaranteed issues, but does include covered bonds. The Company invests in covered bonds issued by financial institutions (“Covered Bonds”). Covered Bonds are senior secured debt instruments issued by financial institutions and backed by over-collateralized pools of public sector or mortgage loans.

The overall duration and currency denomination of the aggregate fixed income portfolio is managed relative to the respective SAA Benchmarks for the P&C and Life operations investment portfolios, both of which incorporate matching currency and duration within a range relative to liabilities. Duration measures bond price volatility and is an indicator of the sensitivity of the price of a bond (or a portfolio of bonds) to changes in interest rates, assuming a parallel change in all global yield curves reflecting the percentage change in price for a 100 basis point change in yield. Management believes that the duration of the aggregate fixed income portfolio is the best single measure of interest rate risk for the aggregate fixed income portfolio.

The maturity profile of the aggregate fixed income portfolio is a function of the maturity profile of estimated loss payments from our liabilities, our capital and expected operating cash flows and, to a lesser extent, the maturity profile of common fixed income benchmarks. For further information on the maturity profile of the fixed income portfolio, see Item 8, Note 5, “Investments,” to the Consolidated Financial Statements included herein.

Enterprise Risk Management

Risk Management Framework

We face strategic and operational risks related to, among others: underwriting activities, financial reporting, changing macroeconomic conditions, investment risks, reserving estimates, changes in laws or regulations, information systems, business interruption and fraud. Our global P&C business, Life operations (which is in run-off) and investment portfolios each have their own set of risks (see Item 1A, “Risk Factors,” for a discussion of such risks). From time to time, these risks may exhibit greater levels of correlation than might be expected over the longer term due to the presence of, to a greater or lesser degree, some common internal or external risk drivers embedded in our businesses that may manifest themselves simultaneously. An enterprise view of risk is required to identify and manage the consequences of these common risks and risk drivers on our profitability, capital strength and liquidity.

Our enterprise risk management (“ERM”) initiatives are led by the Chief Enterprise Risk Officer (“CERO”), who is a member of our leadership team, and who reports to our Chief Executive Officer. The CERO also acts as a liaison between our Enterprise Risk Committee (“ERC” - see below) and the XL-Ireland Board (or its committees), with respect to risk matters. All of our employees are expected to assist in the appropriate and timely identification and management of risks and to enhance the quality and effectiveness of ERM.

Our ERM framework is designed to allow us to identify and understand material risk concentrations, including concentrations that have unattractive risk/reward dynamics so that prompt, appropriate, corrective or mitigating actions can be taken. To do this, we have risk management committees and processes to serve as points of managerial dialogue and convergence across our businesses and functional areas, to create risk aggregation methodologies and to develop specific risk appetites to coordinate the identification, vetting and discussion of risk topics and metrics. As part of our ERM activities, we apply a suite of stress tests, tools, risk indicators, metrics and reporting processes that examine the consequences of low probability/high severity events (including those related to emerging risks) in order to take mitigating actions where required.

Risk Governance

Risk governance relates to the processes by which oversight and decision-making authorities with respect to risks are granted to individuals within the enterprise. Our governance framework establishes accountabilities for tasks and outcomes as well as escalation criteria. Governance processes are designed to ensure that transactions and activities, individually and in the aggregate, are carried out in accordance with our risk policies, philosophies, appetites, limits and risk concentrations, and in a manner consistent with expectations of excellence of integrity, accountability and client service.

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The RFC of the XL-Ireland Board oversees ERM matters. With respect to the responsibilities relating to ERM, the RFC:

 

 

 

 

Oversees ERM activities, including the risk management framework employed by management. In light of the overall risk management framework, the RFC (i) reviews the methodology for establishing our overall risk capacity; (ii) reviews the policies for the establishment of risk limit frameworks, and adherence to such limits; and (iii) reviews and approves enterprise risk limits.

 

 

 

 

Oversees our compliance with any significant enterprise risk limits, authorities and policies. The RFC evaluates what actions to take with respect to such enterprise limits, authorities and policies, and approves any exceptions thereto from time to time as necessary.

 

 

 

 

Reviews our overall risk profile and monitors key risks across our organization as a whole, which may involve coordination with other committees of the Board from time to time as appropriate.

 

 

 

 

Reviews our process controls over model use and development with respect to model risk and model effectiveness, accuracy, and propriety.

 

 

 

 

Monitors our risk management performance and obtains reasonable assurance from management that our risk management policies are effective and are being adhered to.

The review of our overall risk appetites and the evaluation of the risk impact of any material strategic decision being contemplated, including consideration of whether such strategic decision is within the risk profile established by us, is conducted by the full Board. “Risk appetites,” as referred to above, are broad statements used to guide our risk and reward preferences over time, all consistent with, among other factors, business prudence, market opportunities, the underwriting pricing cycle and investment climate. Risk appetites are regularly monitored and can change over time in light of the above. See “Risk Appetite Management” below.

Management oversight of ERM is performed, in part, via a centralized management ERC, which is chaired by the CERO. The ERC is comprised of senior management from our businesses and functions and is charged with developing and monitoring enterprise risk policies, risk appetites, risk limits (and compliance with such limits) and risk aggregations, and identifying key emerging risks and ways to mitigate such risks.

In addition to the ERC, we have established a framework of separate yet complementary ERM subcommittees, each focusing on particular aspects of ERM. These subcommittees include:

 

 

 

 

Economic Capital Model Subcommittee: This subcommittee oversees the development of economic capital models that support ERM activities, and helps set priorities and manage resources related to such models. It reviews assumptions and related methodologies used within our economic capital models, including assessments of model validation, model control and model risk.

 

 

 

 

Liability Subcommittee: This subcommittee supports and assists the ERC’s identification, measurement, management, monitoring and reporting of key underwriting liability and emerging risks.

 

 

 

 

Asset Risk Subcommittee: This subcommittee assists the ERC in its responsibilities in relation to governance and oversight of asset-related risks across the Company, including the investment portfolio. Among its activities are (a) involvement in policy decisions on modeling and quantification of risk measurements; and (b) providing an interpretation and assessment of asset-related risks, with a particular focus on market-related risks. Further, the subcommittee is responsible for coordinating on a regular basis with the Credit Subcommittee of the ERC on asset-related credit risks.

 

 

 

 

Credit Subcommittee: This subcommittee develops and implements the metrics and supporting framework for allocation of credit risk capacity across major business units and functions, including the amount and types of credit exposure.

 

 

 

 

Operational Risk Subcommittee: This subcommittee supports the ERC’s identification, measurement, management and oversight of key operational risks through its oversight of key operational risk management processes and through its review of related operational risk indicators, trends and metrics.

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In addition to the above, risk management subcommittees within each of our businesses function to ensure that risk is managed in accordance with the risk limits, guidelines and tolerances that we have allocated to them.

Risk Appetite Management

Our risk appetite framework guides our strategies relating to, among other things, capital preservation, earnings volatility, capital at risk, operational loss, liquidity standards, claims paying rating and capital structure. This framework also addresses our tolerance to risks from material individual events (e.g., natural or man- made catastrophes such as terrorism), our investment portfolio and realistic disaster scenarios that cross multiple lines of business (and risks related to some or all of the above that may occur concurrently).

In relation to event risk management, we establish net underwriting limits for individual large events as follows:

 

1.

 

 

 

We impose limits for each natural catastrophe peril region at a 1% tail value at risk (“TVaR”) probability. This statistic indicates the average amount of net loss expected to be incurred given that a loss above the 1% exceedance probability level has occurred.

 

2.

 

 

 

For each event type other than natural catastrophes, we impose limits at a 1% exceedance probability. If we were to deploy the full limit, for any given event type, there would be a 1% probability that an event would occur during the next year that would result in a net underwriting loss in excess of the limit.

 

3.

 

 

 

We also impose limits for certain other event types at a 0.4% exceedance probability as described in further detail below. If we were to deploy the full limit, for any such given event type, there would be a 0.4% probability that an event would occur during the next year that would result in a net underwriting loss in excess of the limit.

For planning purposes and to calibrate risk tolerances for business to be written from September 30, 2012 through September 30, 2013, we set our underwriting limits as a percent of September 30, 2012 Tangible Shareholders’ Equity (hereafter, “Tangible Shareholders’ Equity”). Tangible Shareholders’ Equity is defined as Total Shareholders’ Equity less Goodwill and Other Intangible Assets. These limits may be recalibrated, from time to time, to reflect material changes in Total Shareholders’ Equity that may occur after September 30, 2012, at the discretion of management and as overseen by the Board.

Tier I event types (“Tier 1 Events”), which include natural catastrophes, terrorism and other realistic disaster scenarios, and Tier 2 event types (“Tier 2 Events”), which include country risk, longevity risk and pandemic risk, are internal risk classifications for the purposes of defining our risk tolerances. In determining Tier 1 and Tier 2 Events we consider such factors as:

 

 

 

 

Anticipated risk adjusted returns;

 

 

 

 

Strategic risk preferences;

 

 

 

 

Relativity to peers;

 

 

 

 

Shareholder expectations;

 

 

 

 

Robustness of exposure assessment methodology; and

 

 

 

 

Projected enterprise loss potential.

Per event 1% TVaR underwriting limits for North Atlantic Windstorm are set at a level not to exceed approximately 22% of Tangible Shareholders’ Equity. Per event 1% TVaR underwriting limits for North American Earthquake are set at a level not to exceed approximately 20% of Tangible Shareholders’ Equity. Per event 1% TVaR underwriting limits for all other natural catastrophe peril regions are set below the per event 1% TVaR limits described above.

Per event 1% exceedance probability underwriting limits for terrorism and other realistic disaster scenarios are set at a level not to exceed approximately 15% of Tangible Shareholders’ Equity.

Per event 1% exceedance probability underwriting limits for Tier 2 Events are set at a level not to exceed 7.5% of Tangible Shareholders’ Equity.

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Per event 0.4% exceedance probability underwriting limits for certain Tier 2 Events are set at a level not to exceed 10% of Tangible Shareholders’ Equity. The 0.4% exceedance probability limit is used for Tier 2 Events rather than a TVaR measure due to the difficulty in estimating the full distribution of outcomes in the extreme tail of the distribution for these risk types as required for the TVaR measure.

In all instances, the above referenced underwriting limits reflect pre-tax losses net of reinsurance and include inwards and outwards reinstatement premiums related to the specific events being measured. The limits do not contemplate underwriting profits expected to be generated in the absence of catastrophic loss activity.

In setting underwriting limits, we also consider such factors as:

 

 

 

 

Correlation of underwriting risk with other risks (e.g., asset/investment risk, operational risk, etc.);

 

 

 

 

Model risk and robustness of data;

 

 

 

 

Geographical concentrations;

 

 

 

 

Exposures at lower return periods;

 

 

 

 

Expected payback period associated with losses;

 

 

 

 

Projected share of industry loss; and

 

 

 

 

Annual aggregate losses for natural catastrophes at various return periods including a 1% exceedance probability and a 1% TVaR level on both a peril region basis and a portfolio basis.

Loss exposure estimates for all event risks are derived from a combination of commercially available and internally developed models together with the judgment of management, as overseen by the XL-Ireland Board. Actual incurred losses may vary materially from our estimates. Factors that can cause a deviation between estimated and actualized loss potential include:

 

 

 

 

Inaccurate assumption of event frequency and severity;

 

 

 

 

Inaccurate or incomplete data;

 

 

 

 

Changing climate conditions that may add to the unpredictability of frequency and severity of natural catastrophes in certain parts of the world and create additional uncertainty as to future trends and exposures;

 

 

 

 

Future possible increases in property values and the effects of inflation that may increase the severity of catastrophic events to levels above the modeled levels;

 

 

 

 

Natural catastrophe models that incorporate and are critically dependent on meteorological, seismological and other earth science assumptions and related statistical relationships that may not be representative of prevailing conditions and risks, and may therefore misstate how particular events actually materialize, causing a material deviation between forecasted and actual damages associated with such events; and

 

 

 

 

A change in the judicial climate.

For the above and other reasons, the incidence, timing and severity of catastrophes and other event types are inherently unpredictable and it is difficult to estimate the amount of loss any given occurrence will generate. As a consequence, there is material uncertainty around our ability to measure exposures associated with individual events and combinations of events. This uncertainty could cause actual exposures and losses to deviate from those amounts estimated, which in turn can create a material adverse effect on our financial condition and results of operations and may result in substantial liquidation of investments, possibly at a loss, and outflows of cash as losses are paid. For this reason, we carry capital in addition to that required by the specific limits described even if it is in excess of rating agency and regulatory required capital.

For a further discussion on risk appetite management see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Other Key Focuses of Management.”

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Impact of ERM Processes

We believe that our ERM processes improve the quality and timeliness of strategic decisions, enhance the integration of strategic initiatives with the risks related to such initiatives and act as catalysts to improve risk awareness and informed action by us. We believe that the integration of ERM with existing business processes and controls optimizes the risk/reward characteristics of business strategies, enhances our overall risk management culture, and is central to our capital allocation process.

In addition, our ERM processes complement our overall internal control framework by helping to manage the complexity that is inherent within an organization of our size and with the variety of our businesses, investment activities and geographical reach. However, internal controls and ERM can provide only reasonable, not absolute, assurance that control objectives will be met. As a result, the possibility of material financial loss remains in spite of our ERM activities. An investor should carefully consider the risks and all information set forth in this report including the discussion included in Item 1A, “Risk Factors,” Item 7A, “Quantitative and Qualitative Disclosure About Market Risk,” and Item 8, “Financial Statements and Supplementary Data.”

Regulation

Our operating subsidiaries are subject to regulation and supervision in each of the jurisdictions in which they are domiciled and licensed to conduct business. Generally, regulatory authorities can have broad supervisory and administrative powers over such matters as licenses, fitness of management, standards of solvency, material transactions between affiliates, premium rates, policy forms, investments, security deposits, methods of accounting, form and content of financial statements, reserves for unpaid losses and loss adjustment expenses, claims handling, reinsurance, minimum capital and surplus requirements and/or risk based capital standards, dividends and other distributions to shareholders, periodic examinations and annual and other report filings or notifications. See Item 8, Note 23, “Statutory Financial Data,” to the Consolidated Financial Statements included herein. In general, such regulation is for the protection of policyholders rather than shareholders. We cannot predict the potential effect that any new regulations would have on our operating subsidiaries or on our business, results of operations, cash flows or financial condition. See “Risk Factors – The regulatory regimes under which we operate, and potential changes thereto, could have a material adverse effect on our business.” A summary of certain regulatory requirements in the key jurisdictions in which we operate follows.

In addition, XL-Ireland, our ultimate holding company, is domiciled in Ireland. Although XL-Ireland is not an Irish regulated operating entity, the Central Bank of Ireland, or CBI, has informed us that it will be our group supervisor under Solvency II. Adopted by the European Parliament in April 2009, Solvency II is an E.U. directive covering the capital adequacy and risk management of, and regulatory reporting for, European-based (re)insurers. Several steps must be taken by the European Commission, the European Parliament, the Council of Ministers and the European Insurance and Occupational Pensions Authority (“EIOPA”) to implement Solvency II. The final date of implementation and key elements of the framework remain under discussion, but it is widely accepted that the envisaged implementation date of January 1, 2014 will not be met. In October 2012, the European Parliament rescheduled the plenary vote of the Omnibus II Directive from November 2012 to March 2013. The Omnibus II directive sets the date of entry into force of the Solvency II regime and amends the Solvency II framework directive on capital requirements for insurance companies. Following adoption, there are multiple rounds of consultation and publication prior to implementation.

As an Irish public company, XL-Ireland is subject to reporting requirements and certain restrictions under Irish company law. See “Management’s Discussion & Analysis of Financial Condition—Holding Company Liquidity” and Item 8, Note 23, “Statutory Financial Data,” to the Consolidated Financial Statements included herein.

Ireland

Our Irish regulated operating subsidiary, XL Re Europe public limited company, is subject to the regulatory framework established by the CBI. It is required to, among other matters:

 

 

 

  maintain an adequate solvency margin and guarantee fund;

23


 

 

 

 

submit quarterly and annual regulatory returns as well as ad hoc reporting of certain material transactions; and

 

 

 

 

obtain regulatory pre-approval of certain transactions, such as payment of dividends or acquisitions and disposals in the ownership/voting rights of (re)insurance companies.

The CBI has minimum competency and fitness and probity codes that seek to ensure that regulated entities are run by those with appropriate professional qualifications or experience within the CBI’s view, with regulatory pre-approval required for certain key roles. The CBI’s code of corporate governance includes prescriptive rules regarding board role and composition, establishment and operation of board sub-committees and requirements around the approval of risk appetites and the monitoring and reporting of risks. In addition, the CBI has broad supervisory and administrative powers over capital and surplus requirements and the declaration of and payment of dividends or other distributions. Our Irish operating subsidiary is required to seek prior approval from the CBI to reduce its share capital or to pay dividends.

United Kingdom

Our U.K. regulated operating subsidiaries are regulated by the Financial Services Authority (“FSA”). The FSA’s Handbook of Rules and Guidance (the “FSA Rules”) covers all aspects of regulation including capital adequacy, financial and non-financial reporting, the payment of dividends and certain other activities of U.K. regulated firms. Our Lloyd’s managing agency, its managed syndicates and its associated corporate capital vehicles are subject to additional Lloyd’s requirements. The FSA’s Approved Persons regime also subjects certain of our employees and directors to FSA regulation regarding their “fitness.”

In 2010, the U.K. government released plans to abolish the FSA and separate its responsibilities between a number of new agencies and the Bank of England. This is expected to occur in the Spring of 2013. In 2013, the FSA will be replaced by two new regulatory bodies: the Prudential Regulation Authority (“PRA”) and the Financial Conduct Authority (“FCA”). Both the PRA and FCA will have regulatory oversight of our U.K. regulated operating subsidiaries.

Other European Union

Our network of offices in the European Union consists mainly of branches of Irish and U.K. companies and these offices are principally regulated under European directives from their home states of Ireland and the U.K., respectively, rather than by each individual jurisdiction.

Bermuda Operations

The Insurance Act 1978 of Bermuda and related rules and regulations, as amended (the “Bermuda Act”), regulates our Bermuda (re)insurance operating subsidiaries, which must be registered as (re)insurers by the Bermuda Monetary Authority (the “BMA”). The Bermuda Act imposes on Bermuda (re)insurance companies, solvency and liquidity standards, certain restrictions on the declaration and payment of dividends and distributions, certain restrictions on the reduction of statutory capital, auditing and reporting requirements, and grants the BMA powers to supervise and, in certain circumstances, to investigate and intervene in the affairs of (re)insurance companies.

Certain of our Bermuda regulated (re)insurance companies are required to prepare and file annual audited GAAP or International Financial Reporting Standards financial statements, as well as annual statutory financial returns, annual capital and solvency returns and quarterly financial returns.

Our Bermuda regulated general business (re)insurers are required to maintain available statutory capital and surplus at a level equal to or in excess of their enhanced capital requirement (“ECR”). The applicable ECR is established by reference to either the Bermuda Solvency Capital Requirement (“BSCR”), which employs a standard mathematical model that can relate more accurately the risks taken on by (re) insurers to the capital that is dedicated to their business, or a BMA-approved internal capital model. The BMA has also established a target capital level (“TCL”) for each (re)insurer equal to 120% of its ECR. While (re)insurers are not required to maintain their statutory capital and surplus at this level, the TCL acts as an early warning tool for the BMA and failure to maintain statutory capital at least equal to TCL will likely result in increased BMA regulatory oversight. Our Bermuda regulated (re)insurers use the BSCR model to calculate their solvency requirements.

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Under the Bermuda Companies Act 1981, as amended, a Bermuda company may not declare or pay a dividend or make a distribution out of contributed surplus if there are reasonable grounds for believing that: (a) the company is, or would after the payment be, unable to pay its liabilities as they become due; or (b) the realizable value of the company’s assets would thereby be less than its liabilities. Under the Bermuda Act, a Class 4 (re)insurer is prohibited from declaring or paying any dividends of more than 25% of its total statutory capital and surplus unless it certifies to the BMA that it will continue to meet its minimum solvency margin and minimum liquidity ratio.

In addition, neither Class 4 (re)insurers nor certain long-term (re)insurers may reduce their total statutory capital by 15% or more unless they have received the prior approval from the BMA.

United States

In the United States, we are subject to extensive regulation in the jurisdictions in which we conduct our business. The state legislatures and/or state (re)insurance regulators consider or enact laws or regulations that may alter or increase the regulation of (re)insurance companies and (re)insurance holding companies. State laws and regulations that are adopted or amended may be more restrictive than current laws and regulations and may affect our operations, financial condition through lower revenue and/or higher costs of compliance and could adversely affect our results of operations and limit our growth. For example, regulators may choose to restrict the ability of subsidiaries to make payments to their parent companies, reject rate increases or increase the statutory capital requirements of our operating subsidiaries.

There are a number of proposals to amend state insurance laws and regulations in ways that could affect our insurance operating subsidiaries. The National Association of Insurance Commissioners (“NAIC”) has recently adopted or amended model laws on holding company regulation that would provide for supervision of insurers at the corporate group level. Although such changes are only beginning to be considered or adopted by individual state regulators, it can be expected that most state regulators will ultimately adopt them in some form. The various proposals to implement group supervision include uniform standards for insurer corporate governance, group-wide supervision of insurance holding companies, adjustments to risk-based capital calculations to account for group-wide risks and additional regulatory and disclosure requirements for insurance holding companies.

Additionally, the NAIC has undertaken the Solvency Modernization Initiative (“SMI”), which focuses on a review of insurance solvency regulations throughout the U.S. financial regulatory system and will lead to a set of long-term solvency modernization goals. SMI is broad in scope, but the NAIC has stated that its focus will include the U.S. solvency framework, group solvency issues, capital requirements, international accounting and regulatory standards, reinsurance and corporate governance.

Currently, our U.S. regulated operating subsidiaries are required to file detailed annual and, in most states, quarterly reports with state insurance regulators in each of the states in which they are licensed or accredited. In addition, these subsidiaries’ operations and accounts are subject to financial condition and market conduct examination at regular intervals by state regulators. In June of 2012, all three states in which the U.S. insurance and reinsurance subsidiaries are domiciled (New York, Delaware and North Dakota) issued reports on their examination of the financial condition of each of the subsidiaries for the five year period ended December 31, 2010. The reports concluded that all findings from the prior examination had been effectively addressed, and no new findings were reported.

Our U.S. regulated operating subsidiaries are subject to various state statutory and regulatory restrictions that limit the amount of dividends that may be paid from earned surplus without prior approval from regulatory authorities. These restrictions differ by state, but are generally based on a calculation of the lesser of 10% of statutory surplus or 100% of “adjusted net investment income” to the extent that it has not previously been distributed.

While the U.S. federal government currently does not directly regulate the insurance business in the U.S. (other than for flood, nuclear and reinsurance of losses from terrorism), federal legislation and administrative policies can affect the insurance industry. In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) was passed into law. Dodd-Frank requires the creation of a Federal Insurance Office within the Treasury Department that will be focused on national coordination of the insurance sector, systemic risk mitigation and international regulatory cooperation. Although the Federal

25


Insurance Office currently does not directly regulate the insurance industry, under Dodd-Frank it has the power to preempt state insurance regulations that are inconsistent with international agreements regarding insurance regulation, subject to certain exceptions. In addition, Dodd-Frank provides that the Federal Insurance Office must submit a report to Congress on improving U.S. insurance regulation, which must cover the feasibility of future federal regulation of the U.S. insurance industry.

Other International Operations

We have a number of regulated operating subsidiaries outside of the European Union, Bermuda and the United States. The degree of regulation in foreign jurisdictions can vary and licenses issued by foreign authorities are subject to modification or revocation for cause by such authorities. Our subsidiaries could be prevented, for cause, from conducting business in certain of the jurisdictions where they currently operate. While each country imposes licensing, solvency, auditing and financial reporting requirements, the type and extent of the requirements differ substantially. Key areas where country regulations may differ include: (i) the type of financial reports to be filed; (ii) a requirement to use local intermediaries; (iii) the amount of reinsurance permissible; (iv) the scope of any regulation of policy forms and rates; and (v) the type and frequency of regulatory examinations.

In addition to these requirements, our foreign operations are also regulated in various jurisdictions with respect to currency, amount and type of security deposits, amount and type of reserves, amount and type of local investment and limitations on the share of profits to be returned to policyholders on participating policies. A summary of certain regulatory requirements in Switzerland, Latin America and China follows.

Switzerland

Supervision of our Swiss regulated operating subsidiaries is carried out by the Federal Financial Market Supervisory Authority (“FINMA”). The supervisory regime currently comprises both Solvency I requirements and Solvency II type requirements (“Swiss Solvency Test”), the latter of which impose higher capital requirements. Furthermore, direct insurers and insurance branches operating in Switzerland have to comply with “tied assets” requirements. Reinsurance branches of foreign legal entities are exempt from supervision by FINMA and are supervised by the country in which they are domiciled.

The Swiss supervisory regime was considered in EIOPA’s first wave of third country equivalence assessment for Solvency II. EIOPA advised that Switzerland meets the criteria set out in EIOPA’s methodology for equivalence assessments for Article 172 (equivalence for reinsurance supervision) and Article 260 (equivalence for third country group supervision), with certain caveats. For Article 227 (Calculating group solvability), the Swiss regulatory regime was assessed as equivalent, with no caveats.

In September 2012, FINMA and EIOPA signed a Memorandum of Understanding (“MoU”) regarding cooperation in supervision, in particular for insurance groups with international activities in the European Economic Area and Switzerland. The MoU creates a formal basis for cooperation in the following areas: group supervision, assistance in the work of EEA and FINMA colleges of supervisors, action required in emergency situations, safeguarding financial stability by monitoring and assessing risks, interconnectedness and conducting stress tests. This MoU will not modify or supersede any laws or regulatory requirements in force and will not affect any arrangements under the MoU that have previously been signed between FINMA and other national supervisory authorities of the EEA.

Latin America

We have both insurance and reinsurance operations in the Latin America region, with local companies in Brazil and Mexico and representative offices in Argentina and Colombia. Other than the Colombia representative office, all the legal entities in the region are subsidiaries, and there are no branches. Where we do not have a legal entity, we act as a foreign reinsurer. Nearly all regulators in the Latin America region require foreign reinsurers to be registered or licensed to accept reinsurance business.

The extent of regulation in the region varies significantly in the countries in which we conduct business. Typically, each country has regulations relating to solvency, auditing, internal controls and financial reporting, but the type and extent of the requirements differs substantially. Other regulations in the region that impact our operations but are not specific to insurance or reinsurance include those relating to

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foreign currency exchange control, data protection legislation, anti-money laundering legislation and sanctions.

China

Our Chinese regulated operating subsidiary is regulated by the China Insurance Regulatory Commission (the “CIRC”) under the People’s Republic of China Insurance Law. CIRC’s regulatory regime includes requirements relating to licensing, capital, premium and liability, disclosure and periodic reporting and approval or filing of policy wordings and rates.

Employees

At December 31, 2012, we had 4,007 employees. At that date, 232 of our employees were represented by workers’ councils and 418 of our employees were subject to industry-wide collective bargaining agreements in several countries outside the United States.

Available Information

The public can read and copy any materials we file with the U.S. Securities and Exchange Commission (“SEC”) at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public can obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers, including us, that file electronically with the SEC. The address of the SEC’s website is http://www.sec.gov.

Our website address is http://www.xlgroup.com. The information contained on our website is not incorporated by reference into this Annual Report on Form 10-K or any other of our documents filed with or furnished to the SEC.

We make available free of charge, including through our website, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13 (a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC.

We have adopted Corporate Governance Guidelines, written charters for each of the Audit Committee, the Management Development and Compensation Committee, the Nominating, Governance and External Affairs Committee and the Risk and Finance Committee, as well as a Code of Conduct and a related Compliance Program. Each of these documents is posted on our website at http://www.xlgroup.com, and each is available in print to any shareholder who requests it by writing to us at Investor Relations Department, XL Group plc, Harbor Point, 100 Washington Boulevard, Stamford, CT 06902, United States of America.

We intend to post on our website any amendment to, or waiver of, a provision of our Code of Conduct that applies to our Chief Executive Officer, Chief Financial Officer and Corporate Controller or persons performing similar functions and that relates to any element of the code of ethics definition set forth in Item 406 of Regulation S-K under the Securities Act of 1933, as amended.

We intend to use our website as a means of disclosing material non-public information and for complying with our disclosure obligations under Regulation FD. Such disclosures will be included on the website in the “Investor Relations” section. Accordingly, investors should monitor such portions of our website, in addition to following our press releases, SEC filings and public conference calls and webcasts.

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ITEM 1A.

 

RISK FACTORS

 

 

 

Any of the following risk factors could have a significant or material adverse effect on our business, financial condition, results of operations and/or liquidity, in addition to the other information contained in this report. Additional risks not presently known to us or that we currently deem immaterial may also impair our business, financial condition and results of operations.

The occurrence of disasters could adversely affect our financial condition, results of operations, cashflows and prospects.

We have substantial exposure to losses resulting from natural and man-made disasters and other catastrophic events. Catastrophes can be caused by various events, including hurricanes, earthquakes, floods, hailstorms, explosions, severe weather, fires, war and acts of terrorism. Changing climate conditions may add to the unpredictability and frequency of natural disasters in certain parts of the world and create additional uncertainty as to future trends and exposures. The incidence and severity of catastrophes are inherently unpredictable, and it is difficult to predict the timing of such events with statistical certainty or estimate the amount of loss any given occurrence will generate.

The occurrence of claims from catastrophic events is likely to result in substantial volatility in our financial condition, results of operations and cash flows for the fiscal quarter or year in which a catastrophic event occurs, as well as subsequent fiscal periods, and could have a material adverse effect on our financial condition and results of operations and our ability to write new business. This risk is exacerbated due to accounting principles and rules that do not permit (re)insurers to reserve for such catastrophic events until they occur. We expect that future possible increases in the values and concentrations of insured property, the effects of inflation and changes in cyclical weather patterns may increase the severity of catastrophic events in the future. Although we attempt to manage our exposure to catastrophic events, a single catastrophic event could affect multiple geographic zones and lines of business and the frequency or severity of catastrophic events could exceed our estimates, in each case potentially having a material adverse effect on our financial condition, results of operations and cash flows. In addition, while we may, depending on market conditions, purchase catastrophe reinsurance and retrocessional protection, the occurrence of one or more major catastrophes in any given period could result in losses that exceed such reinsurance and retrocessional protection. This could have a material adverse effect on our financial condition and results of operations and may result in substantial liquidation of investments, possibly at a loss, and outflows of cash as losses are paid.

The failure of any of the underwriting risk management strategies that we employ could have a material adverse effect on our financial condition, results of operations and/or liquidity.

We seek to limit our loss exposure by, among other things, writing a number of our reinsurance or retrocession contracts on an excess of loss basis, adhering to maximum limitations on reinsurance written in defined geographical zones, limiting program size for each client and prudently underwriting each program written. In addition, in the case of proportional treaties, we generally seek to use per occurrence limitations or loss ratio caps to limit the impact of losses from any one event. We cannot be sure that all of these loss limitation methods will have the precise risk management impact intended. For instance, although we also seek to limit our loss exposure by geographic diversification, geographic zone limitations involve significant underwriting judgments, including the determination of the area of the zones and the inclusion of a particular policy within a particular zone’s limits. Underwriting involves the exercise of considerable judgment and the making of important assumptions about matters that are inherently unpredictable and beyond our control, and for which historical experience and probability analysis may not provide sufficient guidance. The failure of any of the underwriting risk management strategies that we employ could have a material adverse effect on our financial condition, results of operations and cash flows. Also, we cannot provide assurance that various provisions of our policies, such as limitations or exclusions from coverage or choice of forum, will be enforceable in the manner that we intend and disputes relating to coverage and choice of legal forum may arise, which could materially adversely affect our financial condition and results of operations.

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The insurance and reinsurance industries are historically cyclical and we may experience periods with excess underwriting capacity and unfavorable premium rates.

The insurance and reinsurance industries have historically been cyclical, characterized by periods of intense price competition due to excess underwriting capacity as well as periods when shortages of capacity permitted favorable premium levels. An increase in premium levels is often followed by an increasing supply of insurance and reinsurance capacity, either by capital provided by new entrants or by the commitment of additional capital by existing insurers or reinsurers, which may cause prices to decrease. Either of these factors could lead to a significant reduction in premium rates, less favorable policy terms and conditions and fewer submissions for our underwriting services. In addition to these considerations, changes in the frequency and severity of losses suffered by insureds and insurers may affect the cycles of the insurance and reinsurance industries significantly.

A downgrade or potential downgrade in our financial strength and credit ratings by one or more rating agencies could materially and negatively impact our business, financial condition, results of operations and/or cash flows.

As our ability to underwrite business is dependent upon the quality of our claims paying and financial strength ratings as evaluated by independent rating agencies, a downgrade by any of these institutions could cause our competitive position in the insurance and reinsurance industry to suffer and make it more difficult for us to market our products.

A downgrade below “A-” of our principal insurance and reinsurance subsidiaries by either Standard & Poor’s (“S&P”) or A.M. Best Company (“A.M. Best”), which is two notches below the current S&P and A.M. Best financial strength ratings of “A” (Positive) and “A” (Stable), respectively, for our principal insurance and reinsurance subsidiaries, may trigger termination provisions in a significant amount of our assumed reinsurance agreements and may potentially require us to return unearned premium to cedants. Whether a client would exercise its termination rights after such a downgrade would likely depend on, among other things, the reasons for the downgrade, the extent of the downgrade, prevailing market conditions, the degree of unexpired coverage, and the pricing and availability of replacement reinsurance coverage. Based on premium value, approximately 70% of our in force reinsurance contracts at January 1, 2013 contained provisions allowing clients to terminate those contracts upon a decline in our ratings to below “A-.” In the event of such a downgrade, we cannot predict whether or how many of our clients would actually exercise such termination rights or the extent to which any such terminations would have a material adverse effect on our financial condition, results of operations, cash flows or future prospects or the market price for our securities. A downgrade could also result in both a substantial loss of business for us as ceding companies and brokers that place such business may move to other insurers and reinsurers with higher ratings and the loss of key employees. In addition, due to collateral posting requirements under our letter of credit and revolving credit facility agreements, such a downgrade may require the posting of cash collateral in support of certain “in use” portions of these facilities (see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” under Part II, Item 7 of this report). Specifically, a downgrade below “A-” by A.M. Best would constitute an event of default under the Company’s three largest credit facilities and may trigger such collateral requirements. In certain limited instances, such downgrades may require us to return cash or assets to counterparties or to settle derivative and/or other transactions with the respective counterparties.

In addition to the financial strength ratings of our principal insurance and reinsurance subsidiaries, various rating agencies also publish credit ratings for XL-Cayman. Credit ratings are indicators of a debt issuer’s ability to meet the terms of debt obligations in a timely manner, are part of our overall funding profile and affect our ability to access certain types of liquidity. Downgrades in our credit ratings could have a material adverse effect on our financial condition and results of operations and cash flows in a number of ways, including adversely limiting our access to capital markets, potentially increasing the cost of debt or requiring us to post collateral.

Downgrading of the United States’ credit rating could have a material adverse effect on our business, financial condition and results of operations.

Standard & Poor’s Ratings Services lowered its long-term sovereign credit rating on the United States from “AAA” to “AA+” in August 2011. In addition, Standard & Poor’s Rating Services and Moody’s

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Investor Services maintain a negative outlook on U.S. debt, and both Fitch Ratings and Moody’s Investors Services have warned that they may downgrade the U.S. government’s sovereign credit rating if future budget negotiations to raise the debt ceiling fail, or if steps are not taken to decrease the U.S.’s debt load. Because of the unprecedented nature of negative credit rating actions with respect to U.S. government obligations, the impact of a further downgrade to the U.S. government’s sovereign credit rating or any other further rating actions by any rating agency is inherently unpredictable. Such actions could have material adverse impacts on financial markets and economic conditions in the United States and throughout the world. In turn, this could have a material adverse effect on our business, financial condition and results of operations, including with respect to assets in our investment portfolio, as well as assets in trusts or other collateral arrangements posted by or to us. In addition, further downgrades of the United States’ credit rating could create broader financial turmoil and uncertainty, and could negatively impact the average credit rating quality of our investment portfolio, which could require us to change our minimum average credit quality target.

The sovereign debt crisis in Europe and concerns regarding the instability of Euro-zone countries could have a material adverse effect on our business, financial condition and results of operations.

Global markets and economic conditions have been negatively impacted by the uncertainty relating to the level of sovereign debt of numerous E.U. member states, the ability of those countries to service their sovereign debt obligations and the stability of financial institutions operating within those E.U. member states. This uncertainty has and could in the future result in volatile bond yields on the sovereign debt of E.U. member states and on other European-related corporate debt held within our investment portfolio and could have material adverse impacts on financial markets and economic conditions in the E.U. and throughout the world. In addition, continuing downgrades of sovereign debt could bring down the average credit rating quality of our investment portfolio.

The interdependencies among European economies and financial institutions and between such European economies and financial institutions and those of the rest of the world have also exacerbated concern regarding the stability of European financial markets generally and certain institutions in particular. One or more Euro-zone countries could come under increasing pressure to leave the European Monetary Union or the European Union, or the Euro as the single currency of the Euro-zone could cease to exist if the European Monetary Union were dissolved. These or other actions could ultimately result in the European Union ceasing to exist. Any of these developments, or the perception that any of these developments are likely to occur, could lead to severe economic recession or depression. If one or more countries abandon the Euro or the European Monetary Union dissolves, it may result in uncertainty with respect to the terms, value or enforceability of these bonds, instruments or contracts, which could result in a material loss to us. Similarly, if a country leaving the Euro-zone imposes currency controls, such controls may have a material adverse impact on the value of and our ability to withdraw funds from that country.

Given the extent of our European operations, including that XL-Ireland is domiciled in Ireland, and our European investment holdings, clients and counterparties, persistent volatility in the European financial markets, or the failure of any significant European financial institution arising from the wider implications of the crisis, even if not an immediate counterparty to us, could have a material adverse impact on our business, investment portfolio, liquidity or financial performance. If the current Euro-zone sovereign debt crisis persists or worsens, it could lead to further political uncertainty, material changes to tax policies of Euro-zone countries, financial turmoil and social unrest, affecting the successful implementation of stability measures. Sovereigns, financial institutions and companies may become subject to liquidity shortages and be unable to obtain refinancing or new funding, leading to an increased risk of a default on their existing debt, and measures to reduce debt levels and fiscal deficits could result in a further slowdown of or negative economic growth.

For a discussion of the risks to our business during or following a financial market disruption and risks to our investment portfolio, see the risk factor entitled “We are exposed to significant capital markets risk related to changes in interest rates, credit spreads, equity prices and foreign exchange rates as well as other investment risks, which may adversely affect our results of operations, financial condition or cash flows.” For a discussion of risks associated with the United States’ credit rating, see the risk factor entitled “Downgrading of the United States’ credit rating could have a material adverse effect on our business, financial condition and results of operations.”

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Our efforts to develop new products or expand in targeted markets may not be successful and may create enhanced risks.

A number of our recent and planned business initiatives involve developing new products or expanding existing products in targeted markets. This includes the following efforts, from time to time, to protect or profitably grow market share:

 

 

 

 

We may develop products that insure risks we have not previously insured or contain new coverage or coverage terms.

 

 

 

 

We may refine our underwriting processes.

 

 

 

 

We may seek to expand distribution channels.

 

 

 

 

We may focus on geographic markets within or outside of the United States where we have had relatively little or no market share or operating history.

We may not be successful in introducing new products or expanding in targeted markets and, even if we are successful, these efforts may create enhanced risks. Among other risks:

 

 

 

 

Demand for new products or in new markets may not meet our expectations.

 

 

 

 

To the extent we are able to market new products or expand into new markets, our risk exposures may change, and the data and models we use to manage such exposures may not be as sophisticated as those we use in existing markets or with existing products. This, in turn, could lead to losses in excess of our expectations.

 

 

 

 

Efforts to develop new products or markets have the potential to create or increase distribution channel conflict.

 

 

 

 

In connection with the conversion of existing policyholders to a new product, some policyholders’ pricing may increase, while the pricing for other policyholders may decrease, the net impact of which could negatively impact retention and margins.

 

 

 

 

To develop new products or markets, we may encounter unanticipated operational issues or we may need to make substantial capital and operating expenditures, which may also negatively impact results.

If our efforts to develop new products or expand in targeted markets are not successful, our results could be materially and adversely affected.

We are exposed to significant capital markets risk related to changes in interest rates, credit spreads, equity prices and foreign exchange rates as well as other investment risks, which may adversely affect our results of operations, financial condition or cash flows.

Our operating results are affected by the performance of our investment portfolio. Our assets are invested by a number of investment management service providers under the direction of the Company’s management within the Investment Group in accordance, in general, with detailed investment guidelines set by us under the oversight of the RFC, and established in accordance with our SAA framework for our P&C and Life operations investment portfolios. Although our investment policies stress diversification of risks and conservation of principal and liquidity, our investments are subject to market-wide risks, as noted below, and fluctuations, as well as to risks inherent in particular securities. We are exposed to significant capital markets risks related to changes in interest rates, credit spreads and defaults, market liquidity, equity prices and foreign currency exchange rates. If significant continued market volatility, changes in interest rates, changes in credit spreads and defaults, a lack of pricing transparency, a reduction in market liquidity, declines in equity prices, and the strengthening or weakening of foreign currencies against the U.S. dollar occur, individually or together, this could have a material adverse effect on our consolidated results of operations, financial condition or cash flows through realized losses, impairments, and changes in unrealized positions. Levels of write-down or impairment are impacted by our assessment of the intent to sell securities that have declined in value as well as actual losses as a result of defaults or deterioration in estimates of cash flows. We periodically review our investment portfolio structure and strategy. If, as a result of such review, we determine to reposition or realign portions of the investment portfolio and sell securities in an unrealized loss position, we will incur an other than temporary impairment charge. Any such charge may have a material adverse effect on our results of operations and business.

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For the year ended December 31, 2012, as a result of the prolonged and continued volatility and disruptions in the public debt and equity markets, we incurred realized and unrealized investment losses, as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under Part II, Item 7 of this report. We continue to closely monitor current market conditions and evaluate the long term impact of this market volatility on all of our investment holdings. Depending on market conditions, we could incur additional realized and unrealized losses in future periods, which could have a material adverse effect on the Company’s results of operations, financial condition and business.

Our exposure to interest rate risk relates primarily to the market price and cash flow variability of fixed income instruments that are associated with changes in interest rates. Our investment portfolio contains interest rate sensitive instruments, such as fixed income securities, which have been and may continue to be adversely affected by changes in interest rates from central bank monetary policies, domestic and international economic and political conditions and other factors beyond our control. A rise in interest rates would increase the net unrealized loss position of our investment portfolio, offset by our ability to earn higher rates of return on funds reinvested over time. Conversely, a decline in interest rates would decrease the net unrealized loss position of our investment portfolio, offset by lower rates of return on funds reinvested. We maintain a P&C investment portfolio with diversified maturities that has a weighted average duration that is determined in accordance with its SAA Benchmark based on a dynamic financial analysis of investment assets and liabilities, and that is intended to maximize the Company’s enterprise value subject to accounting, regulatory, capital and risk tolerances. The SAA Benchmarks and portfolios supporting our Life operations are rebalanced regularly to reflect an explicit asset-liability management process. However, for both the P&C and Life operations investment portfolios our estimates of the time and size of our estimated loss payment profile may be inaccurate and despite stochastic investment portfolio modeling, we may be forced to liquidate investments prior to maturity at a loss in order to cover liabilities. In sum, we are economically exposed to interest rate risk on our capital and to the extent that our investment portfolio maturities are a poor hedge of actual liability loss payments.

Our exposure to credit spread risk relates primarily to the market price associated with changes in prevailing market credit spreads and the impact on our holdings of spread products such as corporate and structured and credit-sensitive government-related securities. Approximately 2.8% of our aggregate fixed income portfolio consists of below investment-grade high yield fixed income securities. These securities have a higher degree of credit or default risk and a greater exposure to credit spread risk. Certain sectors within the investment and below investment grade fixed income market, such as structured and corporate credit, may be less liquid in times of economic weakness or market disruptions. While we have put in place procedures to monitor the credit risk and liquidity of our invested assets in general and those impacted by recent credit market issues specifically, it is possible that, in periods of economic weakness or periods of turmoil in capital markets, we may experience default losses in both our investment grade and below investment grade corporate and structured holdings. This may result in a material reduction of net income, capital and cash flows.

We invest a portion of our investment portfolio in common stock or equity-related securities, including alternative funds, private equity funds and other funds. The value of these assets fluctuates, due to changes in the equity and credit markets along with other factors. In times of economic weakness, the market value and liquidity of these assets may decline, and may impact net income, capital and cash flows. In addition, certain of the products offered by our Life operations offer fixed guaranteed returns while debt and equity yields may continue to decline. In addition, the amount of earnings from alternative funds, private investment funds and other funds are not earned evenly across the year, or even from year to year. As a result, the amount of earnings that we record from these investments may vary substantially from quarter to quarter. The timing of distributions from such private investment funds depends on particular events relating to the underlying investments. The ability of an alternative fund to satisfy any redemption request from its investors depends on the underlying liquidity of the alternative fund’s investments. As a result, earnings, distributions and redemptions from these two asset classes may be more difficult to predict, and, if such funds are unable to satisfy our redemption requests, our results of operations, financial condition and cash flows may be adversely impacted. As alternative and private investment funds are collective investment vehicles managed by third parties, we do not control the proceeds once we make our investments, thus subjecting us to a higher level of fraud risk than is the case with our fixed income and equity holdings.

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The functional currencies of our principal insurance and reinsurance subsidiaries include the U.S. dollar, U.K. sterling, the Euro, the Swiss franc and the Canadian dollar. Exchange rate fluctuations relative to the functional currencies may materially impact our financial position, results of operations and cash flows. Many of our non-U.S. subsidiaries maintain both assets and liabilities in currencies different than their functional currency, which exposes us to changes in currency exchange rates.

In addition, locally-required capital levels are invested in local currencies in order to satisfy regulatory requirements and to support local insurance operations regardless of currency fluctuations. Foreign exchange rate risk is reviewed as part of our risk management process and we utilize derivative instruments such as futures, options and foreign currency forward contracts to, among other things, manage our foreign currency exposure. It is possible that these instruments will not effectively mitigate all or a substantial portion of our foreign exchange rate risk, which could adversely impact the Company’s results of operations.

Certain of our investments may be illiquid or are in asset classes that have in times of market stress experienced significant market valuation fluctuations.

We hold certain investments that may lack liquidity or for which the availability of prices or inputs may be reduced in periods of market dislocation, such as non-agency residential mortgage-backed and collateralized debt obligations securities. Even some of our high quality assets have been more illiquid during periods of challenging market conditions. Generally, securities classified as Level 3 pursuant to the fair value hierarchy set forth in authoritative accounting guidance over fair value measurements may be less liquid, may be more difficult to value, requiring significant judgment, and may be more likely to result in sales at materially different amounts than the fair values determined by management.

If we require significant amounts of cash on short notice in excess of normal cash requirements or are required to post or return collateral in connection with certain of our reinsurance contracts, credit agreements, derivative transactions or our invested portfolio, we may have difficulty selling these investments in a timely manner, be forced to sell them for less than we otherwise would have been able to realize, or both.

The reported values of our relatively illiquid types of investments and, in certain circumstances, our high quality, generally liquid asset classes, do not necessarily reflect the lowest current market bid price for the asset. If we were forced to sell certain of our assets in the market, there can be no assurance that we will be able to sell them for the prices at which we have recorded them and we may be forced to sell them at significantly lower prices, particularly at times of extreme market illiquidity. Any such sales could adversely impact the Company’s financial position.

If actual claims exceed our loss reserves, or if changes in the estimated levels of loss reserves are necessary, our financial results and cash flows could be adversely affected.

Our results of operations and financial condition depend upon our ability to assess accurately the potential losses associated with the risks that we insure and reinsure. We establish reserves for unpaid losses and loss adjustment expense (“LAE”) liabilities, which are estimates of future payments of reported and unreported claims for losses and related expenses with respect to insured events that have occurred. The process of establishing reserves for property and casualty claims can be complex and is subject to considerable variability, as it requires the use of informed estimates and judgments. Actuarial estimates of unpaid loss and LAE liabilities are subject to potential errors of estimation, which could be significant, due to the fact that the ultimate disposition of claims incurred prior to the date of such estimation, whether reported or not, is subject to the outcome of events that have not yet occurred. Examples of these events include the accuracy of the factual information on which the estimates were based, especially as estimates develop, jury decisions, court interpretations, legislative changes, changes in the medical condition of claimants, public attitudes, and economic conditions such as inflation.

Recent deficit spending by governments in the Company’s major markets exposes the Company to heightened risk of inflation. Inflation in relation to medical costs, construction costs and tort issues in particular impact the property and casualty industry. However, broader market inflation also poses a risk of increasing overall loss costs. The impact of inflation on loss costs could be more pronounced for those lines of business that are considered “long tail” such as general liability, as they require a relatively long period of time to finalize and settle claims for a given accident year. Changes in the level of inflation also result in an increased level of uncertainty in our estimation of loss reserves, particularly for long tail lines of business. The estimation of loss reserves may also be more difficult during times of adverse economic

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conditions due to unexpected changes in behavior of claimants and policyholders, including an increase in fraudulent reporting of exposures and/or losses, reduced maintenance of insured properties or increased frequency of small claims.

Similarly, the actual emergence of claims for life business may vary from the assumptions underlying the policy benefit reserves, in particular, the future assumed mortality improvements on the blocks of in-payment annuities.

We have an actuarial staff in each of our operating segments and a Chief Actuary who regularly evaluates the levels of loss reserves, taking into consideration factors that may impact the ultimate losses incurred. Any such evaluation could result in future changes in estimates of losses or reinsurance recoverable and would be reflected in our results of operations in the period in which the estimates are changed. Losses and LAE, to the extent that they exceed the applicable reserves, are charged to income as incurred. The reserve for unpaid losses and LAE represents the estimated ultimate losses and LAE less paid losses and LAE, and comprises case reserves and IBNR. During the loss settlement period, which can span many years in duration for casualty business, additional facts regarding individual claims and trends often will become known and case reserves may be adjusted by allocation from IBNR without any change in the overall reserve. In addition, application of statistical and actuarial methods may require the adjustment of the overall reserves upward or downward from time to time. Accordingly, the ultimate settlement of losses may be significantly greater than or less than reported loss and loss expense reserves.

The effects of emerging claim and coverage issues on our business are uncertain.

As industry practices and legal, judicial, social, political and other environmental conditions change, unexpected issues related to claims and coverage may emerge. These issues may adversely affect our business by either extending coverage beyond our underwriting intent or by increasing the number or size of claims, such as the effects that disruptions in the credit markets could have on the number and size of reported claims under directors and officers liability insurance (“D&O”) and professional liability insurance lines of business. In some instances, these changes may not become apparent until some time after we have issued the insurance or reinsurance contracts that are affected by the changes. Historically such claims and coverage issues have occurred at heightened levels during periods of very soft market conditions which often reflect an inflection point in the typical cycle of insurance industry market conditions. In addition, our actual losses may vary materially from our current estimate of the loss based on a number of factors, including receipt of additional information from insureds or brokers, the attribution of losses to coverages that had not previously been considered as exposed and inflation in repair costs due to additional demand for labor and materials. As a result, the full extent of liability under an insurance or reinsurance contract may not be known for many years after such contract is issued and a loss occurs.

There can be no assurance as to the effect that governmental and regulatory actions will have on the marketplace generally or on us in particular.

In response to the financial crises affecting the banking system and financial markets and going concern threats to financial institutions, there have been numerous regulatory and governmental actions in the United States, the U.K. and the Euro-zone, among other countries. The purpose of these legislative and regulatory actions is to stabilize the U.S. and international financial markets, improve the flow of credit, increase employment levels and foster an economic recovery.

Under the Dodd-Frank Act, the Financial Stability Oversight Council (“FSOC”) has issued rules establishing the process and criteria by which companies may be designated as nonbank systemically important financial institutions (“SIFIs”) subject to the examination, enforcement and supervisory authority of the FSOC. Similarly, the Financial Stability Board (“FSB”), consisting of representatives of national financial authorities of the G20 nations, has issued a series of frameworks and recommendations intended to produce significant changes in how financial companies, particularly global systemically important financial institutions (“G- SIFIs”), should be regulated. These frameworks and recommendations address issues such as financial group supervision, capital and solvency standards, systemic economic risk, corporate governance including compensation, and a host of related issues associated with responses to the financial crisis. In addition, the FSB has directed the International Association of Insurance Supervisors (“IAIS”) to create standards relative to these areas for global systemically important insurers (“G-SIIs”) and incorporate them within that body’s Insurance Core Principles. While we do not expect that we will be designated as a SIFI,

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G-SIFI or G-SII, certain of our competitors may be so designated, which may impact market behavior and/or access to capital.

With respect to our investment portfolio, we own a number of Tier 1 and Upper Tier 2 hybrid securities issued by financial institutions including those based in the U.S., Europe and the U.K. There is a risk that, if the capital positions of financial institutions deteriorate further government intervention, particularly nationalization of such institutions, could occur. There is also a risk of regulatory imposed deferral of coupons or decisions by bank management not to call the capital or defer the coupon payments. This may result in losses on the hybrid securities we hold. There is also the risk of further downgrades of these or other securities as rating agencies re-evaluate their rating methodologies, which would negatively impact the regulatory capital of the Life operations or the valuation of our investment portfolio assets generally.

In particular, the current sovereign debt crisis concerning European countries, including Greece, Italy, Ireland, Portugal and Spain, or GIIPS, and related European financial restructuring efforts, may cause the value of the European currencies, including the Euro, to further deteriorate, which in turn could adversely impact Euro-denominated assets held in our investment portfolio or our European book of business. In addition, the European crisis is contributing to instability in global credit markets, as well as the widening of bond yield spreads. Rating agency downgrades on European sovereign debt and continuing concern about the potential default of government issuers or a possible break-up of the European Union has further contributed to this uncertainty. Should governments default on their obligations, there will be a negative impact on both our direct holdings, as well as on non-government issues and financials held within the country of default. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations–Balance Sheet Analysis–European Sovereign Debt Crisis” for an analysis of our fixed maturity portfolio’s exposure to GIIPS.

There can be no assurance as to the effect that any such governmental actions or future regulatory initiatives may have on certain investment instruments in our investment portfolio, or on our competitive position, business or financial position. If global economic and market conditions remain uncertain and volatile, or deteriorate further, we may experience material adverse impacts on our results of operations, financial condition and cash flows.

We may be unable to purchase reinsurance and, even if we are able to successfully purchase reinsurance, we are subject to the possibility of being unable to collect reinsurance when due.

We purchase reinsurance for our own account in order to mitigate the volatility that losses impose on our financial condition. Our clients purchase reinsurance from us to cover part of the risk originally written by them. Retrocessional reinsurance involves a reinsurer ceding to another reinsurer, the retrocessionaire, all or part of the reinsurance that the first reinsurer has assumed. Reinsurance, including retrocessional reinsurance, does not legally discharge the ceding company from its liability with respect to its obligations to its insureds or reinsureds. A reinsurer’s or retrocessionaire’s insolvency, inability or refusal to make timely payments under the terms of its agreements with us, therefore, could have a material adverse effect on us because we remain liable to our insureds and reinsureds. For further information regarding our reinsurance exposure, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

From time to time, market conditions may limit or prevent us from obtaining the types and amounts of reinsurance that we consider adequate for our business needs such that we may not be able to obtain reinsurance or retrocessional reinsurance from entities with satisfactory creditworthiness in amounts that we deem desirable or on terms that we deem appropriate or acceptable.

The impairment of other financial institutions could adversely affect us.

We have exposure to counterparties in various industries, including banks, hedge funds and other investment vehicles, and in reinsurance and other transactions, including derivative transactions. Many of these transactions expose us to credit risk in the event our counterparty fails to perform its obligations. Even if we are entitled to collateral when a counterparty defaults, such collateral may be illiquid or proceeds from such collateral when liquidated may not be sufficient to recover the full amount of the obligation. We also have exposure to financial institutions in the form of secured and unsecured debt instruments and equity securities. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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Since we depend on a few brokers for a large portion of our revenues, loss of business provided by any one of them could adversely affect us.

We market our insurance and reinsurance products worldwide primarily through insurance and reinsurance brokers. AON Corporation, Marsh & McLennan Companies and the Willis Group and their respective subsidiaries each provided significant portions of our gross written premiums for property and casualty operations. Loss of all or a substantial portion of the business provided by one or more of these brokers could have a material adverse effect on our business.

Our reliance on brokers subjects us to credit risk.

In certain jurisdictions, when an insured or ceding insurer pays premiums for policies of insurance or contracts of reinsurance to brokers for further payment to us, such premiums might be considered to have been paid and the insured or ceding insurer will no longer be liable to us for such amounts, whether or not we have actually received the premiums from the broker. In addition, in accordance with industry practice, we generally pay amounts owed on claims under our reinsurance contracts to brokers, and these brokers, in turn, pay these amounts over to the clients that have purchased reinsurance from us. Although the law is unsettled and depends upon the facts and circumstances of the particular case, in some jurisdictions, if a broker fails to make such a claims payment to the insured or ceding insurer, we might remain liable to the insured or ceding insurer for that non-payment. Consequently, we assume a degree of credit risk associated with the brokers with whom we transact business. Due to the unsettled and fact-specific nature of the law governing these types of scenarios and our lack of historical experience with such risks, we are unable to quantify our exposure to this risk.

We are subject to a number of risks associated with our business in emerging markets.

Our insurance and reinsurance subsidiaries conduct business outside the United States, primarily in the U.K., Bermuda, and Europe. We have also continued to pursue opportunities in other countries, including in emerging markets such as Asia, Africa and Latin America. In conducting such business we are subject to a number of significant risks. These risks include restrictions such as price controls, capital controls, exchange controls, ownership limits and other restrictive governmental actions, which could have an adverse effect on our business and our reputation. In addition, some countries, particularly emerging economies, have laws and regulations that lack clarity and, even with local expertise and effective controls, it can be difficult to determine the exact requirements of the local laws. Failure to comply with local laws in a particular market could have a significant and negative effect not only on our business in that market but also on our reputation generally.

Our holding company structure and certain regulatory and other constraints affect our ability to pay dividends, make payments on our debt securities and make other payments.

Our ability to pay dividends or return capital from shareholders’ equity is limited by applicable laws and regulations of the various jurisdictions in which our principal operating subsidiaries operate, certain additional required regulatory approvals and financial covenants contained in our letters of credit and revolving credit facilities.

As holding companies, XL-Ireland and XL-Cayman have no operations of their own and their assets consist primarily of investments in subsidiaries. Accordingly, XL-Ireland and XL-Cayman rely on the availability of dividends and other permissible payments from subsidiaries to make principal and interest payments on debt, to pay operating expenses and ordinary and preferred shareholder dividends, to make capital investments in subsidiaries and to pay other obligations that may arise from time to time. The payment of dividends to us by our insurance and reinsurance subsidiaries is regulated under the laws of the various countries and states, including Bermuda, the U.K., Ireland, Switzerland and in the other jurisdictions where we have regulated subsidiaries, by certain insurance statutes of various states in the United States in which our insurance and reinsurance subsidiaries are licensed to transact business and by the Society of Lloyd’s. For further information regarding regulatory restrictions governing the payment of dividends by the Company’s significant property and casualty subsidiaries in Ireland, Bermuda and the U.S., see Item 8, Note 23, “Statutory Financial Data,” to the Consolidated Financial Statements, and Item 1, “Business – Regulation.”

XL-Ireland is subject to certain legal constraints that affect its ability to pay dividends on or redeem or buyback our ordinary shares. While XL-Ireland’s articles of association authorize its board of directors to

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declare and pay dividends as justified from the profits, under Irish law, XL-Ireland may only pay dividends or buyback or redeem shares using distributable reserves. On July 23, 2010, the Irish High Court approved XL-Ireland’s conversion of share premium to $5.0 billion of distributable reserves, subject to the completion of certain formalities under Irish Company law. These formalities were completed in early August 2010. As of December 31, 2012, XL-Ireland had $3.6 billion in distributable reserves. In addition, no dividend or distribution may be made unless the net assets of XL-Ireland are not less than the aggregate of its share capital plus undistributable reserves and the distribution does not reduce XL-Ireland’s net assets below such aggregate.

In addition, XL-Cayman is subject to certain constraints that affect its ability to pay dividends on its preferred shares. Under Cayman Islands law, XL-Cayman may not declare or pay a dividend if there are reasonable grounds for believing that XL-Cayman is, or would after the payment be, unable to pay its liabilities as they become due in the ordinary course of business. Also, the terms of XL-Cayman’s preferred shares prohibit declaring or paying dividends on the ordinary shares unless full dividends have been declared and paid on the outstanding preferred shares.

The ability to declare and pay dividends may also be restricted by financial covenants in our letters of credit and revolving credit facilities. We were in compliance with all covenants by significant margins at December 31, 2012, and currently remain in compliance.

We may require additional capital in the future, which may not be available to us on satisfactory terms, on a timely basis or at all.

Our future capital requirements depend on many factors, including our ability to write new business successfully and to establish premium rates and reserves at levels sufficient to cover our losses. To the extent that the funds generated by our ongoing operations are insufficient to fund future operating requirements and cover claim payments, or that our capital position is adversely impacted by mark-to-market changes on the investment portfolio, catastrophe events or otherwise, we may need to raise additional funds through financings or curtail our growth and reduce our assets. As a result of the current severe economic conditions that persist in the capital markets, any future financing may not be available on terms that are favorable to us, if at all. Our letter of credit facilities are needed to a significant extent for U.S. cedants, and are effective for such cedants only if the banks issuing letters of credit are on the list of National Association of Insurance Commissioners (“NAIC”) approved banks. If some or all of the issuing banks under our credit facilities cease to be NAIC approved, whether arising from macroeconomic or bank specific events, and we are unable to replace non-approved banks with NAIC approved banks, our letter of credit facility capacity could be significantly diminished. In addition, in the case of a macroeconomic event, such as dissolution of the European Monetary Union, the availability of alternative lending sources may be significantly reduced or non-existent, and the cost of replacement facilities may be significantly increased or prohibitive. Any future equity financings could be dilutive to our existing shareholders or could result in the issuance of securities that have rights, preferences and privileges that are senior to those of our other securities. Our inability to obtain adequate capital could have a material adverse effect on our business, financial condition and results of operations.

Competition in the insurance and reinsurance industries could reduce our operating margins.

The insurance and reinsurance industries are highly competitive. We compete on an international and regional basis with major U.S., Bermudian, European and other international insurers and reinsurers and with underwriting syndicates, some of which have greater financial and management resources and higher ratings than we have. We also compete with new companies that continue to be formed to enter the insurance and reinsurance markets and with alternative products that are intended to compete with reinsurance products, such as insurance/risk-linked securities, catastrophe bonds and derivatives. In recent years capital market participants have been increasingly active in the reinsurance market and markets for related risks. Increased competition could result in fewer submissions, lower premium rates and less favorable policy terms and conditions, which could reduce our margins.

Operational risks, including human or systems failures, are inherent in our business.

Losses can result from operational risk such as, among other things, fraud, errors, failure to document transactions properly or to obtain proper internal authorization, failure to comply with regulatory requirements, information technology failures, failure to appropriately transition new hires or external events. Areas of operational risk can be heightened in discontinued or exited businesses as a result of

37


reduced overall resource allocation and the loss of relevant knowledge and expertise by departing management.

We operate globally, and have two office locations in India that currently provide large portions of our back office support. Our global operations present significant operational risk due to the possibility of disruptions in communication or information processes, whether due to technical difficulties, power failures or destruction or damage to our offices for any reason. If any disruption occurs, our business continuity and disaster recovery plans may not be effective, particularly if natural or man-made catastrophic events occur, and such disruption could harm our results of operations or our reputation in the marketplace.

We believe that our modeling, underwriting and information technology and application systems are critical to our business, as our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. Moreover, our information technology and application systems have been important to our underwriting process and our ability to compete successfully. Our business depends on effective information systems and the integrity and timeliness of the data we use to run our business. Our ability to adequately price products and services, to establish reserves, to provide effective and efficient service to our clients, and to timely and accurately report our financial results also depends significantly on the integrity of the data in our information systems and processes supporting them. Failure of any of these systems or inaccuracies in the data stored therein may jeopardize our ability to service and interact with clients, which could result in significant losses or reputational damage. In addition, we have licensed certain systems and data from third parties. We cannot be certain that we will have access to these, or comparable, service providers, or that our information technology or application systems will continue to operate as intended. We also have outsourced the day-to-day management, custody and record-keeping of our investment portfolio to third-party managers and custodians that we believe to be reputable. A major defect in those investment managers’ investment management strategy, or decision-making could result in management distraction and/or significant financial loss. We also rely on a few brokers for a large portion of our revenues. A major defect in our brokers’, investment managers’ or custodians’ internal controls or information and technology systems could result in management distraction or significant financial loss.

Any ineffectiveness in our internal controls, information technology, application systems, investment management or custody and record keeping could have a material adverse effect on our business.

System security risks, data protection breaches and cyber-attacks could adversely affect our business and results of operations.

Our internal control and information technology and application systems may be vulnerable to threats from computer viruses, natural disasters, unauthorized access, cyber attack and other similar disruptions. Experienced computer programmers and hackers may be able to penetrate our network’s system security measures and misappropriate or compromise confidential information, create system disruptions or cause shutdowns. In addition to our own confidential information, as a (re)insurer, we receive and are required to protect confidential information from clients and other third parties. To the extent any disruption or security breach results in a loss or damage to our data, or inappropriate disclosure of our confidential information or that of others, it could cause significant damage to our reputation, affect our relationships with our customers and clients, lead to claims against us, result in regulatory action and ultimately have a material adverse effect on our business. In addition, we may be required to incur significant costs to mitigate the damage caused by any security breach, or to protect against future damage.

Unanticipated losses from terrorism and uncertainty surrounding the future of the TRIPRA could have a material adverse effect on our financial condition, results of operations and cash flows.

The U.S. Terrorism Risk Insurance Act of 2002 (“TRIA”), as amended, established the Terrorism Risk Insurance Program (“TRIP”), which became effective on November 26, 2002 and was a three-year federal program effective through 2005. On December 22, 2005, President George W. Bush signed a bill extending TRIA (“TRIAE”) for two more years, continuing TRIP through 2007. On December 26, 2007, President George W. Bush signed the Terrorism Risk Insurance Program Reauthorization Act of 2007 (“TRIPRA”) which further extended TRIP for seven years until December 31, 2014 and also eliminated the distinction between foreign and domestic acts of terrorism.

In response to the tightening of supply in certain insurance and reinsurance markets resulting from, among other things, the September 11 event, the TRIP was created upon the enactment of the TRIA of

38


2002 to ensure the availability of commercial insurance coverage for certain terrorist acts in the U.S. This law established a federal program, that has now been extended to December 31, 2014, to help the commercial property and casualty insurance industry cover claims related to future terrorism-related losses and required that coverage for terrorist acts be offered by insurers.

TRIA voided in force terrorism exclusions as of November 26, 2002 for certified terrorism on all TRIA specified property and casualty business. TRIA required covered insurers to make coverage available for certified acts of terrorism on all new and renewal policies issued after TRIA was enacted. TRIA along with further extensions to TRIP, as noted above, allows us to assess a premium charge for terrorism coverage and, if the policyholder declines the coverage or fails to pay the buy-back premium, certified acts of terrorism may then be excluded from the policy, subject, however, to state specific requirements. Terrorism coverage cannot be excluded from workers’ compensation policies. Subject to a premium-based deductible and provided that we have otherwise complied with all the requirements as specified under TRIPRA, we are eligible for reimbursement by the Federal Government for up to 85% of our covered terrorism-related losses arising from a certified terrorist attack. Such payment by the government will, in effect, provide reinsurance protection on a quota share basis. The maximum liability during a program year, including both the Federal Government’s and insurers’ shares, is capped on an aggregated basis at $100 billion. While regulations have been promulgated by the Department of the Treasury (“Treasury”) requiring that Treasury advise participating insurers, such as the Company, in advance of reaching the $100 billion aggregate limit that such aggregate limit could be reached during the program year, there is a risk that the Company will not be given adequate notice of the potential exhaustion of that aggregate limit. Accordingly, the Company could overpay with regard to such losses, and it is unlikely Treasury would reimburse the Company for such losses; moreover, it is unclear whether the Company, in the event of an overpayment, would be able to recover the amount of any such overpayment.

We believe that TRIP and the related legislation have been an effective mechanism to assist policyholders and industry participants with the extreme contingent losses that might be caused by acts of terrorism. Nevertheless, we cannot provide assurance that TRIPRA will be extended beyond 2014, and its expiration or a significant change in terms could have an adverse effect on us, our clients or the insurance industry.

The regulatory regimes under which we operate, and potential changes thereto, could have a material adverse effect on our business.

Our insurance and reinsurance subsidiaries operate in more than 20 countries around the world as well as in all 50 U.S. states. Our operations in each of these jurisdictions are subject to varying degrees of regulation and supervision. The laws and regulations of the jurisdictions in which our insurance and reinsurance subsidiaries are domiciled require, among other things, these subsidiaries to maintain minimum levels of statutory capital, surplus and liquidity, meet solvency standards, submit to periodic examinations of their financial condition and restrict payments of dividends, distributions and reductions of capital in certain circumstances. Statutes, regulations and policies that our insurance and reinsurance subsidiaries are subject to may also restrict the ability of these subsidiaries to write insurance and reinsurance policies, make certain investments and distribute funds.

In recent years, the U.S. insurance regulatory framework has come under increased federal scrutiny. In July 2010, the Dodd-Frank Act was signed into law. The Dodd-Frank Act requires many federal agencies to adopt new rules and regulations that will apply to the financial services industry and also calls for many studies regarding various industry practices. In particular, the Dodd-Frank Act created a Federal Insurance Office within the Treasury that is focused on national coordination of the insurance sector, systemic risk mitigation and international regulatory cooperation. Although the Federal Insurance Office currently does not directly regulate the insurance industry, under the Dodd-Frank Act it has the power to preempt state insurance regulations that are inconsistent with international agreements regarding insurance regulation, subject to certain exceptions. In addition, the Dodd-Frank Act provides that the Federal Insurance Office must submit a report to Congress on improving U.S. insurance regulation, which must cover the feasibility of future federal regulation of the U.S. insurance industry. This study or one of the various other studies required by the legislation could result in additional rulemaking or legislative action, which could negatively impact our business and financial results. While we have not yet been required to make material changes to our business or operations as a result of the Dodd-Frank Act, due to the complexity and broad scope of the Dodd-Frank Act and the time required for regulatory implementation, it is not certain what the scope of

39


future rulemaking or interpretive guidance from the SEC, CFTC or other regulatory agencies may be, and what impact this will have on our compliance costs, business, operations and profitability.

In addition, some state legislatures have considered or enacted laws that may alter or increase state regulation of insurance and reinsurance companies and holding companies. Moreover, the NAIC, which is the organization of insurance regulators from the 50 U.S. states, the District of Columbia and the four U.S. territories, as well as state insurance regulators, regularly reexamine existing laws and regulations.

In addition to these proposals and initiatives in the United States, new capital adequacy and risk management regulations, called Solvency II, were expected to be implemented throughout the European Union by January 1, 2014. However, due to a delay in the vote on the Omnibus II directive by the European Parliament from October 22, 2012, then to November 20, 2012 to the current schedule of March 2013, it is widely accepted that this implementation date will not be met. The Central Bank of Ireland has informed us that it will be our group supervisor under Solvency II. See “Business – Regulation”. Regulations and legislation relating to capital adequacy and risk management are also in the process of being developed or implemented in other jurisdictions. There remains significant uncertainty as to the impact that these various regulations and legislation will have on us; however, such impact could include constraints on our ability to move capital between subsidiaries or require that additional capital be provided to subsidiaries in certain jurisdictions, which may impact our profitability.

Our Bermuda-based operating subsidiaries are subject to the BMA’s risk-based capital standards for (re)insurance companies, which impose required levels of statutory capital and surplus on our Bermuda-based operating standards. While our Bermuda-based operating subsidiaries currently have excess capital and surplus under these requirements, there can be no assurance that such requirements or similar regulations, in their current form or as may be amended in the future, will not have a material adverse effect on our business, financial condition or results of operations.

We may not be able to comply fully with, or obtain desired exemptions from, revised statutes, regulations and policies that govern the conduct of our business. Failure to comply with, or to obtain desired authorizations and/or exemptions under, any applicable laws could result in restrictions on our ability to do business or undertake activities that are regulated in one or more of the jurisdictions in which we operate and could subject us to fines and other sanctions. In addition, changes in the laws or regulations to which we are, or may become subject, or in the interpretations thereof by enforcement or regulatory agencies, could have a material adverse effect on our business, financial condition and results of operations.

Potential government intervention in our industry as a result of recent events and instability in the marketplace for insurance products could hinder our flexibility and negatively affect the business opportunities that may be available to us in the market.

Government intervention and the possibility of future government intervention have created uncertainty in the insurance and reinsurance markets. Government regulators are generally concerned with the protection of policyholders to the exclusion of other constituencies, including shareholders of insurers and reinsurers. While we cannot predict the exact nature, timing or scope of possible governmental initiatives, such proposals could adversely affect our business by, among other things:

 

 

 

 

providing insurance and reinsurance capacity in markets and to consumers that we target, e.g., the creation or expansion of state or federal catastrophe funds such as those in Florida;

 

 

 

 

requiring our participation in industry pools and guarantee associations;

 

 

 

 

expanding the scope of coverage or altering the enforceability of deductibles under existing policies;

 

 

 

 

regulating the terms of insurance and reinsurance policies;

 

 

 

 

ordering the suspension of or otherwise altering the application of insurance laws or regulations; or

 

 

 

 

disproportionately benefiting the companies of one country over those of another.

The insurance industry is also affected by political, judicial and legal developments that may create new and expanded theories of liability, which may result in unexpected claims frequency and severity and delays or cancelations of products and services by insureds, insurers and reinsurers which could adversely affect our business.

For further information regarding government regulation and/or intervention in response to the financial and credit crises, see risk factor entitled “There can be no assurance as to the effect that governmental actions will have on the marketplace generally or on us in particular” above.

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Consolidation in the insurance industry could adversely impact us.

Insurance industry participants may seek to consolidate through mergers and acquisitions. Continued consolidation within the insurance industry will further enhance the already competitive underwriting environment as we would likely experience more robust competition from larger, better capitalized competitors. These consolidated entities may use their enhanced market power and broader capital base to negotiate price reductions for our products and services, and reduce their use of reinsurance, and, as such, we may experience rate declines and possibly write less business.

The loss of one or more key executives or the inability to attract, motivate and retain qualified personnel could adversely affect our ability to conduct business.

Our success depends on our ability to attract new, highly skilled individuals and to motivate and retain our existing key executives and qualified personnel. The loss of the services of any of our key executives or the inability to attract, motivate and retain other highly skilled individuals in the future could adversely affect our ability to conduct our business. In addition, we do not maintain key man life insurance policies with respect to our employees.

A decrease in the fair values of our reporting units may result in future goodwill impairments.

When we acquire an entity, the excess of the purchase price over the net identifiable assets acquired is allocated to goodwill. We conduct impairment tests on our reported goodwill at least annually or more frequently if impairment indicators exist. In performing a goodwill impairment test, we use various methods and make various assumptions to determine the fair value of our reporting units, including the determination of expected future cash flows and/or profitability of such reporting units, and we take into account market value multiples and/or cash flows of entities that we deem to be comparable in nature, scope or size to our reporting units. However, expected future cash flows and/or profitability may be materially and negatively impacted as a result of, among other things, a decrease in renewal activity and new business opportunities, a decrease in retention or our underwriting teams, lower-than-expected yields and/or cash flows from our investment portfolio or higher-than-expected claims activity and magnitude of incurred losses and general economic factors that impact the reporting unit. In addition, previously determined market value multiples and/or cash flows may no longer be relevant as a result of these potential factors. As a result of these potential changes, the estimated fair value of one or more of our reporting units may decrease, causing the carrying value of the net assets assigned to the reporting unit to exceed the fair value of such net assets. If we determine an impairment exists, we adjust the carrying value of goodwill to its implied fair value. The impairment charge is recorded in our income statement in the period in which the impairment is determined. If we are required in the future to record additional goodwill impairments, our financial condition and results of operations would be negatively affected. In connection with fair value measurements and the accounting for goodwill, the use of generally accepted accounting principles requires management to make certain estimates and assumptions. Significant judgment is required in making these estimates and assumptions, and actual results may ultimately be materially different from such estimates and assumptions.

Provisions in our Articles of Association may reduce the voting rights of our ordinary shares.

Our Articles of Association generally provide that shareholders have one vote for each ordinary share held by them and are entitled to vote, on a non-cumulative basis, at all meetings of shareholders. However, the voting power that may be exercised by certain persons or groups may not equal or exceed 10% or more of the voting power conferred by our shares.

In particular, our Articles of Association provide that if, and for so long as, the votes conferred by the Controlled Shares (as defined below) of any person constitute 10% or more of the votes conferred by all our issued shares, the voting rights with respect to the Controlled Shares of such person shall be limited, in the aggregate, to a voting power equal to approximately (but slightly less than) 10%, pursuant to a formula set forth in the our Articles of Association. “Controlled Shares” of a person (as defined in our Articles of Association) include (1) all of our shares owned directly, indirectly or constructively by that person (within the meaning of Section 958 of the Internal Revenue Code of 1986, as amended (the “IRS Code”), and (2) all of our shares owned directly, indirectly or constructively by that person or any “group” of which that person is a part, within the meaning of Section 13(d)(3) of the Exchange Act.

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Provisions in our Articles of Association may restrict the ownership and transfer of our ordinary shares.

Our Articles of Association provide that our Board of Directors shall decline to register a transfer of shares if it appears to our Board of Directors, whether before or after such transfer, that the effect of such transfer would be to increase the number of Controlled Shares of any person to 10% or more of any class of our voting shares, of our total issued shares, or of the total voting power of our total issued shares.

Certain provisions in our charter documents could, among other things, impede an attempt to replace our directors or impose restrictions with respect to a change of control, which could diminish the value of our ordinary shares.

Our Articles of Association contain provisions that may make it more difficult for shareholders to replace directors and could delay or prevent a change of control that a shareholder may consider favorable. These provisions include a staggered board of directors, limitations on the ability of shareholders to remove directors, limitations on voting rights and certain transfer restrictions on our ordinary shares.

As an Irish company, we are subject to the Irish Takeover Rules, under which our Board of Directors is not permitted to take any action that might “frustrate” an offer for our shares once the Board of Directors has received an offer or has reason to believe an offer is or may be imminent without the approval of more than 50% of shareholders entitled to vote at a general meeting of shareholders and/or the consent of the Irish Takeover Panel. This could limit the ability of the Board of Directors to take defensive actions even if the Board of Directors believes that such defensive actions would be in the best interests of the Company and its shareholders.

The Irish Takeover Rules also could discourage an investor from acquiring 30% or more of our outstanding ordinary shares unless such investor was prepared to make a bid to acquire all outstanding ordinary shares. Further, it could be more difficult for us to obtain shareholder approval for a merger or negotiated transaction because of heightened shareholder approval requirements for certain types of transactions under Irish law.

In addition, insurance regulations in certain jurisdictions may also delay or prevent a change of control or limit the ability of a shareholder to acquire in excess of specified amounts of our ordinary shares.

Irish shareholder voting requirements may limit flexibility with respect to certain aspects of capital management.

Irish law allows shareholders to authorize a board of directors to issue shares subsequent to receipt of authorization without further shareholder approval, but this authorization must be renewed after five years. Additionally, subject to specified exceptions, Irish law grants statutory pre-emption rights to existing ordinary shareholders to subscribe for new issuances of shares for cash, but allows such shareholders to authorize the waiver of such statutory pre-emption rights for five years. Our Articles of Association currently provide authority to the Board of Directors to issue shares without further shareholder approval and to waive ordinary shareholders’ statutory pre-emption rights. However, these authorizations expire in 2015, unless renewed by XL-Ireland’s shareholders, and we can provide no assurance that these authorizations and waivers will always be renewed, which could limit our ability to issue equity in the future.

It may be difficult to enforce judgments against XL-Ireland, XL-Cayman or their directors and executive officers.

XL-Ireland is incorporated pursuant to the laws of Ireland. In addition, certain of our directors and officers reside outside the United States and a substantial portion of our assets and the assets of such directors and officers are located outside the United States. As such, it may be difficult or impossible to effect service of process within the United States upon those persons or to recover on judgments of U.S. courts against us or our directors and officers, including judgments predicated upon civil liability provisions of U.S. federal securities laws. We have been advised that there is no treaty between Ireland and the United States providing for the reciprocal enforcement of foreign judgments. The following requirements must be met before the foreign judgment will be deemed to be enforceable in Ireland:

 

 

 

 

the judgment must be for a definite sum;

 

 

 

 

the judgment must be final and conclusive; and

 

 

 

 

the judgment must be provided by a court of competent jurisdiction.

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An Irish court will also exercise its right to refuse judgment if the foreign judgment was obtained by fraud, if the judgment violated Irish public policy, if the judgment is in breach of natural justice or if it is irreconcilable with an earlier foreign judgment.

In addition, XL-Cayman is incorporated pursuant to the laws of the Cayman Islands and is an Irish tax resident. Requirements for enforceability of foreign judgments in Ireland are summarized above. We have been advised that there is doubt as to whether the courts of the Cayman Islands would enforce:

 

 

 

 

judgments of U.S. courts based upon the civil liability provisions of U.S. federal securities laws obtained in actions against XL-Cayman or its directors and officers who reside outside the United States; or

 

 

 

 

original actions brought in the Cayman Islands against these persons or XL-Cayman predicated solely upon U.S. federal securities laws.

We have also been advised that there is no treaty in effect between the United States and the Cayman Islands providing for such enforcement and there are grounds upon which Cayman Islands courts may not enforce judgments of U.S. courts. Some remedies available under the laws of U.S. jurisdictions, including some remedies available under U.S. federal securities laws, may not be allowed in Cayman Islands courts as contrary to public policy.

Current, pending or future lawsuits against us, including putative class action lawsuits, could have a material adverse effect on our results of operations in a particular fiscal quarter or year.

We are subject to lawsuits and arbitrations in the regular course of our business. An adverse resolution of one or more lawsuits or arbitrations could have a material adverse effect on our results of operations in a particular fiscal quarter or year.

Changes in current accounting practices and future pronouncements may materially impact our reported financial results.

Unanticipated developments in accounting practices may require us to incur considerable additional expenses to comply with such developments, particularly if we are required to prepare information relating to prior periods for comparative purposes or to apply the new requirements retroactively. The impact of changes in current accounting practices and future pronouncements cannot be predicted but may affect the calculation of net income, net equity and other relevant financial statement line items and the timing of when impairments and other charges are tested or taken. In particular, recent guidance and ongoing projects put in place by standard setters globally have indicated a possible move away from the current insurance accounting models toward more “fair value” based models which could introduce significant volatility in the earnings of insurance industry participants.

There is a possibility that the Master Agreement entered into at the time of the sale of Syncora and the related commutations and releases could be challenged or that we could be subject to litigation as a result of the Master Agreement. Any such challenge could have a material adverse effect on our financial condition, results of operations, liquidity or the market price of our securities.

We provided certain reinsurance protections (the “Reinsurance Agreements”) with respect to adverse development on certain transactions as well as indemnification under specific facultative and excess of loss coverages for subsidiaries of Syncora: Syncora Guarantee Re and Syncora Guarantee. At June 30, 2008, our total net exposure under facultative agreements with Syncora subsidiaries was approximately $6.4 billion of net par value outstanding. Pursuant to the closing of the Master Agreement, all of these Reinsurance Agreements were commuted.

In addition, through one or more of our subsidiaries, we entered into certain agreements with subsidiaries of Syncora pursuant to which we guaranteed certain obligations of Syncora Guarantee Re and Syncora Guarantee under specific agreements (the “Guarantee Agreements”). At June 30, 2008, the total net par value outstanding of business written by subsidiaries of Syncora which fell under the Guarantee Agreements was approximately $60 billion. Pursuant to the terms of, and required conditions under, the Master Agreement, Syncora Guarantee Re’s facultative quota share reinsurance agreement with Syncora Guarantee, and all individual risk cessions thereunder, and the Financial Security Master Facultative

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Agreement, and all individual risk cessions thereunder, were commuted, thereby rendering the Syncora Guarantee Re guarantee and Financial Security guarantee of no further force and effect.

Following the closing of the Master Agreement, Syncora and its applicable subsidiaries were required to use commercially reasonable efforts to commute the underlying financial guarantees that we had issued to the European Investment Bank (“EIB”) in connection with financial guaranty policies between certain subsidiaries of Syncora Holdings and EIB. This was completed in June 2010.

Under federal bankruptcy laws and comparable provisions of state fraudulent transfer laws (including those applicable in any state insurance insolvency proceeding), Syncora’s commutation and release of our obligations pursuant to the Master Agreement and related agreements would constitute a voidable fraudulent transfer if it was determined that Syncora or any applicable subsidiary thereto, at the time it entered into the Master Agreement or such related agreement:

 

 

 

 

intended to hinder, delay or defraud its creditors; or

 

 

 

 

received less than “reasonably equivalent value” or “fair value consideration” for such release; and either:

 

 

 

 

was insolvent or rendered insolvent by reason of such occurrence; or

 

 

 

 

was engaged in a business or transaction for which its remaining assets constituted unreasonably small capital; or

 

 

 

 

intended to incur, or believed that it would incur, debts beyond its ability to pay such debts as they mature.

Among other regulatory approvals obtained in connection with the Master Agreement and the commutation of the Syncora Guarantee Re/Syncora Guarantee Quota Share, the New York Department of Financial Services (“NYDFS”) issued an approval letter to Syncora Guarantee under Section 1505 of the New York Insurance Law and the Delaware Insurance Department (“DID”) issued an approval letter to Syncora Guarantee Re under Section 5005(a) of the Delaware Insurance Code (effective upon Syncora Guarantee Re’s redomestication to Delaware) (both of which require that the terms of a transaction between an issuer and one or more of its affiliates be fair and equitable) stating, in the case of NYDFS, that the terms of the Master Agreement and each of the commutations are fair and equitable to Syncora Guarantee and do not adversely affect policyholders of Syncora Guarantee and, in the case of the DID, stating that the terms of the Master Agreement and the commutation of the Syncora Guarantee Re/Syncora Guarantee Quota Share were fair and equitable to Syncora Guarantee. The BMA (the domiciliary regulator of Syncora Guarantee Re) also issued an approval letter approving the Master Agreement and each commutation to which Syncora Guarantee Re is a party, including the Syncora Guarantee Re/Syncora Guarantee Quota Share.

There can be no assurance that a court would agree with our, the NYDFS’s, the DID’s, the BMA’s or Syncora’s conclusions, or as to what law or standard a court would ultimately apply in making any such determination or as to how such court would ultimately rule. Further, there can be no assurance that the enforceability of the Master Agreement, the agreements relating thereto and the transactions contemplated thereunder will not be challenged, including under applicable fraudulent transfer laws and/or by asserting any number of other theories for recovery, including third-party beneficiary rights, or that other litigation will not be commenced against us as a result of the Master Agreement and such related agreements and transactions. Additionally, in the event of any liquidation or rehabilitation or similar proceeding of any insurance subsidiary of Syncora, there can be no assurance that any insurance regulator or regulators responsible for such proceedings, in their capacity as liquidator or rehabilitator, would respect the insurance regulatory approvals obtained in connection with the Master Agreement.

We and our non-U.S. insurance subsidiaries may become subject to U.S. tax, which may have a material adverse effect on our results of operations and your investment.

We take the position that neither we nor any of our non-U.S. insurance subsidiaries are engaged in a U.S. trade or business through a U.S. permanent establishment. Accordingly, we take the position that none of our non-U.S. insurance subsidiaries should be subject to U.S. tax (other than U.S. excise tax on insurance and reinsurance premium income attributable to insuring or reinsuring U.S. risks and U.S. withholding tax on some types of U.S. source investment income). However, because there is considerable uncertainty as to the activities that constitute being engaged in a trade or business within the United States, we cannot be certain that the U.S. Internal Revenue Service (the “IRS”) will not contend successfully that

44


we or any of our non-U.S. insurance subsidiaries are engaged in a trade or business in the United States. If we or any of our non-U.S. insurance subsidiaries were considered to be engaged in a trade or business in the United States, any such entity could be subject to U.S. corporate income and additional branch profits taxes on the portion of its earnings effectively connected to such U.S. business, in which case our financial condition and results of operations could be materially adversely affected.

Changes in U.S. tax law might adversely affect an investment in our shares.

Legislation may be introduced in the U.S. Congress attempting to eliminate certain perceived tax advantages of companies (including insurance companies) that have legal domiciles outside the U.S. but have certain U.S. affiliates. For example, one legislative proposal could impose additional limits on the deductibility of interest by foreign-owned U.S. corporations. Another legislative proposal could modify the standards that indicate when a non-U.S. corporation might be treated as a U.S. corporation for U.S. federal income tax purposes if it were considered to be primarily managed and controlled in the U.S. In addition, legislation has been proposed in the U.S. that would severely restrict the ability of a company to utilize affiliate reinsurance to manage its U.S. risks and its capital position. Various proposals have been made that would effectively disallow (in some cases permanently and in others temporarily) part or all of the deduction for premiums ceded to affiliates If any of these proposals, or a similar proposal using the same underlying principles, is enacted, the resulting impact to the Company could have an adverse impact on us or our shareholders. It is possible that other legislative proposals could emerge in the future that could also have an adverse impact on us or our shareholders.

Additionally, the U.S. federal income tax laws and interpretations, including those regarding whether a company is engaged in a trade or business (or has a permanent establishment) within the United States or is a Passive Foreign Investment Company (“PFIC”), or whether U.S. holders would be required to include in their gross income “subpart F income” or the related person insurance income, which we refer to as “RPII” of a Controlled Foreign Corporation (“CFC”), are subject to change, possibly on a retroactive basis. There are currently no regulations regarding the application of the PFIC rules to insurance companies and the regulations regarding RPII are still in proposed form. New regulations or pronouncements interpreting or clarifying such rules may be forthcoming. We cannot be certain if, when or in what form such regulations or pronouncements may be provided and whether such guidance will have a retroactive effect.

We cannot assure you that future legislative action will not increase the amount of U.S. tax payable by us. If an increase occurs, our financial condition and results of operations could be materially adversely affected.

There is U.S. income tax risk associated with reinsurance between U.S. insurance companies and their Bermuda affiliates.

As discussed above, Congress has periodically considered legislation intended to eliminate certain perceived tax advantages of non-U.S. insurance companies and U.S. insurance companies with non-U.S. affiliates, including perceived tax benefits resulting principally from reinsurance between or among U.S. insurance companies and their non-U.S. affiliates. In this regard, section 845 of the IRS Code was amended in 2004 to permit the IRS to reallocate, recharacterize or adjust items of income, deduction or certain other items related to a reinsurance agreement between related parties to reflect the proper “amount, source or character” for each item (in contrast to prior law, which only covered “source and character”). If the IRS were to successfully challenge our reinsurance arrangements under section 845, our financial condition and results of operations could be materially adversely affected and the price of our ordinary shares could be adversely affected.

The Organization for Economic Co-operation and Development has implemented measures and may implement further measures that might change the manner in which we are taxed.

The Organization for Economic Co-operation and Development (the “OECD”) published its current tax agenda in May 2012. In this report, the OECD refers to a number of ongoing initiatives. Any measures implemented as a result of these initiatives could have an impact on how we and other multinational organizations are taxed. We are not able to predict the impact on our tax position from the implementation of any such measures.

The OECD’s “Report on the Attribution of Profits to Permanent Establishments” (the “Report”), issued in 2008, summarized the OECD’s initiative to establish a broad consensus regarding the interpretation and

45


practical application of Article 7 of the OECD Model Tax Convention on Income and Capital (“Article 7”). Article 7 sets forth international tax principles for attributing profits to a permanent establishment and forms the basis of an extensive network of bilateral income tax treaties between OECD member countries and between many OECD member and non-member countries. Part IV of the Report addresses the attribution of profits to a permanent establishment of an enterprise that conducts insurance activities. In 2010, a new version of Article 7 and related commentary was adopted to be used in the negotiation of new treaties and amendments to existing treaties. Although provisions of this new version of Article 7 and related commentary have not and are not expected to change materially the manner in which we are taxed, there can be no assurance that future OECD recommendations related to the Report may not have an adverse impact on us.

If an investor acquires 10% or more of our ordinary shares, it may be subject to taxation under the “controlled foreign corporation” rules.

Under certain circumstances, a U.S. person who owns 10% or more of the voting power of a foreign corporation that is a CFC (a foreign corporation in which 10% U.S. shareholders own more than 50% of the voting power of the foreign corporation or more than 25% of a foreign insurance company) for an uninterrupted period of 30 days or more during a taxable year must include in gross income for U.S. federal income tax purposes such “10% U.S. Shareholder’s” pro rata share of the CFC’s “subpart F income,” even if the subpart F income is not distributed to such 10% U.S. Shareholder, if such 10% U.S. Shareholder owns (directly or indirectly through foreign entities) any shares of the foreign corporation on the last day of the corporation’s taxable year. “Subpart F income” of a foreign insurance corporation typically includes foreign personal holding company income (such as interest, dividends and other types of passive income), as well as insurance and reinsurance income (including underwriting and investment income) attributable to the insurance of risks situated outside the CFC’s country of incorporation.

While provisions in our organizational documents serve to limit voting power on our ordinary shares, it is possible, that the IRS could challenge the effectiveness of these provisions and that a court could sustain such a challenge, in which case an investor’s investment could be materially adversely affected, if the investor is considered to own 10% or more of our shares.

U.S. Persons who hold shares will be subject to adverse tax consequences if we are considered to be a PFIC for U.S. federal income tax purposes.

If we are considered a PFIC for U.S. federal income tax purposes, a U.S. person who owns any of our shares will be subject to adverse tax consequences, including a greater tax liability than might otherwise apply and tax on amounts in advance of when tax would otherwise be imposed, in which case an investor’s investment could be materially adversely affected. In addition, if we were considered a PFIC, upon the death of any U.S. individual owning shares, such individual’s heirs or estate would not be entitled to a “step-up” in the basis of the shares that might otherwise be available under U.S. federal income tax laws. We believe that we are not, have not been, and currently do not expect to become, a PFIC for U.S. federal income tax purposes. We cannot provide assurance, however, that we will not be deemed a PFIC by the IRS in the future. If we were considered a PFIC, it could have material adverse tax consequences for an investor that is subject to U.S. federal income taxation. There are currently no regulations regarding the application of the PFIC provisions to an insurance company. New regulations or pronouncements interpreting or clarifying these rules may be forthcoming. We cannot predict what impact, if any, such guidance would have on an investor that is subject to U.S. federal income taxation.

There are U.S. income tax risks associated with the related person insurance income of our non-U.S. insurance subsidiaries.

If (i) the related person insurance income, which we refer to as “RPII,” of any one of our non-U.S. insurance subsidiaries were to equal or exceed 20% of that subsidiary’s gross insurance income in any taxable year and (ii) U.S. persons were treated as owning 25% or more of the subsidiary’s stock (by vote or value), a U.S. person who owns any ordinary shares, directly or indirectly, on the last day of such taxable year on which the 25% threshold is met would be required to include in its income for U.S. federal income tax purposes that person’s ratable share of that subsidiary’s RPII for the taxable year, determined as if that RPII were distributed proportionately only to U.S. holders at that date, regardless of whether that income is distributed. The amount of RPII earned by a subsidiary (generally premium and related investment income from the direct or indirect insurance or reinsurance of any direct or indirect U.S. holder

46


of shares of that subsidiary or any person related to that holder) would depend on a number of factors, including the identity of persons directly or indirectly insured or reinsured by that subsidiary. Although we do not believe that the 20% threshold will be met in respect of any of our non-U.S. insurance subsidiaries, some of the factors that may affect the result in any period may be beyond our control. Consequently, we cannot provide absolute assurance that we will not exceed the RPII threshold in any taxable year.

The RPII rules provide that if a holder who is a U.S. person disposes of shares in a non-U.S. insurance corporation that had RPII (even if the 20% gross income threshold was not met) and met the 25% ownership threshold at any time during the five-year period ending on the date of disposition, and the holder owned any stock at such time, any gain from the disposition will generally be treated as a dividend to the extent of the holder’s share (taking into account certain rules for determining a U.S. holder’s share of RPII) of the corporation’s undistributed earnings and profits that were accumulated during the period that the holder owned the shares (possibly whether or not those earnings and profits are attributable to RPII). In addition, such a shareholder will be required to comply with specified reporting requirements, regardless of the amount of shares owned. We believe that these rules should not apply to dispositions of our ordinary shares because XL- Ireland is not itself directly engaged in the insurance business. We cannot provide absolute assurance, however, that the IRS will not successfully assert that these rules apply to dispositions of our ordinary shares.

We and our Bermuda insurance subsidiaries may become subject to taxes in Bermuda in the future, which may have a material adverse effect on our financial condition, results of operations and your investment.

Our Bermuda insurance subsidiaries have received from the Ministry of Finance in Bermuda exemptions from any Bermuda taxes that might be imposed on profits, income or any capital asset, gain or appreciation until March 31, 2035. The exemptions are subject to the proviso that they are not construed so as to prevent the application of any tax or duty to persons who are ordinarily residents in Bermuda (the Company and our Bermuda insurance subsidiaries are not so currently designated) and to prevent the application of any tax payable in accordance with the provisions of The Land Tax Act 1967 or otherwise payable in relation to the land leased to us and our Bermuda insurance subsidiaries. XL-Ireland and other Bermuda-based subsidiaries not incorporated in Bermuda have also received similar exemptions as permit companies under the Companies Act of 1981 of Bermuda. These exemptions are expected to be extended to 2035. Our Bermuda insurance subsidiaries are required to pay certain annual Bermuda government fees and certain business fees as an insurer under The Insurance Act 1978 of Bermuda. Currently there is no Bermuda withholding tax on dividends paid by our Bermuda insurance subsidiaries to us. There can be no assurance that the tax rules as presently applied may not change in the future.

XL-Cayman may become subject to taxes in the Cayman Islands after June 2, 2018, which may have a material adverse effect on our results of operations and your investment.

For tax purposes, XL-Cayman is resident in Ireland by virtue of central management and control. In the event Cayman introduces a corporate income tax based on place of incorporation, XL-Cayman would be a dual resident company and potentially subject to tax in both Ireland and Cayman. As there is no double tax treaty between the Cayman Islands and Ireland, XL-Cayman could become subject to taxation in both Ireland and Cayman. Under current Cayman Islands law, we are not obligated to pay any taxes in the Cayman Islands on our income or gains. We have received an undertaking from the Governor-in-Council of the Cayman Islands pursuant to the provisions of the Tax Concessions Law, as amended, that until June 2, 2018, (i) no subsequently enacted law imposing any tax on profits, income, gains or appreciation shall apply to us and (ii) no such tax and no tax in the nature of an estate duty or an inheritance tax shall be payable on any of our ordinary shares, debentures or other obligations. Given the limited duration of the undertaking from the Governor-in-Council of the Cayman Islands, we cannot be certain that we will not be subject to any Cayman Islands tax after June 2, 2018. Such taxation could have a material adverse effect on our financial condition, results of operations and your investment.

Our tax position could be adversely impacted by changes in tax laws, tax treaties or tax regulations or the interpretation or enforcement thereof.

Our tax position could be adversely impacted by changes in tax laws, tax treaties or tax regulations or the interpretation or enforcement thereof by the tax authorities in Ireland, the United States and other jurisdictions, and such changes may be more likely or become more likely in view of recent economic

47


trends in such jurisdictions, particularly if such trends continue. For example, Ireland has suffered from the consequences of worldwide adverse economic conditions and the credit ratings on its debt have been downgraded. Such tax law changes could cause a material and adverse change in our worldwide effective tax rate and we may have to take further action, at potentially significant expense, to seek to mitigate the effect of such changes. Any future amendments to the current income tax treaties between Ireland and other jurisdictions, including the United States, could subject us to increased taxation and/or potentially significant expense.

Dividends you receive may be subject to Irish dividend withholding tax and Irish income tax.

Dividend withholding tax (currently at a rate of 20%) may arise in respect of dividends paid on the Company’s ordinary shares. However, a number of exemptions from dividend withholding tax exist such that ordinary shareholders resident in the United States and ordinary shareholders resident in other specified countries (listed in Annex F attached to the Redomestication Proxy Statement filed with the SEC on March 10, 2010) may be entitled to exemptions from dividend withholding tax if they complete and file certain dividend withholding tax forms. Ordinary shareholders resident in the U.S. that hold their ordinary shares through the Depository Trust Company (“DTC”) will not be subject to dividend withholding tax provided the addresses of the beneficial owners of such ordinary shares in the records of the brokers holding such ordinary shares are in the United States (so that such brokers can further transmit the relevant information to a qualifying intermediary appointed by the Company). Similarly, ordinary shareholders resident in the U.S. that hold their ordinary shares directly instead of beneficially through DTC are not subject to dividend withholding tax if such ordinary shareholders held ordinary shares in the Company on January 12, 2010 and they provided a valid Form W-9 showing a U.S. address to the Company’s transfer agent. However, other ordinary shareholders may be subject to dividend withholding tax, which could adversely affect the price of our ordinary shares.

In addition, ordinary shareholders entitled to an exemption from Irish dividend withholding tax on dividends received from the Company should not be subject to Irish income tax in respect of those dividends, unless they have some connection with Ireland other than their ordinary shareholdings in the Company. Ordinary shareholders who receive dividends subject to Irish dividend withholding tax will generally have no further liability to Irish income tax on those dividends unless they have some connection with Ireland other than their ordinary shareholding in the Company.

A future transfer of your ordinary shares, other than one effected by means of the transfer of book entry interests in DTC, may be subject to Irish stamp duty.

Transfers of our ordinary shares effected by means of the transfer of book entry interests in DTC will not be subject to Irish stamp duty. The majority of our ordinary shares will be traded through DTC, either directly or through brokers who hold such ordinary shares on behalf of customers through DTC. However, if you hold your ordinary shares directly rather than beneficially through DTC (or through a broker that holds your ordinary shares through DTC), any transfer of your ordinary shares could be subject to Irish stamp duty (currently at the rate of 1% of the higher of the price paid or the market value of the ordinary shares acquired). Payment of Irish stamp duty is generally a legal obligation of the transferee. The potential for stamp duty could adversely affect the price of our ordinary shares.

 

 

 

 

 

 

ITEM 1B.

 

UNRESOLVED STAFF COMMENTS

 

 

 

None.

 

 

 

 

 

 

ITEM 2.

 

PROPERTIES

 

 

 

We operate in Bermuda, the United States, Europe and various other locations around the world. In 1997, we acquired commercial real estate in Hamilton, Bermuda for the purpose of securing long-term office space for our worldwide headquarters. The development was completed in April 2001. The total cost of this development, including land, was approximately $126.6 million. We have subsequently sub-leased portions of this property as a part of our broader expense reduction initiatives.

In July 2003, we acquired new offices at 70 Gracechurch Street, London, which have become our London headquarters. The acquisition was made through a purchase, sale and leaseback transaction. The move to the new offices was completed in 2004 and consolidated our London businesses in one location. The capital lease asset and liability associated with this transaction totaled $98.5 million at December 31, 2012.

48


In June 2012, we acquired new offices at 8 St. Stephen’s Green, Dublin, Ireland as our new global headquarters. The acquisition purchase price was $9.6 million. Completion of the new office and consolidation of our existing Dublin locations are expected in mid-2013.

Each of our reporting segments uses the properties described above. All other office facilities throughout the world that are occupied by us and our subsidiaries are leased.

Total rent expense for the years ended December 31, 2012, 2011 and 2010 was $35.6 million, $32.9 million and $31.8 million, respectively. See Item 8, Note 17(d), “Commitments and Contingencies – Properties,” to the Consolidated Financial Statements included herein, for discussion of our lease commitments for real property.

 

 

 

 

 

 

ITEM 3.

 

LEGAL PROCEEDINGS

 

 

 

We are subject to litigation and arbitration in the normal course of its business. These lawsuits and arbitrations principally involve claims on policies of insurance and contracts of reinsurance and are typical for us and for the property and casualty insurance and reinsurance industry in general. Such claims proceedings are considered in connection with our loss and loss expense reserves. Reserves in varying amounts may or may not be established in respect of particular claims proceedings based on many factors, including the legal merits thereof. In addition to litigation relating to insurance and reinsurance claims, we are subject to lawsuits and regulatory actions in the normal course of business that do not arise from or directly relate to claims on insurance or reinsurance policies. These types of actions typically involve, among other things, allegations of underwriting errors or misconduct, employment disputes, actions brought by or on behalf of shareholders or disputes arising from business ventures. The status of these legal actions is actively monitored by management.

Legal actions are subject to inherent uncertainties, and future events could change management’s assessment of the probability or estimated amount of potential losses from pending or threatened legal actions. Based on available information, it is the opinion of management that the ultimate resolution of pending or threatened legal actions other than claims proceedings, both individually and in the aggregate, will not result in losses having a material adverse effect on our financial position or liquidity at December 31, 2012. For further information in relation to legal proceedings, see Item 8, Note 17(g), “Commitments and Contingencies – Litigation,” to the Consolidated Financial Statements included herein.

In August 2005, plaintiffs in a proposed class action (the “Class Action”) that was consolidated into a multidistrict litigation in the United States District Court for the District of New Jersey, captioned In re Brokerage Antitrust Litigation, MDL No. 1663, Civil Action No. 04-5184 (the “MDL”), filed a consolidated amended complaint (the “Amended Complaint”), which named as new defendants approximately 30 entities, including Greenwich Insurance Company, Indian Harbor Insurance Company and XL-Cayman (the “XL Defendants”). In the MDL, the Class Action plaintiffs asserted various claims purportedly on behalf of a class of commercial insureds against approximately 113 insurance companies and insurance brokers through which the named plaintiffs allegedly purchased insurance. The Amended Complaint alleged that the defendant insurance companies and insurance brokers conspired to manipulate bidding practices for insurance policies in certain insurance lines and failed to disclose certain commission arrangements and asserted statutory claims under the Sherman Act, various state antitrust laws and the Racketeer Influenced and Corrupt Organizations Act (“RICO”), as well as common law claims alleging breach of fiduciary duty, aiding and abetting a breach of fiduciary duty and unjust enrichment. By Opinion and Order dated August 31, 2007, the District Court dismissed the Sherman Act claims with prejudice and, by Opinion and Order dated September 28, 2007, the District Court dismissed the RICO claims with prejudice. The plaintiffs then appealed both Orders to the U.S. Court of Appeals for the Third Circuit. On August 16, 2010, the Third Circuit affirmed in large part the District Court’s dismissal. The Third Circuit reversed the dismissal of certain Sherman Act and RICO claims alleged against several defendants including the XL Defendants but remanded those claims to the District Court for further consideration of their adequacy. In light of its reversal and remand of certain of the federal claims, the Third Circuit also reversed the District Court’s dismissal (based on the District Court’s declining to exercise supplemental jurisdiction) of the state-law claims against all defendants. On October 1, 2010, the remaining defendants, including the XL Defendants, filed motions to dismiss the remanded federal claims and the state-law claims. The motions were fully briefed in November 2010. In May 2011, a majority of the remaining defendants, including the XL Defendants, executed a formal Settlement Agreement with the Class Action plaintiffs to settle the Class Action and dismiss all claims with prejudice. The settlement was approved by the District Court by Order

49


dated March 30, 2012. The XL Defendants’ portion of the defendants’ aggregate settlement payment is $6.75 million. Certain objectors filed, but then withdrew, their appeals from the District Court’s March 30, 2012 Order approving the settlement.

Various XL entities have been named as defendants in three of the many tag-along actions that were consolidated into the MDL for pretrial purposes. The complaints in these tag-along actions make allegations similar to those made in the Amended Complaint but do not purport to be class actions. On April 4, 2006, a tag-along complaint was filed in the U.S. District Court for the Northern District of Georgia on behalf of New Cingular Wireless Headquarters LLC and several other corporations including Greenwich Insurance Company, XL Specialty Insurance Company, XL Insurance America, Inc., XL Insurance Company Limited and XL- Cayman. On or about May 21, 2007, a tag-along complaint was filed in the U.S. District Court for the District of New Jersey on behalf of Henley Management Company, Big Bear Properties, Inc., Northbrook Properties, Inc., RCK Properties, Inc., Kitchens, Inc., Aberfeldy LP and Payroll and Insurance Group, Inc. against multiple defendants, including “XL Winterthur International.” On October 12, 2007, a complaint in a third tag-along action was filed in the U.S. District Court for the Northern District of Georgia by Sears, Roebuck & Co., Sears Holdings Corporation, Kmart Corporation and Lands’ End Inc. against many named defendants including X.L. America, Inc., XL Insurance America, Inc., XL Specialty Insurance Company and XL Insurance (Bermuda) Ltd (“XLIB”). On October 17, 2011, the District Court lifted the stay of the tag-along actions, including the three in which the XL entities were named as defendants. On April 30, 2012, the District Court set (and subsequently amended) a pre-trial litigation schedule governing the tag-along actions. The parties are currently engaged in discovery, and the defendants have filed various threshold motions directed to plaintiffs’ complaints. In connection with the settlement mediation ordered by the District Court, the XL defendants reached settlements with the respective plaintiffs in the New Cingular and Henley tag-along actions, and those actions have been dismissed with prejudice. Three XL entities remain as defendants in the Sears tag-along action; XL Insurance America, Inc. and XL Specialty Insurance Company have moved to dismiss the Sears Amended Complaint, while XLIB has moved to compel arbitration of the Sears Plaintiffs’ claims against it pursuant to the arbitration clauses contained in the XLIB insurance policies purchased by the Sears Plaintiffs.

 

 

 

 

 

 

ITEM 4.

 

MINE SAFETY DISCLOSURES

 

 

 

Not applicable.

Executive Officers of the Registrant

The table below sets forth the names, ages and titles of the persons who were the executive officers of the Company at February 25, 2013:

 

 

 

 

 

Name

 

Age

 

Position

Michael S. McGavick

 

 

 

55

   

Chief Executive Officer and Director

Susan L. Cross

 

 

 

52

   

Executive Vice President and Global Chief Actuary

Kirstin Gould

 

 

 

46

   

Executive Vice President, General Counsel and Secretary

Gregory S. Hendrick

 

 

 

47

   

Executive Vice President and Chief Executive of Insurance Operations

W. Myron Hendry

 

 

 

64

   

Executive Vice President and Chief Platform Officer

Peter R. Porrino

 

 

 

56

   

Executive Vice President and Chief Financial Officer

Jacob D. Rosengarten

 

 

 

57

   

Executive Vice President and Chief Enterprise Risk Officer

Sarah E. Street

 

 

 

51

   

Executive Vice President and Chief Investment Officer

James H. Veghte

 

 

 

56

   

Executive Vice President and Chief Executive of Reinsurance Operations

Eileen Whelley

 

 

 

59

   

Executive Vice President and Chief Human Resources Officer

Michael S. McGavick, was appointed as Director of the Company in April 2008 and shortly prior to his commencement as the Company’s Chief Executive Officer on May 1, 2008. Previously, Mr. McGavick was President & CEO of the Seattle-based Safeco Corporation from January 2001 to December 2005. Prior to joining Safeco, Mr. McGavick spent six years with the Chicago-based CNA Financial Corporation, where he held various senior executive positions before becoming President and Chief Operating Officer of the company’s largest commercial insurance operating unit. Mr. McGavick’s insurance industry experience also includes two years as Director of the American Insurance Association’s Superfund Improvement Project in

50


Washington D.C., where he became the Association’s lead strategist in working to transform U.S. Superfund environmental laws.

Susan L. Cross was appointed to the Company’s leadership team in August 2008, serving as Executive Vice President and Global Chief Actuary. Ms. Cross has served as Global Chief Actuary since 2006 and previously was Chief Actuary of the Company’s reinsurance operations from 2004 to 2006 and Chief Actuary of XL Re Bermuda from 2002 to 2004. She also held various actuarial positions in the insurance and reinsurance operations of the Company from 1999 to 2002. Prior to joining the Company, Ms. Cross was Principal and Consulting Actuary at Tillinghast Towers Perrin.

Kirstin Gould was appointed Executive Vice President, General Counsel in September 2007, which position includes her prior responsibilities as General Counsel, Corporate Affairs and Corporate Secretary. In 2008, Ms. Gould also assumed leadership of the Communications, Marketing and Public Affairs department. Ms. Gould was previously Executive Vice President, General Counsel, Corporate Affairs from July 2006 to September 2007 and also served as Chief Corporate Legal Officer from November 2004 to July 2006, and Associate General Counsel from July 2001 to November 2004. Prior to joining the Company in 2000, Ms. Gould was associated with the law firms of Clifford Chance and Dewey Ballantine in New York and London.

Gregory S. Hendrick was appointed Executive Vice President and Chief Executive of Insurance Operations in January 2012. From October 2010 to January 2012, Mr. Hendrick served as Executive Vice President, Strategic Growth. From 2004 to October 2010, Mr. Hendrick served as President and Chief Underwriting Officer of XL Re Ltd. Previously, he served as Lead for U.S. Property Treaty underwriting at XL Re Ltd and Vice President responsible for U.S. Property Underwriting for XL Mid Ocean Reinsurance Ltd. Prior to joining XL, Mr. Hendrick was Assistant Vice President of Treaty Underwriting for the Winterthur Reinsurance Corporation of America.

W. Myron Hendry joined the Company’s leadership team upon his appointment as Executive Vice President, Chief Platform Officer in December 2009. Prior to joining the Company, from 2006 to December 2009, Mr. Hendry served as Business Operations Executive of Bank of America’s Insurance Group, joining there from a merger with Countrywide Insurance Services Group. Prior to the merger, Mr. Hendry served as Managing Director and Chief Operating Officer for Countrywide and prior to this, from 2004 to 2006, Mr. Hendry served as Senior Vice President, Property and Casualty Services at Safeco. From 1971 to 2004, Mr. Hendry held various leadership roles with CNA Insurance, with his last assignment being the Senior Vice President of Worldwide Operations.

Peter R. Porrino was appointed Executive Vice President, Chief Financial Officer in August 2011. Previously, Mr. Porrino served as Ernst & Young’s Global Director of Insurance Industry Services from 1999 to August 2011. Mr. Porrino first joined Ernst & Young in 1978 and served in the firm’s New York and National insurance practices for 15 years before leaving to serve in senior management positions with several insurance companies. This experience includes Zurich Financial Services, where Mr. Porrino served as CFO of Zurich’s NYSE-listed subsidiary, Zurich Reinsurance Centre, Inc. He rejoined Ernst & Young in 1999.

Jacob D. Rosengarten joined the Company’s leadership team and was appointed Executive Vice President, Chief Enterprise Risk Officer in September 2008. Prior to joining the Company, Mr. Rosengarten served as Managing Director of Risk Management and Analytics for Goldman Sachs Asset Management from 1998 to 2008. From 1993 to 1997, Mr. Rosengarten served as Director of Risk and Quantitative Analysis at Commodities Corporation and prior to this, from 1983 to 1992 held progressively senior finance positions at Commodities Corporation.

Sarah E. Street was appointed to the position of Executive Vice President and Chief Investment Officer in October 2006. Ms. Street has also served as the Chief Executive Officer of XL Capital Investment Partners Inc. since April 2001. Prior to joining XL in 2001, Ms. Street held numerous leadership positions at JPMorganChase and its predecessor organizations, working in a number of corporate finance units as well as in the capital markets business of the bank.

James H. Veghte was appointed Executive Vice President, Chief Executive of Reinsurance Operations in January 2006. Mr. Veghte had served as the Chief Executive Officer of XL Reinsurance America Inc. (XLRA) since 2004, having previously served as Chief Operating Officer of the Company’s reinsurance operations and President, Chief Operating Officer & Chief Underwriting Officer of XL Re Ltd. Additional previously held roles with the Company include President of XL Re Latin America Ltd., Chief Operating

51


Officer of Le Mans Re (now the French branch of XL Re Europe Ltd.), General Manager of XL Re Ltd’s London branch and Executive Vice President and Underwriter of XL Mid Ocean Reinsurance Ltd in Bermuda. Prior to joining XL, Mr. Veghte was Senior Vice President and Chief Underwriting Officer of Winterthur Reinsurance Corporation of America.

Eileen Whelley was appointed to the Company’s leadership team in June 2012, serving as Executive Vice President, Chief Human Resources Officer, where she is responsible for global talent acquisition, leadership and professional development, succession planning, compensation and benefit program design and administration, employee relations, organizational effectiveness, performance management, HR information systems and payroll. Prior to joining the Company, from 2006 to 2012, Ms. Whelley served as Executive Vice President, Human Resources, for The Hartford Financial Services Group, Inc. Prior to that, Ms. Whelley spent 17 years at General Electric, where she held a number of human resources leadership roles, including Executive Vice President of Human Resources for NBC Universal and Vice President of Human Resources Excellence for GE Capital. She also served in various HR roles at Citicorp and Standard Oil of Ohio.

Non-Employee Directors of the Registrant

Robert R. Glauber has been the non-executive Chairman of the Board since April 2009 and a director since September 2006, having originally served on our Board from 1998 to May 2005. Mr. Glauber is presently a Lecturer at the Harvard Kennedy School of Government.

Ramani Ayer has been a director since February 2011. Previously, Mr. Ayer served as the Chairman of the board and Chief Executive Officer of The Hartford Financial Services Group Inc., a leading provider of insurance and wealth management services.

Dale Comey has been a director since November 2001. Previously, Mr. Comey was Executive Vice President of ITT Corporation, where he was responsible for directing the operations of several business units, including ITT Hartford and ITT Financial Corporation.

Herbert N. Haag has been a director since June 2006. Previously, Mr. Haag was the founding President and CEO of the Bermuda-based reinsurer PartnerRe Ltd.

Suzanne B. Labarge has been a director since October 2011. Previously Ms. Labarge served as the Vice Chairman and Chief Risk Officer of Royal Bank of Canada (RBC Financial Group), a diversified financial services company.

Joseph Mauriello has been a director since January 2006. Previously, Mr. Mauriello was the Deputy Chairman, Chief Operating Officer and a director of KPMG LLP (United States) and KPMG Americas Region, a leading provider of audit, tax and advisory services.

Eugene M. McQuade has been a director since July 2004. Mr. McQuade currently serves as the CEO and a director of Citibank, N.A., the commercial banking arm of Citigroup, and is a member of Citigroup’s Operating Committee.

Clayton S. Rose has been a director since December 2009. Mr. Rose is presently a Professor of Management Practice at the Harvard Business School.

Sir John M. Vereker has been a director since November 2007. Previously, Sir John Vereker was the Governor and Commander-in-Chief of Bermuda.

52


PART II

 

 

 

 

 

 

ITEM 5.

 

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

 

 

Our ordinary shares, $0.01 par value per share, are listed on the NYSE under the symbol “XL.”

The following table sets forth the high, low and closing sales prices per share of our ordinary shares per fiscal quarter, as reported on the New York Stock Exchange Composite Tape:

 

 

 

 

 

 

 

 

 

High

 

Low

 

Close

2012:

 

 

 

 

 

 

1st Quarter

 

 

$

 

22.03

 

 

 

$

 

18.86

 

 

 

$

 

21.69

 

2nd Quarter

 

 

$

 

22.64

 

 

 

$

 

19.52

 

 

 

$

 

21.04

 

3rd Quarter

 

 

$

 

24.89

 

 

 

$

 

19.90

 

 

 

$

 

24.03

 

4th Quarter

 

 

$

 

25.78

 

 

 

$

 

23.15

 

 

 

$

 

25.06

 

2011:

 

 

 

 

 

 

1st Quarter

 

 

$

 

24.82

 

 

 

$

 

21.17

 

 

 

$

 

24.60

 

2nd Quarter

 

 

$

 

25.43

 

 

 

$

 

20.53

 

 

 

$

 

21.98

 

3rd Quarter

 

 

$

 

22.65

 

 

 

$

 

17.94

 

 

 

$

 

18.80

 

4th Quarter

 

 

$

 

23.00

 

 

 

$

 

17.69

 

 

 

$

 

19.77

 

The number of record holders of ordinary shares at February 25, 2012 was 171. This figure does not represent the actual number of beneficial owners of our ordinary shares because such shares are frequently held in “street name” by securities dealers and others for the benefit of individual owners who may vote the shares.

In 2012, four quarterly dividends of $0.11 per share were paid to all ordinary shareholders of record as of March 15, June 15, September 14 and December 14. In 2011, four quarterly dividends of $0.11 per share were paid to all ordinary shareholders of record as of March 15, June 15, September 15 and December 15. On February 22, 2013, the XL-Ireland Board of Directors announced a quarterly dividend of $0.14 per share, payable to all ordinary shareholders of record as of March 15, 2013.

The declaration and payment of future dividends will be at the discretion of the XL-Ireland Board of Directors and will depend upon many factors, including our earnings, financial condition, business needs, consideration of other methods of returning capital to shareholders, capital and surplus requirements of our operating subsidiaries and regulatory and contractual restrictions.

As a holding company, our assets consist primarily of investments in subsidiaries. Accordingly, we rely on the availability of dividends and other permissible payments from our subsidiaries to pay ordinary and preferred dividends. Our subsidiaries payment of dividends to us are regulated under the laws of various jurisdictions including Bermuda, the U.K., Ireland, Switzerland, the Society of Lloyd’s and certain insurance statutes of various states in the United States in which our principal operating subsidiaries are licensed to transact business and the other jurisdictions where we have regulated subsidiaries. In addition, under Irish law, XL-Ireland may only pay dividends or buyback or redeem shares using distributable reserves. In addition, no dividend or distribution may be made unless the net assets of XL-Ireland are not less than the aggregate of its share capital plus undistributable reserves and the distribution does not reduce XL-Ireland’s net assets below such aggregate. See Item 1, “Business – Regulation,” Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, Note 23, “Statutory Financial Data,” to the Consolidated Financial Statements included herein, for further discussion.

53


The following table summarizes our equity compensation plan information at December 31, 2012:

 

 

 

 

 

 

 

 

 

Number of Securities to be
Issued Upon Exercise of
Outstanding Options,
Warrants and Rights

 

Weighted Average
Exercise Price of
Outstanding Options,
Warrants and Rights

 

Number of Securities
Remaining Available
for Future Issuance
Under Share-Based
Compensation Plans
(Excluding Securities
in column (a))

Plan Category

 

(a)

 

(b)

 

(c)

Share-based compensation plans approved by security holders (1)

 

 

 

12,091,017

 

 

 

 

38.50

 

 

 

 

15,694,705

 

Share-based compensation plans not approved by security holders (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

12,091,017

 

 

 

 

38.50

 

 

 

 

15,694,705

 

 

 

 

 

 

 

 


 

 

(1)

 

 

 

Pertains to our 1991 Performance Incentive Program and the Directors Stock & Option Plan. Includes for the 1991 Performance Incentive Program, 11,813,517 securities to be issued upon exercise of outstanding options, warrants and rights, a $38.34 weighted average exercise price of outstanding options, warrants and rights, and 15,556,359 securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column a). Includes for the Directors Stock & Option Plan, 277,500 securities to be issued upon exercise of outstanding options, warrants and rights, a $45.34 weighted average exercise price of outstanding options, warrants and rights, and 138,346 securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column a).

 

(2)

 

 

 

In relation to the 1991 Performance Incentive Program (the “Program”), of such maximum number of ordinary shares at December 31, 2012, shares can be issued as any form of award, except that, for each restricted stock, restricted stock unit, stock appreciation rights, or performance share award issued, the number of ordinary shares available under the Program will be reduced by two shares. In the event that an award issued under the Program expires or is terminated unexercised as to any shares covered thereby, or shares are forfeited for any reason under the Program, such shares shall thereafter be again available for issuance under the Program. At the Management Development and Compensation Committee’s discretion, these shares may be granted as stock options, performance shares, restricted stock, restricted stock units, stock appreciation rights or any combination of these provided that the combined total number of shares granted does not exceed either the overall share authorization described within the Program for performance shares, stock appreciation rights, restricted stock and restricted stock units.

Purchases of Equity Securities by the Issuer and Affiliate Purchasers

The following table provides information about purchases by us during the quarter ended December 31, 2012 of equity securities that are registered by us pursuant to Section 12 of the Exchange Act:

 

 

 

 

 

 

 

 

 

 

 

Total Number
of Shares
Purchased

 

Average Price
Paid
per Share

 

Total Number
of Shares
Purchased as
Part of Publicly
Announced
Plans or
Programs

 

Approximate
Value of Shares
that May Yet Be
Under the Plans or
Purchased
Programs (1) (2)

October 1, 2012 to October 31, 2012

 

 

 

 

 

 

$

 

 

 

 

 

 

 

 

$

 

400.0 million

 

November 1, 2012 to November 30, 2012

 

 

 

2,750

 

 

 

 

24.59

 

 

 

 

 

 

 

 

400.0 million

 

December 1, 2012 to December 31, 2012

 

 

 

2,085,149

 

 

 

 

24.78

 

 

 

 

2,085,149

 

 

 

 

348.4 million

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

2,087,899

 

 

 

$

 

24.78

 

 

 

 

2,085,149

 

 

 

$

 

348.4 million

 

 

 

 

 

 

 

 

 

 


 

 

(1)

 

 

 

Shares purchased in connection with the vesting of restricted shares granted under our restricted stock plan do not represent shares purchased as part of publicly announced plans or programs. All such purchases were made in connection with satisfying tax withholding obligations of those employees. These shares were not purchased as part of our share buyback program noted below.

 

(2)

 

 

 

On February 27, 2012, we announced that the XL-Ireland Board of Directors approved a share buyback program, authorizing the purchase of up to $750 million of our ordinary shares (the “February 2012 Program”). This authorization replaced the approximately $190 million remaining under the share buyback program that was authorized in November 2010. During 2012, we purchased and canceled 18.3 million ordinary shares under the February 2012 Program for $401.6 million. At December 31, 2012, $348.4 million remained available for purchase under this program. Between January 1 and February 22, 2013 we purchased and canceled an additional 3.8 million shares for $98.4 million. All share buybacks were carried out by way of redemption in accordance with Irish law and XL-Ireland’s constitutional documents. All shares so redeemed were canceled upon redemption. On February 22, 2013, we announced that the XL-Ireland Board of Directors approved a new share buyback program, authorizing the purchase of up to $850 million of our ordinary shares. This replaced the approximately $250 million remaining under the February 2012 Program.

54


Ordinary Share Performance Graph

Set forth below is a line graph comparing the yearly dollar change in the cumulative total shareholder return over a five-year period on our ordinary shares from December 31, 2007 through December 31, 2012 as compared to the cumulative total return of the Standard & Poor’s 500 Stock Index and the cumulative total return of the Standard & Poor’s Property & Casualty Insurance Index. The companies included in these indices or noted as competitors under Item 1, “Business,” may not be included in our compensation peer group.

The graph shows the value on December 31, 2008, 2009, 2010, 2011 and 2012, of a $100 investment made on December 31, 2007, with all dividends reinvested.

The remaining information required by this Item is omitted because a definitive proxy statement that involves the election of directors will be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year pursuant to Regulation 14A, which information is incorporated by reference.

55


 

 

 

 

 

 

ITEM 6.

 

SELECTED FINANCIAL DATA

 

 

 

The selected consolidated financial data below is based upon our fiscal year end of December 31. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and the Notes thereto presented under Item 8.

 

 

 

 

 

 

 

 

 

 

 

 

 

2012

 

2011

 

2010

 

2009

 

2008

 

 

(U.S. dollars in thousands, except per share amounts)

Income Statement Data:

 

 

 

 

 

 

 

 

 

 

Net premiums earned

 

 

$

 

6,090,441

 

 

 

$

 

5,690,130

 

 

 

$

 

5,414,061

 

 

 

$

 

5,706,840

 

 

 

$

 

6,640,102

 

Net investment income

 

 

 

1,012,348

 

 

 

 

1,137,769

 

 

 

 

1,198,038

 

 

 

 

1,319,823

 

 

 

 

1,768,977

 

Net realized gains (losses) on investments

 

 

 

14,098

 

 

 

 

(188,359

)

 

 

 

 

(270,803

)

 

 

 

 

(921,437

)

 

 

 

 

(962,054

)

 

Net realized and unrealized gains (losses) on derivative instruments

 

 

 

5,221

 

 

 

 

(10,738

)

 

 

 

 

(33,843

)

 

 

 

 

(33,647

)

 

 

 

 

(73,368

)

 

Net income (loss) from investment fund affiliates (1)

 

 

 

58,504

 

 

 

 

26,253

 

 

 

 

51,102

 

 

 

 

78,867

 

 

 

 

(277,696

)

 

Fee income and other

 

 

 

49,868

 

 

 

 

41,748

 

 

 

 

40,027

 

 

 

 

43,201

 

 

 

 

52,158

 

Net losses and loss expenses incurred (2)

 

 

 

3,765,482

 

 

 

 

4,078,391

 

 

 

 

3,211,800

 

 

 

 

3,168,837

 

 

 

 

3,962,898

 

Claims and policy benefits – life operations

 

 

 

486,198

 

 

 

 

535,074

 

 

 

 

513,833

 

 

 

 

677,562

 

 

 

 

769,004

 

Acquisition costs, operating expenses and foreign exchange gains and losses

 

 

 

2,097,989

 

 

 

 

1,869,688

 

 

 

 

1,751,060

 

 

 

 

1,996,052

 

 

 

 

1,924,908

 

Interest expense

 

 

 

172,205

 

 

 

 

205,592

 

 

 

 

213,643

 

 

 

 

216,504

 

 

 

 

351,800

 

Loss on settlement of guarantee

 

 

 

 

 

 

 

 

 

 

 

23,500

 

 

 

 

 

 

 

 

 

Extinguishment of debt

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

22,527

 

Impairment of goodwill

 

 

 

 

 

 

 

429,020

 

 

 

 

 

 

 

 

 

 

 

 

989,971

 

Income (loss) before non-controlling interests, net income from operating affiliates and income tax expense

 

 

 

708,606

 

 

 

 

(420,962

)

 

 

 

 

684,746

 

 

 

 

134,714

 

 

 

 

(872,989

)

 

Income (loss) from operating affiliates (1)(2)

 

 

 

55,810

 

 

 

 

76,786

 

 

 

 

121,372

 

 

 

 

60,480

 

 

 

 

(1,458,246

)

 

Preference share dividends (3)

 

 

 

 

 

 

 

74,521

 

 

 

 

80,200

 

 

 

 

78,645

 

Net income (loss) attributable to ordinary shareholders

 

 

 

651,134

 

 

 

 

(474,760

)

 

 

 

 

585,472

 

 

 

 

206,607

 

 

 

 

(2,632,458

)

 

56


 

 

 

 

 

 

 

 

 

 

 

 

 

2012

 

2011

 

2010

 

2009

 

2008

 

 

(U.S. dollars in thousands, except per share amounts)

Per Share Data:

 

 

 

 

 

 

 

 

 

 

Earnings (loss) per ordinary share and ordinary share equivalent – basic (4)(5)

 

 

$

 

2.12

 

 

 

$

 

(1.52

)

 

 

 

$

 

1.74

 

 

 

$

 

0.61

 

 

 

$

 

(10.94

)

 

Earnings (loss) per ordinary share and ordinary share equivalent – diluted (4)(5)

 

 

$

 

2.10

 

 

 

$

 

(1.52

)

 

 

 

$

 

1.73

 

 

 

$

 

0.61

 

 

 

$

 

(10.94

)

 

Weighted average ordinary shares and ordinary share equivalents outstanding – diluted (4)

 

 

 

310,282

 

 

 

 

312,896

 

 

 

 

337,709

 

 

 

 

340,966

 

 

 

 

240,657

 

Cash dividends per ordinary share

 

 

$

 

0.44

 

 

 

$

 

0.44

 

 

 

$

 

0.40

 

 

 

$

 

0.40

 

 

 

$

 

1.14

 

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

Total investments – available for sale (“AFS”)

 

 

$

 

28,818,982

 

 

 

$

 

27,017,285

 

 

 

$

 

27,677,553

 

 

 

$

 

29,307,171

 

 

 

$

 

27,464,510

 

Total investments – held to maturity (“HTM”)

 

 

 

2,814,447

 

 

 

 

2,668,978

 

 

 

 

2,728,335

 

 

 

 

546,067

 

 

 

 

 

Cash and cash equivalents

 

 

 

2,618,378

 

 

 

 

3,825,125

 

 

 

 

3,022,868

 

 

 

 

3,643,697

 

 

 

 

4,353,826

 

Investments in affiliates

 

 

 

1,126,875

 

 

 

 

1,052,729

 

 

 

 

1,127,181

 

 

 

 

1,185,604

 

 

 

 

1,552,789

 

Unpaid losses and loss expenses recoverable

 

 

 

3,382,101

 

 

 

 

3,654,948

 

 

 

 

3,671,887

 

 

 

 

3,584,028

 

 

 

 

3,997,722

 

Premiums receivable

 

 

 

2,568,861

 

 

 

 

2,411,611

 

 

 

 

2,414,912

 

 

 

 

2,597,602

 

 

 

 

3,135,985

 

Total assets

 

 

 

45,387,779

 

 

 

 

44,665,265

 

 

 

 

44,995,040

 

 

 

 

45,663,894

 

 

 

 

45,702,786

 

Unpaid losses and loss expenses

 

 

 

20,484,121

 

 

 

 

20,613,901

 

 

 

 

20,531,607

 

 

 

 

20,823,524

 

 

 

 

21,650,315

 

Future policy benefit reserves

 

 

 

4,812,045

 

 

 

 

4,845,394

 

 

 

 

5,075,127

 

 

 

 

5,490,119

 

 

 

 

5,452,865

 

Unearned premiums

 

 

 

3,755,920

 

 

 

 

3,555,310

 

 

 

 

3,484,830

 

 

 

 

3,651,310

 

 

 

 

4,217,931

 

Notes payable and debt

 

 

 

1,672,778

 

 

 

 

2,275,327

 

 

 

 

2,457,003

 

 

 

 

2,451,417

 

 

 

 

3,189,734

 

Shareholders’ equity

 

 

 

11,856,397

 

 

 

 

10,756,130

 

 

 

 

10,599,769

 

 

 

 

9,432,417

 

 

 

 

6,116,831

 

Fully diluted tangible book value per ordinary share

 

 

$

 

33.35

 

 

 

$

 

28.31

 

 

 

$

 

27.14

 

 

 

$

 

22.13

 

 

 

$

 

12.88

 

Operating Ratios:

 

 

 

 

 

 

 

 

 

 

Loss and loss expense ratio (6)

 

 

 

65.3

%

 

 

 

 

76.6

%

 

 

 

 

63.8

%

 

 

 

 

61.5

%

 

 

 

 

66.2

%

 

Underwriting expense ratio (7)

 

 

 

31.0

%

 

 

 

 

30.9

%

 

 

 

 

31.0

%

 

 

 

 

32.1

%

 

 

 

 

28.7

%

 

Combined ratio (8)

 

 

 

96.3

%

 

 

 

 

107.5

%

 

 

 

 

94.8

%

 

 

 

 

93.6

%

 

 

 

 

94.9

%

 


 

 

(1)

 

 

 

We generally record the income related to alternative fund affiliates on a one-month lag and the private investment fund affiliates on a three-month lag in order for us to meet the filing deadlines for its periodic reports. We generally record the income related to operating affiliates on a three-month lag.

 

(2)

 

 

 

In 2008, net loss from operating affiliates includes losses totaling approximately $1.4 billion related to the closing of the Master Agreement as well as losses recorded throughout 2008 and up until the closing of the Master Agreement that were associated with previous reinsurance and guarantee agreements with Syncora. In 2010, net income from operating affiliates included $50.2 million relating to sale of a majority of our shareholding in Primus Guaranty Ltd.

 

(3)

 

 

 

Preference dividends represent dividends on the Redeemable Series C preference ordinary shares and the Series D and E preference ordinary shares. Following our Redomestication, subsequent to July 1, 2010, the Redeemable Series C preference ordinary shares and the Series E preference ordinary shares represent non-controlling interests in our consolidated financial statements. For additional information see Item 8, Note 1, “General,” to the Consolidated Financial Statements.

 

(4)

 

 

 

Effective for the fiscal year beginning January 1, 2009 and for all interim periods within 2009, we adopted final authoritative guidance that addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing basic earnings per share (“EPS”) pursuant to the two-class method described in EPS guidance. A share-based payment award that contains a non-forfeitable right to receive cash when dividends are paid to ordinary shareholders irrespective of whether that award ultimately vests is considered a participating security as these rights to dividends provide a non-contingent transfer of value to the holder of the share-based payment award. Accordingly, these awards are included in the computation of basic EPS pursuant to the two-class method. Under the terms of our restricted stock awards, grantees are entitled to receive dividends on the unvested portions of their awards. There is no requirement to return these dividends in the event the unvested awards are forfeited in the future. Accordingly, this guidance had an impact on our EPS calculations. All prior period EPS data presented has been adjusted retrospectively to conform to the provisions of this guidance. The adoption of this guidance reduced basic loss per ordinary share for fiscal 2008 by $0.08 and reduced diluted loss per ordinary share for fiscal 2008.

 

(5)

 

 

 

Effective April 1, 2009, we adopted final authoritative guidance that addressed the treatment of credit losses on investments. This guidance was not applied retroactively.

57


 

(6)

 

 

 

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

 

(7)

 

 

 

The underwriting expense ratio related to the property and casualty operations is the sum of acquisition expenses and operating expenses for the Insurance and Reinsurance segments divided by net premiums earned for the Insurance and Reinsurance segments. See Item 8, Note 4, “Segment Information,” to the Consolidated Financial Statements included herein, for further information.

 

(8)

 

 

 

The combined ratio related to the property and casualty operations is the sum of the loss and loss expense ratio and the underwriting expense ratio. A combined ratio under 100% represents an underwriting profit and over 100% represents an underwriting loss.

58


 

 

 

 

 

 

ITEM 7.

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

 

 

This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains forward-looking statements which involve inherent risks and uncertainties. Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements. These statements are based upon current plans, estimates and expectations. Actual results may differ materially from those projected in such forward-looking statements, and therefore undue reliance should not be placed on them. See “Cautionary Note Regarding Forward-Looking Statements,” for a list of additional factors that could cause actual results to differ materially from those contained in any forward-looking statement.

This discussion and analysis should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto presented under Item 8.

Certain aspects of our business have loss experience characterized as low frequency and high severity. This may result in volatility in both our results of operations and financial condition.

Index

 

 

 

Cautionary Note Regarding Forward-Looking Statements

 

 

 

60

 

Executive Overview

 

 

 

61

 

Results of Operations and Key Financial Measures

 

 

 

63

 

Reconciliation of Non-GAAP Measures

 

 

 

66

 

Significant Items Affecting the Results of Operations

 

 

 

66

 

Other Key Focuses of Management

 

 

 

69

 

Critical Accounting Policies and Estimates

 

 

 

70

 

Segments

 

 

 

83

 

Income Statement Analysis

 

 

 

84

 

Insurance

 

 

 

84

 

Reinsurance

 

 

 

88

 

Life Operations

 

 

 

91

 

Investment Performance

 

 

 

92

 

Investment Activities

 

 

 

93

 

Net Realized Gains and Losses on Investments and Other-Than-Temporary Declines in the Value Of Investments

 

 

 

94

 

Net Realized and Unrealized Gains and Losses on Derivative Instruments

 

 

 

94

 

Other Revenues and Expenses

 

 

 

95

 

Balance Sheet Analysis

 

 

 

97

 

Investments

 

 

 

97

 

Gross and Net Unrealized Gains and Losses on Investments

 

 

 

98

 

Fair Value Measurements of Assets and Liabilities

 

 

 

104

 

Unpaid Losses and Loss Expenses

 

 

 

105

 

Unpaid Losses and Loss Expenses Recoverable and Reinsurance Balances Receivable

 

 

 

106

 

Liquidity and Capital Resources

 

 

 

107

 

Holding Company Liquidity

 

 

 

108

 

Sources of Liquidity

 

 

 

109

 

Capital Resources

 

 

 

110

 

Covenants

 

 

 

114

 

Cross-Default and Other Provisions in Debt Instruments

 

 

 

114

 

Long-Term Contractual Obligations

 

 

 

115

 

Variable Interest Entities and Other Off-Balance Sheet Arrangements

 

 

 

115

 

Recent Accounting Pronouncements

 

 

 

116

 

59


Cautionary Note Regarding Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995 (“PSLRA”) provides a “safe harbor” for forward-looking statements. Any prospectus, prospectus supplement, Annual Report to ordinary shareholders, proxy statement, Form 10-K, Form 10-Q or Form 8-K or any other written or oral statements made by us or on our behalf may include forward-looking statements that reflect our current views with respect to future events and financial performance. Such statements include forward-looking statements both with respect to us in general, and to the insurance and reinsurance sectors in particular (both as to underwriting and investment matters). Statements that include the words “expect,” “intend,” “plan,” “believe,” “project,” “anticipate,” “will,” “may” and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the PSLRA or otherwise.

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

 

 

 

 

changes in the size of our claims relating to natural or man-made catastrophe losses due to the preliminary nature of some reports and estimates of loss and damage to date;

 

 

 

 

trends in rates for property and casualty insurance and reinsurance;

 

 

 

 

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

 

 

 

 

changes in ratings or rating agency policies or practices;

 

 

 

 

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

 

 

 

 

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

 

 

 

 

our ability to successfully implement our business strategy;

 

 

 

 

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

 

 

 

 

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

 

 

 

 

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

 

 

 

 

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

 

 

 

 

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

 

 

 

 

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

 

 

 

 

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

 

 

 

 

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

 

 

 

 

the ability of our subsidiaries to pay dividends to XL-Ireland and XL-Cayman;

 

 

 

 

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

 

 

 

 

changes in regulations or laws applicable to XL-Ireland or our subsidiaries, brokers or customers;

 

 

 

 

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

 

 

 

 

changes in the availability, cost or quality of reinsurance;

60


 

 

 

 

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

 

 

 

 

loss of key personnel;

 

 

 

 

changes in accounting policies or practices or the application thereof;

 

 

 

 

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

 

 

 

 

the effects of mergers, acquisitions and divestitures;

 

 

 

 

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

 

 

 

 

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

 

 

 

 

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

 

 

 

 

our ability to realize the expected benefits from the Redomestication; and

 

 

 

 

the other factors set forth in Item 1A, “Risk Factors,” and our other documents on file with the SEC.

The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included herein or elsewhere. We undertake no obligation to update publicly or revise any forward-looking statement, whether as a result of new information, future developments or otherwise, except as required by the federal securities laws.

Executive Overview

Background

We are, through our subsidiaries, a global insurance and reinsurance company providing property, casualty and specialty products to industrial, commercial and professional firms, insurance companies and other enterprises on a worldwide basis. We operate in markets where we believe our underwriting expertise and financial strength represent a relative advantage. We earn revenue primarily from net premiums written and earned. For further information regarding our operations, see Item 1, “Business.”

Impact of Recent Natural Catastrophes

In both 2011 and 2012, the global insurance and reinsurance markets experienced significant losses from natural catastrophes. See “Significant Items Affecting Results of Operations—1) The impact of significant large loss events” below for a discussion of our loss estimates for the year ended December 31, 2012 from natural catastrophes.

Underwriting Environment and Outlook for 2013

The property and casualty insurance and reinsurance markets have historically been cyclical, meaning that based on market conditions, there have been periods where premium rates are high and policy terms and conditions are more favorable to us (a “hard market”) and there have been periods where premium rates decline and policy terms and conditions are less favorable (a “soft market”). Market conditions are driven primarily by competition in the marketplace, the supply of capital in the industry, investment yields and the frequency and severity of loss events. Our goal is to build long-term shareholder value by capitalizing on current opportunities and managing through any cyclical downturns by reducing our property and casualty book of business and exposures if and when rates deteriorate during soft market periods.

In 2012, we continued to focus on strategic growth initiatives, building on the significant investments we have made in recent years to achieve greater efficiency from improved systems, to create a platform from which we can grow as markets allow and to expand our margins. The following outlines some of these growth initiatives as well as recent renewal activity and January 2013 rate indications for each of our Insurance and Reinsurance segments together with any potential trends relevant to our P&C operations.

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Insurance

The trading environment for the core lines of insurance business that we write remains competitive. However, the favorable pricing trends that we began seeing in late 2011 have continued throughout 2012. While we continue our disciplined underwriting approach to grow on a very selective basis and exit lines where margins are unacceptable, our retention ratios and new business development continue to remain strong as we move premium rates upward in nearly all of our businesses.

We continue to develop new business opportunities in several areas, including our North American construction and surety businesses, which were announced in 2010, and our political risk and trade credit, and North America inland marine businesses, which were announced during the fourth quarter of 2011. We also continue to expand existing businesses such as adding property, excess auto and excess liability to our excess & surplus business and expanding local underwriting in our North America excess casualty business by adding underwriters in Dallas, Atlanta and Exton, PA. Geographic expansion also continues with the opening of an office in China in April 2011 and an office in Brazil in June of 2012—complementing the Reinsurance operation with an Insurance segment branch offering Casualty, Property, Professional and Specialty products.

With regard to market conditions, within the Insurance segment’s core lines of business, fourth quarter and full year 2012 renewals reflected sustainable rate increases both in aggregate and across nearly all business lines. For the full year, we experienced positive pricing of over 3%, and in our North America P&C business unit the increase was more than 6%. Professional pricing was also positive for the year where there was material improvement in the U.S. D&O book where rate increases exceeded 5% during the fourth quarter and nearly 4% for the full the year. International P&C and Specialty also finished the year with positive rate increases in the low single digits, with a very strong fourth quarter for IPC, but a flat quarter for Specialty due to the competitive December airline renewals.

We continue to focus on those lines of business that we believe provide the best return on capital, including the writing of selective new business and remaining committed to the underwriting actions necessary to improve our margins. For 2013, initial indications are consistent with current market conditions described above.

Reinsurance

As noted above, the pricing environment on the primary side is showing rate growth but both the primary and reinsurance markets remain highly competitive with substantial capacity available in both traditional and non-traditional forms. In general, January 1 renewals saw pricing in line with management’s expectations, with positive pricing across the loss impacted catastrophe books of business and certain specialty lines, while casualty lines remained highly competitive.

In property catastrophe lines we saw loss impacted programs from Storm Sandy experience 10 to 15% rate increases while renewal rates for non-loss impacted U.S. programs were flat. In Europe, with the exception of Italy where we saw double digit increases as a result of the earthquake, prices decreased in the 3 to 5% range. For specialty lines, there were significant price increases in the marine lines due to Storm Sandy, which was the latest in a series of significant losses into that market, while rates in the aviation lines were flat to down 5% due to continued good experience. The casualty markets in both the U.S. and International still remain highly competitive. We saw certain ceding companies increasing their retention levels, a pattern we have seen repeatedly in recent years, while reinsurers that tried to increase their line size at renewal, did so with limited success.

The Reinsurance segment continues to develop new business opportunities in several areas and in 2013, we expect to continue to build upon the strategic growth achieved in recent years and will utilize our broad market relationships and experience to seek opportunities to achieve this.

There can be no assurance, however, that such (re)insurance rate conditions or growth opportunities will be sustained or further materialize, or lead to improvements in our books of business. See “Cautionary Note Regarding Forward-Looking Statements.”

62


Investment Environment

We seek to generate book value growth and investment income from investment activities through the total returns on our investment portfolio. During the year ended December 31, 2012, credit spreads tightened and interest rates declined in the majority of the currencies in which we hold assets. Net investment income yields were negatively impacted by lower interest rates and spreads, which in turn reduced prevailing yields on reinvestment income. Net realized gains resulted from sales transactions primarily from a repositioning of the Agency RMBS portfolio and sales of equity and non-U.S. Sovereign Government securities. The impact of tightening credit spreads and decreasing interest rates during 2012 was the primary reason for the improvement in the net unrealized position on fixed maturities and short-term investments over the course of the year. For further information, see “Investment Activities” below.

Results of Operations and Key Financial Measures

Results of Operations

The following table presents an analysis of our net income (loss) attributable to ordinary shareholders and other financial measures (described below) for the years ended December 31, 2012, 2011 and 2010:

 

 

 

 

 

 

 

(U.S. dollars in thousands, except share and per share amounts)

 

2012

 

2011

 

2010

Net income (loss) attributable to ordinary shareholders

 

 

$

 

651,134

 

 

 

$

 

(474,760

)

 

 

 

$

 

585,472

 

Earnings (loss) per ordinary share – basic

 

 

$

 

2.12

 

 

 

$

 

(1.52

)

 

 

 

$

 

1.74

 

Earnings (loss) per ordinary share – diluted

 

 

$

 

2.10

 

 

 

$

 

(1.52

)

 

 

 

$

 

1.73

 

Weighted average number of ordinary shares and ordinary share equivalents – basic

 

 

 

307,372

 

 

 

 

312,896

 

 

 

 

336,283

 

Weighted average number of ordinary shares and ordinary share equivalents – diluted

 

 

 

310,282

 

 

 

 

312,896

 

 

 

 

337,709

 

Key Financial Measures

The following are some of the financial measures management considers important in evaluating our operating performance:

 

 

 

 

 

 

 

(U.S. dollars in thousands, except ratios)

 

2012

 

2011

 

2010

Underwriting profit (loss) – P&C operations

 

 

$

 

216,138

 

 

 

$

 

(397,353

)

 

 

 

$

 

262,494

 

Combined ratio – P&C operations

 

 

 

96.3

%

 

 

 

 

107.5

%

 

 

 

 

94.8

%

 

Net investment income – P&C operations

 

 

$

 

712,906

 

 

 

$

 

819,708

 

 

 

$

 

884,866

 

Operating net income

 

 

$

 

614,102

 

 

 

$

 

89,464

 

 

 

$

 

809,650

 

Operating net income per share

 

 

$

 

1.98

 

 

 

$

 

0.28

 

 

 

$

 

2.40

 

Return on average ordinary shareholders’ equity

 

 

 

6.5

%

 

 

 

 

(5.0

)%

 

 

 

 

6.5

%

 

Operating return on average ordinary shareholders’ equity

 

 

 

6.2

%

 

 

 

 

0.9

%

 

 

 

 

9.0

%

 

Book value per ordinary share

 

 

$

 

35.18

 

 

 

$

 

29.81

 

 

 

$

 

30.33

 

Fully diluted tangible book value per ordinary share

 

 

$

 

33.35

 

 

 

$

 

28.31

 

 

 

$

 

27.14

 

The following are descriptions of these key financial measures and a brief discussion of the factors influencing them:

Underwriting profit – property and casualty (“P&C”) operations

One way that we evaluate the performance of our insurance and reinsurance operations is by underwriting profit or loss. We do not measure performance based on the amount of gross premiums written. Underwriting profit or loss is calculated from premiums earned less net losses incurred and expenses related to underwriting activities. Our underwriting profit (loss) in the year ended December 31, 2012 was consistent with the combined ratio discussed below.

Combined ratio – P&C operations

In the P&C industry, the combined ratio is a widely used measure of underwriting profitability. The combined ratio is calculated from the net losses incurred and underwriting expenses as a ratio of the net

63


premiums earned for our insurance and reinsurance operations. A combined ratio of less than 100% indicates an underwriting profit and greater than 100% reflects an underwriting loss.

Our combined ratio of 96.3% for the year ended December 31, 2012 was lower than the 107.5% combined ratio in 2011, primarily due to a decrease in the loss and loss expense ratio while the underwriting expense ratio was flat. The loss and loss expense ratio, which is the ratio of losses and loss expenses incurred to net premiums earned, has decreased as a result of lower levels of catastrophe losses and other large loss events as compared to 2011. The underwriting expense ratio, which was flat year on year, is the ratio of the sum of acquisition costs and operating expenses to the net premiums earned.

Our combined ratio of 107.5% for the year ended December 31, 2011 was higher than the 94.8% combined ratio in 2010, primarily as a result of an increase in the loss and loss expense ratio while the underwriting expense ratio was flat. The loss and loss expense ratio increased in 2011 as a result of higher levels of catastrophe losses and other large loss events in both the insurance and reinsurance segments. For further information on our combined ratio, see “Income Statement Analysis” below.

Net investment income – P&C operations

Net investment income related to P&C operations, which includes interest and dividend income together with the amortization of premium and discount on fixed maturities and short-term investments, net of related investment expenses, is an important measure that affects our overall profitability. Our largest liability relates to our unpaid loss reserves, and our investment portfolio provides liquidity for claims settlements of these reserves as they become due. As a result, a significant part of the investment portfolio is invested in fixed income securities. Net investment income is influenced by a number of factors, including the amounts and timing of inward and outward cash flows, the level of interest rates and credit spreads and changes in overall asset allocation. See the segment results at “Investment Activities” below for a discussion of our net investment income for the year ended December 31, 2012.

Operating net income and Operating net income per share

Operating net income is a non-GAAP financial measure defined as net income (loss) attributable to ordinary shareholders excluding: (1) our net realized gains and losses on investments, net of tax, (2) our net realized and unrealized gains and losses on derivatives, net of tax, (3) our share of items (1) and (2) for our insurance company affiliates for the periods presented, (4) goodwill impairment charges, net of tax, (5) the gains recognized on our repurchase of XL-Cayman’s preference ordinary shares and (6) foreign exchange gains or losses, net of tax. We evaluate the performance of and manage our business to produce an underwriting profit. In addition to presenting net income (loss), we believe that showing operating net income (loss) enables investors and other users of our financial information to analyze our performance in a manner similar to how we analyze performance. In this regard, we believe that providing only a GAAP presentation of net income (loss) makes it more difficult for users of our financial information to evaluate our underlying business. We also believe that the equity analysts and certain rating agencies that follow us (and the insurance industry as a whole) exclude these items from their analyses for the same reasons and they request that we provide this non-GAAP financial information on a regular basis. A reconciliation of our net income (loss) attributable to ordinary shareholders to operating net income (loss) is provided at the end of “Key Financial Measures” below.

Operating net income per share is derived from the non-GAAP operating net income measure by dividing operating net income by the weighted average number of ordinary shares and ordinary share equivalents outstanding for each period.

Return on average ordinary shareholders’ equity (“ROE”)

ROE is another non-GAAP financial measure that we consider important in evaluating our operating performance and view as a key measure of return generated for ordinary shareholders. ROE is calculated by dividing the net income (loss) attributable to ordinary shareholders for any period by the average of the opening and closing ordinary shareholders’ equity. We establish minimum target ROEs for our total operations, segments and lines of business. If our minimum ROE targets over the longer term are not met with respect to any line of business, we seek to modify and/or exit this line. In addition, among other

64


factors, compensation of our senior officers is dependent on the achievement of our performance goals to enhance ordinary shareholder value as measured by ROE (adjusted for certain items considered to be “non-operating” in nature).

In 2012, ROE was 6.5%, which was 11.5 percentage points higher than 2011 when it was negative 5.0%. In 2011, ROE was negative due to the net loss from the significant catastrophe losses and the impairment of goodwill and other large loss events which are discussed under “Significant Items Affecting the Results of Operations.”

Operating return on average ordinary shareholders’ equity (“Operating ROE”)

Operating ROE is another non-GAAP financial measure that we consider important in evaluating our operating performance. Operating ROE is derived from the non-GAAP operating net income measure by dividing the operating net income for any period by the average of the opening and closing ordinary shareholders’ equity.

In 2012, Operating ROE was 6.2%, which was 5.3 percentage points higher than 2011 when it was 0.9%. This was the result of the lower operating net income in 2011 due to the significant catastrophe losses and other large loss events, both discussed under “Significant Items Affecting the Results of Operations.” A reconciliation of Net income (loss) attributable to ordinary shareholders to operating net income (loss) is provided at “Reconciliation of Non-GAAP Measures” included herein.

Book value per ordinary share

We view the change in our book value per ordinary share as an additional measure of our performance, representing the value generated for our ordinary shareholders each period, and we believe that this measure (along with the diluted measures described below) is a key driver of our share price over time. Book value per ordinary share, a non-GAAP financial measure, is calculated by dividing ordinary shareholders’ equity (total shareholders’ equity less non-controlling interest in equity of consolidated subsidiaries) by the number of outstanding ordinary shares at the applicable period end. Book value per ordinary share is affected primarily by net income (loss), by any changes in the net unrealized gains and losses on our investment portfolio, by currency translation adjustments and by the impact of any share buyback or issuance activity. Ordinary shareholders’ equity was $10.5 billion and $9.4 billion and the number of ordinary shares outstanding was 298.7 million and 315.7 million at December 31, 2012 and 2011, respectively. Ordinary shares outstanding include all ordinary shares legally issued and outstanding (as disclosed on the face of the balance sheet) as well as all director share units outstanding.

Book value per ordinary share increased by $5.37 in 2012 as compared to a decrease of $0.52 during 2011. The increase in 2012 was primarily due the net income attributable to ordinary shareholders, an increase in net unrealized gains on investments and the benefit of share buyback activity.

The decrease in 2011 was primarily due to the net loss attributable to ordinary shareholders of $474.8 million and the impact of the settlement of the forward purchase contracts associated with the 10.75% equity security units (the “10.75% Units”), which resulted in the issuance of an aggregate of 30,456,600 ordinary shares, partially offset by an increase in net unrealized gains on available for sale investments and the benefit of share buyback activity.

Fully diluted tangible book value per ordinary share

Fully diluted tangible book value per ordinary share is a non-GAAP financial measure and is calculated by dividing ordinary shareholders’ equity excluding intangible assets (as disclosed on the face of the balance sheet) by the number of outstanding ordinary shares at any period end combined with the impact from dilution of share-based compensation and certain conversion features where dilutive. Fully diluted tangible book value per ordinary share increased by $5.04 and $1.17 during the years ended December 31, 2012 and 2011, respectively, as a result of the factors noted above.

65


Reconciliation of Non-GAAP Measures

The following is a reconciliation of net income (loss) attributable to ordinary shareholders to operating net income (loss) and also includes the calculation of return on average ordinary shareholders’ equity (based on operating net income (loss)) for the years ended December 31, 2012, 2011 and 2010:

 

 

 

 

 

 

 

(U.S. dollars in thousands, except percentages)

 

2012

 

2011

 

2010

Net income (loss) attributable to ordinary shareholders

 

 

$

 

651,134

 

 

 

$

 

(474,760

)

 

 

 

$

 

585,472

 

Impairment of goodwill, net of tax

 

 

 

 

 

 

 

417,566

 

 

 

 

 

Net realized losses (gains) on investments, net of tax

 

 

 

(38,235

)

 

 

 

 

178,432

 

 

 

 

270,803

 

Net realized and unrealized losses (gains) on derivatives, net of tax

 

 

 

(5,216

)

 

 

 

 

3,914

 

 

 

 

29,932

 

Net realized and unrealized losses (gains) on investments and derivatives related to the Company’s insurance company affiliates

 

 

 

(301

)

 

 

 

 

(322

)

 

 

 

 

(52,623

)

 

Foreign exchange (gains) losses, net of tax

 

 

 

6,720

 

 

 

 

(34,016

)

 

 

 

 

(7,318

)

 

Gain on repurchase of non-controlling interest preference ordinary shares

 

 

 

 

 

 

 

(1,350

)

 

 

 

 

(16,616

)

 

 

 

 

 

 

 

 

Operating net income (loss):

 

 

$

 

614,102

 

 

 

$

 

89,464

 

 

 

$

 

809,650

 

 

 

 

 

 

 

 

Per ordinary share results:

 

 

 

 

 

 

Net income (loss) attributable to ordinary shareholders

 

 

$

 

2.10

 

 

 

$

 

(1.52

)

 

 

 

$

 

1.73

 

Operating net income (loss)

 

 

$

 

1.98

 

 

 

$

 

0.28

 

 

 

$

 

2.40

 

Weighted average ordinary shares outstanding:

 

 

 

 

 

 

Basic

 

 

 

307,371,726

 

 

 

 

312,896,165

 

 

 

 

336,282,630

 

Diluted – Net income

 

 

 

310,282,466

 

 

 

 

312,896,165

 

 

 

 

337,708,643

 

Diluted – Operating net income

 

 

 

310,282,466

 

 

 

 

316,318,339

 

 

 

 

337,708,643

 

Operating return on average ordinary shareholders’ equity:

 

 

 

 

Closing ordinary shareholders’ equity

 

 

$

 

10,510,072

 

 

 

$

 

9,411,658

 

 

 

$

 

9,597,473

 

Average ordinary shareholders’ equity

 

 

$

 

9,960,865

 

 

 

$

 

9,504,565

 

 

 

$

 

9,007,152

 

Operating net income (loss)

 

 

$

 

614,102

 

 

 

$

 

89,464

 

 

 

$

 

809,650

 

Operating ROE

 

 

 

6.2

%

 

 

 

 

0.9

%

 

 

 

 

9.0

%

 

 

 

 

 

 

 

 

Significant Items Affecting the Results of Operations

Our net income and other financial measures as shown above for the year ended December 31, 2012 have been affected by, among other things, the following significant items:

 

1)

 

 

 

The impact of significant large loss events;

 

2)

 

 

 

Continuing competitive factors impacting the underwriting environment;

 

3)

 

 

 

Net favorable prior year loss development; and

 

4)

 

 

 

Market movement impacts on our investment portfolio.

1) The impact of significant large loss events

Natural Catastrophe Losses

The following table outlines the underwriting losses and loss ratio impact for the Insurance and Reinsurance segments from natural catastrophes for the years ended December 31:

 

 

 

 

 

 

 

 

 

 

 

 

 

(U.S. dollars in thousands, except ratios)

 

Natural Catastrophe
Underwriting Losses

 

Natural Catastrophe
Loss Ratio Impact

 

2012

 

2011

 

2010

 

2012

 

2011

 

2010

Insurance

 

 

$

 

223,148

 

 

 

$

 

355,256

 

 

 

$

 

135,771

 

 

 

 

5.5

%

 

 

 

 

9.6

%

 

 

 

 

3.8

%

 

Reinsurance

 

 

 

241,169

 

 

 

 

405,870

 

 

 

 

158,574

 

 

 

 

13.8

%

 

 

 

 

25.2

%

 

 

 

 

10.6

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total P&C

 

 

$

 

464,317

 

 

 

$

 

761,126

 

 

 

$

 

294,345

 

 

 

 

8.2

%

 

 

 

 

14.4

%

 

 

 

 

5.8

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

66


Notable natural catastrophes during 2012 included Storm Sandy (“Sandy”), U.S. tornadoes and the large earthquake in Italy.

Notable natural catastrophes during 2011 included the March 11, 2011 earthquake and tsunami in Japan, the earthquake that struck Christchurch, New Zealand on February 22, 2011, the 2011 flooding events in Australia, the severe weather occurrences, including tornado activity, in the United States during April and May 2011, the Atlantic Hurricanes (Hurricane Irene and Tropical Storm Lee) and the Thailand floods.

Notable natural catastrophes during 2010 included the Chilean Earthquake, European Windstorm Xynthia, U.S. tornadoes and hailstorm activity, the New Zealand Earthquake and floods in Central Europe, China, Poland and Queensland, Australia.

Our loss estimates are based on combinations of our review of individual treaties and policies expected to be impacted, commercial model outputs, client data received to the date the estimates are made, and consideration of expectations of total insured market loss estimates if available, both from published sources and our internal analysis. Our loss estimates involve the exercise of considerable judgment due to the complexity and scale of the insured events, and are, accordingly, subject to revision as additional information becomes available. Actual losses may differ materially from these preliminary estimates.

The following are analyses of the financial impact on our results of operations for the year ended December 31, 2012 from natural catastrophes:

 

 

 

 

 

 

 

(U.S. dollars in thousands, except ratios)

 

2012

 

Insurance

 

Reinsurance

 

Total

Operating data:

 

 

 

 

 

 

Catastrophe reinstatement premium earned:

 

 

 

 

 

 

Sandy

 

 

$

 

(11,813

)

 

 

 

$

 

25,560

 

 

 

$

 

13,747

 

Other natural catastrophes (1) (2)

 

 

 

(958

)

 

 

 

 

3,503

 

 

 

 

2,545

 

 

 

 

 

 

 

 

Total net premiums earned

 

 

$

 

(12,771

)

 

 

 

$

 

29,063

 

 

 

$

 

16,292

 

 

 

 

 

 

 

 

Gross losses and loss expenses:

 

 

 

 

 

 

Sandy

 

 

$

 

(207,106

)

 

 

 

$

 

(242,622

)

 

 

 

$

 

(449,728

)

 

Other natural catastrophes (1) (2)

 

 

 

(89,528

)

 

 

 

 

(41,352

)

 

 

 

 

(130,880

)

 

 

 

 

 

 

 

 

Total gross losses and loss expenses

 

 

$

 

(296,634

)

 

 

 

$

 

(283,974

)

 

 

 

$

 

(580,608

)

 

 

 

 

 

 

 

 

Losses and loss expenses recoverable:

 

 

 

 

 

 

Sandy

 

 

$

 

68,379

 

 

 

$

 

12,305

 

 

 

$

 

80,684

 

Other natural catastrophes (1) (2)

 

 

 

17,878

 

 

 

 

1,437

 

 

 

 

19,315

 

 

 

 

 

 

 

 

Total losses and loss expenses recoverable

 

 

$

 

86,257

 

 

 

$

 

13,742

 

 

 

$

 

99,999

 

 

 

 

 

 

 

 

Underwriting loss – P&C Operations:

 

 

 

 

 

 

Sandy

 

 

$

 

(150,540

)

 

 

 

$

 

(204,757

)

 

 

 

$

 

(355,297

)

 

Other natural catastrophes (1) (2)

 

 

 

(72,608

)

 

 

 

 

(36,412

)

 

 

 

 

(109,020

)

 

 

 

 

 

 

 

 

Total underwriting loss

 

 

$

 

(223,148

)

 

 

 

$

 

(241,169

)

 

 

 

$

 

(464,317

)

 

 

 

 

 

 

 

 

Loss ratio impact for year ended December 31, 2012

 

 

 

5.5

%

 

 

 

 

13.8

%

 

 

 

 

8.2

%

 

 

 

 

 

 

 

 


 

 

(1)

 

 

 

For the Insurance segment, for the year ended December 31, 2012, Other natural catastrophes include Italy snow storm, U.S.Tornadoes, Italy earthquake, Hurricane Isaac, Costa Rica Earthquake and New South Wales floods.

 

(2)

 

 

 

For the Reinsurance segment for the year ended December 31, 2012, Other natural catastrophes include U.S.Tornadoes, Italy earthquake, Hurricane Isaac, and Calgary hailstorm.

For further details see the segment results in the “Income Statement Analysis” below.

Large Non-Catastrophe Loss Events

In the year ended December 31, 2012, our results from operations were impacted by significant losses from large non-catastrophe loss events in both the Insurance and Reinsurance segments. In 2012, the impact was mainly related to a single large marine loss during the first quarter. Management’s loss estimate for this large marine loss at December 31, 2012, net of reinsurance recoveries and reinstatement premiums, was $58.5 million, of which $26.4 million was attributable to the Insurance segment and $32.1 million to the

67


Reinsurance segment. In addition, the results from operations during the year ended December 31, 2012 were affected by crop losses attributable to the severe drought conditions in the United States in 2012. Our preliminary loss estimate for these drought and crop losses net of reinsurance recoveries and reinstatement premiums was $30.8 million, all attributable to the Reinsurance segment.

See “Income Statement Analysis,” herein for further information regarding these large loss events within each applicable operating segment.

2) Continuing competitive factors impacting the underwriting environment

Soft market conditions were experienced across most lines of business throughout 2010, 2011 and 2012. This resulted in an overall decrease in gross and net premiums written in 2010 but these amounts increased in 2011 and 2012 due to new strategic initiatives and certain rate improvements. For further information in relation to the underwriting environment, including details relating to rates and retention, see “Executive Overview – Underwriting Environment and Outlook for 2013,” above.

3) Net favorable prior year loss development

Net favorable prior year loss development occurs when there is a decrease to loss reserves recorded at the beginning of the year, resulting from actual or reported loss development for prior years that is less than expected. Net prior year adverse loss development occurs when there is an increase to loss reserves recorded at the beginning of the year, resulting from actual or reported loss development for prior years exceeding expected loss development.

The following table presents the net (favorable) adverse prior year loss development of our loss and loss expense reserves for our property and casualty operations, which include the Insurance and Reinsurance segments for each of the years indicated:

 

 

 

 

 

 

 

(U.S. dollars in thousands)

 

2012

 

2011

 

2010

Insurance

 

 

$

 

(140,067

)

 

 

 

$

 

(76,516

)

 

 

 

$

 

(127,411

)

 

Reinsurance

 

 

 

(175,828

)

 

 

 

 

(208,351

)

 

 

 

 

(245,451

)

 

 

 

 

 

 

 

 

Total

 

 

$

 

(315,895

)

 

 

 

$

 

(284,867

)

 

 

 

$

 

(372,862

)

 

 

 

 

 

 

 

 

See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, Note 10, “Losses and Loss Expenses,” to the Consolidated Financial Statements included herein, for further information regarding the developments in prior year loss reserve estimates for each of the years indicated within each of our operating segments.

4) Market movement impacts on the Company’s investment portfolio

During the year ended December 31, 2012, credit spreads tightened and interest rates declined in the majority of the currencies in which we hold assets. The net impact of the market conditions on our investment portfolio was favorable and resulted in a positive mark to market change of $942.7 million on available for sale investments. This represents an approximately 2.1% appreciation in average assets for the year ended December 31, 2012.

The following table provides further detail regarding the movements in relevant credit markets, as well as in government interest rates using selected market indices:

 

 

 

 

 

 

 

Interest Rate Movement for the year
ended December 31, 2012 (1)
(‘+’/‘-’ represents increases / decreases
in interest rates)

 

Credit Spread Movement for the year ended
December 31, 2012 (2)
(‘+’/‘-’ represents widening / tightening of
credit spreads)

United States

 

-11 basis points (5 year Treasury)

 

-104 basis points (US Corporate A rated)
-35 basis points (US Mortgage Master Index)
-120 basis points (US CMBS, AAA rated)

United Kingdom

 

-15 basis points (10 year Gilt)

 

-72 basis points (UK Corporate, AA rated)

Euro-zone

 

-46 basis points (5 year Bund)

 

-170 basis points (Europe Corporate, A rated)


 

 

(1)

 

 

 

Source: Bloomberg Finance L.P.

 

(2)

 

 

 

Source: Merrill Lynch Global Indices.

68


Net realized gains on investments in the year ended December 31, 2012 totaled $14.1 million, including $94.8 million from sales activities partially offset by net realized losses of approximately $80.7 million related to other-than-temporary declines in investment (“OTTI”) charges on certain of our fixed income investments. For further analysis of this, see “Results of Operations” below.

Other Key Focuses of Management

We remain focused on, among other things, managing capital, enhancing enterprise risk management capabilities and monitoring regulatory change. Details of these initiatives are outlined below.

Capital Management

Fundamental to supporting our business model is our ability to underwrite business, which is largely dependent upon the quality of our claims paying and financial strength ratings as evaluated by independent rating agencies. As a result, in the event that we are downgraded, our ability to write business, as well as our financial condition and/or results of operations, could be adversely affected.

Buybacks of Ordinary Shares

On February 27, 2012, we announced that the XL-Ireland Board of Directors approved the February 2012 Program, authorizing the purchase of up to $750 million of our ordinary shares. This authorization replaced the approximately $190 million remaining under the share buyback program that was authorized in November 2010. During 2012, we purchased and canceled 18.3 million ordinary shares under the February 2012 Program for $401.6 million. At December 31, 2012, $348.4 million remained available for purchase under this program. Between January 1 and February 22, 2013 we purchased and canceled an additional 3.8 million shares for $98.4 million. All share buybacks were carried out by way of redemption in accordance with Irish law and XL-Ireland’s constitutional documents. All shares so redeemed were canceled upon redemption. On February 22, 2013, we announced that the XL-Ireland Board of Directors approved a new share buyback program, authorizing the purchase of up to $850 million of our ordinary shares. This replaced the approximately $250 million remaining under the February 2012 Program.

Repayment of the 6.5% Guaranteed Senior Notes due January 2012 (the “XLCFE Notes”)

On January 15, 2012, the $600 million principal amount outstanding on the XLCFE Notes, which were issued by XL Capital Finance (Europe) plc, was repaid at maturity. For further detail, see Item 1, Note 13, “Notes Payable and Debt Financing Arrangements,” to the Consolidated Financial Statements included herein.

Risk Management

Our risk management and risk appetite framework is detailed in Item 1, “Business – Enterprise Risk Management,” included herein. The table below shows our estimated per event net 1% and 0.4% exceedance probability exposures for certain peak natural catastrophe peril regions. These estimates assume that amounts due from reinsurance and retrocession purchases are 100% collectible. There may be credit or other disputes associated with these potential receivables.

 

 

 

 

 

 

 

 

 

 

 

 

 

Geographical Zone
(U.S. dollars in millions)

 

Peril

 

Measurement
Date
of In-Force
Exposures (1)

 

1% Exceedance
Probability

 

0.4% Exceedance
Probability

 

Probable
Maximum
Loss (2)

 

Percentage
of Tangible
Shareholders’
Equity at
December 31,
2012

 

Probable
Maximum
Loss (2)

 

Percentage
of Tangible
Shareholders’
Equity at
December 31,
2012

North Atlantic

 

 

 

Windstorm

 

 

 

 

October 1, 2012

 

 

 

$

 

1,283

 

 

 

 

11.2

%

 

 

 

$

 

1,708

 

 

 

 

14.9

%

 

North America

 

 

 

Earthquake

 

 

 

 

October 1, 2012

 

 

 

 

838

 

 

 

 

7.3

%

 

 

 

 

1,371

 

 

 

 

12.0

%

 

Europe

 

 

 

Windstorm

 

 

 

 

October 1, 2012

 

 

 

 

509

 

 

 

 

4.4

%

 

 

 

 

708

 

 

 

 

6.2

%

 

Japan

 

 

 

Earthquake

 

 

 

 

October 1, 2012

 

 

 

 

284

 

 

 

 

2.5

%

 

 

 

 

358

 

 

 

 

3.1

%

 

Japan

 

 

 

Windstorm

 

 

 

 

October 1, 2012

 

 

 

 

195

 

 

 

 

1.7

%

 

 

 

 

265

 

 

 

 

2.3

%

 

69



 

 

(1)

 

 

 

Detailed analyses of aggregated in-force exposures and maximum loss levels are done periodically. The measurement dates represent the date of the last completed detailed analysis by geographical zone.

 

(2)

 

 

 

Probable maximum losses, which include secondary uncertainty that incorporates variability around the expected probable maximum loss for each event, do not represent our maximum potential exposures and are pre-tax.

See “Significant Items Affecting the Results of Operations – 1) The impact of significant large loss events” above.

Regulatory Change

Management continues to actively monitor and assess the various regulatory initiatives and legislation that impacts us or in the future could impact us. For example, management has been focused on Solvency II, which was adopted by the European Parliament in April 2009. This is an E.U. directive covering the capital adequacy and risk management of, and regulatory reporting for, European-based (re)insurers, as well as a new supervisory regime for the insurance industry. Several steps must be taken by the European Commission, the European Parliament, the Council of Ministers and EIOPA to implement Solvency II. The final date of implementation and key elements of the framework remain under discussion, but it is widely accepted that the envisaged implementation date of January 1, 2014 will not be met. However, management currently continues to prepare for potential Solvency II implementation at a future date. See Item 1, “Business – Regulation.”

Critical Accounting Policies and Estimates

The following are considered to be our critical accounting policies and estimates due to the judgments and uncertainties affecting the application of these policies and/or the likelihood that materially different amounts would be reported under different conditions or using different assumptions. If actual events differ significantly from the underlying assumptions or estimates applied for any or all of the accounting policies (either individually or in the aggregate), there could be a material adverse effect on our results of operations, financial condition and liquidity. We have discussed these critical accounting policies with the Audit Committee of our Board of Directors.

Other significant accounting policies are nevertheless important to an understanding of our Consolidated Financial Statements. Policies such as those related to revenue recognition, financial instruments and consolidation require difficult judgments on complex matters that are often subject to multiple sources of authoritative guidance. See Item 8, Note 2, “Significant Accounting Policies,” to the Consolidated Financial Statements included herein for further information.

1) Unpaid Loss and Loss Expenses and Unpaid Loss and Loss Expenses Recoverable

As we earn premiums for the underwriting risks we assume, we also establish an estimate of the expected ultimate losses related to the premium. Loss reserves for unpaid loss and loss expenses are established due to the significant periods of time that may elapse between the occurrence, reporting and settlement of a loss. The process of establishing reserves for unpaid property and casualty claims can be complex and is subject to considerable variability, as it requires the use of informed estimates and judgments. These estimates and judgments are based on numerous factors, and may be revised as additional experience and other data become available and are reviewed, as new or improved methodologies are developed or as current laws change. Loss reserves include:

 

a)

 

 

 

Case reserves – reserves for reported losses and loss expenses that have not yet been settled; and

 

b)

 

 

 

IBNR reserves – reserves for incurred but not reported losses or for reported losses over and above the amount of case reserves.

Case Reserves

Case reserves for our property and casualty operations are established by management based on amounts reported from insureds or ceding companies and consultation with legal counsel, and represent the estimated ultimate cost of events or conditions that have been reported to or specifically identified by us. The method of establishing case reserves for reported claims differs among our operations.

70


With respect to our insurance operations, we are notified of insured losses and record a case reserve for the estimated amount of the settlement, if any. The estimate reflects the judgment of claims personnel based on general reserving practices, the experience and knowledge of such personnel regarding the nature of the specific claim and, where appropriate, advice of legal counsel. Reserves are also established to provide for the estimated expense of settling claims, including legal and other fees and the general expenses of administering the claims adjustment process. With respect to our reinsurance operations, case reserves for reported claims are generally established based on reports received from ceding companies. Additional case reserves may be established by us to reflect the estimated ultimate cost of a loss. The uncertainty in the reserving process for reinsurers is due, in part, to the time lags inherent in reporting from the original claimant to the primary insurer to the reinsurer. As a predominantly broker market reinsurer for both excess-of-loss and proportional contracts, we are subject to a potential additional time lag in the receipt of information as the primary insurer reports to the broker who in turn reports to us.

Since we rely on information regarding paid losses, case reserves and IBNR provided by ceding companies in order to assist us in estimating our liability for unpaid losses and LAE, we maintain certain procedures in order to help determine the completeness and accuracy of such information. Periodically, management assesses the reporting activities of our ceding companies on the basis of qualitative and quantitative criteria. In addition to conferring with ceding companies or brokers on claims matters, our claims personnel conduct periodic audits of specific claims and the overall claims procedures of our ceding companies at their offices. We rely on our ability to effectively monitor the claims handling and claims reserving practices of ceding companies in order to help establish the proper reinsurance premium for reinsurance agreements and to establish proper loss reserves. Disputes with ceding companies have been rare and generally have been resolved through negotiation.

In addition to information received from ceding companies on reported claims, we also utilize information on the pattern of ceding company loss reporting and loss settlements from previous catastrophic events in order to estimate our ultimate liability related to catastrophic events such as hurricanes. Commercial catastrophe model analyses and zonal aggregate exposures are utilized to assess potential client loss before and after an event. Initial cedant loss reports are generally obtained shortly after a catastrophic event, with subsequent updates received as new information becomes available. We actively request loss updates from cedants periodically while there is still considerable uncertainty for an event, often for the first year following an event. Our claim settlement processes also incorporate an update to the total loss reserve at the time a claim payment is made to a ceding company.

While the reliance on loss reports from ceding companies may increase the level of uncertainty associated with the estimation of total loss reserves for property catastrophe reinsurance relative to direct property insurance, there are several factors which serve to reduce the uncertainty in loss reserve estimates for property catastrophe reinsurance. First, for large natural catastrophe events, aggregate limits in property catastrophe reinsurance contracts are generally fully exhausted by the loss reserve estimates. Second, as a reinsurer, we have access to information from a broad cross section of the insurance industry. We utilize such information in order to perform consistency checks on the data provided by ceding companies and are able to identify trends in loss reporting and settlement activity and incorporate such information in our estimate of IBNR reserves. Finally, we also supplement the loss information received from cedants with loss estimates developed by market share techniques and/or from third party catastrophe models applied to exposure data supplied by cedants.

IBNR Reserves

IBNR reserves represent management’s best estimate, at a given point in time, of the amount in excess of case reserves that is needed for the future settlement and loss adjustment costs associated with claims incurred. It is possible that the ultimate liability may differ materially from these estimates. Because the ultimate amount of unpaid losses and LAE is uncertain, we believe that quantitative techniques to estimate these amounts are enhanced by professional and managerial judgment. Management reviews the IBNR estimates produced by our actuaries who determine the best estimate of the liabilities to record in our financial statements. We consider this single point estimate to be the mean expected outcome.

IBNR reserves are estimated by our actuaries using several standard actuarial methodologies including the loss ratio method, the loss development or chain ladder method, the Bornhuetter-Ferguson (“BF”)

71


method and frequency and severity approaches. IBNR related to a specific event may be based on our estimated exposure to an industry loss and may include the use of catastrophe modeling software. On a quarterly basis, IBNR reserves are reviewed by our actuaries, and are adjusted as new information becomes available. Any such adjustments are accounted for as changes in estimates and are reflected in the results of operations in the period in which they are made.

Our actuaries use one set of assumptions in calculating the single point estimate, which includes actual loss data, loss development factors, loss ratios, reported claim frequency and severity. The actuarial reviews and documentation are completed in accordance with professional actuarial standards with reserves established on a basis consistent with GAAP. The selected assumptions reflect the actuary’s judgment based on historical data and experience combined with information concerning current underwriting, economic, judicial, regulatory and other influences on ultimate claim settlements.

When estimating IBNR reserves, each of our insurance and reinsurance business units segregate business into exposure classes. Within each class, the business is further segregated by either the year in which the contract incepted (“underwriting year”), the year in which the claim occurred (“accident year”), or the year in which the claim is reported (“report year”). The majority of the Insurance segment is reviewed on an accident year basis. Professional lines insurance business is reviewed on a report year basis due to the claims made nature of the underlying policies. The majority of the Reinsurance segment is reviewed on an underwriting year basis. In each case we believe the selected method most accurately represents the economic condition of the business.

Generally, initial actuarial estimates of IBNR reserves not related to a specific event are based on the loss ratio method applied to each class of business. Actual paid losses and case reserves (“reported losses”) are subtracted from expected ultimate losses to determine IBNR reserves. The initial expected ultimate losses involve management judgment and are based on historical information for that class of business; which includes loss ratios, market conditions, changes in pricing and conditions, underwriting changes, changes in claims emergence, and other factors that may influence expected ultimate losses.

Over time, as a greater number of claims are reported, actuarial estimates of IBNR are based on the BF method and loss development techniques. The BF method utilizes actual loss data and the expected patterns of loss emergence, combined with an initial expectation of ultimate losses to determine an estimate of ultimate losses. This method may be appropriate when there is limited actual loss data and a relatively less stable pattern of loss emergence. The chain ladder method utilizes actual loss and expected patterns of loss emergence to determine an estimate of ultimate losses that is independent of the initial expectation of ultimate losses. This method may be appropriate when there is a relatively stable pattern of loss emergence and a relatively larger number of reported claims. Multiple estimates of ultimate losses using a variety of actuarial methods are calculated for each of our classes of business for each year of loss experience. Our actuaries look at each class and determine the most appropriate point estimate based on the characteristics of the particular class and other relevant factors, such as historical ultimate loss ratios, the presence of individual large losses, and known occurrences that have not yet resulted in reported losses. Once our actuaries make their determination of the most appropriate point estimate for each class, this information is aggregated and presented to management for review and approval.

The pattern of loss emergence is determined using actuarial analysis and judgment and is based on the historical patterns of the recording of paid and reported losses by us, as well as industry information. Information that may cause historical patterns to differ from future patterns is considered and reflected in expected patterns as appropriate. For property, marine and aviation insurance, losses are generally reported within 2 to 3 years from the beginning of the accident year. For casualty insurance, loss emergence patterns can vary from 3 years to over 20 years depending on the type of business. For other insurance, loss emergence patterns fall between the property and casualty insurance. For reinsurance business, loss reporting lags the corresponding insurance classes often by at least one quarter due to the need for loss information to flow from the ceding companies to us generally via reinsurance intermediaries. Such lags in loss reporting are reflected in the actuary’s selections of loss reporting patterns used in establishing our reserves.

Such estimates are not precise because, among other things, they are based on predictions of future developments and estimates of future trends in claim severity, claim frequency and other issues. In the process of estimating IBNR reserves, provisions for economic inflation and changes in the social and legal

72


environment are considered, but involve considerable judgment. When estimating IBNR reserves, more judgment is typically required for lines of business with longer loss emergence patterns.

Due to the low frequency and high severity nature of some of the business underwritten by us, our reserve estimates are highly dependent on actuarial and management judgment and are therefore uncertain. In property classes, there can be additional uncertainty in loss estimation related to large catastrophe events. With wind events, such as hurricanes, the damage assessment process may take more than a year. The cost of claims is subject to volatility due to supply shortages for construction materials and labor. In the case of earthquakes, the damage assessment process may take several years as buildings are discovered to have structural weaknesses not initially detected. The uncertainty inherent in IBNR reserve estimates is particularly pronounced for casualty coverages, such as excess liability, professional liability coverages and workers’ compensation, where information emerges relatively slowly over time.

Our three types of property and casualty reserve exposure with the longest tails are:

 

(1)

 

 

 

high layer excess casualty insurance;

 

(2)

 

 

 

casualty reinsurance; and

 

(3)

 

 

 

discontinued asbestos and long-tail environmental business.

Certain aspects of our casualty operations complicate the actuarial process for establishing reserves. Certain casualty business written by our insurance operations is high layer excess casualty business, meaning that our liability attaches after large deductibles, including self insurance or insurance from sources other than us. We commenced writing this type of business in 1986 and issued policies in forms that were different from traditional policies used by the industry at that time. Initially, there was a lack of industry data available for this type of business. Consequently, the basis for establishing loss reserves by us for this type of business was largely judgmental and based upon our own reported loss experience, which was used as a basis for determining ultimate losses and, therefore, IBNR reserves. Over time, the amount of available historical loss experience data has increased. As a result, we have obtained a larger statistical base to assist in establishing reserves for these excess casualty insurance claims.

High layer excess casualty insurance claims typically involve claims relating to (i) a “shock loss” such as an explosion or transportation accident causing severe damage to persons and/or property over a short period of time, (ii) a “non-shock” loss where a large number of claimants are exposed to injurious conditions over a longer period of time, such as exposure to chemicals or pharmaceuticals or (iii) a professional liability loss such as a medical malpractice claim. In each case, these claims are ultimately settled following extensive negotiations and legal proceedings. This process typically takes 5 to 15 years following the date of loss.

Reinsurance operations by their nature add further complications to the reserving process, particularly for casualty business written, in that there is an inherent lag in the timing and reporting of a loss event from an insured or ceding company to the reinsurer. This reporting lag creates an even longer period of time between the policy inception and when a claim is finally settled. As a result, more judgment is required to establish reserves for ultimate claims in our reinsurance operations.

In our reinsurance operations, case reserves for reported claims are generally established based on reports received from ceding companies. Additional case reserves may be established by us to reflect our estimated ultimate cost of a loss.

Casualty reinsurance business involves reserving methods that generally include historical aggregated claim information as reported by ceding companies, combined with the results of claims and underwriting reviews of a sample of the ceding company’s claims and underwriting files. Therefore, we do not always receive detailed claim information for this line of business.

Discontinued asbestos and long-tail environmental business was contained within certain policies previously written by NAC Re Corp. (now known as XL Reinsurance America Inc.), prior to its acquisition by us; from business of Winterthur purchased by us from AXA Insurance in 2001; and from a loss portfolio transfer in 2006. At December 31, 2012, total gross unpaid losses and loss expenses in respect of this business represented less than 1% of unpaid losses and loss expenses. See Note 10(f), “Losses and Loss Expenses – Discontinued Asbestos and Run-Off Environmental Related Claims,” to the Consolidated Financial Statements included herein for further information.

73


Except for certain workers’ compensation (including long-term disability) and certain U.K. motor liabilities, we do not discount our unpaid losses and loss expenses. We utilize tabular reserving for workers’ compensation unpaid losses that are considered fixed and determinable. The unpaid losses for the annuity component of U.K. motor claims are discounted to reflect the long tail nature of the structured settlements. For further discussion, see Note 10, “Losses and Loss Expenses,” to the Consolidated Financial Statements included herein.

Loss and loss expenses are charged to income as they are incurred. These charges include loss and loss expense payments and any changes in case and IBNR reserves. During the loss settlement period, additional facts regarding claims are reported. As these additional facts are reported, it may be necessary to increase or decrease the unpaid losses and loss expense reserves. The actual final liability may be significantly different than prior estimates.

The amount of our net unpaid losses and loss expenses relating to our operating segments at December 31, 2012 and 2011 was as follows.

 

 

 

 

 

(U.S. dollars in thousands)

 

2012

 

2011

Insurance

 

 

$

 

11,384,855

 

 

 

$

 

11,374,315

 

Reinsurance

 

 

 

5,737,564

 

 

 

 

5,609,658

 

 

 

 

 

 

Net unpaid losses and loss expenses

 

 

$

 

17,122,419

 

 

 

$

 

16,983,973

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Unpaid Losses and Loss Expenses

(U.S. dollars in millions)

 

2012

 

2011

 

Case
Reserves

 

IBNR
Reserves

 

Total
Reserves

 

Case
Reserves

 

IBNR
Reserves

 

Total
Reserves

Insurance:

 

 

 

 

 

 

 

 

 

 

 

 

Professional

 

 

$

 

1,399

 

 

 

$

 

3,040

 

 

 

$

 

4,439

 

 

 

$

 

1,244

 

 

 

$

 

3,175

 

 

 

$

 

4,419

 

Casualty

 

 

 

1,362

 

 

 

 

3,014

 

 

 

 

4,376

 

 

 

 

1,395

 

 

 

 

2,919

 

 

 

 

4,314

 

Property

 

 

 

367

 

 

 

 

199

 

 

 

 

566

 

 

 

 

473

 

 

 

 

299

 

 

 

 

772

 

Specialty

 

 

 

674

 

 

 

 

568

 

 

 

 

1,242

 

 

 

 

734

 

 

 

 

559

 

 

 

 

1,293

 

Other (1)

 

 

 

243

 

 

 

 

518

 

 

 

 

761

 

 

 

 

196

 

 

 

 

380

 

 

 

 

576

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

$

 

4,045

 

 

 

$

 

7,339

 

 

 

$

 

11,384

 

 

 

$

 

4,042

 

 

 

$

 

7,332

 

 

 

$

 

11,374

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reinsurance:

 

 

 

 

 

 

 

 

 

 

 

 

Casualty (2)

 

 

$

 

1,490

 

 

 

$

 

2,039

 

 

 

$

 

3,529

 

 

 

$

 

1,501

 

 

 

$

 

1,999

 

 

 

$

 

3,500

 

Property catastrophe (3)

 

 

 

166

 

 

 

 

248

 

 

 

 

414

 

 

 

 

180

 

 

 

 

197

 

 

 

 

377

 

Other property

 

 

 

462

 

 

 

 

538

 

 

 

 

1,000

 

 

 

 

410

 

 

 

 

467

 

 

 

 

877

 

Marine, energy, aviation and satellite

 

 

 

387

 

 

 

 

119

 

 

 

 

506

 

 

 

 

399

 

 

 

 

71

 

 

 

 

470

 

Other (1)

 

 

 

180

 

 

 

 

109

 

 

 

 

289

 

 

 

 

163

 

 

 

 

223

 

 

 

 

386