XNYS:AWH Allied World Assurance Co Holdings AG Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

(Mark One)

 

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

For the quarterly period ended: March 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: 001-32938

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

(Exact Name of Registrant as Specified in Its Charter)

 

Switzerland   98-0681223

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

Lindenstrasse 8

6340 Baar

Zug, Switzerland

(Address of Principal Executive Offices and Zip Code)

41-41-768-1080

(Registrant’s Telephone Number, Including Area Code)

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 þ  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 such shorter period that the registrant was required to submit and post such files). Yes þ  No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer þ

  Accelerated filer ¨    Non-accelerated filer ¨   Smaller reporting company ¨
     (Do not check if a 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 þ

As of May 1, 2012, 36,357,812 common shares were outstanding.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page  
   PART I    FINANCIAL INFORMATION   

ITEM 1.

  

Financial Statements

     1   

ITEM 2.

  

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

     28   

ITEM 3.

  

Quantitative and Qualitative Disclosures About Market Risk

     51   

ITEM 4.

  

Controls and Procedures

     53   
   PART II   

ITEM 1.

  

Legal Proceedings

     54   

ITEM 1A.

  

Risk Factors

     54   

ITEM 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     55   

ITEM 3.

  

Defaults Upon Senior Securities

     55   

ITEM 4.

  

Mine Safety Disclosures

     55   

ITEM 5.

  

Other Information

     55   

ITEM 6.

  

Exhibits

     55   

SIGNATURES

     57   

EXHIBIT INDEX

     58   


Table of Contents

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements.

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

as of March 31, 2012 and December 31, 2011

(Expressed in thousands of United States dollars, except share and per share amounts)

 

     As of
March 31,
2012
    As of
December 31,
2011
 

ASSETS:

    

Fixed maturity investments available for sale, at fair value (amortized cost: 2012: $40,674; 2011: $226,397)

   $ 44,250     $ 244,016  

Fixed maturity investments trading, at fair value (amortized cost: 2012: $6,156,050; 2011: $6,207,991)

     6,271,237       6,254,686  

Equity securities trading, at fair value (cost: 2012: $424,617; 2011: $356,370)

     459,639       367,483  

Other invested assets trading, at fair value

     522,065       540,409  
  

 

 

   

 

 

 

Total investments

     7,297,191       7,406,594  

Cash and cash equivalents

     825,986       633,996  

Restricted cash

     287,113       82,608  

Insurance balances receivable

     748,137       652,158  

Prepaid reinsurance

     214,702       226,721  

Reinsurance recoverable

     1,056,780       1,002,919  

Accrued investment income

     33,452       38,263  

Net deferred acquisition costs

     125,645       100,334  

Goodwill

     268,376       268,376  

Intangible assets

     53,264       53,898  

Balances receivable on sale of investments

     367,997       580,443  

Net deferred tax assets

     19,171       22,646  

Other assets

     58,464       53,202  
  

 

 

   

 

 

 

Total assets

   $ 11,356,278     $ 11,122,158  
  

 

 

   

 

 

 

LIABILITIES:

    

Reserve for losses and loss expenses

   $ 5,331,418     $ 5,225,143  

Unearned premiums

     1,253,454       1,078,412  

Reinsurance balances payable

     93,262       124,539  

Balances due on purchases of investments

     546,791       616,728  

Senior notes

     798,014       797,949  

Dividends payable

     13,795       14,302  

Accounts payable and accrued liabilities

     73,723       116,063  
  

 

 

   

 

 

 

Total liabilities

   $ 8,110,457     $ 7,973,136  
  

 

 

   

 

 

 

SHAREHOLDERS’ EQUITY:

    

Common shares: 2012: par value CHF 13.69 per share and 2011: par value CHF 14.03 per share (2012: 40,003,642; 2011: 40,003,642 shares issued and 2012: 36,786,067; 2011: 37,742,131 shares outstanding)

     543,452       557,153  

Additional paid-in capital

     48,003       78,225  

Treasury shares, at cost (2012: 3,217,575; 2011: 2,261,511)

     (201,865     (136,590

Retained earnings

     2,853,906       2,635,750  

Accumulated other comprehensive income: net unrealized gains on investments, net of tax

     2,325       14,484  
  

 

 

   

 

 

 

Total shareholders’ equity

     3,245,821       3,149,022  
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 11,356,278     $ 11,122,158  
  

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

-1-


Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

for the three months ended March 31, 2012 and 2011

(Expressed in thousands of United States dollars, except share and per share amounts)

 

     Three Months Ended
March 31,
 
     2012     2011  

REVENUES:

    

Gross premiums written

   $ 680,929     $ 560,688  

Premiums ceded

     (91,976     (79,817
  

 

 

   

 

 

 

Net premiums written

     588,953       480,871  

Change in unearned premiums

     (187,063     (145,995
  

 

 

   

 

 

 

Net premiums earned

     401,890       334,876  

Net investment income

     47,209       50,208  

Net realized investment gains

     133,581       50,376  
  

 

 

   

 

 

 
     582,680       435,460  
  

 

 

   

 

 

 

EXPENSES:

    

Net losses and loss expenses

     225,202       304,452  

Acquisition costs

     47,138       38,082  

General and administrative expenses

     70,366       67,956  

Amortization and impairment of intangible assets

     633       767  

Interest expense

     13,756       13,742  

Foreign exchange gain

     (81     (442
  

 

 

   

 

 

 
     357,014       424,557  
  

 

 

   

 

 

 

Income before income taxes

     225,666       10,903  

Income tax expense

     7,510       2,283  
  

 

 

   

 

 

 

NET INCOME

     218,156       8,620  
  

 

 

   

 

 

 

Other comprehensive loss:

    

Unrealized losses on investments arising during the period net of applicable deferred income tax benefit for the three months ended March 31, 2012: $28; 2011: $964

     (52     (8,044

Reclassification adjustment for net realized investment gains included in net income, net of applicable income tax

     (12,107     (16,128
  

 

 

   

 

 

 

Other comprehensive loss

     (12,159     (24,172
  

 

 

   

 

 

 

COMPREHENSIVE INCOME (LOSS)

   $ 205,997     $ (15,552
  

 

 

   

 

 

 

PER SHARE DATA

    

Basic earnings per share

   $ 5.86     $ 0.23  

Diluted earnings per share

   $ 5.70     $ 0.21  

Weighted average common shares outstanding

     37,205,166       38,199,867  

Weighted average common shares and common share equivalents outstanding

     38,284,635       40,383,523  

Dividends paid per share

   $ 0.375     $   

See accompanying notes to the consolidated financial statements.

 

-2-


Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

for the three months ended March 31, 2012 and 2011

(Expressed in thousands of United States dollars)

 

     Share
Capital
    Additional
Paid-in
Capital
    Treasury
Shares
    Accumulated
Other
Comprehensive
Income
    Retained
Earnings
     Total  

December 31, 2011

   $ 557,153     $ 78,225     $ (136,590   $ 14,484     $ 2,635,750      $ 3,149,022  

Net income

                                 218,156        218,156  

Dividends — par value reduction

     (13,701                                  (13,701

Other comprehensive loss

                          (12,159             (12,159

Stock compensation

            (30,222     27,748                      (2,474

Share repurchases

                   (93,023                    (93,023
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

March 31, 2012

   $ 543,452     $ 48,003     $ (201,865   $ 2,325     $ 2,853,906      $ 3,245,821  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

December 31, 2010

   $ 600,055     $ 170,239     $ (112,811   $ 57,135     $ 2,361,202      $ 3,075,820  

Net income

                                 8,620        8,620  

Other comprehensive loss

                          (24,172             (24,172

Stock compensation

            (41,453     45,758                      4,305  

Share repurchase

                   (60,000                    (60,000

Repurchase of founder warrants

            (53,620                           (53,620
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

March 31, 2011

   $ 600,055     $ 75,166     $ (127,053   $ 32,963     $ 2,369,822      $ 2,950,953  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

See accompanying notes to the consolidated financial statements.

 

-3-


Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

for the three months ended March 31, 2012 and 2011

(Expressed in thousands of United States dollars)

 

     Three Months Ended
March 31,
 
     2012     2011  

CASH FLOWS PROVIDED BY OPERATING ACTIVITIES:

    

Net income

   $ 218,156     $ 8,620  

Adjustments to reconcile net income to cash provided by operating activities:

    

Net realized gains on sales of investments

     (12,165     (21,624

Mark to market adjustments

     (122,334     (34,248

Stock compensation expense

     5,471       5,850  

Insurance balances receivable

     (95,979     (39,909

Prepaid reinsurance

     12,019       11,939  

Reinsurance recoverable

     (53,861     (47,935

Accrued investment income

     4,811       (808

Net deferred acquisition costs

     (25,311     (16,294

Net deferred tax assets

     5,358       86  

Other assets

     (6,866     (978

Reserve for losses and loss expenses

     106,275       221,455  

Unearned premiums

     175,042       134,057  

Reinsurance balances payable

     (31,277     (7,880

Accounts payable and accrued liabilities

     (42,340     (42,618

Other items, net

     5,818       5,202  
  

 

 

   

 

 

 

Net cash provided by operating activities

     142,817       174,915  
  

 

 

   

 

 

 

CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:

    

Purchases of fixed maturity investments — available for sale

            (352

Purchases of fixed maturity investments — trading

     (1,039,294     (2,332,315

Purchases of equity securities

     (99,037     (97,893

Purchases of other invested assets

     (1,050     (171,048

Sales of fixed maturity investments — available for sale

     116,303       340,418  

Sales of fixed maturity investments — trading

     1,328,702       2,036,961  

Sales of equity securities

     23,707       12,509  

Sales of other invested assets

     28,569       40,135  

Purchases of fixed assets

     (567     (1,639

Change in restricted cash

     (204,506     44,351  
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     152,827       (128,873
  

 

 

   

 

 

 

CASH FLOWS USED IN FINANCING ACTIVITIES:

    

Dividends paid — par value reduction

     (14,208       

Proceeds from the exercise of stock options

     3,332       3,224  

Share repurchases

     (93,023     (60,000

Repurchase of founder warrants

            (53,620
  

 

 

   

 

 

 

Net cash used in financing activities

     (103,899     (110,396
  

 

 

   

 

 

 

Effect of exchange rate changes on foreign currency cash

     245       1,339  

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     191,990       (63,015

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

     633,996       756,995  
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 825,986     $ 693,980  
  

 

 

   

 

 

 

Supplemental disclosure of cash flow information:

    

— Cash paid for income taxes

   $ 3,454     $   

— Cash paid for interest expense

   $ 18,750     $ 18,750  

See accompanying notes to the consolidated financial statements.

 

-4-


Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

1. GENERAL

Allied World Assurance Company Holdings, AG, a Swiss holding company (“Allied World Switzerland”), through its wholly-owned subsidiaries (collectively, the “Company”), provides property and casualty insurance and reinsurance on a worldwide basis through operations in Bermuda, the United States, Europe, Hong Kong and Singapore.

2. BASIS OF PREPARATION AND CONSOLIDATION

These unaudited condensed consolidated financial statements include the accounts of the Company and have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with Article 10 of Regulation S-X as promulgated by the U.S. Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, these unaudited condensed consolidated financial statements reflect all adjustments that are normal and recurring in nature and necessary for a fair presentation of financial position and results of operations as of the end of and for the periods presented. The results of operations for any interim period are not necessarily indicative of the results for a full year.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The significant estimates reflected in the Company’s financial statements include, but are not limited to:

 

   

The premium estimates for certain reinsurance agreements,

 

   

Recoverability of deferred acquisition costs,

 

   

The reserve for outstanding losses and loss expenses,

 

   

Valuation of ceded reinsurance recoverables,

 

   

Determination of impairment of goodwill and other intangible assets, and

 

   

Valuation of financial instruments.

Intercompany accounts and transactions have been eliminated on consolidation and all entities meeting consolidation requirements have been included in the consolidation.

These unaudited condensed consolidated financial statements, including these notes, should be read in conjunction with the Company’s audited consolidated financial statements, and related notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

3. NEW ACCOUNTING PRONOUNCEMENTS

In October 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-26, “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts” (“ASU 2010-26”). ASU 2010-26 clarifies what costs associated with acquiring or renewing insurance contracts can be deferred and amortized over the coverage period. Under the revised guidance of ASU 2010-26, incremental direct costs that result directly from and are essential to the insurance contract and would not have been incurred had the insurance contract not been written are costs that may be capitalized, including costs relating to activities specifically performed by the Company such as underwriting, policy issuance and processing. The Company adopted ASU 2010-26 retrospectively on January 1, 2012. The adoption of ASU 2010-26 did not have an impact on consolidated shareholders’ equity or net income as the Company had not previously capitalized costs that did not meet the requirement for capitalization of the revised standard.

In May 2011, the FASB issued ASU 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (“ASU 2011-04”). ASU 2011-04 provides a consistent meaning for the term “fair value” between the FASB and International Accounting Standards Board and establishes common requirements for measuring and disclosing information related thereto. The Company adopted ASU 2011-04 prospectively on January 1, 2012. The adoption of ASU 2011-04 did not have an impact on consolidated shareholders’ equity or net income or the Company’s fair value measurements. Refer to Note 6 for the Company’s related disclosures.

 

-5-


Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

In June 2011, the FASB issued ASU 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”). ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in shareholders’ equity, requires consecutive presentation of the statement of net income and other comprehensive income, and requires the presentation of reclassification adjustments on the face of the financial statements from other comprehensive income to net income. In December 2011, ASU 2011-05 was updated by ASU 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05” (“ASU 2011-12”) to defer the presentation requirements of reclassification adjustments required by ASU 2011-05. The Company adopted ASU 2011-05 on January 1, 2012. The adoption of ASU 2011-05 and the related updates from ASU 2011-12 did not have an impact on the presentation of the financial statements.

In September 2011, the FASB issued ASU 2011-08, “Testing Goodwill for Impairment” (“ASU 2011-08”). ASU 2011-08 simplifies how goodwill is tested for impairment by permitting entities to assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The results of the qualitative assessment will determine if an entity needs to proceed with the two-step goodwill impairment test. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The Company adopted ASU 2011-08 on January 1, 2012. The adoption of ASU 2011-08 did not have an impact on consolidated shareholders’ equity or net income.

4. INVESTMENTS

a) Available for Sale Securities

The amortized cost, gross unrealized gains, gross unrealized losses and fair value of the Company’s available for sale investments by category are as follows:

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair Value  
March 31, 2012                           

U.S. Government and Government agencies

   $ 28,123      $ 1,920      $      $ 30,043  

States, municipalities and political subdivisions

     11,551        1,656               13,207  

Corporate debt:

          

Industrials

     1,000                       1,000  
  

 

 

    

 

 

    

 

 

   

 

 

 

Total fixed maturity investments, available for sale

   $ 40,674      $ 3,576      $      $ 44,250  
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2011

          

U.S. Government and Government agencies

   $ 31,309      $ 2,321      $      $ 33,630  

States, municipalities and political subdivisions

     29,128        4,351               33,479  

Corporate debt:

          

Financial institutions

     17,431        348        (292     17,487  

Industrials

     73,539        4,268               77,807  

Utilities

     74,990        6,623               81,613  
  

 

 

    

 

 

    

 

 

   

 

 

 

Total fixed maturity investments, available for sale

   $ 226,397      $ 17,911      $ (292   $ 244,016  
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

b) Trading Securities

Securities accounted for at fair value with changes in fair value recognized in the unaudited condensed consolidated statements of operations and comprehensive income (loss) (“consolidated income statements”) by category are as follows:

 

     March 31, 2012      December 31, 2011  
     Fair Value      Amortized Cost      Fair Value      Amortized Cost  

U.S. Government and Government agencies

   $ 1,330,872      $ 1,321,573      $ 1,278,265      $ 1,263,948  

Non-U.S. Government and Government agencies

     307,112        300,392        256,756        251,784  

States, municipalities and political subdivisions

     161,186        154,748        133,902        128,633  

Corporate debt:

           

Financial institutions

     1,018,454        998,078        1,161,904        1,174,308  

Industrials

     1,041,178        1,019,205        987,006        974,731  

Utilities

     97,875        95,177        105,564        103,262  

Residential mortgage-backed:

           

Non-agency residential

     354,402        335,192        302,827        314,077  

Agency residential

     1,159,640        1,139,995        1,183,893        1,156,913  

Commercial mortgage-backed

     309,696        301,590        331,371        326,697  

Asset-backed

     490,822        490,100        513,198        513,638  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturity investments, trading

   $ 6,271,237      $ 6,156,050      $ 6,254,686      $ 6,207,991  
  

 

 

    

 

 

    

 

 

    

 

 

 
     March 31, 2012      December 31, 2011  
     Fair Value      Original Cost      Fair Value      Original Cost  

Equity securities

   $ 459,639      $ 424,617      $ 367,483      $ 356,370  

Other invested assets (1)

     522,065        490,146        540,409        529,851  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 981,704      $ 914,763      $ 907,892      $ 886,221  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Within the Company’s financial statements and footnotes “other invested assets” include the Company’s investments in both hedge funds and private equity funds.

c) Contractual Maturity Dates

The contractual maturity dates of available for sale fixed maturity investments are as follows:

 

     March 31, 2012  
     Amortized Cost      Fair Value  

Due within one year

   $ 5,317      $ 5,358  

Due after one year through five years

     20,864        22,206  

Due after five years through ten years

     11,484        13,054  

Due after ten years

     3,009        3,632  
  

 

 

    

 

 

 
   $ 40,674      $ 44,250  
  

 

 

    

 

 

 

Expected maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.

d) Other Invested Assets

Included in other invested assets are the Company’s hedge fund and private equity investments. As of the balance sheet date, the Company held interests in 21 funds with a total fair value of $522,065, which comprised 6.2% of the total fair value of its investments and cash and cash equivalents. The fair values of these assets have been estimated using the net asset value per share of the funds.

In general, the hedge funds in which the Company is invested require at least 30 days notice of redemption, and may be redeemed on a monthly, quarterly, semi-annual, annual or longer basis, depending on the fund. Certain hedge funds have lock-up periods ranging from 1 to 3 years from initial investment. A lock-up period refers to the initial amount of time an investor is contractually required to invest before having the ability to redeem. Interests in private equity funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund. Funds that provide for periodic redemptions may, depending on the funds’ governing documents, have the ability to deny or delay a redemption request, called a “gate.” The fund may implement this restriction because the aggregate amount of redemption requests as of a particular date exceeds a specified level, generally ranging from 15% to 25% of the fund’s net assets. The gate is a method for executing an orderly redemption process that

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

allows for redemption requests to be executed in a timely manner to reduce the possibility of adversely affecting the remaining investors in the fund. Typically, the imposition of a gate delays a portion of the requested redemption, with the remaining portion settled in cash sometime after the redemption date. Certain funds may impose a redemption fee on early redemptions.

Details regarding the redemption characteristics of the other invested assets portfolio as of March 31, 2012 were as follows:

 

Fund Type

   Fair Value as of
March 31, 2012
     Investments
with
Redemption
Restrictions
     Estimated
Remaining
Restriction
Period
     Investments
without
Redemption
Restrictions
     Redemption
Frequency(1)
     Redemption
Notice Period(1)
   Unfunded
Commitments
 

Private equity (primary and

                    

secondary)

   $ 78,930      $ 78,930        4 -10 Years       $             $ 113,618  

Mezzanine debt

     22,805        22,805        10 Years                       91,773  

Distressed

     7,136        7,136        6 Years                       11,099  
  

 

 

    

 

 

       

 

 

          

 

 

 

Total private equity

     108,871        108,871                         216,490  
  

 

 

    

 

 

       

 

 

          

 

 

 

Distressed

     41,855        1,131        2 Years         40,724        Quarterly       45 - 60 Days         

Equity long/short

     165,991        46,156        <1 Year         119,835        Quarterly       30 - 60 Days        

Multi-strategy

     135,520        25,995         2 Years         109,525        Quarterly       45 - 90 Days        

Event driven

     69,828                   69,828        Annual       45 - 60 Days        
  

 

 

    

 

 

       

 

 

          

 

 

 

Total hedge funds

     413,194        73,282           339,912                
  

 

 

    

 

 

       

 

 

          

 

 

 

Total other invested assets

   $ 522,065      $ 182,153         $ 339,912            $ 216,490  
  

 

 

    

 

 

       

 

 

          

 

 

 

 

(1) The redemption frequency and notice periods only apply to the investments without redemption restrictions.

 

   

Private equity funds: These funds buy limited partnership interests from existing limited partners of primary private equity funds. As owners of private equity funds seek liquidity, they can sell their existing investments, plus any remaining commitment, to secondary market participants. These funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.

 

   

Mezzanine debt funds: Mezzanine debt funds invest primarily in privately negotiated mezzanine investments. The funds’ strategies will focus primarily on providing capital to upper middle market and middle market companies, and private equity sponsors, in connection with leveraged buyouts, mergers and acquisitions, recapitalizations, growth financings and other corporate transactions. The most common position in the capital structure will be between the senior secured debt holder and the equity; however, the funds will utilize a flexible approach when structuring investments, which may include secured debt, subordinated debt, preferred stock and/or private equity. These funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.

 

   

Distressed funds: In distressed debt investing, managers take positions in the debt of companies experiencing significant financial difficulties, including bankruptcy, or in certain positions of the capital structure of structured securities. The manager relies on the fundamental analysis of these securities, including the claims on the assets and the likely return to bondholders. Certain funds cannot be redeemed because the investments include restrictions that do not allow for redemption until termination of the fund.

 

   

Equity long/short funds: In equity long/short funds, managers take long positions in companies they deem to be undervalued and short positions in companies they deem to be overvalued. Long/short managers may invest in countries, regions or sectors and vary by their use of leverage and target net long position.

 

   

Multi-strategy funds: These funds may utilize many strategies employed by specialized funds including distressed investing, equity long/short, merger arbitrage, convertible arbitrage, fixed income arbitrage and macro trading.

 

   

Event driven funds: Event driven strategies seek to deploy capital into specific securities whose returns are affected by a specific event that affects the value of one or more securities of a company. Returns for such securities are linked primarily to the specific outcome of the events and not by the overall direction of the bond or stock markets. Examples could include mergers and acquisitions (arbitrage), corporate restructurings and spin-offs and capital structure arbitrage.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

e) Net Investment Income

 

     Three Months Ended
March 31,
 
     2012     2011  

Fixed maturity investments

   $ 46,886     $ 50,946  

Equity securities and other invested assets

     4,074       2,196  

Cash and cash equivalents

     607       318  

Expenses

     (4,358     (3,252
  

 

 

   

 

 

 

Net investment income

   $ 47,209     $ 50,208  
  

 

 

   

 

 

 

f) Components of Realized Gains and Losses

 

     Three Months Ended
March 31,
 
     2012     2011  

Gross realized gains on sale of invested assets

   $ 39,169     $ 43,557  

Gross realized losses on sale of invested assets

     (21,907     (21,932

Net realized and unrealized gains (losses) on derivatives

     6,684       (5,496

Mark-to-market changes: debt securities trading

     68,490       13,464  

Mark-to-market changes: other invested assets and equity securities

     41,145       20,783  
  

 

 

   

 

 

 

Net realized investment gains

   $ 133,581     $ 50,376  
  

 

 

   

 

 

 

Proceeds from sale of available for sale securities

   $ 199,408     $ 343,520  

g) Pledged Assets

As of March 31, 2012 and December 31, 2011, $2,019,694 and $2,029,138, respectively, of cash and cash equivalents and investments were deposited, pledged or held in trust accounts in favor of ceding companies and other counterparties or government authorities to comply with reinsurance contract provisions and insurance laws.

In addition, as of March 31, 2012 and December 31, 2011, a further $1,107,278 and $1,044,236, respectively, of cash and cash equivalents and investments were pledged as collateral for the Company’s letter of credit facility. See Note 9 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 for details on the credit facility.

h) Analysis of Unrealized Losses

The following table summarizes the market value of those available for sale investments in an unrealized loss position for periods less than and greater than 12 months:

 

     March 31, 2012      December 31, 2011  
     Gross Fair
Value
     Unrealized
Loss
     Gross Fair
Value
     Unrealized
Loss
 

Less than 12 months

           

Corporate debt:

           

Financial institutions

   $       $       $ 9,440      $ (292
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturity investments, available for sale

   $       $       $ 9,440      $ (292
  

 

 

    

 

 

    

 

 

    

 

 

 

As of March 31, 2012 and December 31, 2011, there were nil and three securities, respectively, in an unrealized loss position.

 

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

i) Other-than-temporary impairment charges

Following the Company’s review of the securities in the investment portfolio during the three months ended March 31, 2012 and 2011, no securities were considered to be other-than-temporarily impaired.

5. DERIVATIVE INSTRUMENTS

As of March 31, 2012 and December 31, 2011, none of the Company’s derivatives were designated as hedges. The following table summarizes information on the location and amounts of derivative fair values in the unaudited condensed consolidated balance sheets (“consolidated balance sheets”):

 

     March 31, 2012      December 31, 2011  
     Asset
Derivative
Notional
Amount
     Asset
Derivative
Fair Value
     Liability
Derivative
Notional
Amount
     Liability
Derivative
Fair Value
     Asset
Derivative
Notional
Amount
     Asset
Derivative
Fair Value
     Liability
Derivative
Notional
Amount
     Liability
Derivative
Fair Value
 

Derivatives not designated as hedging instruments

  

Put options (1)

   $       $       $       $       $ 4,461      $ 336      $       $   

Foreign exchange contracts (2)

     185,983        3,828        124,602        2,514        91,162        2,030        339,533        8,934  

Interest rate futures (2)

     70,400        2,072        277,100        159        680,650        977        292,000        3,467  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total derivatives

   $ 256,383      $ 5,900      $ 401,702      $ 2,673      $ 776,273      $ 3,343      $ 631,533      $ 12,401  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Asset and liability derivatives relating to the put options are classified within “equity securities trading, at fair value” on the consolidated balance sheets.

 

(2) All other asset and liability derivatives are classified within “other assets” or “accounts payable and accrued liabilities” on the consolidated balance sheets.

The following table provides the net realized and unrealized gains (losses) on derivatives not designated as hedges recorded in the consolidated income statements:

 

     Three Months Ended
March 31,
 
     2012     2011  

Foreign exchange contracts

   $ 939     $ 1,255  
  

 

 

   

 

 

 

Total included in foreign exchange gain

     939       1,255  
  

 

 

   

 

 

 

Put options

     (336       

Foreign exchange contracts

     (2,305       

Interest rate futures

     9,325       (5,496
  

 

 

   

 

 

 

Total included in net realized investment gains

     6,684       (5,496
  

 

 

   

 

 

 

Total realized and unrealized gains (losses) on derivatives

   $ 7,623     $ (4,241
  

 

 

   

 

 

 

Derivative Instruments Not Designated as Hedging Instruments

The Company is exposed to foreign currency risk in its investment portfolio. Accordingly, the fair values of the Company’s investment portfolio are partially influenced by the change in foreign exchange rates. The Company entered into foreign currency forward contracts to manage the effect of this foreign currency risk. These foreign currency hedging activities have not been designated as specific hedges for financial reporting purposes.

The Company also purchases and sells interest rate future contracts to actively manage the duration and yield curve positioning of its fixed income portfolio. Interest rate futures can efficiently increase or decrease the overall duration of the portfolio. Additionally, interest rate future contracts can be utilized to obtain the desired position along the yield curve in order to protect against certain future yield curve shapes.

 

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ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

The Company purchases index put options to actively manage the Company’s equity portfolio.

The Company’s insurance and reinsurance subsidiaries and branches operate in various foreign countries and consequently the Company’s underwriting portfolio is exposed to foreign currency risk. The Company manages foreign currency risk by seeking to match liabilities under the insurance policies and reinsurance contracts that it writes and that are payable in foreign currencies with cash and investments that are denominated in such currencies. When necessary, the Company may also use derivatives to economically hedge un-matched foreign currency exposures, specifically forward contracts and currency options.

6. FAIR VALUE OF FINANCIAL INSTRUMENTS

In accordance with U.S. GAAP, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. There is a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon whether the inputs to the valuation of an asset or liability are observable or unobservable in the market at the measurement date, with quoted market prices being the highest level (Level 1) and unobservable inputs being the lowest level (Level 3). A fair value measurement will fall within the level of the hierarchy based on the input that is significant to determining such measurement. The three levels are defined as follows:

 

   

Level 1: Observable inputs to the valuation methodology that are quoted prices (unadjusted) for identical assets or liabilities in active markets.

 

   

Level 2: Observable inputs to the valuation methodology other than quoted market prices (unadjusted) for identical assets or liabilities in active markets. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical assets in markets that are not active and inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.

 

   

Level 3: Inputs to the valuation methodology that are unobservable for the asset or liability.

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

The following table shows the fair value of the Company’s financial instruments and where in the fair value hierarchy the fair value measurements are included as of the dates indicated below:

 

                   Fair value measurement using:  

March 31, 2012

   Carrying
amount
     Total fair value      Quoted prices in
active markets for
identical assets
(Level 1)
     Significant other
observable inputs
(Level 2)
     Significant
unobservable
inputs

(Level 3)
 

Available for sale securities:

              

U.S. Government and Government agencies

   $ 30,043      $ 30,043      $ 30,043      $       $   

States, municipalities and political subdivisions

     13,207        13,207                13,207          

Corporate debt

     1,000        1,000                1,000          
  

 

 

    

 

 

          

Total available for sale fixed maturity investments

     44,250        44,250           
  

 

 

    

 

 

          

Trading securities:

              

U.S. Government and Government agencies

   $ 1,330,873      $ 1,330,873      $ 958,933      $ 371,940      $   

Non-U.S. Government and Government agencies

     307,112        307,112                307,112          

States, municipalities and political subdivisions

     161,186        161,186                161,186          

Corporate debt

     2,157,507        2,157,507                2,157,507          

Mortgage-backed

     1,823,737        1,823,737                1,645,363        178,374  

Asset-backed

     490,822        490,822                248,428        242,394  
  

 

 

    

 

 

          

Total trading fixed maturity investments

     6,271,237        6,271,237           
  

 

 

    

 

 

          

Total fixed maturity investments

     6,315,487        6,315,487           
  

 

 

    

 

 

          

Equity securities

     459,639        459,639        459,639                  

Other invested assets

     522,065        522,065                        522,065  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 7,297,191      $ 7,297,191      $ 1,448,615      $ 4,905,743      $ 942,833  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Derivative assets: (1)

              

Foreign exchange contracts

   $ 3,828      $ 3,828      $       $ 3,828      $   

Interest rate futures

     2,072        2,072                2,072          
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Derivative liabilities: (1)

              

Foreign exchange contracts

   $ 2,514      $ 2,514      $       $ 2,514      $   

Interest rate futures

     159        159                159          
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Senior notes

   $ 798,014      $ 889,987      $       $ 889,987      $   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Asset and liability derivatives relating to foreign exchange contracts and interest rate futures are classified within “other assets” or “accounts payable and accrued liabilities” on the consolidated balance sheets.

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

                   Fair value measurement using:  

December 31, 2011

   Carrying
amount
     Total fair value      Quoted prices in
active markets for
identical assets
(Level 1)
     Significant other
observable inputs
(Level 2)
     Significant
unobservable
inputs

(Level 3)
 

Available for sale securities:

              

U.S. Government and Government agencies

   $ 33,630      $ 33,630      $ 33,630      $       $   

States, municipalities and political subdivisions

     33,479        33,479                33,479          

Corporate debt

     176,907        176,907                176,907          
  

 

 

    

 

 

          

Total available for sale fixed maturity investments

     244,016        244,016           
  

 

 

    

 

 

          

Trading securities:

              

U.S. Government and Government agencies

   $ 1,278,265      $ 1,278,265      $ 1,054,003      $ 224,262      $   

Non-U.S. Government and Government agencies

     256,756        256,756                256,756          

States, municipalities and political subdivisions

     133,902        133,902                133,902          

Corporate debt

     2,254,474        2,254,474                2,254,474          

Mortgage-backed

     1,818,091        1,818,091                1,568,887        249,204  

Asset-backed

     513,198        513,198                418,453        94,745  
  

 

 

    

 

 

          

Total trading fixed maturity investments

     6,254,686        6,254,686           
  

 

 

    

 

 

          

Total fixed maturity investments

     6,498,702        6,498,702           
  

 

 

    

 

 

          

Equity securities

     367,483        367,483        367,483                  

Other invested assets

     540,409        540,409                        540,409  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 7,406,594      $ 7,406,594      $ 1,455,116      $ 5,067,120      $ 884,358  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Derivative assets: (1)

              

Foreign exchange contracts

   $ 2,030      $ 2,030      $       $ 2,030      $   

Interest rate futures

     977        977                977          
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Derivative liabilities: (1)

              

Foreign exchange contracts

   $ 8,934      $ 8,934      $       $ 8,934      $   

Interest rate futures

     3,467        3,467                3,467          
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Senior notes

   $ 797,949      $ 872,731      $       $ 872,731      $   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Asset and liability derivatives relating to foreign exchange contracts and interest rate futures are classified within “other assets” or “accounts payable and accrued liabilities” on the consolidated balance sheets.

The following describes the valuation techniques used by the Company to determine the fair value of financial instruments held as of the balance sheet date.

U.S. government and government agencies: Comprised primarily of bonds issued by the U.S. treasury, the Federal Home Loan Bank, the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association. The fair values of the Company’s U.S. government securities are based on quoted market prices in active markets and are included in the Level 1 fair value hierarchy. The Company believes the market for U.S. treasury securities is an actively traded market given the high level of daily trading volume. The fair values of U.S. government agency securities are priced using the spread above the risk-free yield curve. As the yields for the risk-free yield curve and the spreads for these securities are observable market inputs, the fair values of U.S. government agency securities are included in the Level 2 fair value hierarchy.

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

Non-U.S. government and government agencies: Comprised of fixed income obligations of non-U.S. governmental entities. The fair values of these securities are based on prices obtained from international indices and are included in the Level 2 fair value hierarchy.

States, municipalities and political subdivisions: Comprised of fixed income obligations of U.S. domiciled state and municipality entities. The fair values of these securities are based on prices obtained from the new issue market, and are included in the Level 2 fair value hierarchy.

Corporate debt: Comprised of bonds issued by corporations that are diversified across a wide range of issuers and industries. The fair values of corporate bonds that are short-term are priced using spread above the London Interbank Offered Rate yield curve, and the fair value of corporate bonds that are long-term are priced using the spread above the risk-free yield curve. The spreads are sourced from broker-dealers, trade prices and the new issue market. As the significant inputs used to price corporate bonds are observable market inputs, the fair values of corporate bonds are included in the Level 2 fair value hierarchy.

Mortgage-backed: Primarily comprised of residential and commercial mortgages originated by both U.S. government agencies (such as the Federal National Mortgage Association) and non-U.S. government agencies. The fair values of mortgage-backed securities originated by U.S. government agencies and non-U.S. government agencies are based on a pricing model that incorporates prepayment speeds and spreads to determine appropriate average life of mortgage-backed securities. The spreads are sourced from broker-dealers, trade prices and the new issue market. As the significant inputs used to price the mortgage-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the mortgage-backed securities are broker-dealer quotes and the Company is not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 hierarchy.

Asset-backed: Principally comprised of bonds backed by pools of automobile loan receivables, home equity loans, credit card receivables and collateralized loan obligations originated by a variety of financial institutions. The fair values of asset-backed securities are priced using prepayment speed and spread inputs that are sourced from the new issue market or broker-dealer quotes. As the significant inputs used to price the asset-backed securities are observable market inputs, the fair values of these securities are included in the Level 2 fair value hierarchy, unless the significant inputs used to price the asset-backed securities are broker-dealer quotes and the Company is not able to determine if those quotes are based on observable market inputs, in which case the fair value is included in the Level 3 hierarchy.

Equity securities: The fair value of the equity securities are priced from market exchanges and therefore included in the Level 1 fair value hierarchy.

Other invested assets: Comprised of funds invested in a range of diversified strategies. In accordance with U.S. GAAP, the fair values of the funds are based on the net asset value of the funds as reported by the fund manager that the Company believes is an unobservable input, and as such, the fair values of those funds are included in the Level 3 fair value hierarchy.

Derivative instruments: The fair value of foreign exchange contracts and interest rate futures are priced from quoted market prices for similar exchange-traded derivatives and pricing valuation models that utilize independent market data inputs. The fair value of derivatives are included in the Level 2 fair value hierarchy.

Senior notes: The fair value of the senior notes is based on reported trades. As of March 31, 2012, the 7.50% Senior Notes and 5.50% Senior Notes (each as defined in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011) were traded at 115.5% and 104.2% of their principal amount, providing an effective yield of 3.6% and 4.9%, respectively. The fair value of the senior notes is included in the Level 2 fair value hierarchy.

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

The following is a reconciliation of the beginning and ending balance of financial instruments using significant unobservable inputs (Level 3):

 

    

Fair value measurement using significant

unobservable inputs (Level 3):

 
     Other invested assets     Mortgage-backed     Asset-backed  

Three Months Ended March 31, 2012

      

Opening balance

   $ 540,409     $ 249,204     $ 94,745  

Total realized and unrealized gains included in net income

     27,756       4,695       1,074  

Total realized and unrealized losses included in net income

     (12,233     (2,105     (96

Purchases

     1,050       9,213       34,813  

Sales

     (34,917     (81,862     (16,009

Transfers into Level 3 from Level 2

            4,981       129,926  

Transfers out of Level 3 into Level 2(1)

            (5,752     (2,059
  

 

 

   

 

 

   

 

 

 

Ending balance

   $ 522,065     $ 178,374     $ 242,394  
  

 

 

   

 

 

   

 

 

 

Three Months Ended March 31, 2011

      

Opening balance

   $ 347,632     $ 172,558     $ 48,707  

Total realized and unrealized gains included in net income

     16,449       2,374       118  

Total realized and unrealized losses included in net income

     (4,769     (827     (25

Purchases

     151,048       32,777       83,009  

Sales

     (40,361     (8,957     (426

Transfers into Level 3 from Level 2

            61,695       12,555  

Transfers out of Level 3 into Level 2(1)

            (25,533     (109
  

 

 

   

 

 

   

 

 

 

Ending balance

   $ 469,999     $ 234,087     $ 143,829  
  

 

 

   

 

 

   

 

 

 

 

(1) Transfers out of Level 3 are primarily attributable to the availability of market observable information.

The Company attempts to verify the significant inputs used by broker-dealers in determining the fair value of the securities priced by them. If the Company could not obtain sufficient information to determine if the broker-dealers were using significant observable inputs, such securities have been transferred to the Level 3 fair value hierarchy. The Company believes the prices obtained from the broker-dealers are the best estimate of fair value of the securities being priced as the broker-dealers are typically involved in the initial pricing of the security, and the Company has compared the price per the broker-dealer to other pricing sources and noted no material differences. The Company recognizes transfers between levels at the end of the reporting period. There were no transfers between Level 1 and Level 2 during the period.

The Company’s external investment accounting service provider receives prices from internationally recognized independent pricing services to measure the fair values of its fixed maturity investments. Pricing sources are evaluated and selected in a manner to ensure that the most reliable sources are used. The independent pricing sources obtain market quotations and actual transaction prices for securities that have quoted prices in active markets. Each pricing service has its own proprietary method for determining the fair value of securities that are not actively traded. In general, these methods involve the use of “matrix pricing” in which the independent pricing service uses observable market inputs, including, but not limited to, reported trades, benchmark yields, broker-dealer quotes, interest rates, prepayment speeds, default rates and such other inputs as are available from market sources to determine a reasonable fair value.

All of the Company’s securities classified as Level 3, other than investments in other invested assets, are valued based on unadjusted broker-dealer quotes. This includes less liquid securities such as lower quality asset-backed securities, commercial mortgage-backed securities, and residential mortgage-backed securities. The primary valuation inputs include monthly payment information, the probability of default, loss severity rates and estimated prepayment rates. Significant changes in these inputs in isolation would result in a significantly lower or higher fair value measurement. In general, a change in the assumption of the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity in an event of default and prepayment rates.

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

The Company records the unadjusted price provided and validates this price through a process that, includes, but is not limited to, monthly and/or quarterly: (i) comparison of prices between two independent sources, with significant differences requiring additional price sources; (ii) quantitative analysis (e.g., comparing the quarterly return for each managed portfolio to their target benchmark, with significant differences identified and investigated); (iii) evaluation of methodologies used by external parties to calculate fair value, including a review of the inputs used for pricing; (iv) comparing the price to the Company’s knowledge of the current investment market; and (v) back-testing, which includes randomly selecting purchased or sold securities and comparing the executed prices to the fair value estimates from the pricing service. In addition to internal controls, management relies on the effectiveness of the valuation controls in place at the Company’s external investment accounting service provider (supported by a Statement on Standards for Attestation Engagements No. 16 report) in conjunction with regular discussion and analysis of the investment portfolio’s structure and performance.

7. RESERVE FOR LOSSES AND LOSS EXPENSES

The reserve for losses and loss expenses consists of the following:

 

     March 31,
2012
     December 31,
2011
 

Outstanding loss reserves

   $ 1,421,705      $ 1,366,466  

Reserves for losses incurred but not reported

     3,909,713        3,858,677  
  

 

 

    

 

 

 

Reserve for losses and loss expenses

   $ 5,331,418      $ 5,225,143  
  

 

 

    

 

 

 

The table below is a reconciliation of the beginning and ending liability for unpaid losses and loss expenses. Losses incurred and paid are reflected net of reinsurance recoverables.

 

     Three Months Ended
March 31,
 
     2012     2011  

Gross liability at beginning of period

   $ 5,225,143     $ 4,879,188  

Reinsurance recoverable at beginning of period

     (1,002,919     (927,588
  

 

 

   

 

 

 

Net liability at beginning of period

     4,222,224       3,951,600  
  

 

 

   

 

 

 

Net losses incurred related to:

    

Current year

     264,684       348,802  

Prior years

     (39,482     (44,350
  

 

 

   

 

 

 

Total incurred

     225,202       304,452  
  

 

 

   

 

 

 

Net paid losses related to:

    

Current year

     1,614       1,699  

Prior years

     175,520       134,358  
  

 

 

   

 

 

 

Total paid

     177,134       136,057  
  

 

 

   

 

 

 

Foreign exchange revaluation

     4,346       5,125  
  

 

 

   

 

 

 

Net liability at end of period

     4,274,638       4,125,120  

Reinsurance recoverable at end of period

     1,056,780       975,523  
  

 

 

   

 

 

 

Gross liability at end of period

   $ 5,331,418     $ 5,100,643  
  

 

 

   

 

 

 

For the three months ended March 31, 2012, the Company had net favorable reserve development in each of its segments due to actual loss emergence being lower than initially expected. Net favorable reserve development was recognized in each segment, primarily related to the general casualty, professional liability and healthcare insurance and reinsurance lines of business.

For the three months ended March 31, 2011, the Company had net favorable reserve development in its international and reinsurance segments due to actual loss emergence being lower than initially expected. The majority of the net favorable reserve development was recognized in the international insurance and reinsurance segment in the 2005 through 2007 loss years related to the healthcare line of business as well as the general casualty and professional liability insurance and reinsurance lines of business. The Company had net unfavorable reserve development in its U.S. insurance segment due to actual loss emergence being higher than initially expected. The majority of the net unfavorable reserve development was recognized in the 2006 loss year related to the professional liability line of business.

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

While the Company has experienced favorable development in its insurance and reinsurance lines, there is no assurance that conditions and trends that have affected the development of liabilities in the past will continue. It is not appropriate to extrapolate future redundancies based on prior years’ development. The methodology of estimating loss reserves is periodically reviewed to ensure that the key assumptions used in the actuarial models continue to be appropriate.

8. INCOME TAXES

Under Swiss law, a resident company is subject to income tax at the federal, cantonal and communal levels that is levied on net income. Income attributable to permanent establishments or real estate located abroad is excluded from the Swiss tax base. Allied World Switzerland is a holding company and, therefore, is exempt from cantonal and communal income tax. As a result, Allied World Switzerland is subject to Swiss income tax only at the federal level. Allied World Switzerland is a resident of the Canton of Zug and, as such, is subject to an annual cantonal and communal capital tax on the taxable equity of Allied World Switzerland in Switzerland. Allied World Switzerland has a Swiss operating company resident in the Canton of Zug. The operating company is subject to federal, cantonal and communal income tax and to annual cantonal and communal capital tax.

Under current Bermuda law, Allied World Assurance Company Holdings, Ltd (“Allied World Bermuda”) and its Bermuda subsidiaries are not required to pay taxes in Bermuda on either income or capital gains. Allied World Bermuda and Allied World Assurance Company, Ltd have received an assurance from the Bermuda Minister of Finance under the Exempted Undertakings Tax Protection Act 1966 of Bermuda, that in the event of any such taxes being imposed, Allied World Bermuda and Allied World Assurance Company, Ltd will be exempted until March 2035.

Certain subsidiaries of Allied World Switzerland file U.S. federal income tax returns and various U.S. state income tax returns, as well as income tax returns in the United Kingdom, Ireland, Switzerland, Hong Kong and Singapore. To the best of the Company’s knowledge, there are no income tax examinations pending by any tax authority.

Management has deemed all material tax positions to have a greater than 50% likelihood of being sustained based on technical merits if challenged. The Company does not expect any material unrecognized tax benefits within 12 months of January 2012.

9. SHAREHOLDERS’ EQUITY

a) Authorized shares

The issued share capital consists of the following:

 

     March 31,
2012
     December 31,
2011
 

Common shares issued and fully paid, 2012: CHF 13.69 per share; 2011: CHF 14.03 per share

     40,003,642        40,003,642  
  

 

 

    

 

 

 

Share capital at end of period

   $ 543,452      $ 557,153  
  

 

 

    

 

 

 

 

     Three Months Ended
March 31, 2012
 

Total shares issued at beginning and end of period

     40,003,642  
  

 

 

 

Treasury shares issued, balance at beginning of period

     2,261,511  

Shares repurchased

     1,430,804  

Shares issued out of treasury

     (474,740
  

 

 

 

Total treasury shares at end of period

     3,217,575  
  

 

 

 

Total shares outstanding at end of period

     36,786,067  
  

 

 

 

As of March 31, 2012, there were outstanding 36,756,827 voting common shares and 29,240 non-voting common shares.

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

Allied World Switzerland’s articles of association authorize its board of directors to increase the share capital by a maximum amount of 20% of the share capital registered in the commercial register up to CHF 108,976 or 7,960,260 voting shares, and create conditional capital of 7,200,000 voting shares.

b) Share Warrants

In conjunction with the private placement offering at the formation of Allied World Bermuda, Allied World Bermuda granted warrant agreements to certain founding shareholders to acquire up to 5,500,000 common shares at an exercise price of $34.20 per share. These warrants were exercisable in certain limited conditions, including a public offering of common shares. All warrants granted were repurchased by the Company.

In February 2011, the Company repurchased the last outstanding warrant owned by American International Group, Inc. (“AIG”) in a privately negotiated transaction. The warrant entitled AIG to purchase 2,000,000 of the Company’s common shares for $34.20 per share. The Company repurchased the warrant for an aggregate purchase price of $53,620. The repurchase of the warrant was recognized as a reduction in “additional paid-in capital” on the consolidated balance sheets. The repurchase was executed separately from the share repurchase program discussed in Note 9(d) below. After this repurchase, AIG has no warrants remaining and no other disclosed equity interest in the Company.

c) Dividends

Under Swiss law, distributions to shareholders may be paid only if the Company has sufficient distributable profits from previous fiscal years, or if the Company has freely distributable reserves, each as presented on the audited stand-alone statutory balance sheet. Distributions to shareholders out of the share and participation capital may be made by way of a capital reduction in the form of a reduction to par value to achieve a similar result as the payment of a dividend.

On May 5, 2011, the shareholders approved the Company’s proposal to pay cash dividends in the form of a distribution by way of par value reductions. The aggregate reduction amount was paid (and is expected to be paid) to shareholders in quarterly installments of $0.375 per share. The Company made a quarterly dividend payment of $14,208 on January 6, 2012 to shareholders of record, resulting in a par value reduction of CHF 0.35.

d) Share repurchase

In May 2010, the Company established a share repurchase program in order to repurchase its common shares. Repurchases may be effected from time to time through open market purchases, privately negotiated transactions, tender offers or otherwise. The timing, form and amount of the share repurchases under the program will depend on a variety of factors, including market conditions, the Company’s capital position, legal requirements and other factors. Shares repurchased have been classified as “Treasury shares, at cost” on the consolidated balance sheets. The Company will issue shares out of treasury principally related to the Company’s employee benefit plans. The Company’s share repurchases were as follows:

 

     March 31,
2012
     March 31,
2011
 

Common shares repurchased

     1,430,804        969,163  

Total cost of shares repurchased

   $ 93,023      $ 60,000  

Average price per share

   $ 65.01      $ 61.91  

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

10. EMPLOYEE BENEFIT PLANS

a) Employee option plan

The Company has implemented the Allied World Assurance Company Holdings, AG Third Amended and Restated 2001 Employee Stock Option Plan (the “Plan”). A summary of the options outstanding under the Plan as of March 31, 2012 and the changes during the three months then ended are as follows:

 

     Three Months Ended March 31, 2012  
           Weighted Average  
     Options     Exercise Price  

Outstanding at beginning of period

     1,525,853     $ 45.72  

Exercised

     (83,026     40.13  

Forfeited

     (13,494     52.91  
  

 

 

   

Outstanding at end of period

     1,429,333     $ 45.98  
  

 

 

   

b) Stock incentive plan

The Company has implemented the Allied World Assurance Company Holdings, AG Third Amended and Restated 2004 Stock Incentive Plan (the “Stock Incentive Plan”). A summary of the options outstanding under the Stock Incentive Plan as of March 31, 2012 and the changes during the three months then ended are as follows:

 

     Three Months Ended March 31, 2012  
     RSUs and     Weighted Average  
     Performance-Based     Grant Date Fair  
     Equity Awards     Value  

Outstanding at beginning of period

     653,136     $ 47.23  

RSUs granted

     35,064       66.88  

Performance-based equity awards granted

     94,169       66.88  

RSUs forfeited

     (5,739     31.78  

RSUs fully vested

     (107,453     43.93  
  

 

 

   

Outstanding at end of period

     669,177     $ 41.75  
  

 

 

   

The Company granted performance-based equity awards in lieu of utilizing the LTIP (as defined in Note 10(c)). The performance-based equity awards are structured in exactly the same form as shares issued under the LTIP in terms of vesting restrictions and achievement of established performance criteria. For the performance-based equity awards granted in 2012, 2011 and 2010, the Company anticipates that the performance goals are likely to be achieved. Based on the performance goals, the performance-based equity awards granted in 2012, 2011 and 2010 are expensed at 100% of the fair market value of Allied World Switzerland’s common shares on the date of grant. The expense is recognized over the performance period.

The compensation expense for RSUs and performance-based equity awards is based on the fair market value of Allied World Switzerland’s common shares at the date of grant. The Company has assumed a weighted average annual forfeiture rate, excluding performance-based equity awards, of 2.85% in determining the compensation expense over the service period. The Company believes it is unlikely that performance-based equity awards will be forfeited as these awards are issued to senior management. Thus, no forfeiture rate is applied to the performance-based equity awards.

c) Long-term incentive plan

The Company has implemented the Allied World Assurance Company Holdings, AG Third Amended and Restated Long-Term Incentive Plan (“LTIP”). Each award under the LTIP represents the right to receive a number of common shares in the future, based upon the achievement of established performance criteria during the applicable performance period. A summary of the LTIP awards outstanding as of March 31, 2012 and the changes during the three months then ended are as follows:

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

     Three Months Ended March 31, 2012  
           Weighted Average  
           Grant Date Fair  
     LTIP     Value  

Outstanding LTIP awards at beginning of period

     324,036     $ 39.78  

Additional LTIP awards granted due to achievement of performance criteria

     147,574       39.44  

LTIP fully vested

     (442,721     39.44  
  

 

 

   

Outstanding LTIP at end of period

     28,889     $ 39.78  
  

 

 

   

The compensation expense for the LTIP is based on the fair market value of Allied World Switzerland’s common shares at the time of grant.

d) Cash-equivalent stock awards

As part of the Company’s annual year-end compensation awards, the Company granted both stock-based awards and cash-equivalent stock awards. The cash-equivalent awards were granted to employees who received RSUs and performance-based equity awards and were granted in lieu of granting the full award as a stock-based award. The cash-equivalent RSU awards vest pro-rata over four years from the date of grant. The cash-equivalent performance-based equity awards vest after a three-year performance period. As the cash-equivalent awards are settled in cash, the Company establishes a liability equal to the product of the fair market value of Allied World Switzerland’s common shares as of the end of the reporting period and the total awards outstanding. The liability is included in “accounts payable and accrued liabilities” in the consolidated balance sheets and changes in the liability are recorded in “general and administrative expenses” in the consolidated income statements.

The following table shows the total stock related compensation expense relating to the stock options, RSUs and performance-based equity awards, LTIP and cash equivalent awards:

 

     Three Months Ended  
     March 31,  
     2012      2011  

Stock options

   $ 1,687      $ 1,179  

RSUs and performance-based equity awards

     3,690        3,822  

LTIPs

     94        849  

Cash-equivalent stock awards

     8,198        5,169  
  

 

 

    

 

 

 

Total

   $ 13,669      $ 11,019  
  

 

 

    

 

 

 

11. EARNINGS PER SHARE

The following table sets forth the comparison of basic and diluted earnings per share:

 

     Three Months Ended  
     March 31,  
     2012      2011  

Basic earnings per share:

     

Net income

   $ 218,156      $ 8,620  

Weighted average common shares outstanding

     37,205,166        38,199,867  
  

 

 

    

 

 

 

Basic earnings per share

   $ 5.86      $ 0.23  
  

 

 

    

 

 

 

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

     Three Months Ended  
     March 31,  
     2012      2011  

Diluted earnings per share:

     

Net income

   $ 218,156      $ 8,620  

Weighted average common shares outstanding

     37,205,166        38,199,867  

Share equivalents:

     

Warrants and options

     378,392        679,820  

Restricted stock units

     144,931        575,436  

LTIP awards

     556,146        928,400  

Weighted average common shares and common share equivalents outstanding — diluted

     38,284,635        40,383,523  
  

 

 

    

 

 

 

Diluted earnings per share

   $ 5.70      $ 0.21  
  

 

 

    

 

 

 

For the three months ended March 31, 2012 and 2011, a weighted average of 358,144 and 440,548 employee stock options and RSUs were considered anti-dilutive and were therefore excluded from the calculation of the diluted earnings per share, respectively.

12. SEGMENT INFORMATION

The determination of reportable segments is based on how senior management monitors the Company’s underwriting operations. Management monitors the performance of its direct underwriting operations based on the geographic location of the Company’s offices, the markets and customers served and the type of accounts written. The Company is currently organized into three operating segments: U.S. insurance, international insurance and reinsurance. All product lines fall within these classifications.

The U.S. insurance segment includes the Company’s direct specialty insurance operations in the United States. This segment provides both direct property and specialty casualty insurance primarily to non-Fortune 1000 North American domiciled accounts. The international insurance segment includes the Company’s direct insurance operations in Bermuda, Europe, Singapore and Hong Kong. This segment provides both direct property and casualty insurance primarily to Fortune 1000 North American domiciled accounts and mid-sized to large non-North American domiciled accounts. The reinsurance segment includes the Company’s reinsurance operations in the U.S., Bermuda, Europe and Asia. This segment provides reinsurance of property, general casualty, professional liability, specialty lines and property catastrophe coverages written by insurance companies. The Company presently writes reinsurance on both a treaty and a facultative basis, targeting several niche reinsurance markets.

Responsibility and accountability for the results of underwriting operations are assigned by major line of business within each segment. Because the Company does not manage its assets by segment, investment income, interest expense and total assets are not allocated to individual reportable segments. General and administrative expenses are allocated to segments based on various factors, including staff count and each segment’s proportional share of gross premiums written.

Management measures results for each segment on the basis of the “loss and loss expense ratio,” “acquisition cost ratio,” “general and administrative expense ratio” and the “combined ratio.” The “loss and loss expense ratio” is derived by dividing net losses and loss expenses by net premiums earned. The “acquisition cost ratio” is derived by dividing acquisition costs by net premiums earned. The “general and administrative expense ratio” is derived by dividing general and administrative expenses by net premiums earned. The “combined ratio” is the sum of the “loss and loss expense ratio,” the “acquisition cost ratio” and the “general and administrative expense ratio.”

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

The following tables provide a summary of the segment results:

 

Three Months Ended March 31, 2012

   U.S. Insurance     International
Insurance
    Reinsurance     Total  

Gross premiums written

   $ 204,211     $ 113,590     $ 363,128     $ 680,929  

Net premiums written

     153,846       72,609       362,498       588,953  

Net premiums earned

     153,358       79,871       168,661       401,890  

Net losses and loss expenses

     (97,704     (38,100     (89,398     (225,202

Acquisition costs

     (19,972     528       (27,694     (47,138

General and administrative expenses

     (31,044     (22,401     (16,921     (70,366
  

 

 

   

 

 

   

 

 

   

 

 

 

Underwriting income

     4,638       19,898       34,648       59,184  

Net investment income

           47,209  

Net realized investment gains

           133,581  

Amortization and impairment of intangible assets

           (633

Interest expense

           (13,756

Foreign exchange gain

           81  
        

 

 

 

Income before income taxes

         $ 225,666  
        

 

 

 

Loss and loss expense ratio

     63.7     47.7     53.0     56.0

Acquisition cost ratio

     13.0     (0.7 %)      16.4     11.7

General and administrative expense ratio

     20.2     28.0     10.0     17.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Combined ratio

     96.9     75.0     79.4     85.2
  

 

 

   

 

 

   

 

 

   

 

 

 

 

Three Months Ended March 31, 2011

   U.S. Insurance     International
Insurance
    Reinsurance     Total  

Gross premiums written

   $ 183,302     $ 111,325     $ 266,061     $ 560,688  

Net premiums written

     139,902       74,910       266,059       480,871  

Net premiums earned

     135,481       76,290       123,105       334,876  

Net losses and loss expenses

     (115,831     (71,184     (117,437     (304,452

Acquisition costs

     (18,102     1,856       (21,836     (38,082

General and administrative expenses

     (30,799     (20,728     (16,429     (67,956
  

 

 

   

 

 

   

 

 

   

 

 

 

Underwriting loss

     (29,251     (13,766     (32,597     (75,614

Net investment income

           50,208  

Net realized investment gains

           50,376  

Amortization and impairment of intangible assets

           (767

Interest expense

           (13,742

Foreign exchange gain

           442  
        

 

 

 

Income before income taxes

         $ 10,903  
        

 

 

 

Loss and loss expense ratio

     85.5     93.3     95.4     90.9

Acquisition cost ratio

     13.4     (2.4 %)      17.7     11.4

General and administrative expense ratio

     22.7     27.2     13.3     20.3
  

 

 

   

 

 

   

 

 

   

 

 

 

Combined ratio

     121.6     118.1     126.4     122.6
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

The following table shows an analysis of the Company’s net premiums written by geographic location of the Company’s subsidiaries. All intercompany premiums have been eliminated.

 

     Three Months Ended
March 31,
 
     2012      2011  

United States

   $ 338,598      $ 263,231  

Bermuda

     154,245        146,331  

Europe

     61,727        51,876  

Singapore

     29,184        15,236  

Hong Kong

     5,199        4,197  
  

 

 

    

 

 

 

Total net premiums written

   $ 588,953      $ 480,871  
  

 

 

    

 

 

 

13. COMMITMENTS AND CONTINGENCIES

In April 2006, a complaint entitled New Cingular Wireless Headquarters, LLC et al. v. Marsh & McLennan Companies, Inc., et al. was filed against numerous brokers and 78 insurers including Allied World Assurance Company, Ltd. Plaintiffs allege that the broker defendants used a variety of illegal schemes and anti-competitive practices that resulted in the plaintiffs either paying more for insurance products or receiving less beneficial terms than the competitive market would have produced. Plaintiffs seek equitable and legal remedies, including injunctive relief, consequential and punitive damages, treble damages and attorneys’ fees. Due to various pending procedural matters, the litigation has not progressed beyond the discovery phase. While it is not possible to predict the outcome of the litigation, the Company does not believe that the outcome will have a material effect on its operations or financial position.

The Company may become involved in various claims and legal proceedings that arise in the normal course of our business, which are not likely to have a material effect on the Company’s results of operations.

14. CONDENSED CONSOLIDATED GUARANTOR FINANCIAL STATEMENTS

The following tables present unaudited condensed consolidating financial information as of March 31, 2012 and December 31, 2011 and for the three months ended March 31, 2012 and 2011 for Allied World Switzerland (the “Parent Guarantor”) and Allied World Bermuda (the “Subsidiary Issuer”). The Subsidiary Issuer is a direct 100% owned subsidiary of the Parent Guarantor. Investments in subsidiaries are accounted for by the Parent Guarantor under the equity method for purposes of the supplemental consolidating presentation. Earnings of subsidiaries are reflected in the Parent Guarantor’s investment accounts and earnings. The Parent Guarantor fully and unconditionally guarantees the senior notes issued by the Subsidiary Issuer.

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

Unaudited Condensed Consolidating Balance Sheet:

 

As of March 31, 2012

   Allied World
Switzerland
(Parent
Guarantor)
    Allied World
Bermuda
(Subsidiary
Issuer)
    Other Allied
World
Subsidiaries
     Consolidating
Adjustments
    Allied World
Switzerland
Consolidated
 

ASSETS:

           

Investments

   $      $      $ 7,297,191      $      $ 7,297,191  

Cash and cash equivalents

     95,286       29,675       701,025               825,986  

Insurance balances receivable

                   748,137               748,137  

Reinsurance recoverable

                   1,056,780               1,056,780  

Net deferred acquisition costs

                   125,645               125,645  

Goodwill and intangible assets

                   321,640               321,640  

Balances receivable on sale of investments

                   367,997               367,997  

Investments in subsidiaries

     3,177,570       4,100,638               (7,278,208       

Due (to) from subsidiaries

     (4,997     (7,141     12,138                 

Other assets

     1,578       6,023       605,301               612,902  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total assets

   $ 3,269,437     $ 4,129,195     $ 11,235,854      $ (7,278,208   $ 11,356,278  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

LIABILITIES:

           

Reserve for losses and loss expenses

   $      $      $ 5,331,418      $      $ 5,331,418  

Unearned premiums

                   1,253,454               1,253,454  

Reinsurance balances payable

                   93,262               93,262  

Balances due on purchases of investments

                   546,791               546,791  

Senior notes

            798,014                      798,014  

Other liabilities

     23,616       12,625       51,277               87,518  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total liabilities

     23,616       810,639       7,276,202               8,110,457  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total shareholders’ equity

     3,245,821       3,318,556       3,959,652        (7,278,208     3,245,821  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 3,269,437     $ 4,129,195     $ 11,235,854      $ (7,278,208   $ 11,356,278  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

As of December 31, 2011

   Allied World
Switzerland
(Parent
Guarantor)
    Allied World
Bermuda
(Subsidiary
Issuer)
    Other Allied
World
Subsidiaries
     Consolidating
Adjustments
    Allied World
Switzerland
Consolidated
 

ASSETS:

           

Investments

   $      $      $ 7,406,594      $      $ 7,406,594  

Cash and cash equivalents

     112,672       8,886       512,438               633,996  

Insurance balances receivable

                   652,158               652,158  

Reinsurance recoverable

                   1,002,919               1,002,919  

Net deferred acquisition costs

                   100,334               100,334  

Goodwill and intangible assets

                   322,274               322,274  

Balances receivable on sale of investments

                   580,443               580,443  

Investments in subsidiaries

     3,064,066       3,964,585               (7,028,651       

Due (to) from subsidiaries

     (4,853     (6,769     11,622                 

Other assets

     1,504       6,367       415,569               423,440  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total assets

   $ 3,173,389     $ 3,973,069     $ 11,004,351      $ (7,028,651   $ 11,122,158  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

LIABILITIES:

           

Reserve for losses and loss expenses

   $      $      $ 5,225,143      $      $ 5,225,143  

Unearned premiums

                   1,078,412               1,078,412  

Reinsurance balances payable

                   124,539               124,539  

Balances due on purchases of investments

                   616,728               616,728  

Senior notes

            797,949                      797,949  

Other liabilities

     24,367       17,688       88,310               130,365  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total liabilities

     24,367       815,637       7,133,132               7,973,136  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total shareholders’ equity

     3,149,022       3,157,432       3,871,219        (7,028,651     3,149,022  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 3,173,389     $ 3,973,069     $ 11,004,351      $ (7,028,651   $ 11,122,158  
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

Unaudited Condensed Consolidating Income Statement:

 

Three months ended March 31, 2012

   Allied World
Switzerland
(Parent
Guarantor)
    Allied World
Bermuda
(Subsidiary
Issuer)
    Other Allied
World
Subsidiaries
    Consolidating
Adjustments
    Allied World
Switzerland
Consolidated
 

Net premiums earned

   $      $      $ 401,890     $      $ 401,890  

Net investment income

     9       3       47,197              47,209  

Net realized investment losses

                   133,581              133,581  

Net losses and loss expenses

                   (225,202            (225,202

Acquisition costs

                   (47,138            (47,138

General and administrative expenses

     (3,956     (1,152     (65,258            (70,366

Amortization of intangible assets

                   (633            (633

Interest expense

            (13,756                   (13,756

Foreign exchange gain (loss)

     89       (25     17              81  

Income tax (expense) benefit

     444              (7,954            (7,510

Equity in earnings of consolidated subsidiaries

     221,570       234,307              (455,877       
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME (LOSS)

   $ 218,156     $ 219,377     $ 236,500     $ (455,877   $ 218,156  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized losses on investments arising during the period net of applicable deferred income tax benefit of $28

                   (52            (52

Reclassification adjustment for net realized investment gains included in net income, net of applicable income tax

                   (12,107            (12,107
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive loss

                   (12,159            (12,159
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

COMPREHENSIVE INCOME (LOSS)

   $ 218,156     $ 219,377     $ 224,341     $ (455,877   $ 205,997  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Three months ended March 31, 2011

   Allied World
Switzerland
(Parent
Guarantor)
    Allied World
Bermuda
(Subsidiary
Issuer)
    Other Allied
World
Subsidiaries
    Consolidating
Adjustments
    Allied World
Switzerland
Consolidated
 

Net premiums earned

   $      $      $ 334,876      $      $ 334,876  

Net investment income

     30        14        50,164               50,208  

Net realized investment gains

                   50,376               50,376  

Net losses and loss expenses

                   (304,452            (304,452

Acquisition costs

                   (38,082            (38,082

General and administrative expenses

     (1,064     (2,744     (64,148            (67,956

Amortization of intangible assets

                   (767            (767

Interest expense

            (13,742                   (13,742

Foreign exchange gain (loss)

     4        (241     679               442  

Income tax (expense) benefit

                   (2,283            (2,283

Equity in earnings of consolidated subsidiaries

     9,650        26,363               (36,013       
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NET INCOME (LOSS)

   $ 8,620      $ 9,650      $ 26,363      $ (36,013   $ 8,620  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized losses on investments arising during the period net of applicable deferred income tax benefit of $964

                   (8,044            (8,044

Reclassification adjustment for net realized investment gains included in net income, net of applicable income tax

                   (16,128            (16,128
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive loss

                   (24,172            (24,172
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

COMPREHENSIVE INCOME (LOSS)

   $ 8,620      $ 9,650      $ 2,191      $ (36,013   $ (15,552
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

Unaudited Condensed Consolidating Cash Flows:

 

Three Months Ended March 31, 2012

   Allied World
Switzerland
(Parent
Guarantor)
    Allied World
Bermuda
(Subsidiary
Issuer)
     Other Allied
World
Subsidiaries
    Consolidating
Adjustments
     Allied World
Switzerland
Consolidated
 

CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES

   $ 86,607     $ 20,789      $ 35,666     $       $ 143,062  
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:

            

Purchase of fixed maturity investments—trading

                    (1,039,294             (1,039,294

Purchases of equity securities and other invested assets

                    (100,087             (100,087

Sales of fixed maturity investments—available for sale

                    116,303               116,303  

Sales of fixed maturity investments—trading

                    1,328,702               1,328,702  

Sale of equity securities and other invested assets

                    52,276               52,276  

Other

                    (205,073             (205,073
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Net cash provided by (used in) investing activities

                    152,827               152,827  
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:

            

Partial par value reduction

     (14,208                            (14,208

Proceeds from the exercise of stock options

     3,332                              3,332  

Share repurchase

     (93,023                            (93,023

Other

                                     
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Net cash provided by (used in) financing activities

     (103,899                            (103,899
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     (17,292     20,789        188,493               191,990  

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

     112,672       8,886        512,438               633,996  
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 95,380     $ 29,675      $ 700,931     $       $ 825,986  
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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Table of Contents

ALLIED WORLD ASSURANCE COMPANY HOLDINGS, AG

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in thousands of United States dollars, except share, per share, percentage and ratio information)

 

Three Months Ended March 31, 2011

   Allied World
Switzerland
(Parent
Guarantor)
    Allied World
Bermuda
(Subsidiary
Issuer)
    Other Allied
World
Subsidiaries
    Consolidating
Adjustments
     Allied World
Switzerland
Consolidated
 

CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:

   $ (2,805   $ (16,740   $ 195,799     $       $ 176,254  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:

           

Purchase of fixed maturity investments—available for sale

                   (352             (352

Purchase of fixed maturity investments—trading

                   (2,332,315             (2,332,315

Purchases of equity securities and other invested assets

                   (268,941             (268,941

Sales of fixed maturity investments—available for sale

                   340,418               340,418  

Sales of fixed maturity investments—trading

                   2,036,961               2,036,961  

Sale of equity securities and other invested assets

                   52,644               52,644  

Other assets

                   42,712               42,712  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net cash provided by (used in) investing activities

                   (128,873             (128,873
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:

           

Proceeds from the exercise of stock options

     3,224                             3,224  

Share repurchase

     (60,000                           (60,000

Repurchase of founder warrants

            (53,620                    (53,620

Other

     (507     (943     1,450                 
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net cash provided by (used in) financing activities

     (57,283     (54,563     1,450               (110,396
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     (60,088     (71,303     68,376               (63,015

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

     138,488       125,663       492,844               756,995  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 78,400     $ 54,360     $ 561,220     $       $ 693,980  
  

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

15. SUBSEQUENT EVENTS

On May 3, 2012, the Company’s shareholders approved the following proposals:

The Company will pay dividends in the form of a distribution by way of par value reductions. The aggregate reduction amount will be paid to shareholders in quarterly installments of $0.375 per share. The Company expects to distribute such dividends in August 2012, September 2012, December 2012, and March 2013. Any declaration and payment of dividends by the Company will depend upon the Company’s results of operations, financial condition and cash requirements, and will be subject to Swiss law and other related factors described in the Company’s Proxy Statement for its 2012 Annual Shareholder Meeting.

The Company established a new $500 million share repurchase program. Under the terms of this new share repurchase program, common shares repurchased shall be designated for cancellation and shall be cancelled upon shareholder approval.

The Company will cancel 2,326,900 voting common shares and 173,100 non-voting common shares held in treasury, subject to a required filing with the Swiss Commercial Register in Zug.

 

-27-


Table of Contents

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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q. References in this Form 10-Q to the terms “we,” “us,” “our,” “the company” or other similar terms mean the consolidated operations of Allied World Assurance Company Holdings, AG, a Swiss holding company, and our consolidated subsidiaries, unless the context requires otherwise. References in this Form 10-Q to the term “Allied World Switzerland” or “Holdings” means only Allied World Assurance Company Holdings, AG. References to “Allied World Bermuda” mean only Allied World Assurance Company Holdings, Ltd, a Bermuda holding company. References to “our insurance subsidiaries” may include our reinsurance subsidiaries. References in this Form 10-Q to $ are to the lawful currency of the United States and to CHF are to the lawful currency of Switzerland. References in this Form 10-Q to Holdings’ “common shares” mean its registered voting shares and non-voting participation certificates.

Note on Forward-Looking Statement

This Form 10-Q and other publicly available documents may include, and our officers and representatives may from time to time make, projections concerning financial information and statements concerning future economic performance and events, plans and objectives relating to management, operations, products and services, and assumptions underlying these projections and statements. These projections and statements are forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995 and are not historical facts but instead represent only our belief regarding future events, many of which, by their nature, are inherently uncertain and outside our control. These projections and statements may address, among other things, our strategy for growth, product development, financial results and reserves. Actual results and financial condition may differ, possibly materially, from these projections and statements and therefore you should not place undue reliance on them. Factors that could cause our actual results to differ, possibly materially, from those in the specific projections and statements are discussed throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations and in “Risk Factors” in Item 1A. of Part I of our 2011 Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”) on February 29, 2012 (the “2011 Form 10-K”). We are under no obligation (and expressly disclaim any such obligation) to update or revise any forward-looking statement that may be made from time to time, whether as a result of new information, future developments or otherwise.

Overview

Our Business

We write a diversified portfolio of property and casualty insurance and reinsurance internationally through our subsidiaries and branches based in Bermuda, Europe, Hong Kong, Singapore and the United States as well as our Lloyd’s Syndicate 2232. We manage our business through three operating segments: U.S. insurance, international insurance and reinsurance. As of March 31, 2012, we had approximately $11.4 billion of total assets, $3.2 billion of total shareholders’ equity and $4.0 billion of total capital, which includes shareholders’ equity and senior notes.

During the three months ended March 31, 2012, we continued to experience rate increases on property lines that had experienced significant loss activity in the prior year. We also started to see rate improvement during the quarter on some of our casualty lines of business in certain jurisdictions. We believe that there are opportunities where certain products have attractive premium rates and that the expanded breadth of our operations allows us to target those classes of business. Given these trends, we continue to be selective in the insurance policies and reinsurance contracts we underwrite. Our consolidated gross premiums written increased by $120.2 million, or 21.4%, for the three months ended March 31, 2012 compared to the three months ended March 31, 2011. Our net income increased by $209.6 million to $218.2 million compared to the three months ended March 31, 2011, primarily as a result of lower net losses and loss expenses. The three months ended March 31, 2011 included $132.2 million in property catastrophe losses in the Asia-Pacific region while there were no significant catastrophe losses for the three months ended March 31, 2012. Net realized investment gains increased $83.2 million for the three months ended March 31, 2012 compared to the same period in 2011, benefiting from spread tightening and an improvement in the equity markets.

 

-28-


Table of Contents

Financial Highlights

 

     Three Months Ended March 31,  
     2012     2011  
     ($ in millions except share, per
share and percentage data)
 

Gross premiums written

   $ 680.9      $ 560.7   

Net income

     218.2        8.6   

Operating income (loss)

     91.5        (41.3

Basic earnings per share:

    

Net income

   $ 5.86      $ 0.23   

Operating income (loss)

   $ 2.46      $ (1.08

Diluted earnings per share:

    

Net income

   $ 5.70      $ 0.21   

Operating income (loss)

   $ 2.39      $ (1.02

Weighted average common shares outstanding:

    

Basic

     37,205,166        38,199,867   

Diluted

     38,284,635        40,383,523   

Basic book value per common share

   $ 88.24      $ 77.86   

Diluted book value per common share

   $ 85.48      $ 74.23   

Annualized return on average equity

    

(ROAE), net income

     27.4     1.2

Annualized ROAE, operating income (loss)

     11.5     (5.6 %) 

Non-GAAP Financial Measures

In presenting the company’s results, management has included and discussed certain non-GAAP financial measures, as such term is defined in Item 10(e) of Regulation S-K promulgated by the SEC. Management believes that these non-GAAP measures, which may be defined differently by other companies, better explain the company’s results of operations in a manner that allows for a more complete understanding of the underlying trends in the company’s business. However, these measures should not be viewed as a substitute for those determined in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).

Operating income & operating income per share

Operating income is an internal performance measure used in the management of our operations and represents after-tax operational results excluding, as applicable, net realized investment gains or losses, net impairment charges recognized in earnings, net foreign exchange gain or loss, impairment of intangible assets and other non-recurring items. We exclude net realized investment gains or losses, net impairment charges recognized in earnings, net foreign exchange gain or loss and any other non-recurring items from our calculation of operating income because these amounts are heavily influenced by and fluctuate in part according to the availability of market opportunities and other factors. We exclude impairment of intangible assets as these are non-recurring charges. In addition to presenting net income determined in accordance with U.S. GAAP, we believe that showing operating income enables investors, analysts, rating agencies and other users of our financial information to more easily analyze our results of operations and our underlying business performance. Operating income should not be viewed as a substitute for U.S. GAAP net income. The following is a reconciliation of operating income to its most closely related U.S. GAAP measure, net income.

 

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Table of Contents
     Three Months Ended March 31,  
     2012     2011  
     ($ in millions except per
share data)
 

Net income

   $ 218.2      $ 8.6   

Add after tax affect of:

    

Net realized investment gains

     (126.6     (49.5

Foreign exchange gain

     (0.1     (0.4
  

 

 

   

 

 

 

Operating income (loss)

   $ 91.5      $ (41.3
  

 

 

   

 

 

 

Basic per share data:

    

Net income

   $ 5.86      $ 0.23   

Add after tax affect of:

    

Net realized investment gains

     (3.40     (1.30

Foreign exchange gain

     —          (0.01
  

 

 

   

 

 

 

Operating income (loss)

   $ 2.46      $ (1.08
  

 

 

   

 

 

 

Diluted per share data:

    

Net income