XNYS:WRB WR Berkley Corp Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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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 June 30, 2012
or
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
For the Transition Period from                      to                     .
Commission File Number 1-15202

W. R. BERKLEY CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
 
22-1867895
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
 
 
475 Steamboat Road, Greenwich, Connecticut
 
06830
(Address of principal executive offices)
 
(Zip Code)
 
(203) 629-3000
 
 
(Registrant’s telephone number, including area code)
 
 
 
 
 
None
 
Former name, former address and former fiscal year, if changed since last report.
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 o
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 o
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.
Large accelerated filer þ
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
 
 
(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 o     No þ
Number of shares of common stock, $.20 par value, outstanding as of July 31, 2012: 137,135,952
 



TABLE OF CONTENTS



Part I — FINANCIAL INFORMATION
Item 1.
Financial Statements
W. R. BERKLEY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(Dollars in thousands)
 
June 30,
2012
 
December 31,
2011
Assets
 
 
 
Investments:
 
 
 
Fixed maturity securities
$
11,826,928

 
$
11,312,037

Equity securities available for sale
561,785

 
443,439

Arbitrage trading account
419,249

 
397,312

Investment funds
728,505

 
680,638

Loans receivable
325,073

 
263,187

Real estate
360,787

 
342,905

Total investments
14,222,327

 
13,439,518

Cash and cash equivalents
1,012,220

 
911,742

Premiums and fees receivable
1,347,305

 
1,206,204

Due from reinsurers
1,270,036

 
1,215,679

Accrued investment income
135,702

 
133,776

Prepaid reinsurance premiums
305,689

 
258,271

Deferred policy acquisition costs
386,783

 
364,937

Real estate, furniture and equipment
264,413

 
262,275

Goodwill
87,865

 
87,865

Trading account receivables from brokers and clearing organizations
275,844

 
318,240

Current federal and foreign income taxes

 
9,670

Other assets
153,922

 
195,696

Total assets
$
19,462,106

 
$
18,403,873

Liabilities and Equity
 
 
 
Liabilities:
 
 
 
Reserves for losses and loss expenses
$
9,488,668

 
$
9,337,134

Unearned premiums
2,380,002

 
2,189,575

Due to reinsurers
299,220

 
241,204

Trading account securities sold but not yet purchased
40,520

 
62,514

Current federal and foreign income taxes
15,537

 

Deferred federal and foreign income taxes
31,665

 
2,835

Other liabilities
881,170

 
866,229

Junior subordinated debentures
243,102

 
242,997

Senior notes and other debt
1,865,380

 
1,500,503

Total liabilities
15,245,264

 
14,442,991

Equity:
 
 
 
Preferred stock, par value $.10 per share:
 
 
 
Authorized 5,000,000 shares; issued and outstanding - none

 

Common stock, par value $.20 per share:
 
 
 
Authorized 500,000,000 shares, issued and outstanding, net of treasury shares, 137,167,115 and 137,520,019 shares, respectively
47,024

 
47,024

Additional paid-in capital
944,263

 
941,109

Retained earnings
4,711,836

 
4,491,162

Accumulated other comprehensive income
416,355

 
354,851

Treasury stock, at cost, 97,950,803 and 97,597,899 shares, respectively
(1,911,694
)
 
(1,880,790
)
Total stockholders’ equity
4,207,784

 
3,953,356

Noncontrolling interests
9,058

 
7,526

Total equity
4,216,842

 
3,960,882

Total liabilities and equity
$
19,462,106

 
$
18,403,873


See accompanying notes to interim consolidated financial statements.


1



W. R. BERKLEY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(Dollars in thousands, except per share data)
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
 
2011
REVENUES:
 
 
 
 
 
 
 
Net premiums written
$
1,190,991

 
$
1,057,415

 
$
2,394,517

 
$
2,140,718

Change in net unearned premiums
(43,634
)
 
(40,171
)
 
(147,509
)
 
(140,977
)
Net premiums earned
1,147,357

 
1,017,244

 
2,247,008

 
1,999,741

Net investment income
161,250

 
149,072

 
318,869

 
295,198

Insurance service fees
27,036

 
25,035

 
50,913

 
47,208

Net investment gains:
 
 
 
 
 
 
 
Net realized gains on investment sales
24,286

 
23,290

 
67,763

 
52,574

Change in valuation allowance, net of other-than-temporary impairments

 
(400
)
 
4,014

 
(400
)
Net investment gains
24,286

 
22,890

 
71,777

 
52,174

Revenues from wholly-owned investees
55,434

 
56,134

 
105,109

 
110,021

Other income
384

 
574

 
776

 
958

Total revenues
1,415,747

 
1,270,949

 
2,794,452

 
2,505,300

OPERATING COSTS AND EXPENSES:
 
 
 
 
 
 
 
Losses and loss expenses
731,202

 
674,276

 
1,410,674

 
1,281,371

Other operating costs and expenses
448,758

 
403,658

 
880,537

 
789,787

Expenses from wholly-owned investees
54,931

 
55,855

 
106,261

 
109,671

Interest expense
32,417

 
28,132

 
61,238

 
56,249

Total operating costs and expenses
1,267,308

 
1,161,921

 
2,458,710

 
2,237,078

Income before income taxes
148,439

 
109,028

 
335,742

 
268,222

Income tax expense
(39,535
)
 
(26,908
)
 
(91,606
)
 
(70,507
)
Net income before noncontrolling interests
108,904

 
82,120

 
244,136

 
197,715

Noncontrolling interests
(66
)
 
64

 
20

 
59

Net income to common stockholders
$
108,838

 
$
82,184

 
$
244,156

 
$
197,774

NET INCOME PER SHARE:
 
 
 
 
 
 
 
Basic
$
0.79

 
$
0.58

 
$
1.77

 
$
1.40

Diluted
0.76

 
0.56

 
1.70

 
1.34


See accompanying notes to interim consolidated financial statements.





2


W. R. BERKLEY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(Dollars in thousands)
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
 
2011
Net income before noncontrolling interests
$
108,904

 
$
82,120

 
$
244,136

 
$
197,715

Other comprehensive income (loss):
 
 
 
 
 
 
 
Change in unrealized foreign exchange gains (losses)
(17,257
)
 
(1,007
)
 
(1,674
)
 
9,853

Unrealized holding gains on investment securities arising during the period, net of taxes
55,385

 
92,271

 
108,491

 
86,054

Reclassification adjustment for net investment gains included in net income, net of taxes
(15,850
)
 
(14,336
)
 
(46,932
)
 
(33,126
)
Change in unrecognized pension obligation, net of taxes
823

 
707

 
1,647

 
1,411

Other comprehensive income
23,101

 
77,635

 
61,532

 
64,192

Comprehensive income
132,005

 
159,755

 
305,668

 
261,907

Comprehensive (income) loss to the noncontrolling interest
(71
)
 
(4
)
 
(8
)
 
47

Comprehensive income to common stockholders
$
131,934

 
$
159,751

 
$
305,660

 
$
261,954


See accompanying notes to interim consolidated financial statements.

3


W. R. BERKLEY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)
(Dollars in thousands)
 
For the Six Months Ended
 
June 30,
 
2012
 
2011
COMMON STOCK:
 
 
 
Beginning and end of period
$
47,024

 
$
47,024

ADDITIONAL PAID-IN CAPITAL:
 
 
 
Beginning of period
$
941,109

 
$
935,099

Stock options exercised and restricted stock units issued, net of tax
(12,092
)
 
(23,936
)
Restricted stock units expensed
14,792

 
12,524

Stock issued to directors
454

 
308

End of period
$
944,263

 
$
923,995

RETAINED EARNINGS:
 
 
 
Beginning of period
$
4,491,162

 
$
4,143,207

Net income to common stockholders
244,156

 
197,774

Dividends
(23,482
)
 
(21,275
)
End of period
$
4,711,836

 
$
4,319,706

ACCUMULATED OTHER COMPREHENSIVE INCOME:
 
 
 
Unrealized investment gains (losses):
 
 
 
Beginning of period
$
430,419

 
$
334,747

Unrealized gains on securities not other-than-temporarily impaired
60,275

 
53,342

Unrealized gains (losses) on other-than-temporarily impaired securities
1,256

 
(426
)
End of period
491,950

 
387,663

Currency translation adjustments:
 
 
 
Beginning of period
(61,239
)
 
(42,488
)
Net change in period
(1,674
)
 
9,853

End of period
(62,913
)
 
(32,635
)
Net pension asset:
 
 
 
Beginning of period
(14,329
)
 
(15,696
)
Net change in period
1,647

 
1,411

End of period
(12,682
)
 
(14,285
)
Total accumulated other comprehensive income
$
416,355

 
$
340,743

TREASURY STOCK:
 
 
 
Beginning of period
$
(1,880,790
)
 
$
(1,750,494
)
Stock exercised/vested
23,393

 
37,156

Stock repurchased
(54,878
)
 
(59,159
)
Stock issued to directors
581

 
564

End of period
$
(1,911,694
)
 
$
(1,771,933
)
NONCONTROLLING INTERESTS:
 
 
 
Beginning of period
$
7,526

 
$
6,980

Contributions
1,524

 
332

Net loss
(20
)
 
(59
)
Other comprehensive income, net of tax
28

 
12

End of period
$
9,058

 
$
7,265

See accompanying notes to interim consolidated financial statements.

4


W. R. BERKLEY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(Dollars in thousands)
 
For the Six Months Ended
 
June 30,
 
2012
 
2011
CASH FROM (USED IN) OPERATING ACTIVITIES:
 
 
 
Net income to common stockholders
$
244,156

 
$
197,774

Adjustments to reconcile net income to net cash from operating activities:
 
 
 
Net investment gains
(71,777
)
 
(52,174
)
Depreciation and amortization
47,147

 
33,179

Noncontrolling interests
(20
)
 
(59
)
Investment funds
(63,243
)
 
(25,218
)
Stock incentive plans
15,827

 
13,026

Change in:
 
 
 
Arbitrage trading account
(1,535
)
 
(4,319
)
Premiums and fees receivable
(139,183
)
 
(148,144
)
Reinsurance accounts
(46,182
)
 
(71,887
)
Deferred policy acquisition costs
(21,637
)
 
(30,255
)
Deferred income taxes
(4,244
)
 
21,037

Reserves for losses and loss expenses
151,975

 
163,604

Unearned premiums
188,902

 
203,515

Other
12,225

 
(83,687
)
Net cash from (used in) operating activities
312,411

 
216,392

CASH FROM (USED IN) INVESTING ACTIVITIES:
 
 
 
Proceeds from sale of fixed maturity securities
370,902

 
707,598

Proceeds from sale of equity securities
70,274

 
100,837

Distributions from (contributions to) investment funds
23,090

 
(124,201
)
Proceeds from maturities and prepayments of fixed maturity securities
922,961

 
774,127

Purchase of fixed maturity securities
(1,658,418
)
 
(1,419,857
)
Purchase of equity securities
(184,751
)
 
(44,736
)
Real estate purchased
(15,475
)
 
(117,893
)
Change in loans receivable
(61,886
)
 
43,700

Net additions to real estate, furniture and equipment
(20,376
)
 
(18,679
)
Change in balances due to security brokers
38,700

 
73,311

Payment for business purchased, net of cash acquired

 
(8,579
)
Net cash from (used in) investing activities
(514,979
)
 
(34,372
)
CASH FROM (USED IN) FINANCING ACTIVITIES:
 
 
 
Net proceeds from issuance of debt
364,044

 

Net proceeds from stock options exercised
4,776

 
13,217

Repayment of debt

 
624

Cash dividends to common stockholders
(11,042
)
 
(21,273
)
Purchase of common treasury shares
(48,346
)
 
(59,159
)
Other, net
19,500

 
22,635

Net cash from (used in) financing activities
328,932

 
(43,956
)
Net impact on cash due to change in foreign exchange rates
(25,886
)
 
13,865

Net change in cash and cash equivalents
100,478

 
151,929

Cash and cash equivalents at beginning of year
911,742

 
642,952

Cash and cash equivalents at end of period
$
1,012,220

 
$
794,881

See accompanying notes to interim consolidated financial statements.

5


W. R. Berkley Corporation and Subsidiaries
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(1) General
The accompanying unaudited consolidated financial statements of W. R. Berkley Corporation and its subsidiaries (the “Company”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information. Accordingly, they do not include all the information and notes required by GAAP for annual financial statements. The unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring items, which are necessary to present fairly the Company’s financial position and results of operations on a basis consistent with the prior audited consolidated financial statements. Operating results for interim periods are not necessarily indicative of the results that may be expected for the year. All significant intercompany accounts and transactions have been eliminated. The preparation of financial statements requires the use of management estimates. For further information related to a description of areas of judgment and estimates and other information necessary to understand the Company’s financial position and results of operations, refer to the audited consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. Reclassifications have been made in the 2011 financial statements as originally reported to conform to the presentation of the 2012 financial statements.
The income tax provision has been computed based on the Company’s estimated annual effective tax rate. The effective tax rate for the quarter differs from the federal income tax rate of 35% principally because of tax-exempt investment income.

(2) Per Share Data
The Company presents both basic and diluted net income per share (“EPS”) amounts. Basic EPS is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted EPS is based upon the weighted average number of common and common equivalent shares outstanding during the period and is calculated using the treasury stock method for stock incentive plans. Common equivalent shares are excluded from the computation in periods in which they have an anti-dilutive effect. Stock options for which the exercise price exceeds the average market price over the period have an anti-dilutive effect on EPS and, accordingly, are excluded from the calculation.
The weighted average number of common shares used in the computation of basic and diluted earnings per share was as follows (amounts in thousands):
 
 
For the Three Months Ended
 
For the Six Months Ended
 
 
June 30,
 
June 30,
 
 
2012
 
2011
 
2012
 
2011
Basic
 
138,181

 
141,637

 
137,997

 
141,408

Diluted
 
143,528

 
147,677

 
143,506

 
147,614



(3) Recent Accounting Pronouncements
In October 2010, the Financial Accounting Standards Board ("FASB") issued guidance regarding the treatment of costs associated with acquiring or renewing insurance contracts. This guidance modified the definition of the types of costs that can be capitalized and specifies that the costs must be directly related to the successful acquisition of a new or renewed insurance contract. The Company adopted this guidance effective January 1, 2012 and retrospectively adjusted its previously issued financial statements.


6


A summary of the impact of the adoption of this new guidance is shown below (dollars in thousands except per share amounts):
 
Previously Reported
As Adjusted
At December 31, 2011:
 
 
Deferred policy acquisition costs
$
448,795

$
364,937

Deferred tax liability
31,623

2,835

Stockholders' equity
4,008,426

3,953,356

 
 
 
For the Six Months Ended June 30, 2011:
 
Other operating costs and expenses
$
787,190

$
789,787

Income before income taxes
270,819

268,222

Federal and foreign income taxes
(71,309
)
(70,507
)
Net income
199,569

197,774

 
 
 
Basic net income per share
$
1.41

$
1.40

Diluted net income per share
1.35

1.34

 
 
 
For the Three Months Ended June 30, 2011:
 
Other operating costs and expenses
$
402,359

$
403,658

Income before income taxes
110,327

109,028

Federal and foreign income taxes
(27,309
)
(26,908
)
Net income
83,082

82,184

 
 
 
Basic net income per share
$
0.59

$
0.58

Diluted net income per share
0.56

0.56

The impact of applying this guidance retrospectively was a reduction in stockholders' equity of $51 million as of December 31, 2010.

In May 2011, the FASB issued guidance related to measuring and disclosing fair values. The Company's adoption of the updated guidance effective January 1, 2012 resulted in a change in the presentation of the Company's consolidated financial statements but did not have any impact on the Company's results of operations, financial position or liquidity.
 
In June 2011, the FASB issued guidance relating to the presentation of the components of net income and other comprehensive income. The Company's adoption of the updated guidance effective January 1, 2012 resulted in a change in the presentation of the Company's consolidated financial statements but did not have any impact on the Company's results of operations, financial position or liquidity.

All recently issued but not yet effective accounting and reporting guidance is either not applicable to the Company or is not expected to have a material impact on the Company.


(4) Statements of Cash Flow
Interest payments were $55,616,000 and $56,171,000 and income taxes paid were $68,118,000 and $37,516,000 in the six months ended June 30, 2012 and 2011, respectively.




7


(5) Investments in Fixed Maturity Securities
At June 30, 2012 and December 31, 2011, investments in fixed maturity securities were as follows:
 
(Dollars in thousands)
Amortized
Cost
 
Gross Unrealized
 
Fair
Value
 
Carrying
Value
Gains
 
Losses
 
June 30, 2012
 
 
 
 
 
 
 
 
 
Held to maturity:
 
 
 
 
 
 
 
 
 
State and municipal
$
76,626

 
$
15,570

 
$

 
$
92,196

 
$
76,626

Residential mortgage-backed
34,626

 
5,667

 

 
40,293

 
34,626

Corporate
4,996

 
685

 

 
5,681

 
4,996

Total held to maturity
116,248

 
21,922

 

 
138,170

 
116,248

Available for sale:
 
 
 
 
 
 
 
 
 
U.S. government and government agency
905,046

 
80,624

 
(126
)
 
985,544

 
985,544

State and municipal
4,841,035

 
329,947

 
(16,273
)
 
5,154,709

 
5,154,709

Mortgage-backed securities:
 
 
 
 
 
 
 
 
 
Residential (1)
1,408,119

 
55,356

 
(11,226
)
 
1,452,249

 
1,452,249

Commercial
172,404

 
6,420

 
(105
)
 
178,719

 
178,719

Corporate
2,763,032

 
169,660

 
(19,904
)
 
2,912,788

 
2,912,788

Foreign
969,400

 
61,654

 
(4,383
)
 
1,026,671

 
1,026,671

Total available for sale
11,059,036

 
703,661

 
(52,017
)
 
11,710,680

 
11,710,680

Total investments in fixed maturity securities
$
11,175,284

 
$
725,583

 
$
(52,017
)
 
$
11,848,850

 
$
11,826,928

December 31, 2011
 
 
 
 
 
 
 
 
 
Held to maturity:
 
 
 
 
 
 
 
 
 
State and municipal
$
74,354

 
$
12,546

 
$

 
$
86,900

 
$
74,354

Residential mortgage-backed
35,759

 
5,610

 

 
41,369

 
35,759

Corporate
4,996

 
717

 

 
5,713

 
4,996

Total held to maturity
115,109

 
18,873

 

 
133,982

 
115,109

Available for sale:
 
 
 
 
 
 
 
 
 
U.S. government and government agency
906,924

 
69,920

 
(351
)
 
976,493

 
976,493

State and municipal
5,031,275

 
308,345

 
(16,550
)
 
5,323,070

 
5,323,070

Mortgage-backed securities:
 
 
 
 
 
 
 
 
 
Residential (1)
1,416,427

 
75,635

 
(15,894
)
 
1,476,168

 
1,476,168

Commercial
105,383

 
4,054

 
(1,018
)
 
108,419

 
108,419

Corporate
2,328,200

 
132,311

 
(36,087
)
 
2,424,424

 
2,424,424

Foreign
850,838

 
42,165

 
(4,649
)
 
888,354

 
888,354

Total available for sale
10,639,047

 
632,430

 
(74,549
)
 
11,196,928

 
11,196,928

Total investments in fixed maturity securities
$
10,754,156

 
$
651,303

 
$
(74,549
)
 
$
11,330,910

 
$
11,312,037

___________
(1)
Gross unrealized losses for residential mortgage-backed securities include $5,735,000 and $7,668,000 as of June 30, 2012 and December 31, 2011, respectively, related to the non-credit portion of other-than-temporary impairments (“OTTI”) recognized in other comprehensive income.


8


The amortized cost and fair value of fixed maturity securities at June 30, 2012, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because certain issuers may have the right to call or prepay obligations.
 
(Dollars in thousands)
Amortized
Cost
 
Fair Value
Due in one year or less
$
865,253

 
$
882,883

Due after one year through five years
3,287,781

 
3,463,096

Due after five years through ten years
2,494,584

 
2,719,280

Due after ten years
2,912,517

 
3,112,330

Mortgage-backed securities
1,615,149

 
1,671,261

Total
$
11,175,284

 
$
11,848,850

At June 30, 2012, there were no investments, other than investments in United States government and government agency securities, which exceeded 10% of common stockholders’ equity.

(6) Investments in Equity Securities Available for Sale
At June 30, 2012 and December 31, 2011, investments in equity securities available for sale were as follows:
 
(Dollars in thousands)
Cost
 
Gross Unrealized
 
Fair
Value
 
Carrying
Value
Gains
 
Losses
 
June 30, 2012
 
 
 
 
 
 
 
 
 
Common stocks
$
337,557

 
$
104,104

 
$
(2,415
)
 
$
439,246

 
$
439,246

Preferred stocks
120,105

 
11,391

 
(8,957
)
 
122,539

 
122,539

Total
$
457,662

 
$
115,495

 
$
(11,372
)
 
$
561,785

 
$
561,785

December 31, 2011
 
 
 
 
 
 
 
 
 
Common stocks
$
209,210

 
$
113,660

 
$
(2,888
)
 
$
319,982

 
$
319,982

Preferred stocks
133,183

 
5,139

 
(14,865
)
 
123,457

 
123,457

Total
$
342,393

 
$
118,799

 
$
(17,753
)
 
$
443,439

 
$
443,439


(7) Arbitrage Trading Account
At June 30, 2012 and December 31, 2011, the fair value and carrying value of the arbitrage trading account were $419 million and $397 million, respectively. The primary focus of the trading account is merger arbitrage. Merger arbitrage is the business of investing in the securities of publicly held companies which are the targets in announced tender offers and mergers. Arbitrage investing differs from other types of investing in its focus on transactions and events believed likely to bring about a change in value over a relatively short time period (usually four months or less). The Company believes that this makes arbitrage investments less vulnerable to changes in general financial market conditions.


9




(8) Net Investment Income
Net investment income consists of the following:
 
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
(Dollars in thousands)
2012
 
2011
 
2012
 
2011
Investment income earned on:
 
 
 
 
 
 
 
Fixed maturity securities, including cash and cash equivalents and loans receivable
$
119,835

 
$
124,172

 
$
239,123

 
$
245,113

Investment funds
35,619

 
15,502

 
63,242

 
31,889

Arbitrage trading account
60

 
5,827

 
6,541

 
11,042

Equity securities available for sale
3,829

 
3,485

 
6,979

 
6,749

Real estate
3,348

 
1,172

 
5,524

 
2,344

Gross investment income
162,691

 
150,158

 
321,409

 
297,137

 
 
 
 
 
 
 
 
Investment expense
(1,441
)
 
(1,086
)
 
(2,540
)
 
(1,939
)
Net investment income
$
161,250

 
$
149,072

 
$
318,869

 
$
295,198


(9) Investment Funds
Investment funds consist of the following:
 
Carrying Value
as of
 
Income (Losses)
from Investment Funds
 
June 30,
 
December 31,
 
For the Six Months Ended June 30,
(Dollars in thousands)
2012
 
2011
 
2012
 
2011
Real estate
$
381,907

 
$
373,413

 
$
11,290

 
$
10,647

Energy
140,802

 
98,974

 
49,780

 
23,133

Arbitrage
57,346

 
58,008

 
(662
)
 
354

Other
148,450

 
150,243

 
2,834

 
(2,245
)
Total
$
728,505

 
$
680,638

 
$
63,242


$
31,889


The Company's share of the earnings or losses of investment funds is generally reported on a one-quarter lag in order to facilitate the timely completion of the Company's financial statements. Subsequent to June 30, 2012, the Company received financial information for its investments in energy funds. The Company's share of net losses reported by energy funds for their second quarter of 2012 is estimated to be $20 million pre-tax, or $13 million after-tax. The Company will report this loss, together with the results for other investment funds, in the third quarter of 2012.

(10) Real Estate

Real estate is directly owned property held for investment. At June 30, 2012, real estate consists of two office buildings in London, including one in operation and one under development, and a long-term ground lease in Washington D.C. Future minimum rental income expected on operating leases relating to real estate held for investment is $1,418,000 in 2012, $1,460,000 in 2013, $1,504,000 in 2014, $1,549,000 in 2015, $1,596,000 in 2016 and $330,657,000 thereafter.



10


(11) Loans Receivable
Loans receivable are as follows:
 
 
 
 
(Dollars in thousands)
June 30, 2012
 
December 31, 2011
Total loans receivable
$
325,073

 
$
263,187

 
 
 
 
Valuation allowance:
 
 
 
  Specific
$
10,465

 
$
19,041

  General
2,567

 
764

  Total
$
13,032

 
$
19,805

 
 
 
 
Impaired loans:
 
 
 
  With a specific valuation allowance
$
12,820

 
$
29,702

  Without a valuation allowance
30,431

 
30,357

  Unpaid principal balance
53,250

 
93,922

 
 
 
 
For the Six Months Ended June 30,
2012
 
2011
  Decrease in valuation allowance
$
6,773

 
$

  Loans receivable charged off
85

 

 
 
 
 
For the Three Months Ended June 30,
 
 
 
  Increase in valuation allowance
123

 

  Loans receivable charged off

 


Loans receivable in non-accrual status were $13 million and $30 million at June 30, 2012 and December 31, 2011, respectively. If these loans had been current, additional interest income of $0.2 million and $0.2 million would have been recognized in accordance with their original terms for the six months ended June 30, 2012 and 2011, respectively.
The Company monitors the performance of its loans receivable and assesses the ability of the borrower to pay principal and interest based upon loan structure, underlying property values, cash flow and related financial and operating performance of the property and market conditions. Loans receivable with a potential for default are further assessed using discounted cash flow analysis and comparable cost and sales methodologies, if appropriate.
The Company's six largest loans receivable, which have an aggregate amortized cost of $181 million and an aggregate fair value of $172 million at June 30, 2012, are secured by commercial real estate located primarily in New York City, California, Hawaii and Boston. These loans earn interest at floating LIBOR-based interest rates and have maturities (inclusive of extension options) through March 2016. As part of the evaluation process, the Company reviews certain credit quality indicators for these loans. The Company utilizes an internal risk rating system to assign a risk to each of its commercial loans. The loan rating system takes into consideration credit quality indicators including loan to value ratios, which compare the outstanding loan amount to the estimated value of the property, the borrower's financial condition and performance with respect to loan terms, the Company's position in the capital structure, and the overall leverage in the capital structure. Based on this rating system, two loans with an aggregate cost basis of $41 million were considered to be impaired at June 30, 2012. For each of these loans, a determination was made as to the amount of loss in the event of a default and whether the loss is probable. The results of the determination were considered in connection with the valuation allowance noted above. An additional credit quality indicator is the debt service coverage ratio, which compares a property's net operating income to the borrower's principal and interest payments. At June 30, 2012, each of the six largest loans referred to above had a debt service coverage ratio greater than 3.0, except one that is lower due to a recent and temporary rate abatement.


11


  


(12) Realized and Unrealized Investment Gains
Realized and unrealized investment gains are as follows:
 
  
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
(Dollars in thousands)
2012
 
2011
 
2012
 
2011
Realized investment gains:
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Gains
$
5,652

 
$
8,957

 
$
20,607

 
$
14,837

Losses
(1,763
)
 
(1,016
)
 
(2,306
)
 
(2,509
)
Equity securities available for sale
18,188

 
14,289

 
44,426

 
38,221

Other
18

 

 
1,535

 

Sales of investment funds
2,191

 
1,060

 
3,501

 
2,025

Change in valuation allowance, net of other-than -temporary impairments (1)

 
(400
)
 
4,014

 
(400
)
Total net investment gains before income taxes
24,286

 
22,890

 
71,777

 
52,174

Income tax expense
(8,436
)
 
(8,554
)
 
(24,845
)
 
(19,048
)
Total net investment gains
$
15,850

 
$
14,336

 
$
46,932

 
$
33,126

Change in unrealized gains of available for sale securities:
 
 
 
 
 
 
 
Fixed maturity securities
$
71,138

 
$
101,205

 
$
90,560

 
$
71,918

Less non-credit portion of OTTI recognized in other comprehensive income
190

 
(900
)
 
1,933

 
(656
)
Equity securities available for sale
(8,518
)
 
18,486

 
3,077

 
6,101

Investment funds
(2,651
)
 
816

 
(974
)
 
4,190

Total change in unrealized gains (losses) before income taxes and noncontrolling interests
60,159

 
119,607

 
94,596

 
81,553

Income tax expense (benefit)
(20,624
)
 
(41,672
)
 
(33,037
)
 
(28,625
)
Noncontrolling interests
(5
)
 
(68
)
 
(28
)
 
(12
)
Total change in net unrealized gains
$
39,530

 
$
77,867

 
$
61,531

 
$
52,916

_________
(1) For the six months ended June 30, 2012, this represents a valuation allowance reduction of $7 million, partially offset by an other-than-temporary impairment of $3 million.

12




(13) Securities in an Unrealized Loss Position
The following table summarizes all securities in an unrealized loss position at June 30, 2012 and December 31, 2011 by the length of time those securities have been continuously in an unrealized loss position: 
  
Less Than 12 Months
 
12 Months or Greater
 
Total
(Dollars in thousands)
Fair Value
 
Gross
Unrealized
Losses
 
Fair Value
 
Gross
Unrealized
Losses
 
Fair Value
 
Gross
Unrealized
Losses
June 30, 2012
 
 
 
 
 
 
 
 
 
 
 
U.S. government and agency
$
18,412

 
$
126

 
$

 
$

 
$
18,412

 
$
126

State and municipal
118,623

 
977

 
206,125

 
15,296

 
324,748

 
16,273

Mortgage-backed securities
281,422

 
2,358

 
62,418

 
8,973

 
343,840

 
11,331

Corporate
215,838

 
1,997

 
84,614

 
17,907

 
300,452

 
19,904

Foreign
103,524

 
4,112

 
7,959

 
271

 
111,483

 
4,383

Fixed maturity securities
737,819

 
9,570

 
361,116

 
42,447

 
1,098,935

 
52,017

Common stocks
62,293

 
2,415

 

 

 
62,293

 
2,415

Preferred stocks
23,302

 
1,485

 
38,567

 
7,472

 
61,869

 
8,957

Equity securities
85,595

 
3,900

 
38,567

 
7,472

 
124,162

 
11,372

Total
$
823,414

 
$
13,470

 
$
399,683

 
$
49,919

 
$
1,223,097

 
$
63,389

 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2011
 
 
 
 
 
 
 
 
 
 
 
U.S. government and agency
$
24,668

 
$
169

 
$
4,800

 
$
182

 
$
29,468

 
$
351

State and municipal
131,417

 
827

 
183,205

 
15,723

 
314,622

 
16,550

Mortgage-backed securities
172,729

 
2,439

 
94,243

 
14,473

 
266,972

 
16,912

Corporate
341,764

 
8,327

 
125,654

 
27,760

 
467,418

 
36,087

Foreign
197,560

 
4,078

 
7,159

 
571

 
204,719

 
4,649

Fixed maturity securities
868,138

 
15,840

 
415,061

 
58,709

 
1,283,199

 
74,549

Common stocks
47,098

 
2,888

 

 

 
47,098

 
2,888

Preferred stocks
23,782

 
125

 
45,314

 
14,740

 
69,096

 
14,865

Equity securities
70,880

 
3,013

 
45,314

 
14,740

 
116,194

 
17,753

Total
$
939,018

 
$
18,853

 
$
460,375

 
$
73,449

 
$
1,399,393

 
$
92,302

Fixed Maturity Securities – A summary of the Company’s non-investment grade fixed maturity securities that were in an unrealized loss position at June 30, 2012 is presented in the table below.  
(Dollars in thousands)
Number of
Securities
 
Aggregate
Fair Value
 
Gross
Unrealized
Loss
Unrealized loss less than $5 million:
 
 
 
 
 
Mortgage-backed securities
10

 
$
36,128

 
$
2,362

Corporate
11

 
21,363

 
1,914

State and municipal
4

 
32,400

 
2,407

Foreign
5

 
9,339

 
2,092

Unrealized loss $5 million or more:
 
 
 
 
 
Mortgage-backed security (1)
1

 
17,058

 
5,359

Total
31

 
$
116,288

 
$
14,134

_______________
(1) This investment is a residential mortgage-backed security that was evaluated based on the performance of the underlying collateral under various economic and default scenarios. The security has met its contractual obligations and the Company expects that it will continue to meet those contractual payment obligations as they become due. Based on this evaluation, the Company does not consider the investment to be OTTI.


13


For OTTI of fixed maturity securities that management does not intend to sell or, more likely than not, would not be required to sell, the portion of the decline in value considered to be due to credit factors is recognized in earnings and the portion of the decline in value considered to be due to non-credit factors is recognized in other comprehensive income. For the six months ended June 30, 2012 and 2011, there were no changes in the portion of impairments recognized in earnings for those securities that have been impaired due to both credit factors and non-credit factors.
 
The Company has evaluated its fixed maturity securities in an unrealized loss position and believes the unrealized losses are due primarily to temporary market and sector-related factors rather than to issuer-specific factors. None of these securities are delinquent or in default under financial covenants. Based on its assessment of these issuers, the Company expects them to continue to meet their contractual payment obligations as they become due and does not consider any of these securities to be OTTI.
Preferred Stocks – At June 30, 2012, there were five preferred stocks in an unrealized loss position, with an aggregate fair value of $62 million and a gross unrealized loss of $9 million. Three of those preferred stocks with an aggregate fair value of $26 million and a gross unrealized loss of $6 million were rated non-investment grade. Based upon management’s view of the underlying value of these securities, the Company does not consider these preferred stocks to be OTTI.
Common Stocks – At June 30, 2012, the Company owned five common stocks in an unrealized loss position with an aggregate fair value of $62 million and an aggregate unrealized loss of $2 million. The Company does not consider these common stocks to be OTTI.

(14) Fair Value Measurements
The Company’s fixed maturity and equity securities available for sale and its trading account securities are carried at fair value. 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.” The Company utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for similar assets in active markets. Level 3 inputs are unobservable inputs for the asset or liability. Unobservable inputs may only be used to measure fair value to the extent that observable inputs are not available.
Because many fixed maturity securities do not trade on a daily basis, the Company utilizes pricing models and processes which may include benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. Market inputs used to evaluate securities include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. Quoted prices are often unavailable for recently issued securities, securities that are infrequently traded or securities that are only traded in private transactions. For publicly traded securities for which quoted prices are unavailable, the Company determines fair value based on independent broker quotations and other observable market data. For securities traded only in private negotiations, the Company determines fair value based primarily on the cost of such securities, which is adjusted to reflect prices of recent placements of securities of the same issuer, financial projections, credit quality and business developments of the issuer and other relevant information.



14


The following tables present the assets and liabilities measured at fair value, on a recurring basis, as of June 30, 2012 and December 31, 2011 by Level:
 
(Dollars in thousands)
Total
 
Level 1
 
Level 2
 
Level 3
June 30, 2012
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
Fixed maturity securities available for sale:
 
 
 
 
 
 
 
U.S. government and agency
$
985,544

 
$

 
$
985,544

 
$

State and municipal
5,154,709

 

 
5,154,709

 

Mortgage-backed securities
1,630,968

 

 
1,630,968

 

Corporate
2,912,788

 

 
2,846,495

 
66,293

Foreign
1,026,671

 

 
1,026,671

 

Total fixed maturity securities available for sale
11,710,680

 

 
11,644,387

 
66,293

Equity securities available for sale:
 
 
 
 
 
 
 
Common stocks
439,246

 
437,837

 

 
1,409

Preferred stocks
122,539

 

 
119,695

 
2,844

Total equity securities available for sale
561,785

 
437,837

 
119,695

 
4,253

Arbitrage trading account
419,249

 
300,580

 
117,884

 
785

Total
$
12,691,714

 
$
738,417

 
$
11,881,966

 
$
71,331

Liabilities:
 
 
 
 
 
 
 
Securities sold but not yet purchased
$
40,520

 
$
39,411

 
$
1,089

 
$
20

December 31, 2011
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
Fixed maturity securities available for sale:
 
 
 
 
 
 
 
U.S. government and agency
$
976,493

 
$

 
$
976,493

 
$

State and municipal
5,323,070

 

 
5,323,070

 

Mortgage-backed securities
1,584,587

 

 
1,584,587

 

Corporate
2,424,424

 

 
2,356,596

 
67,828

Foreign
888,354

 

 
888,354

 

Total fixed maturity securities available for sale
11,196,928

 

 
11,129,100

 
67,828

Equity securities available for sale:
 
 
 
 
 
 
 
Common stocks
319,982

 
318,423

 

 
1,559

Preferred stocks
123,457

 

 
111,154

 
12,303

Total equity securities available for sale
443,439

 
318,423

 
111,154

 
13,862

Arbitrage trading account
397,312

 
208,516

 
187,945

 
851

Total
$
12,037,679

 
$
526,939

 
$
11,428,199

 
$
82,541

Liabilities:
 
 
 
 
 
 
 
Securities sold but not yet purchased
$
62,514

 
$
62,493

 
$

 
$
21

There were no significant transfers between Levels 1 and 2 during the six months ended June 30, 2012 or during the year ended December 31, 2011.








15


The following tables summarize changes in Level 3 assets and liabilities for the six months ended June 30, 2012 and for the year ended December 31, 2011:
 
  
 
 
Gains (Losses) Included in
 
 
(Dollars in thousands)
Beginning
Balance
 
Earnings
 
Other
Comprehensive
Income
 
Purchases
 
(Sales)
 
Maturities
 
Transfer in
 
Ending
Balance
For the six months ended June 30, 2012:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities available for sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate
$
67,828

 
$
156

 
$
4,244

 
$
148

 
$

 
$
(6,083
)
 
$

 
$
66,293

Total
67,828

 
156

 
4,244

 
148

 

 
(6,083
)
 

 
66,293

Equity securities available for sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common stocks
1,559

 

 

 

 
(150
)
 

 

 
1,409

Preferred stocks
12,303

 
2,095

 
(2,088
)
 

 
(9,466
)
 

 

 
2,844

Total
13,862

 
2,095

 
(2,088
)
 

 
(9,616
)
 

 

 
4,253

Arbitrage trading account
851

 
(81
)
 





 

 
15

 
785

Total
$
82,541

 
$
2,170

 
$
2,156

 
$
148

 
$
(9,616
)
 
$
(6,083
)
 
$
15

 
$
71,331

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Securities sold but not yet purchased
$
21

 
$
(1
)
 
$

 
$

 
$

 
$

 
$

 
$
20

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the year ended December 31, 2011
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturity securities available for sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate
$
88,063

 
$
(454