BERKLEY W R CORP - FORM 10-Q - May 7, 2018

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EX-32.1 - CERTIFICATION OF CEO AND CFO - BERKLEY W R CORPwrb331201810qex321.htm
EX-31.2 - CERTIFICATION OF CFO - BERKLEY W R CORPwrb331201810qex312.htm
EX-31.1 - CERTIFICATION OF CEO - BERKLEY W R CORPwrb331201810qex311.htm
EX-10.1 - FORM OF 2018 PERFORMANCE UNIT AWARD AGREEMENT - BERKLEY W R CORPwrb331201810qex101.htm


 
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, 2018
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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth 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)
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
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 May 1, 2018: 121,669,098
 



TABLE OF CONTENTS



Part I — FINANCIAL INFORMATION
Item 1.
Financial Statements
W. R. BERKLEY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
 
March 31,
2018
 
December 31,
2017
 
(Unaudited)
 
(Audited)
Assets
 
 
 
Investments:
 
 
 
Fixed maturity securities
$
13,343,132

 
$
13,551,250

Investment funds
1,161,127

 
1,155,677

Real estate
1,833,337

 
1,469,601

Arbitrage trading account
744,859

 
617,649

Equity securities

496,034

 
576,647

Loans receivable
75,902

 
79,684

Total investments
17,654,391

 
17,450,508

Cash and cash equivalents
956,603

 
950,471

Premiums and fees receivable
1,845,723

 
1,773,844

Due from reinsurers
1,868,667

 
1,783,200

Deferred policy acquisition costs
513,586

 
507,549

Prepaid reinsurance premiums
490,582

 
472,009

Trading account receivables from brokers and clearing organizations
26,667

 
189,280

Property, furniture and equipment
424,751

 
422,960

Goodwill
178,945

 
178,945

Accrued investment income
143,974

 
136,597

Other assets
483,943

 
434,554

Total assets
$
24,587,832

 
$
24,299,917

 
 
 
 
Liabilities and Equity
 
 
 
Liabilities:
 
 
 
Reserves for losses and loss expenses
$
11,784,895

 
$
11,670,408

Unearned premiums
3,404,003

 
3,290,180

Due to reinsurers
248,746

 
246,460

Trading account securities sold but not yet purchased
29,453

 
64,358

Federal and foreign income taxes
96,735

 
98,091

Other liabilities
852,255

 
981,987

Senior notes and other debt
1,782,139

 
1,769,052

Subordinated debentures
897,426

 
728,218

Total liabilities
19,095,652

 
18,848,754

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, 121,543,951 and 121,514,852 shares, respectively
47,024

 
47,024

Additional paid-in capital
1,057,230

 
1,048,283

Retained earnings
7,322,201

 
6,956,882

Accumulated other comprehensive (loss) income
(258,982
)
 
68,541

Treasury stock, at cost, 113,573,967 and 113,603,066 shares, respectively
(2,715,697
)
 
(2,709,386
)
Total stockholders’ equity
5,451,776

 
5,411,344

Noncontrolling interests
40,404

 
39,819

Total equity
5,492,180

 
5,451,163

Total liabilities and equity
$
24,587,832

 
$
24,299,917


See accompanying notes to interim consolidated financial statements.

1



W. R. BERKLEY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In thousands, except per share data)

 
For the Three Months Ended March 31,
 
 
2018
 
2017
REVENUES:
 
 
 
Net premiums written
$
1,665,338

 
$
1,646,838

Change in net unearned premiums
(97,930
)
 
(76,796
)
Net premiums earned
1,567,408

 
1,570,042

Net investment income
174,518

 
148,858

Net realized and unrealized gains on investments
48,464

 
52,348

Revenues from non-insurance businesses
70,171

 
65,390

Insurance service fees
30,675

 
33,280

Other income
11

 
500

Total revenues
1,891,247

 
1,870,418

OPERATING COSTS AND EXPENSES:
 
 
 
Losses and loss expenses
963,219

 
979,603

Other operating costs and expenses
610,439

 
603,700

Expenses from non-insurance businesses
69,543

 
66,019

Interest expense
37,056

 
36,799

Total operating costs and expenses
1,680,257

 
1,686,121

Income before income taxes
210,990

 
184,297

Income tax expense
(43,417
)
 
(59,623
)
Net income before noncontrolling interests
167,573

 
124,674

Noncontrolling interests
(1,177
)
 
(1,227
)
Net income to common stockholders
$
166,396

 
$
123,447

 
 
 
 
NET INCOME PER SHARE:
 
 
 
Basic
$
1.32

 
$
1.01

Diluted
$
1.30

 
$
0.96


See accompanying notes to interim consolidated financial statements.





2


W. R. BERKLEY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME (UNAUDITED)
(In thousands)
 
For the Three Months Ended March 31,
 
 
2018
 
2017
Net income before noncontrolling interests
$
167,573

 
$
124,674

Other comprehensive (loss) income:
 
 
 
Change in unrealized currency translation adjustments
12,799

 
22,735

Change in unrealized investment gains, net of taxes
(125,772
)
 
(8,831
)
Other comprehensive (loss) income
(112,973
)
 
13,904

Comprehensive income
54,600

 
138,578

Noncontrolling interests
(1,188
)
 
(1,208
)
Comprehensive income to common stockholders
$
53,412

 
$
137,370


See accompanying notes to interim consolidated financial statements.

3


W. R. BERKLEY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)
(In thousands)
 
For the Three Months Ended March 31,
 
 
2018

2017
COMMON STOCK:
 
 
 
Beginning and end of period
$
47,024

 
$
47,024

ADDITIONAL PAID-IN CAPITAL:
 
 
 
Beginning of period
$
1,048,283

 
$
1,037,446

Restricted stock units issued
(487
)
 
(667
)
Restricted stock units expensed
9,434

 
10,810

End of period
$
1,057,230

 
$
1,047,589

RETAINED EARNINGS:
 
 
 
Beginning of period
$
6,956,882

 
$
6,595,987

Cumulative effect adjustment resulting from changes in accounting principles
215,939

 
—

Net income to common stockholders
166,396

 
123,447

Dividends
(17,016
)
 
(15,759
)
End of period
$
7,322,201

 
$
6,703,675

ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME:
 
 
 
Unrealized investment gains:
 
 
 
Beginning of period
$
375,421

 
$
427,154

Cumulative effect adjustment resulting from changes in accounting principles
(214,539
)
 
—

Unrealized losses on securities not other-than-temporarily impaired
(125,796
)
 
(8,913
)
Unrealized gains on other-than-temporarily impaired securities
13

 
101

End of period
35,099

 
418,342

Currency translation adjustments:
 
 
 
Beginning of period
(306,880
)
 
(371,586
)
Net change in period
12,799

 
22,735

End of period
(294,081
)
 
(348,851
)
Total accumulated other comprehensive (loss) income
$
(258,982
)
 
$
69,491

TREASURY STOCK:
 
 
 
Beginning of period
$
(2,709,386
)
 
$
(2,688,817
)
Stock exercised/vested
488

 
644

Stock repurchased
(6,799
)
 
—

End of period
$
(2,715,697
)
 
$
(2,688,173
)
NONCONTROLLING INTERESTS:
 
 
 
Beginning of period
$
39,819

 
$
33,926

(Distributions) contributions
(603
)
 
3,801

Net income
1,177

 
1,227

Other comprehensive income (loss), net of tax
11

 
(19
)
End of period
$
40,404

 
$
38,935

See accompanying notes to interim consolidated financial statements.

4


W. R. BERKLEY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
 
For the Three Months Ended March 31,
 
 
2018
 
2017
CASH (USED IN) FROM OPERATING ACTIVITIES:
 
 
 
Net income to common stockholders
$
166,396

 
$
123,447

Adjustments to reconcile net income to net cash from operating activities:
 
 
 
Net realized and unrealized gains on investments
(48,464
)
 
(52,348
)
Depreciation and amortization
29,027

 
18,133

Noncontrolling interests
1,177

 
1,227

Investment funds
(40,354
)
 
(26,649
)
Stock incentive plans
9,434

 
10,780

Change in:
 
 
 
Arbitrage trading account
497

 
2,350

Premiums and fees receivable
(74,492
)
 
(59,244
)
Reinsurance accounts
(100,379
)
 
67,205

Deferred policy acquisition costs
(6,851
)
 
(6,126
)
Income taxes
50,505

 
50,595

Reserves for losses and loss expenses
120,063

 
10,424

Unearned premiums
116,627

 
113,483

Other
(243,221
)
 
(177,805
)
Net cash (used in) from operating activities
(20,035
)
 
75,472

CASH USED IN INVESTING ACTIVITIES:
 
 
 
Proceeds from sale of fixed maturity securities
2,004,008

 
719,969

Proceeds from sale of equity securities
152,949

 
51,854

Distributions from (contributions to) investment funds
33,695

 
(11,290
)
Proceeds from maturities and prepayments of fixed maturity securities
97,911

 
888,423

Purchase of fixed maturity securities
(2,085,683
)
 
(1,767,208
)
Purchase of equity securities
(44,219
)
 
(103
)
Real estate purchased
(336,601
)
 
(48,710
)
Change in loans receivable
2,058

 
3,147

Net additions to property, furniture and equipment
(14,102
)
 
(12,457
)
Change in balances due to security brokers
58,500

 
(22,034
)
Payment for business purchased net of cash acquired
—

 
(71,346
)
Net cash used in investing activities
(131,484
)
 
(269,755
)
CASH FROM (USED IN) FINANCING ACTIVITIES:
 
 
 
Repayment of senior notes and other debt
(23
)
 
(1,475
)
Net proceeds from issuance of debt
181,792

 
—

Cash dividends to common stockholders
(17,016
)
 
—

Purchase of common treasury shares
(6,799
)
 
—

Other, net
(544
)
 
(1,281
)
Net cash from (used in) financing activities
157,410

 
(2,756
)
Net impact on cash due to change in foreign exchange rates
241

 
10,147

Net change in cash and cash equivalents
6,132

 
(186,892
)
Cash and cash equivalents at beginning of year
950,471

 
795,285

Cash and cash equivalents at end of period
$
956,603

 
$
608,393

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 unaudited consolidated financial statements, which include the accounts of W. R. Berkley Corporation and its subsidiaries (the “Company”) have been prepared on the basis of 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 in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the revenues and expenses reflected during the reporting period. 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, 2017. Reclassifications have been made in the 2017 financial statements as originally reported to conform to the presentation of the 2018 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 21% principally because of tax-exempt investment income, as well as tax on income from foreign jurisdictions with different tax rates.

(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 (including 4,847,303 and 4,087,731 common shares held in a grantor trust as of March 31, 2018 and 2017, respectively). The common shares held in the grantor trust are for delivery upon settlement of vested but mandatorily deferred restricted stock units ("RSUs"). Shares held by the grantor trust do not affect diluted shares outstanding since the shares deliverable under vested RSUs were already included in diluted shares outstanding. Diluted EPS is based upon the weighted average number of basic 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.
The weighted average number of common shares used in the computation of basic and diluted earnings per share was as follows:
 
For the Three Months Ended March 31,
 
(In thousands)
2018
 
2017
Basic
126,375

 
121,893

Diluted
128,125

 
128,453


(3) Recent Accounting Pronouncements
Recently adopted accounting pronouncements:
In May 2014, the Financial Accounting Standards Board ("FASB") issued ASU 2014-09, Revenue from Customers. ASU 2014-09 clarifies the principles for recognizing revenue. While insurance contracts are not within the scope of this updated guidance, the Company’s insurance service fee revenue and non-insurance business revenue are subject to this updated guidance. The updated guidance requires an entity to recognize revenue as performance obligations are met, in order to reflect the transfer of promised goods or services to customers in an amount that reflects the consideration the entity is entitled to receive for those goods or services. The updated guidance, as amended by ASU 2015-14, was effective for public business entities for annual and interim reporting periods beginning after December 15, 2017. The Company adopted this guidance on January 1, 2018 on a prospective basis. The impact of applying this guidance prospectively was a cumulative effect adjustment that increased retained earnings, a component of stockholders' equity, by $1 million after-tax.
    

6


In January 2016, the FASB issued ASU 2016-01, Financial Instruments.  ASU 2016-01 amends the accounting guidance for financial instruments to require all equity investments with readily determinable fair values to be measured at fair value with changes in the fair value recognized in net income (other than those accounted for under equity method of accounting or those that result in consolidation of the investee).  The updated guidance was effective for public business entities for annual reporting periods beginning after December 15, 2017 and interim periods within those years. The Company adopted this updated guidance on January 1, 2018 on a prospective basis. The impact of applying this guidance prospectively was a cumulative effect adjustment that increased retained earnings and decreased accumulated other comprehensive income ("AOCI") by offsetting amounts of $291 million, resulting in no net impact to total stockholders' equity. Following the adoption, the Company reported changes in fair value related to equity securities within net realized and unrealized gains on investments.

In February 2018, the FASB issued ASU 2018-02, Reporting Comprehensive Income, which amends previous guidance to allow a reclassification to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017 (the “Tax Act”). The amount of the reclassification includes the effect of the change in the U.S. federal corporate income tax rate on the gross deferred tax amounts and related valuation allowances, if any, at the date of the enactment of the Tax Act related to items in AOCI. The updated guidance will be effective for reporting periods beginning after December 15, 2018, and is eligible for early adoption. The Company adopted this updated guidance on January 1, 2018. The impact of applying this guidance was a cumulative effect adjustment that decreased retained earnings and increased AOCI by offsetting amounts of $76 million, resulting in no net impact to total stockholders' equity.

All other accounting and reporting standards that have become effective in 2018 were either not applicable to the Company or their adoption did not have a material impact on the Company. 
Accounting and reporting standards that are not yet effective:
In February 2016, the FASB issued ASU 2016-02, Leases, which amends the accounting and disclosure guidance for leases.  This guidance retains the two classifications of a lease, as either an operating or finance lease, both of which will require lessees to recognize a right-of-use asset and a lease liability for leases with terms of more than 12 months. The right-of-use asset and the lease liability will be determined based upon the present value of cash flows. Finance leases will reflect the financial arrangement by recognizing interest expense on the lease liability separately from the amortization expense of the right-of-use asset. Operating leases will recognize lease expense (with no separate recognition of interest expense) on a straight-line basis over the term of the lease. The accounting by lessors is not significantly changed by the updated guidance.  The updated guidance is effective for reporting periods beginning after December 15, 2018, and can be adopted prospectively or will require that the earliest comparative period presented include the measurement and recognition of existing leases with an adjustment to equity as if the updated guidance had always been applied. The Company is currently evaluating the impact that the adoption of this guidance will have on its results of operations, financial position and liquidity.

     In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses, which amends the accounting guidance for credit losses on financial instruments. The updated guidance amends the current other-than-temporary impairment model for available-for-sale debt securities by requiring the recognition of impairments relating to credit losses through an allowance account and limits the amount of credit loss to the difference between a security’s amortized cost basis and its fair value. This guidance also applies a new current expected credit loss model for determining credit-related impairments for financial instruments measured at amortized cost.  The updated guidance is effective for reporting periods beginning after December 15, 2019. The Company will not be able to determine the impact the adoption of this guidance will have on its results of operations, financial position or liquidity until the year the guidance becomes effective.

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




7


(4) Consolidated Statement of Comprehensive (Loss) Income

The following table presents the components of the changes in accumulated other comprehensive (loss) income ("AOCI"):
(In thousands)
Unrealized Investment Gains (Losses)
 
                             Currency Translation Adjustments
 
Accumulated Other Comprehensive (Loss) Income
As of and for the three months ended March 31, 2018
 
 
 
 
Changes in AOCI
 
 
 
 
Beginning of period
$
375,421

 
$
(306,880
)
 
$
68,541

Cumulative effect adjustment resulting from changes in accounting principles
(214,539
)
 
—

 
(214,539
)
Restated beginning of period
160,882

 
(306,880
)
 
(145,998
)
Other comprehensive (loss) income before reclassifications
(118,189
)
 
12,799

 
(105,390
)
Amounts reclassified from AOCI
(7,583
)
 
—

 
(7,583
)
Other comprehensive (loss) income
(125,772
)
 
12,799

 
(112,973
)
Unrealized investment gain related to noncontrolling interest
(11
)
 
—

 
(11
)
End of period
$
35,099

 
$
(294,081
)
 
$
(258,982
)
Amounts reclassified from AOCI
 
 
 
 
 
Pre-tax
$
(9,599
)
(1)
$
—

 
$
(9,599
)
Tax effect
2,016

(2)
—

 
2,016

After-tax amounts reclassified
$
(7,583
)
 
$
—

 
$
(7,583
)
Other comprehensive (loss) income
 
 
 
 
 
Pre-tax
$
(160,848
)
 
$
12,799

 
$
(148,049
)
Tax effect
35,076

 
—

 
35,076

Other comprehensive (loss) income
$
(125,772
)
 
$
12,799

 
$
(112,973
)
 
 
 
 
 
 
As of and for the three months ended March 31, 2017:
 
 
 
 
Changes in AOCI
 
 
 
 
Beginning of period
$
427,154

 
$
(371,586
)
 
$
55,568

Other comprehensive income before reclassifications
19,994

 
22,735

 
42,729

Amounts reclassified from AOCI
(28,825
)
 
—

 
(28,825
)
Other comprehensive (loss) income
(8,831
)
 
22,735

 
13,904

Unrealized investment loss related to noncontrolling interest
19

 
—

 
19

End of period
$
418,342

 
$
(348,851
)
 
$
69,491

Amounts reclassified from AOCI
 
 
 
 
 
Pre-tax
$
(44,346
)
(1)
$
—

 
$
(44,346
)
Tax effect
15,521

(2)
—

 
15,521

After-tax amounts reclassified
$
(28,825
)
 
$
—

 
$
(28,825
)
Other comprehensive (loss) income
 
 
 
 
 
Pre-tax
$
(9,571
)
 
$
22,735

 
$
13,164

Tax effect
740

 
—

 
740

Other comprehensive (loss) income
$
(8,831
)
 
$
22,735

 
$
13,904

 
 
 
 
 
 
_________________________
(1) Net realized and unrealized gains on investments in the consolidated statements of income.
(2) Income tax expense in the consolidated statements of income.


8


(5) Statements of Cash Flow
Interest payments were $61,890,000 and $61,782,000 and income taxes paid were none and $1,610,000 in the three months ended March 31, 2018 and 2017, respectively.

(6) Investments in Fixed Maturity Securities
At March 31, 2018 and December 31, 2017, investments in fixed maturity securities were as follows:
 
(In thousands)
Amortized
Cost
 
Gross Unrealized
 
Fair
Value
 
Carrying
Value
Gains
 
Losses
 
March 31, 2018
 
 
 
 
 
 
 
 
 
Held to maturity:
 
 
 
 
 
 
 
 
 
State and municipal
$
66,459

 
$
12,185

 
$
—

 
$
78,644

 
$
66,459

Residential mortgage-backed
12,772

 
988

 
—

 
13,760

 
12,772

Total held to maturity
79,231

 
13,173

 
—

 
92,404

 
79,231

Available for sale:
 
 
 
 
 
 
 
 
 
U.S. government and government agency
479,330

 
6,692

 
(6,113
)
 
479,909

 
479,909

State and municipal:
 
 
 
 
 
 
 
 
 
Special revenue
2,644,248

 
36,059

 
(22,675
)
 
2,657,632

 
2,657,632

State general obligation
404,710

 
12,113

 
(2,610
)
 
414,213

 
414,213

Pre-refunded
443,852

 
18,131

 
(87
)
 
461,896

 
461,896

Corporate backed
368,073

 
7,415

 
(1,610
)
 
373,878

 
373,878

Local general obligation
389,887

 
17,227

 
(3,209
)
 
403,905

 
403,905

Total state and municipal
4,250,770

 
90,945

 
(30,191
)
 
4,311,524

 
4,311,524

Mortgage-backed securities:
 
 
 
 
 
 
 
 
 
Residential (1)
1,067,814

 
6,233

 
(22,334
)
 
1,051,713

 
1,051,713

Commercial
338,683

 
1,164

 
(4,563
)
 
335,284

 
335,284

Total mortgage-backed securities
1,406,497

 
7,397

 
(26,897
)
 
1,386,997

 
1,386,997

Asset-backed
2,101,896

 
11,435

 
(11,640
)
 
2,101,691

 
2,101,691

Corporate:
 
 
 
 
 
 
 
 
 
Industrial
2,378,793

 
27,145

 
(31,817
)
 
2,374,121

 
2,374,121

Financial
1,411,529

 
22,100

 
(15,031
)
 
1,418,598

 
1,418,598

Utilities
270,915

 
8,163

 
(4,546
)
 
274,532

 
274,532

Other
43,682

 
1

 
(233
)
 
43,450

 
43,450

Total corporate
4,104,919

 
57,409

 
(51,627
)
 
4,110,701

 
4,110,701

Foreign
850,866

 
25,791

 
(3,578
)
 
873,079

 
873,079

Total available for sale
13,194,278

 
199,669

 
(130,046
)
 
13,263,901

 
13,263,901

Total investments in fixed maturity securities
$
13,273,509

 
$
212,842

 
$
(130,046
)
 
$
13,356,305

 
$
13,343,132


9


(In thousands)
Amortized
Cost
 
Gross Unrealized
 
Fair
Value
 
Carrying
Value
Gains
 
Losses
December 31, 2017
 
 
 
 
 
 
 
 
 
Held to maturity:
 
 
 
 
 
 
 
 
 
State and municipal
$
65,882

 
$
14,499

 
$
—

 
$
80,381

 
$
65,882

Residential mortgage-backed
13,450

 
1,227

 
—

 
14,677

 
13,450

Total held to maturity
79,332

 
15,726

 
—

 
95,058

 
79,332

Available for sale:
 
 
 
 
 
 
 
 
 
U.S. government and government agency
372,748

 
8,824

 
(3,832
)
 
377,740

 
377,740

State and municipal:
 
 
 
 
 
 
 
 
 
Special revenue
2,663,245

 
53,512

 
(10,027
)
 
2,706,730

 
2,706,730

State general obligation
439,358

 
16,087

 
(711
)
 
454,734

 
454,734

Pre-refunded
436,241

 
22,701

 
(9
)
 
458,933

 
458,933

Corporate backed
375,268

 
10,059

 
(860
)
 
384,467

 
384,467

Local general obligation
417,955

 
23,242

 
(967
)
 
440,230

 
440,230

Total state and municipal
4,332,067

 
125,601

 
(12,574
)
 
4,445,094

 
4,445,094

Mortgage-backed securities:
 
 
 
 
 
 
 
 
 
Residential (1)
1,043,629

 
9,304

 
(13,547
)
 
1,039,386

 
1,039,386

Commercial
261,652

 
1,521

 
(2,628
)
 
260,545

 
260,545

Total mortgage-backed securities
1,305,281

 
10,825

 
(16,175
)
 
1,299,931

 
1,299,931

Asset-backed
2,111,132

 
11,024

 
(10,612
)
 
2,111,544

 
2,111,544

Corporate:
 
 
 
 
 
 
 
 
 
Industrial
2,574,400

 
52,210

 
(7,718
)
 
2,618,892

 
2,618,892

Financial
1,402,161

 
37,744

 
(5,138
)
 
1,434,767

 
1,434,767

Utilities
284,886

 
11,316

 
(1,248
)
 
294,954

 
294,954

Other
40,560

 
5

 
(66
)
 
40,499

 
40,499

Total corporate
4,302,007

 
101,275

 
(14,170
)
 
4,389,112

 
4,389,112

Foreign
819,345

 
32,018

 
(2,866
)
 
848,497

 
848,497

Total available for sale
13,242,580

 
289,567

 
(60,229
)
 
13,471,918

 
13,471,918

Total investments in fixed maturity securities
$
13,321,912


$
305,293

 
$
(60,229
)
 
$
13,566,976

 
$
13,551,250

____________
(1)
Gross unrealized gains (losses) for residential mortgage-backed securities include $89,704 and $76,467 as of March 31, 2018 and December 31, 2017, respectively, related to securities with the non-credit portion of other-than-temporary impairments (“OTTI”) recognized in accumulated other comprehensive income.

The amortized cost and fair value of fixed maturity securities at March 31, 2018, 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.
 
(In thousands)
Amortized
Cost
 
Fair Value
Due in one year or less
$
813,191

 
$
816,313

Due after one year through five years
4,580,074

 
4,621,880

Due after five years through ten years
3,110,432

 
3,158,810

Due after ten years
3,350,543

 
3,358,545

Mortgage-backed securities
1,419,269

 
1,400,757

Total
$
13,273,509

 
$
13,356,305

At March 31, 2018 and December 31, 2017, there were no investments that exceeded 10% of common stockholders' equity, other than investments in United States government and government agency securities.



10


(7) Investments in Equity Securities
At March 31, 2018 and December 31, 2017, investments in equity securities were as follows:
 
(In thousands)
Cost
 
Gross Unrealized (1)
 
Fair
Value
 
Carrying
Value
Gains
 
Losses
 
March 31, 2018
 
 
 
 
 
 
 
 
 
Common stocks
$
95,447

 
$
232,206

 
$
(7,218
)
 
$
320,435

 
$
320,435

Preferred stocks
124,150

 
53,423

 
(1,974
)
 
175,599

 
175,599

Total
$
219,597

 
$
285,629

 
$
(9,192
)
 
$
496,034

 
$
496,034

December 31, 2017
 
 
 
 
 
 
 
 
 
Common stocks
$
81,855

 
$
272,309

 
$
(1,960
)
 
$
352,204

 
$
352,204

Preferred stocks
124,150

 
102,890

 
(2,597
)
 
224,443

 
224,443

Total
$
206,005

 
$
375,199

 
$
(4,557
)
 
$
576,647

 
$
576,647

______________________
(1) Effective January 1, 2018, the Company adopted new accounting guidance that requires all equity investments with readily determinable fair values (subject to certain exceptions) to be measured at fair value with changes in the fair value recognized through net income. Refer to Note 3 for additional information.

(8) Arbitrage Trading Account
At March 31, 2018 and December 31, 2017, the fair and carrying values of the arbitrage trading account were $745 million and $618 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 uses put options, call options and swap contracts in order to mitigate the impact of potential changes in market conditions on the merger arbitrage trading account. These options and contracts are reported at fair value. As of March 31, 2018, the fair value of long option contracts outstanding was $1.0 million (notional amount of $17.6 million) and the fair value of short option contracts outstanding was $0.2 million (notional amount of $27.0 million). Other than with respect to the use of these trading account securities, the Company does not make use of derivatives.


(9) Net Investment Income
Net investment income consists of the following: 
 
For the Three Months Ended March 31,
 
(In thousands)
2018
 
2017
Investment income earned on:
 
 
 
Fixed maturity securities, including cash and cash equivalents and loans receivable
$
123,246

 
$
112,346

Investment funds
40,354

 
26,649

Arbitrage trading account
5,191

 
6,360

Real estate
6,568

 
4,566

Equity securities
646

 
639

Gross investment income
176,005

 
150,560

Investment expense
(1,487
)
 
(1,702
)
Net investment income
$
174,518

 
$
148,858




11


(10) Investment Funds
The Company evaluates whether it is an investor in a variable interest entity ("VIE"). Such entities do not have sufficient equity at risk to finance their activities without additional subordinated financial support, or the equity investors, as a group, do not have the characteristics of a controlling financial interest (primary beneficiary).  The Company determines whether it is the primary beneficiary of an entity subject to consolidation based on a qualitative assessment of the VIE's capital structure, contractual terms, nature of the VIE's operations and purpose, and the Company's relative exposure to the related risks of the VIE on the date it becomes initially involved in the VIE and on an ongoing basis. The Company is not the primary beneficiary in any of its investment funds, and accordingly, carries its interests in investment funds under the equity method of accounting.
    
The Company’s maximum exposure to loss with respect to these investments is limited to the carrying amount reported on the Company’s consolidated balance sheet and its unfunded commitments, which were $376 million as of March 31, 2018.
Investment funds consisted of the following:
 
Carrying Value as of
 
Income from
Investment Funds
 
March 31,
 
December 31,
 
For the Three Months Ended March 31,
(In thousands)
2018
 
2017
 
2018
 
2017
Real estate
$
624,716

 
$
606,995

 
$
26,051

 
$
4,532

Energy
80,833

 
82,882

 
74

 
3,245

Other funds
455,578

 
465,800

 
14,229

 
18,872

Total
$
1,161,127

 
$
1,155,677

 
$
40,354


$
26,649


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 consolidated financial statements.

(11) Real Estate

Investment in real estate represents directly owned property held for investment, as follows:    
 
Carrying Value
 
March 31,
 
December 31,
(In thousands)
2018
 
2017
Properties in operation
$
739,405

 
$
451,691

Properties under development
1,093,932

 
1,017,910

Total
$
1,833,337

 
$
1,469,601


In 2018, properties in operation included a long-term ground lease in Washington, D.C., a hotel in Memphis, Tennessee, two office complexes in New York City and office buildings in West Palm Beach and Palm Beach, Florida. Properties in operation are net of accumulated depreciation and amortization of $29,477,000 and $25,646,000 as of March 31, 2018 and December 31, 2017, respectively. Related depreciation expense was $3,815,000 and $1,648,000 for the three months ended March 31, 2018 and 2017, respectively. Future minimum rental income expected on operating leases relating to properties in operation is $38,716,924 in 2018, $54,741,633 in 2019, $53,127,758 in 2020, $52,210,617 in 2021, $48,472,505 in 2022, $41,829,736 in 2023 and $498,985,951 thereafter.

Properties under development include an office building in London and a mixed-use project in Washington, D.C.


12


(12) Loans Receivable
Loans receivable are as follows:
(In thousands)
March 31, 2018
 
December 31, 2017
Amortized cost (net of valuation allowance):
 
 
 
  Real estate loans
$
63,191

 
$
66,057

  Commercial loans
12,711

 
13,627

  Total
$
75,902

 
$
79,684

 
 
 
 
Fair value:
 
 
 
  Real estate loans
$
64,026

 
$
66,917

  Commercial loans
14,212

 
15,130

  Total
$
78,238

 
$
82,047

 
 
 
 
Valuation allowance:
 
 
 
  Specific
$
1,200

 
$
1,200

  General
2,183

 
2,183

  Total
$
3,383

 
$
3,383

 
 
 
 
 
For the Three Months Ended March 31,
 
 
2018
 
2017
  Decrease in valuation allowance
$
—

 
$
(14
)
Loans receivable in non-accrual status were $1.5 million and $4.3 million as of March 31, 2018 and December 31, 2017, 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 real estate loans are secured by commercial real estate primarily located in New York. These loans generally earn interest at floating LIBOR-based interest rates and have maturities (inclusive of extension options) through August 2025. The commercial loans are with small business owners who have secured the related financing with the assets of the business. Commercial loans primarily earn interest on a fixed basis and have varying maturities generally not exceeding 10 years.
In evaluating the real estate loans, the Company considers their 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 position in the capital structure, the overall leverage in the capital structure and other market conditions. Based on these considerations, none of the real estate loans were considered to be impaired at March 31, 2018, and accordingly, the Company determined that a specific valuation allowance was not required.


13


(13) Net Realized and Unrealized Gains (Losses) on Investments

 Net realized and unrealized gains (losses) on investments are as follows:
 
For the Three Months Ended March 31,
(In thousands)
2018
 
2017
Net realized and unrealized gains (losses) on investments in earnings
 
 
 
Fixed maturity securities:
 
 
 
Gains
$
13,339

 
$
5,605

Losses
(3,740
)
 
(3,965
)
Equity securities (1):
 
 
 
Net realized gains on investment sales
122,321

 
42,707

Change in unrealized gains
(94,205
)
 
—

Investment funds
119

 
1,267

Real estate
7,998

 
3,300

Loans receivable
2,058

 
—

Other
574

 
3,434

Net realized and unrealized gains on investments in earnings before OTTI
48,464

 
52,348

Other-than-temporary impairments (2)
—

 
—

   Net realized and unrealized gains on investments in earnings
48,464

 
52,348

Income tax expense
(10,177
)
 
(18,322
)
    After-tax net realized and unrealized gains on investments in earnings
$
38,287

 
$
34,026

Change in unrealized investment gains of available for sale securities:
 
 
 
Fixed maturity securities
$
(159,727
)
 
$
37,984

Previously impaired fixed maturity securities
13

 
101

Equity securities available for sale (3)
—

 
(48,862
)
Investment funds
(1,134
)
 
1,206

Total change in unrealized investment gains
(160,848
)
 
(9,571
)
Income tax benefit
35,076

 
740

Noncontrolling interests
(11
)
 
19

After-tax change in unrealized investment gains of available for sale securities
$
(125,783
)
 
$
(8,812
)
______________________
(1) The net realized gains or losses on investment sales represent the total gains or losses from the purchase dates of the equity securities. The change in unrealized gains consists of two components: (i) the reversal of the gain or loss recognized in previous periods on equity securities sold and (ii) the change in unrealized gain or loss resulting from mark-to-market adjustments on equity securities still held.
(2) There were no other than temporary impairments (OTTI) for the three months ended March 31, 2018 and 2017.
(3) Effective January 1, 2018, the Company adopted new accounting guidance that requires all equity investments with readily determinable fair values (subject to certain exceptions) to be measured at fair value with changes in the fair value recognized in net income. The Company recorded an adjustment of $291 million to opening AOCI net of tax as a result of this guidance. Refer to Note 3 for further information.


 




14


(14) Fixed Maturity Securities in an Unrealized Loss Position
The following tables summarize all fixed maturity securities in an unrealized loss position at March 31, 2018 and December 31, 2017 by the length of time those securities have been continuously in an unrealized loss position: 
  
Less Than 12 Months
 
12 Months or Greater
 
Total
(In thousands)
Fair Value
 
Gross
Unrealized
Losses
 
Fair Value
 
Gross
Unrealized
Losses
 
Fair Value
 
Gross
Unrealized
Losses
March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
U.S. government and government agency
$
138,917

 
$
2,978

 
$
71,224

 
$
3,135

 
$
210,141

 
$
6,113

State and municipal
1,514,028

 
20,922

 
303,246

 
9,269

 
1,817,274

 
30,191

Mortgage-backed securities
754,800

 
12,603

 
362,331

 
14,294

 
1,117,131

 
26,897

Asset-backed securities
1,271,743

 
9,444

 
160,263

 
2,196

 
1,432,006

 
11,640

Corporate
1,912,850

 
42,874

 
168,813

 
8,753

 
2,081,663

 
51,627

Foreign government
216,681

 
3,301

 
25,541

 
277

 
242,222

 
3,578

Fixed maturity securities
$
5,809,019

 
$
92,122

 
$
1,091,418

 
$
37,924

 
$
6,900,437

 
$
130,046

 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
U.S. government and government agency
$
92,167

 
$
1,491

 
$
72,055

 
$
2,341

 
$
164,222

 
$
3,832

State and municipal
735,972

 
5,944

 
345,755

 
6,630

 
1,081,727

 
12,574

Mortgage-backed securities
480,435

 
5,110

 
373,956

 
11,065

 
854,391

 
16,175

Asset-backed securities
1,127,309

 
8,298

 
167,412

 
2,314

 
1,294,721

 
10,612

Corporate
1,103,747

 
8,224

 
170,858

 
5,946

 
1,274,605

 
14,170

Foreign government
244,139

 
2,615

 
25,824

 
251

 
269,963

 
2,866

Fixed maturity securities
$
3,783,769

 
$
31,682

 
$
1,155,860

 
$
28,547

 
$
4,939,629

 
$
60,229

A summary of the Company’s non-investment grade fixed maturity securities that were in an unrealized loss position at March 31, 2018 is presented in the table below:  
($ in thousands)
Number of
Securities
 
Aggregate
Fair Value
 
Gross Unrealized
Loss
Corporate
10

 
$
86,345

 
$
4,429

Foreign government
8

 
$
30,997

 
$
739

Asset-backed securities
3

 
370

 
140

Mortgage-backed securities
5

 
4,532

 
117

State and municipal
1

 
3,641

 
3

Total
27

 
$
125,885

 
$
5,428


For OTTI of fixed maturity securities that management does not intend to sell or to be required to sell, the portion of the decline in value that is considered to be due to credit factors is recognized in earnings, and the portion of the decline in value that is considered to be due to non-credit factors is recognized in other comprehensive income.
     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.


15


(15) Fair Value Measurements

The Company’s fixed maturity securities, equity securities and arbitrage 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, as follows:
Level 1 - Quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.  
Level 2 - Quoted prices for similar assets or valuations based on inputs that are observable.
Level 3 - Estimates of fair value based on internal pricing methodologies using unobservable inputs. Unobservable inputs are only used to measure fair value to the extent that observable inputs are not available.
Substantially, all of the Company’s fixed maturity securities were priced by independent pricing services. The prices provided by the independent pricing services are estimated based on observable market data in active markets utilizing pricing models and processes, which may include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, sector groupings, matrix pricing and reference data. The pricing services may prioritize inputs differently on any given day for any security based on market conditions, and not all inputs are available for each security evaluation on any given day. The pricing services used by the Company have indicated that they will only produce an estimate of fair value if objectively verifiable information is available. The determination of whether markets are active or inactive is based upon the volume and level of activity for a particular asset class. The Company reviews the prices provided by pricing services for reasonableness and periodically performs independent price tests of a sample of securities to ensure proper valuation.
If prices from independent pricing services are not available for fixed maturity securities, the Company estimates the fair value. For Level 2 securities, the Company utilizes pricing models and processes which may include benchmark yields, sector groupings, matrix pricing, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, bids, offers and reference data. Where broker quotes are used, the Company generally requests two or more quotes and sets a price within the range of quotes received based on its assessment of the credibility of the quote and its own evaluation of the security. The Company generally does not adjust quotes received from brokers. 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.
For Level 3 securities, the Company generally uses a discounted cash flow model to estimate the fair value of fixed maturity securities. The cash flow models are based upon assumptions as to prevailing credit spreads, interest rate and interest rate volatility, time to maturity and subordination levels. Projected cash flows are discounted at rates that are adjusted to reflect illiquidity, where appropriate.

    

16


The following tables present the assets and liabilities measured at fair value on a recurring basis as of March 31, 2018 and December 31, 2017 by level:
(In thousands)
Total
 
Level 1
 
Level 2
 
Level 3
March 31, 2018
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
Fixed maturity securities available for sale:
 
 
 
 
 
 
 
U.S. government and government agency
$
479,909

 
$
—

 
$
479,909

 
$
—

State and municipal
4,311,524

 
—

 
4,311,524

 
—

Mortgage-backed securities
1,386,997

 
—

 
1,386,997

 
—

Asset-backed securities
2,101,691

 
—

 
2,101,528

 
163

Corporate
4,110,701

 
—

 
4,110,701

 
—

Foreign government
873,079

 
—

 
873,079

 
—

Total fixed maturity securities available for sale
13,263,901

 
—

 
13,263,738

 
163

Equity securities:
 
 
 
 
 
 
 
Common stocks
320,435

 
311,329

 
—

 
9,106

Preferred stocks
175,599

 
—

 
164,756

 
10,843

Total equity securities
496,034

 
311,329

 
164,756

 
19,949

Arbitrage trading account
744,859

 
434,470

 
306,547

 
3,842

Total
$
14,504,794

 
$
745,799

 
$
13,735,041

 
$
23,954

Liabilities:
 
 
 
 
 
 
 
Trading account securities sold but not yet purchased
$
29,453

 
$
29,444

 
$
9

 
$
—

 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
Fixed maturity securities available for sale:
 
 
 
 
 
 
 
U.S. government and government agency
$
377,740

 
$
—

 
$
377,740

 
$
—

State and municipal
4,445,094

 
—

 
4,445,094

 
—

Mortgage-backed securities
1,299,931

 
—

 
1,299,931

 
—

Asset-backed securities
2,111,544

 
—

 
2,111,372

 
172

Corporate
4,389,112

 
—

 
4,389,112

 
—

Foreign government
848,497

 
—

 
848,497

 
—

Total fixed maturity securities available for sale
13,471,918

 
—

 
13,471,746

 
172

Equity securities:
 
 
 
 
 
 
 
Common stocks
352,204

 
342,834

 
—

 
9,370

Preferred stocks
224,443

 
—

 
213,600

 
10,843

Total equity securities
576,647

 
342,834

 
213,600

 
20,213

Arbitrage trading account
617,649

 
471,420

 
146,229

 
—

Total
$
14,666,214

 
$
814,254

 
$
13,831,575

 
$
20,385

Liabilities:
 
 
 
 
 
 
 
Trading account securities sold but not yet purchased
$
64,358

 
$
64,358

 
$
—

 
$
—

There were no significant transfers between Levels 1 and 2 during the three months ended March 31, 2018 or during the year ended December 31, 2017.




17


The following tables summarize changes in Level 3 assets and liabilities for the three months ended March 31, 2018 and for the year ended December 31, 2017:
 
  
Gains (Losses) Included in:
(In thousands)
Beginning
Balance
 
Earnings (Losses)
 
Other
Comprehensive
Income (Loss)
 
Impairments
 
Purchases
 
(Sales)
 
Paydowns / Maturities
 
Transfers
 
Ending
Balance
In / (Out)
Three Months Ended March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturities securities available for sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Asset-backed securities
$
172

 
$
2

 
$
4

 
$
—

 
$
—

 
$
(15
)
 
$
—

 
$
—

 
$
163

Total
172

 
2

 
4

 
—

 
—

 
(15
)
 
—

 
—

 
163

Equity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common stocks
9,370

 
(264
)
 
—

 
—

 
—

 
—

 
—

 
—

 
9,106

Preferred stocks
10,843

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
10,843

Total
20,213

 
(264
)
 
—

 
—

 
—

 
—

 
—

 
—

 
19,949

Arbitrage trading account
—

 
(40
)
 
—

 
—

 
3,882

 
—

 
—

 
—

 
3,842

Total
$
20,385

 
$
(302
)
 
$
4

 
$
—

 
$
3,882

 
$
(15
)
 
$
—

 
$
—

 
$
23,954

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Year ended December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed maturities securities available for sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Asset-backed securities
$
183

 
$
3

 
$
34

 
$
—

 
$
—

 
$
(48
)
 
$
—

 
$
—

 
$
172

Total
183

 
3

 
34

 
—

 
—

 
(48
)
 
—

 
—

 
172

Equity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common stocks
8,754

 
—

 
616

 
—

 
—

 
—

 
—

 
—

 
9,370

Preferred stocks
3,662

 
8

 
—

 
—

 
7,173

 
—

 
—

 
—

 
10,843

Total
12,416

 
8

 
616

 
—

 
7,173

 
—

 
—

 
—

 
20,213

Arbitrage trading account
—

 
8

 
—

 
—

 
—

 
(8
)
 
—

 
—

 
—

Total
$
12,599

 
$
19

 
$
650

 
$
—

 
$
7,173

 
$
(56
)
 
$
—

 
$
—

 
$
20,385

During the three months ended March 31, 2018 and for the year ended December 31, 2017, there were no transfers out of Level 3.





18


(16) Reserves for Loss and Loss Expenses

The Company's reserves for losses and loss expenses are comprised of case reserves and incurred but not reported liabilities ("IBNR"). When a claim is reported, a case reserve is established for the estimated ultimate payment based upon known information about the claim. As more information about the claim becomes available over time, case reserves are adjusted up or down as appropriate. Reserves are also established on an aggregate basis to provide for IBNR liabilities and expected loss reserve development on reported claims.

Loss reserves included in the Company’s financial statements represent management’s best estimates based upon an actuarially derived point estimate and other considerations. The Company uses a variety of actuarial techniques and methods to derive an actuarial point estimate for each operating unit. These methods include paid loss development, incurred loss development, paid and incurred Bornhuetter-Ferguson methods and frequency and severity methods. In circumstances where one actuarial method is considered more credible than the others, that method is used to set the point estimate. The actuarial point estimate may also be based on a judgmental weighting of estimates produced from each of the methods considered. Industry loss experience is used to supplement the Company’s own data in selecting “tail factors” in areas where the Company’s own data is limited. The actuarial data is analyzed by line of business, coverage and accident or policy year, as appropriate, for each operating unit.

The establishment of the actuarially derived loss reserve point estimate also includes consideration of qualitative factors that may affect the ultimate losses. These qualitative considerations include, among others, the impact of re-underwriting initiatives, changes in the mix of business, changes in distribution sources and changes in policy terms and conditions.

The key assumptions used to arrive at the best estimate of loss reserves are the expected loss ratios, rate of loss cost inflation, and reported and paid loss emergence patterns. Expected loss ratios represent management’s expectation of losses at the time the business is priced and written, before any actual claims experience has emerged. This expectation is a significant determinant of the estimate of loss reserves for recently written business where there is little paid or incurred loss data to consider. Expected loss ratios are generally derived from historical loss ratios adjusted for the impact of rate changes, loss cost trends and known changes in the type of risks underwritten. Expected loss ratios are estimated for each key line of business within each operating unit. Expected loss cost inflation is particularly important for the long-tail lines, such as excess casualty, and claims with a high medical component, such as workers’ compensation. Reported and paid loss emergence patterns are used to project current reported or paid loss amounts to their ultimate settlement value. Loss development factors are based on the historical emergence patterns of paid and incurred losses, and are derived from the Company’s own experience and industry data. The paid loss emergence pattern is also significant to excess and assumed workers’ compensation reserves because those reserves are discounted to their estimated present value based upon such estimated payout patterns.

Loss frequency and severity are measures of loss activity that are considered in determining the key assumptions described in our discussion of loss and loss expense reserves, including expected loss ratios, rate of loss cost inflation and reported and paid loss emergence patterns. Loss frequency is a measure of the number of claims per unit of insured exposure, and loss severity is a measure of the average size of claims. Factors affecting loss frequency include the effectiveness of loss controls and safety programs and changes in economic activity or weather patterns. Factors affecting loss severity include changes in policy limits, retentions, rate of inflation and judicial interpretations.

Another factor affecting estimates of loss frequency and severity is the loss reporting lag, which is the period of time between the occurrence of a loss and the date the loss is reported to the Company. The length of the loss reporting lag affects our ability to accurately predict loss frequency (loss frequencies are more predictable for lines with short reporting lags) as well as the amount of reserves needed for incurred but not reported losses (less IBNR is required for lines with short reporting lags). As a result, loss reserves for lines with short reporting lags are likely to have less variation from initial loss estimates. For lines with short reporting lags, which include commercial automobile, primary workers’ compensation, other liability (claims-made) and property business, the key assumption is the loss emergence pattern used to project ultimate loss estimates from known losses paid or reported to date. For lines of business with long reporting lags, which include other liability (occurrence), products liability, excess workers’ compensation and liability reinsurance, the key assumption is the expected loss ratio since there is often little paid or incurred loss data to consider. Historically, the Company has experienced less variation from its initial loss estimates for lines of businesses with short reporting lags than for lines of business with long reporting lags.

The key assumptions used in calculating the most recent estimate of the loss reserves are reviewed each quarter and adjusted, to the extent necessary, to reflect the latest reported loss data, current trends and other factors observed.

        


19



The table below provides a reconciliation of the beginning and ending reserve balances:
 
March 31,
(In thousands)
2018
 
2017
Net reserves at beginning of year
$
10,056,914

 
$
9,590,265

Net provision for losses and loss expenses:
 
 
 
Claims occurring during the current year (1)
956,181

 
958,684

(Decrease) increase in estimates for claims occurring in prior years (2) (3)
(3,582
)
 
8,727

Loss reserve discount accretion
10,620

 
12,192

Total
963,219

 
979,603

Net payments for claims:
 

 
 

Current year
111,030

 
97,461

Prior year
810,709

 
773,571

Total
921,739

 
871,032

Foreign currency translation
2,501

 
23,204

Net reserves at end of period
10,100,895

 
9,722,040

Ceded reserve at end of period
1,684,000

 
1,502,284

Gross reserves at end of period
$
11,784,895

 
$
11,224,324

_______________________________________
(1)
Claims occurring during the current year are net of loss reserve discounts of $6,448,000 and $5,761,000 for the three months ended March 31, 2018 and 2017, respectively.
(2)
The decrease or increase in estimates for claims occurring in prior years is net of loss reserve discount. On an undiscounted basis, the estimates for claims occurring in prior years decreased by $6,662,000 and increased by $4,841,000 for the three months ended March 31, 2018 and 2017, respectively.
(3)
For certain retrospectively rated insurance policies and reinsurance agreements, reserve development is offset by additional or return premiums. Favorable development, net of additional and return premiums, was $12 million and $2 million for the three months ended March 31, 2018 and 2017, respectively.

During the three months ended March 31, 2018, favorable prior year development (net of additional and return premiums) of $12.2 million included $16.3 million of favorable development for the Insurance segment, offset by $4.1 million of adverse development for the Reinsurance segment. The favorable development for the Insurance segment was primarily attributable to workers’ compensation business. The favorable workers’ compensation development was spread across many accident years, including prior to 2008, but was most significant in accident years 2015 through 2017. The favorable workers’ compensation development reflects a continuation of the benign loss cost trends experienced during recent years, particularly the favorable claim frequency trends (i.e., number of reported claims per unit of exposure). The adverse development for the Reinsurance segment was mainly driven by US casualty facultative business from accident years 2008 and prior related to construction projects.

During the three months ended March 31, 2017, favorable prior year development (net of additional and return premiums) of $2.4 million included $26.2 million of favorable development for the Insurance segment, largely offset by $23.8 million of adverse development for the Reinsurance segment. The favorable development for the Insurance segment was primarily attributable to workers' compensation business, including excess workers' compensation. The favorable workers' compensation development was spread across many accident years, including prior to 2008, but was most significant in accident years 2014 and 2015. The favorable workers' compensation development reflects a continuation of the benign loss cost trends experienced during 2016, particularly the favorable claim frequency trends ( i.e., number of reported claims per unit of exposure). The adverse development for the Reinsurance segment was almost entirely due to reserve strengthening associated with claims impacted by the change in the Ogden discount rate in the U.K. The Ogden rate is the discount rate used to calculate lump-sum bodily injury payouts in the U.K. and was recently reduced by the U.K. Ministry of Justice from +2.5% to -0.75%. The adverse development mostly related to U.K. motor bodily injury claims which we reinsured on an excess of loss basis in accident years 2012 through 2016.


20


(17) Fair Value of Financial Instruments
The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments:
  
March 31, 2018
 
December 31, 2017
(In thousands)
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
Assets:
 
 
 
 
 
 
 
Fixed maturity securities
$
13,343,132

 
$
13,356,305

 
$
13,551,250

 
$
13,566,976

Equity securities
496,034

 
496,034

 
576,647

 
576,647

Arbitrage trading account
744,859

 
744,859

 
617,649

 
617,649

Loans receivable
75,902

 
78,238

 
79,684

 
82,047

Cash and cash equivalents
956,603

 
956,603

 
950,471

 
950,471

Trading account receivables from brokers and clearing organizations
26,667

 
26,667

 
189,280

 
189,280

Liabilities:
 
 
 
 
 
 
 
Due to broker
74,450

 
74,450

 
15,920

 
15,920

Trading account securities sold but not yet purchased
29,453

 
29,453

 
64,358

 
64,358

Subordinated debentures
897,426

 
929,948

 
728,218

 
769,060

Senior notes and other debt
1,782,139

 
1,921,635

 
1,769,052

 
1,945,313

The estimated fair values of the Company’s fixed maturity securities, equity securities and arbitrage trading account securities are based on various valuation techniques that rely on fair value measurements as described in Note 15 above. The fair value of loans receivable are estimated by using current institutional purchaser yield requirements for loans with similar credit characteristics, which is considered a Level 2 input. The fair value of the senior notes and other debt and the subordinated debentures is based on spreads for similar securities, which is considered a Level 2 input.

(18) Reinsurance

The following is a summary of reinsurance financial information:
 
For the Three Months Ended March 31,
 
(In thousands)
2018
 
2017
Written premiums:
 
 
 
Direct
$
1,787,235

 
$
1,721,062

Assumed
192,187

 
215,145

Ceded
(314,084
)
 
(289,369
)
Total net premiums written
$
1,665,338

 
$
1,646,838

 
 
 
 
Earned premiums:
 
 
 
Direct
$
1,674,550

 
$
1,613,364

Assumed
188,866

 
208,626

Ceded
(296,008
)
 
(251,948
)
Total net premiums earned
$
1,567,408

 
$
1,570,042

 
 
 
 
Ceded losses and loss expenses incurred
$
238,995

 
$
35,192

Ceded commissions earned
$
66,356

 
$
56,550

The Company reinsures a portion of its insurance exposures in order to reduce its net liability on individual risks and catastrophe losses. The Company also cedes premiums to state assigned risk plans and captive insurance companies. Estimated amounts due from reinsurers are reported net of reserves for uncollectible reinsurance of $1 million as of both March 31, 2018 and December 31, 2017.


21


(19) Restricted Stock Units
Pursuant to its stock incentive plan, the Company may issue restricted stock units ("RSUs") to employees of the Company and its subsidiaries. The RSUs generally vest three to five years from the award date and are subject to other vesting and forfeiture provisions contained in the award agreement. RSUs are expensed pro-ratably over the vesting period. RSU expenses were $9 million and $11 million for the three months ended March 31, 2018 and 2017, respectively. A summary of RSUs issued in the three months ended March 31, 2018 and 2017 follows:
 
($ in thousands)
Units
 
Fair Value
2018
4,174

 
$
290

2017
1,853

 
$
129


(20) Litigation and Contingent Liabilities
In the ordinary course of business, the Company is subject to disputes, litigation and arbitration arising from its insurance and reinsurance businesses. These matters are generally related to insurance and reinsurance claims and are considered in the establishment of loss and loss expense reserves. In addition, the Company may also become involved in legal actions which seek extra-contractual damages, punitive damages or penalties, including claims alleging bad faith in handling of insurance claims. The Company expects its ultimate liability with respect to such matters will not be material to its financial condition. However, adverse outcomes on such matters are possible, from time to time, and could be material to the Company’s results of operations in any particular financial reporting period.
  
(21) Business Segments
The Company’s reportable segments include the following two business segments, plus a corporate segment:
•
Insurance - predominantly commercial insurance business, including excess and surplus lines, admitted lines and specialty personal lines throughout the United States, as well as insurance business in the United Kingdom, Continental Europe, South America, Canada, Mexico, Scandinavia, Asia and Australia.
•
Reinsurance - reinsurance business on a facultative and treaty basis, primarily in the United States, the United Kingdom, Continental Europe, Australia, the Asia-Pacific Region and South Africa.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies. Income tax expense and benefits are calculated based upon the Company's overall effective tax rate.

22


Summary financial information about the Company's reporting segments is presented in the following tables. Income (loss) before income taxes by segment includes allocated investment income. Identifiable assets by segment are those assets used in or allocated to the operation of each segment.
  
Revenues
 
 
 
 
(In thousands)
Earned
Premiums
 
Investment
Income 
 
Other
 
Total (1)
 
Pre-Tax
Income
(Loss)
 
Net Income
(Loss) to Common Stockholders
Three months ended March 31, 2018
 
 
 
 
 
 
 
 
 
 
Insurance
$
1,432,337

 
$
135,862

 
$
18,968

 
$
1,587,167

 
$
229,028

 
$
181,626

Reinsurance
135,071

 
24,650

 
—

 
159,721

 
14,592

 
11,654

Corporate, other and eliminations (2)
—

 
14,006

 
81,889

 
95,895

 
(81,094
)
 
(65,170
)
Net realized and unrealized gains on investments
—

 
—

 
48,464

 
48,464

 
48,464

 
38,286

  Total
$
1,567,408

 
$
174,518

 
$
149,321

 
$
1,891,247

 
$
210,990

 
$
166,396

Three months ended March 31, 2017
 
 
 
 
 
 
 
 
 
 
Insurance
$
1,413,170

 
$
111,909

 
$
18,287

 
$
1,543,366

 
$
199,994

 
$
134,095

Reinsurance
156,872

 
24,778

 
—

 
181,650

 
4,594

 
3,099

Corporate, other and eliminations (2)
—

 
12,171

 
80,883

 
93,054

 
(72,639
)
 
(47,773
)
Net realized and unrealized gains on investments
—

 
—

 
52,348

 
52,348

 
52,348

 
34,026

  Total
$
1,570,042

 
$
148,858

 
$
151,518

 
$
1,870,418

 
$
184,297

 
$
123,447

_________________
(1) Revenues for Insurance from foreign countries for the three months ended March 31, 2018 and 2017 were $183 million and $184 million, respectively. Revenues for Reinsurance from foreign countries for the three months ended March 31, 2018 and 2017 were $56 million and $49 million, respectively.
(2) Corporate, other and eliminations represent corporate revenues and expenses that are not allocated to business segments.
Identifiable Assets
(In thousands)
March 31, 2018
 
December 31, 2017
Insurance
$
19,322,526

 
$
19,263,193

Reinsurance
3,093,808

 
3,169,731

Corporate, other and eliminations
2,171,498

 
1,866,993

  Consolidated
$
24,587,832

 
$
24,299,917


23



Net premiums earned by major line of business are as follows:
 
For the Three Months Ended March 31,
 
(In thousands)
2018
 
2017
Insurance:
 
 
 
Other liability
$
464,167

 
$
451,830

Workers’ compensation
365,948

 
361,136

Short-tail lines (1)
295,105

 
296,790

Commercial automobile
175,199

 
170,571

Professional liability
131,918

 
132,843

Total Insurance
1,432,337

 
1,413,170

 
 
 
 
Reinsurance:
 
 
 
Casualty
90,570

 
94,739

Property
44,501

 
62,133

Total Reinsurance
135,071

 
156,872

 
 
 
 
Total
$
1,567,408

 
$
1,570,042

______________
(1) Short-tail lines include commercial multi-peril (non-liability), inland marine, accident and health, fidelity and surety, boiler and machinery and other lines.




24


SAFE HARBOR STATEMENT
    
This is a “Safe Harbor” Statement under the Private Securities Litigation Reform Act of 1995. Any forward-looking statements contained herein, including statements related to our outlook for the industry and for our performance for the year 2018 and beyond, are based upon the Company’s historical performance and on current plans, estimates and expectations. The inclusion of this forward-looking information should not be regarded as a representation by us or any other person that the future plans, estimates or expectations contemplated by us will be achieved. They are subject to various risks and uncertainties, including but not limited to: the cyclical nature of the property casualty industry; the impact of significant competition, including new alternative entrants to the industry; the long-tail and potentially volatile nature of the insurance and reinsurance business; product demand and pricing; claims development and the process of estimating reserves; investment risks, including those of our portfolio of fixed maturity securities and investments in equity securities, including investments in financial institutions, municipal bonds, mortgage-backed securities, loans receivable, investment funds, including real estate, merger arbitrage, energy related and private equity investments; the effects of emerging claim and coverage issues; the uncertain nature of damage theories and loss amounts; natural and man-made catastrophic losses, including as a result of terrorist activities; general economic and market activities, including inflation, interest rates, and volatility in the credit and capital markets; the impact of the conditions in the financial markets and the global economy, and the potential effect of legislative, regulatory, accounting or other initiatives taken in response, on our results and financial condition; foreign currency and political risks (including those associated with the United Kingdom's withdrawal from the European Union, or "Brexit") relating to our international operations; our ability to attract and retain key personnel and qualified employees; continued availability of capital and financing; the success of our new ventures or acquisitions and the availability of other opportunities; the availability of reinsurance; our retention under the Terrorism Risk Insurance Program Reauthorization Act of 2015; the ability of our reinsurers to pay reinsurance recoverables owed to us; other legislative and regulatory developments, including those related to business practices in the insurance industry; credit risk related to our policyholders, independent agents and brokers; changes in the ratings assigned to us or our insurance company subsidiaries by rating agencies; the availability of dividends from our insurance company subsidiaries; potential difficulties with technology and/or data security; the effectiveness of our controls to ensure compliance with guidelines, policies and legal and regulatory standards; and other risks detailed from time to time in the Company’s filings with the Securities and Exchange Commission. These risks and uncertainties could cause our actual results for the year 2018 and beyond to differ materially from those expressed in any forward-looking statement we make. Any projections of growth in our revenues would not necessarily result in commensurate levels of earnings. Our future financial performance is dependent upon factors discussed in our Annual Report on Form 10-K, elsewhere in this Form 10-Q and our other SEC filings. Forward-looking statements speak only as of the date on which they are made. Except to the extent required by applicable laws, the Company does not undertake any obligation to update or revise any forward-looking statement, whether as a result of new information, future developments or otherwise.

25


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

Overview
W. R. Berkley Corporation is an insurance holding company that is among the largest commercial lines writers in the United States and operates worldwide in two segments of the property and casualty business: Insurance and Reinsurance. Our decentralized structure provides us with the flexibility to respond quickly and efficiently to local or specific market conditions and to pursue specialty business niches. It also allows us to be closer to our customers in order to better understand their individual needs and risk characteristics. While providing our business units with certain operating autonomy, our structure allows us to capitalize on the benefits of economies of scale through centralized capital, investment, reinsurance, enterprise risk management, and actuarial, financial and corporate legal staff support. The Company’s primary sources of revenues and earnings are its insurance operations and its investments.
An important part of our strategy is to form new operating units to capitalize on various business opportunities. Over the years, the Company has formed numerous operating units that are focused on important parts of the economy in the U.S., including healthcare, cyber security, energy and agriculture, and on growing international markets, including the Asia-Pacific region, South America and Mexico.
The profitability of the Company’s insurance business is affected primarily by the adequacy of premium rates. The ultimate adequacy of premium rates is not known with certainty at the time an insurance policy is issued because premiums are determined before claims are reported. The ultimate adequacy of premium rates is affected mainly by the severity and frequency of claims, which are influenced by many factors, including natural and other disasters, regulatory measures and court decisions that define and change the extent of coverage and the effects of economic inflation on the amount of compensation for injuries or losses. General insurance prices are also influenced by available insurance capacity, i.e., the level of statutory capital and surplus employed in the industry, and the industry’s willingness to deploy that capital.
The Company’s profitability is also affected by its investment income and investment gains. The Company’s invested assets are invested principally in fixed maturity securities. The return on fixed maturity securities is affected primarily by general interest rates, as well as the credit quality and duration of the securities. Returns available on fixed maturity investments have been at historically low levels for an extended period.
The Company invests in equity securities, merger arbitrage securities, investment funds (including energy related funds), private equity, loans and real estate related assets. The Company's investments in investment funds and its other alternative investments have experienced, and the Company expects to continue to experience, greater fluctuations in investment income.
Effective January 1, 2018, the Company adopted new accounting standards including ASU 2014-09, Revenue from Customers, ASU 2016-01, Financial Instruments and ASU 2018-02, Reporting Comprehensive Income. Refer to Note 3 in the financial statements for further information on the accounting guidance and impact of adoption for each on the Company's results and financial position.    
Critical Accounting Estimates
The following presents a discussion of accounting policies and estimates relating to reserves for losses and loss expenses, assumed premiums and other-than-temporary impairments of investments. Management believes these policies and estimates are the most critical to its operations and require the most difficult, subjective and complex judgments.
Reserves for Losses and Loss Expenses. To recognize liabilities for unpaid losses, either known or unknown, insurers establish reserves, which is a balance sheet account representing estimates of future amounts needed to pay claims and related expenses with respect to insured events which have occurred. Estimates and assumptions relating to reserves for losses and loss expenses are based on complex and subjective judgments, often including the interplay of specific uncertainties with related accounting and actuarial measurements. Such estimates are also susceptible to change as significant periods of time may elapse between the occurrence of an insured loss, the report of the loss to the insurer, the ultimate determination of the cost of the loss and the insurer’s payment of that loss.
In general, when a claim is reported, claims personnel establish a “case reserve” for the estimated amount of the ultimate payment based upon known information about the claim at that time. The estimate represents an informed judgment based on general reserving practices and reflects the experience and knowledge of the claims personnel regarding the nature and value of the specific type of claim. Reserves are also established on an aggregate basis to provide for losses incurred but not reported (“IBNR”) to the insurer, potential inadequacy of case reserves and the estimated expenses of settling claims, including legal and other fees and general expenses of administrating the claims adjustment process. Reserves are established based upon the then current legal interpretation of coverage provided.

26


In examining reserve adequacy, several factors are considered in estimating the ultimate economic value of losses. These factors include, among other things, historical data, legal developments, changes in social attitudes and economic conditions, including the effects of inflation. The actuarial process relies on the basic assumption that past experience, adjusted judgmentally for the effects of current developments and anticipated trends, is an appropriate basis for predicting future outcomes. Reserve amounts are based on management’s informed estimates and judgments using currently available data. As additional experience and other data become available and are reviewed, these estimates and judgments may be revised. This may result in reserve increases or decreases that would be reflected in our results in periods in which such estimates and assumptions are changed.
Reserves do not represent an exact calculation of liability. Rather, reserves represent an estimate of what management expects the ultimate settlement and claim administration will cost. While the methods for establishing reserves are well tested over time, some of the major assumptions about anticipated loss emergence patterns are subject to uncertainty. These estimates, which generally involve actuarial projections, are based on management’s assessment of facts and circumstances then known, as well as estimates of trends in claims severity and frequency, judicial theories of liability and other factors, including the actions of third parties which are beyond the Company’s control. These variables are affected by external and internal events, such as inflation and economic volatility, judicial and litigation trends, reinsurance coverage, legislative changes and claim handling and reserving practices, which make it more difficult to accurately predict claim costs. The inherent uncertainties of estimating reserves are greater for certain types of liabilities where long periods of time elapse before a definitive determination of liability is made. Because setting reserves is inherently uncertain, the Company cannot provide assurance that its current reserves will prove adequate in light of subsequent events.
Loss reserves included in the Company’s financial statements represent management’s best estimates based upon an actuarially derived point estimate and other considerations. The Company uses a variety of actuarial techniques and methods to derive an actuarial point estimate for each operating unit. These methods include paid loss development, incurred loss development, paid and incurred Bornhuetter-Ferguson methods and frequency and severity methods. In circumstances where one actuarial method is considered more credible than the others, that method is used to set the point estimate. For example, the paid loss and incurred loss development methods rely on historical paid and incurred loss data. For new lines of business, where there is insufficient history of paid and incurred claims data, or in circumstances where there have been significant changes in claim practices, the paid and incurred loss development methods would be less credible than other actuarial methods. The actuarial point estimate may also be based on a judgmental weighting of estimates produced from each of the methods considered. Industry loss experience is used to supplement the Company’s own data in selecting “tail factors” and in areas where the Company’s own data is limited. The actuarial data is analyzed by line of business, coverage and accident or policy year, as appropriate, for each operating unit.
The establishment of the actuarially derived loss reserve point estimate also includes consideration of qualitative factors that may affect the ultimate losses. These qualitative considerations include, among others, the impact of re-underwriting initiatives, changes in the mix of business, changes in distribution sources and changes in policy terms and conditions. Examples of changes in terms and conditions that can have a significant impact on reserve levels are the use of aggregate policy limits, the expansion of coverage exclusions, whether or not defense costs are within policy limits, and changes in deductibles and attachment points.
The key assumptions used to arrive at the best estimate of loss reserves are the expected loss ratios, rate of loss cost inflation, and reported and paid loss emergence patterns. Expected loss ratios represent management’s expectation of losses at the time the business is written, before any actual claims experience has emerged. This expectation is a significant determinant of the estimate of loss reserves for recently written business where there is little paid or incurred loss data to consider. Expected loss ratios are generally derived from historical loss ratios adjusted for the impact of rate changes, loss cost trends and known changes in the type of risks underwritten. Expected loss ratios are estimated for each key line of business within each operating unit. Expected loss cost inflation is particularly important for the long-tail lines, such as excess casualty, and claims with a high medical component, such as workers’ compensation. Reported and paid loss emergence patterns are used to project current reported or paid loss amounts to their ultimate settlement value. Loss development factors are based on the historical emergence patterns of paid and incurred losses, and are derived from the Company’s own experience and industry data. The paid loss emergence pattern is also significant to excess and assumed workers’ compensation reserves because those reserves are discounted to their estimated present value based upon such estimated payout patterns. Management believes the estimates and assumptions it makes in the reserving process provide the best estimate of the ultimate cost of settling claims and related expenses with respect to insured events which have occurred; however, different assumptions and variables could lead to significantly different reserve estimates.
Loss frequency and severity are measures of loss activity that are considered in determining the key assumptions described in our discussion of loss and loss expense reserves, including expected loss ratios, rate of loss cost inflation and reported and paid loss emergence patterns. Loss frequency is a measure of the number of claims per unit of insured exposure, and loss severity is a measure of the average size of claims. Factors affecting loss frequency include the effectiveness of loss

27


controls and safety programs and changes in economic activity or weather patterns. Factors affecting loss severity include changes in policy limits, retentions, rate of inflation and judicial interpretations.
Another factor affecting estimates of loss frequency and severity is the loss reporting lag, which is the period of time between the occurrence of a loss and the date the loss is reported to the Company. The length of the loss reporting lag affects our ability to accurately predict loss frequency (loss frequencies are more predictable for lines with short reporting lags) as well as the amount of reserves needed for incurred but not reported losses (less IBNR is required for lines with short reporting lags). As a result, loss reserves for lines with short reporting lags are likely to have less variation from initial loss estimates. For lines with short reporting lags, which include commercial automobile, primary workers’ compensation, other liability (claims-made) and property business, the key assumption is the loss emergence pattern used to project ultimate loss estimates from known losses paid or reported to date. For lines of business with long reporting lags, which include other liability (occurrence), products liability, excess workers’ compensation and liability reinsurance, the key assumption is the expected loss ratio since there is often little paid or incurred loss data to consider. Historically, the Company has experienced less variation from its initial loss estimates for lines of businesses with short reporting lags than for lines of business with long reporting lags.
The key assumptions used in calculating the most recent estimate of the loss reserves are reviewed each quarter and adjusted, to the extent necessary, to reflect the latest reported loss data, current trends and other factors observed. If the actual level of loss frequency and severity are higher or lower than expected, the ultimate losses will be different than management’s estimate. The following table reflects the impact of changes (which could be favorable or unfavorable) in frequency and severity, relative to our assumptions, on our loss estimate for claims occurring in 2017:
(In thousands)
Frequency (+/-)
Severity (+/-)
1%
 
5%
 
10%
1%
$
79,667

 
$
239,794

 
$
439,953

5%
239,794

 
406,263

 
614,349

10%
439,953

 
614,349

 
832,344

Our net reserves for losses and loss expenses of approximately $10.1 billion as of March 31, 2018 relate to multiple accident years. Therefore, the impact of changes in frequency or severity for more than one accident year could be higher or lower than the amounts reflected above. The impact of such changes would likely be manifested gradually over the course of many years, as the magnitude of the changes became evident.
Approximately $1.7 billion, or 17%, of the Company’s net loss reserves as of March 31, 2018 relate to the Reinsurance segment. There is a higher degree of uncertainty and greater variability regarding estimates of assumed loss reserves because those estimates are based, in part, upon information received from ceding companies. If information received from ceding companies is not timely or correct, the Company’s estimate of ultimate losses may not be accurate. Furthermore, due to delayed reporting of claim information by ceding companies, the claim settlement tail for assumed reinsurance is extended. Management considers the impact of delayed reporting in its selection of assumed loss development factors.
Information received from ceding companies is used to set initial expected loss ratios, to establish case reserves and to estimate reserves for incurred but not reported losses on assumed reinsurance business. This information, which is generally provided through reinsurance intermediaries, is gathered through the underwriting process and from periodic claim reports and other correspondence with ceding companies. The Company performs underwriting and claim audits of selected ceding companies to determine the accuracy and completeness of information provided to the Company. The information received from the ceding companies is supplemented by the Company’s own loss development experience with similar lines of business as well as industry loss trends and loss development benchmarks.
Following is a summary of the Company’s reserves for losses and loss expenses by business segment:
(In thousands)
March 31, 2018
 
December 31, 2017
Insurance
$
8,415,984

 
$
8,341,622

Reinsurance
1,684,911

 
1,715,292

Net reserves for losses and loss expenses
10,100,895

 
10,056,914

Ceded reserves for losses and loss expenses
1,684,000

 
1,613,494

Gross reserves for losses and loss expenses
$
11,784,895

 
$
11,670,408

    


28


Following is a summary of the Company’s net reserves for losses and loss expenses by major line of business:
 
(In thousands)
Reported Case
Reserves
 
Incurred But
Not Reported
 
Total
March 31, 2018
 
 
 
 
 
Other liability
$
1,289,211

 
$
2,235,130

 
$
3,524,341

Workers’ compensation (1)
1,561,486

 
1,242,754

 
2,804,239

Professional liability
294,457

 
619,821

 
914,277

Commercial automobile
355,785

 
277,551

 
633,336

Short-tail lines (2)
263,793

 
275,997

 
539,790

Total Insurance
3,764,732

 
4,651,252

 
8,415,984

Reinsurance (1)
908,358

 
776,553

 
1,684,911

Total
$
4,673,090

 
$
5,427,805

 
$
10,100,895

 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
Other liability
$
1,261,957

 
$
2,189,596

 
$
3,451,553

Workers’ compensation (1)
1,543,379

 
1,242,501

 
2,785,880

Professional liability
295,269

 
618,107

 
913,376

Commercial automobile
364,900

 
269,942

 
634,842

Short-tail lines (2)
297,777

 
258,194

 
555,971

Total Insurance
3,763,282

 
4,578,340

 
8,341,622

Reinsurance (1)
919,497

 
795,795

 
1,715,292

Total
$
4,682,779

 
$
5,374,135

 
$
10,056,914

___________
(1) Reserves for workers’ compensation and reinsurance are net of an aggregate net discount of $583 million and $591
million as of March 31, 2018 and December 31, 2017, respectively.
(2) Short-tail lines include commercial multi-peril (non-liability), inland marine, accident and health, fidelity and surety, boiler and machinery and other lines.

The Company evaluates reserves for losses and loss adjustment expenses on a quarterly basis. Changes in estimates of prior year losses are reported when such changes are made. The changes in prior year loss reserve estimates are generally the result of ongoing analysis of recent loss development trends. Original estimates are increased or decreased as additional information becomes known regarding individual claims and aggregate claim trends.
    
Certain of the Company's insurance and reinsurance contracts are retrospectively rated, whereby the Company collects more or less premiums based on the level of loss activity. For those contracts, changes in loss and loss adjustment expenses for prior years may be fully or partially offset by additional or return premiums.

Net prior year development (i.e. the sum of prior year reserve changes and prior year earned premiums changes) for the three months ended March 31, 2018 and 2017 are as follows:
 
(In thousands)
2018
 
2017
Net decrease (increase) in prior year loss reserves
$
3,582

 
$
(8,727
)
Increase in prior year earned premiums
8,622

 
11,173

Net favorable prior year development
$
12,204

 
$
2,446

         
During the three months ended March 31, 2018, favorable prior year development (net of additional and return premiums) of $12.2 million included $16.3 million of favorable development for the Insurance segment, offset by $4.1 million of adverse development for the Reinsurance segment. The favorable development for the Insurance segment was primarily attributable to workers’ compensation business. The favorable workers’ compensation development was spread across many accident years, including prior to 2008, but was most significant in accident years 2015 through 2017. The favorable workers’ compensation development reflects a continuation of the benign loss cost trends experienced during recent years, particularly the favorable claim frequency trends (i.e., number of reported claims per unit of exposure). The adverse

29


development for the Reinsurance segment was mainly driven by US casualty facultative business from accident years 2008 and prior related to construction projects.

During the three months ended March 31, 2017, favorable prior year development (net of additional and return premiums) of $2.4 million included $26.2 million of favorable development for the Insurance segment, largely offset by $23.8 million of adverse development for the Reinsurance segment. The favorable development for the Insurance segment was primarily attributable to workers' compensation business, including excess workers' compensation. The favorable workers' compensation development was spread across many accident years, including prior to 2008, but was most significant in accident years 2014 and 2015. The favorable workers' compensation development reflects a continuation of the benign loss cost trends experienced during 2016, particularly the favorable claim frequency trends ( i.e., number of reported claims per unit of exposure). The adverse development for the Reinsurance segment was almost entirely due to reserve strengthening associated with claims impacted by the change in the Ogden discount rate in the U.K. The Ogden rate is the discount rate used to calculate lump-sum bodily injury payouts in the U.K. and was recently reduced by the U.K. Ministry of Justice from +2.5% to -0.75%. The adverse development mostly related to U.K. motor bodily injury claims which we reinsured on an excess of loss basis in accident years 2012 through 2016.

Reserve Discount. The Company discounts its liabilities for certain workers’ compensation reserves. The amount of workers’ compensation reserves that were discounted was $1,838 million and $1,855 million at March 31, 2018 and December 31, 2017, respectively. The aggregate net discount for those reserves, after reflecting the effects of ceded reinsurance, was $583 million and $591 million at March 31, 2018 and December 31, 2017, respectively. At March 31, 2018, discount rates by year ranged from 2.0% to 6.5%, with a weighted average discount rate of 3.8%.

             Substantially all of the workers’ compensation discount (97% of total discounted reserves at March 31, 2018) relates to excess workers’ compensation reserves. In order to properly match loss expenses with income earned on investment securities supporting the liabilities, reserves for excess workers’ compensation business are discounted using risk-free discount rates determined by reference to the U.S. Treasury yield curve. These rates are determined annually based on the weighted average rate for the period. Once established, no adjustments are made to the discount rate for that period, and any increases or decreases in loss reserves in subsequent years are discounted at the same rate, without regard to when any such adjustments are recognized. The expected loss and loss expense payout patterns subject to discounting are derived from the Company’s loss payout experience.  

        The Company also discounts reserves for certain other long-duration workers’ compensation reserves (representing approximately 3% of total discounted reserves at March 31, 2018), including reserves for quota share reinsurance and reserves related to losses regarding occupational lung disease. These reserves are discounted at statutory rates permitted by the Department of Insurance of the State of Delaware.
    
         Assumed Reinsurance Premiums. The Company estimates the amount of assumed reinsurance premiums that it will receive under treaty reinsurance agreements at the inception of the contracts. These premium estimates are revised as the actual amount of assumed premiums is reported to the Company by the ceding companies. As estimates of assumed premiums are made or revised, the related amount of earned premiums, commissions and incurred losses associated with those premiums are recorded. Estimated assumed premiums receivable were approximately $51 million at March 31, 2018 and $56 million at December 31, 2017. The assumed premium estimates are based upon terms set forth in reinsurance agreements, information received from ceding companies during the underwriting and negotiation of agreements, reports received from ceding companies and discussions and correspondence with reinsurance intermediaries. The Company also considers its own view of market conditions, economic trends and experience with similar lines of business. These premium estimates represent management’s best estimate of the ultimate amount of premiums to be received under its assumed reinsurance agreements.
Other-Than-Temporary Impairments (OTTI) of Investments. The cost of securities is adjusted where appropriate to include a provision for decline in value which is considered to be other-than-temporary. An other-than-temporary decline is considered to occur in investments where there has been a sustained reduction in fair value and where the Company does not expect the fair value to recover prior to the time of sale or maturity.
The Company classifies its fixed maturity securities by credit rating, primarily based on ratings assigned by credit rating agencies. For purposes of classifying securities with different ratings, the Company uses the average of the credit ratings assigned, unless in limited situations the Company’s own analysis indicates an internal rating is more appropriate. Securities that are not rated by a rating agency are evaluated and classified by the Company on a case-by-case basis.
Fixed Maturity Securities – For securities that we intend to sell or, more likely than not, would be required to sell, a decline in value below amortized cost is considered to be OTTI. The amount of OTTI is equal to the difference between amortized cost and fair value at the balance sheet date. For securities that we do not intend to sell or expect to be required to

30


sell, a decline in value below amortized cost is considered to be an OTTI if we do not expect to recover the entire amortized cost basis of a security (i.e., the present value of cash flows expected to be collected is less than the amortized cost basis of the security).
The portion of the decline in value considered to be a credit loss (i.e., the difference between the present value of cash flows expected to be collected and the amortized cost basis of the security) is recognized in earnings. The portion of the decline in value not considered to be a credit loss (i.e., the difference in the present value of cash flows expected to be collected and the fair value of the security) is recognized in other comprehensive income.
Impairment assessments for structured securities, including mortgage-backed securities and asset-backed securities, collateralized debt obligations and corporate debt, are generally evaluated based on the performance of the underlying collateral under various economic and default scenarios that may involve subjective judgments and estimates by management. Modeling these securities involves various factors, such as projected default rates, the nature and realizable value of the collateral, if any, the ability of the issuer to make scheduled payments, historical performance and other relevant economic and performance factors. If an OTTI determination is made, a discounted cash flow analysis is used to ascertain the amount of the credit impairment.

The following table provides a summary of fixed maturity securities in an unrealized loss position as of March 31, 2018:
($ in thousands)
Number of
Securities
 
Aggregate
Fair Value
 
Gross Unrealized
Loss
Unrealized loss less than 20% of amortized cost
1,018

 
$
6,900,270

 
$
129,939

Unrealized loss of 20% or greater of amortized cost:
 
 
 
 
 
Twelve months and longer
3

 
167

 
107

Total
1,021

 
$
6,900,437

 
$
130,046

A summary of the Company’s non-investment grade fixed maturity securities that were in an unrealized loss position at March 31, 2018 is presented in the table below:
($ in thousands)
Number of
Securities
 
Aggregate
Fair Value
 
Gross Unrealized
Loss
Corporate
10

 
$
86,345

 
$
4,429

Foreign government
8

 
$
30,997

 
$
739

Asset-backed securities
3

 
370

 
140

Mortgage-backed securities
5

 
4,532

 
117

State and municipal
1

 
3,641

 
3

Total
27

 
$
125,885

 
$
5,428

    
The Company has evaluated its fixed maturity securities in an unrealized loss position and believes the unrealized loss is 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.
Loans Receivable – The Company monitors the performance of its loans receivable, including current market conditions for each loan and the ability to collect principal and interest. For loans where the Company determines it is probable that the contractual terms will not be met, an analysis is performed and a valuation reserve is established, if necessary, with a charge to earnings. Loans receivable are reported net of a valuation reserve of $3 million at both March 31, 2018 and December 31, 2017.
The Company monitors the performance of its loans receivable and assesses the ability of each 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.

31


Fair Value Measurements. The Company’s fixed maturity available for sale securities, equity securities, 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. The fair value of the vast majority of the Company’s portfolio is based on observable data (other than quoted prices) and, accordingly, is classified as Level 2.

In classifying particular financial securities in the fair value hierarchy, the Company uses its judgment to determine whether the market for a security is active and whether significant pricing inputs are observable. The Company determines the existence of an active market by assessing whether transactions occur with sufficient frequency and volume to provide reliable pricing information. The Company determines whether inputs are observable based on the use of such information by pricing services and external investment managers, the uninterrupted availability of such inputs, the need to make significant adjustments to such inputs and the volatility of such inputs over time. If the market for a security is determined to be inactive or if significant inputs used to price a security are determined to be unobservable, the security is categorized in Level 3 of the fair value hierarchy.
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 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 data, projections and business developments of the issuer and other relevant information.
The following is a summary of pricing sources for the Company's fixed maturity securities available for sale as of March 31, 2018:
($ in thousands)
Carrying
Value
 
Percent
of Total
Pricing source:
 
 
 
Independent pricing services
$
13,081,232

 
98.6
%
Syndicate manager
41,523

 
0.3

Directly by the Company based on:
 
 
 
Observable data
140,983

 
1.1

Cash flow model
163

 
—

Total
$
13,263,901

 
100.0
%

Independent pricing services – Substantially all of the Company’s fixed maturity securities available for sale were priced by independent pricing services (generally one U.S. pricing service plus additional pricing services with respect to a limited number of foreign securities held by the Company). The prices provided by the independent pricing services are generally based on observable market data in active markets (e.g., broker quotes and prices observed for comparable securities). The determination of whether markets are active or inactive is based upon the volume and level of activity for a particular asset class. The Company reviews the prices provided by pricing services for reasonableness based upon current trading levels for similar securities. If the prices appear unusual to the Company, they are re-examined and the value is either confirmed or revised. In addition, the Company periodically performs independent price tests of a sample of securities to ensure proper valuation and to verify our understanding of how securities are priced. As of March 31, 2018, the Company did not make any adjustments to the prices provided by the pricing services. Based upon the Company’s review of the methodologies used by the independent pricing services, these securities were classified as Level 2.
Syndicate manager – The Company has a 15% participation in a Lloyd’s syndicate, and the Company’s share of the securities owned by the syndicate is priced by the syndicate’s manager. The majority of the securities are liquid, short duration fixed maturity securities. The Company reviews the syndicate manager’s pricing methodology and audited financial statements

32


and holds discussions with the syndicate manager as necessary to confirm its understanding and agreement with security prices. Based upon the Company’s review of the methodologies used by the syndicate manager, these securities were classified as Level 2.
Observable data – If independent pricing is not available, the Company prices the securities directly. Prices are based on observable market data where available, including current trading levels for similar securities and non-binding quotations from brokers. The Company generally requests two or more quotes. If more than one quote is received, the Company sets a price within the range of quotes received based on its assessment of the credibility of the quote and its own evaluation of the security. The Company generally does not adjust quotes obtained from brokers. Since these securities were priced based on observable data, they were classified as Level 2.
Cash flow model – If the above methodologies are not available, the Company prices securities using a discounted cash flow model based upon assumptions as to prevailing credit spreads, interest rates and interest rate volatility, time to maturity and subordination levels. Discount rates are adjusted to reflect illiquidity where appropriate. These securities were classified as Level 3.



33


Results of Operations for the Three Months Ended March 31, 2018 and 2017
 
Business Segment Results
Following is a summary of gross and net premiums written, net premiums earned, loss ratios (losses and loss expenses incurred expressed as a percentage of premiums earned), expense ratios (underwriting expenses expressed as a percentage of premiums earned) and United States Generally Accepted Accounting Principles (“GAAP”) combined ratios (sum of loss ratio and expense ratio) for each of our business segments for the three months ended March 31, 2018 and 2017. The GAAP combined ratio represents a measure of underwriting profitability, excluding investment income. A GAAP combined ratio in excess of 100 indicates an underwriting loss; a number below 100 indicates an underwriting profit.
($ in thousands)
2018
 
2017
Insurance:
 
 
 
Gross premiums written
$
1,837,971

 
$
1,769,405

Net premiums written
1,543,052

 
1,494,135

Net premiums earned
1,432,337

 
1,413,170

Loss ratio
60.6
%
 
60.9
%
Expense ratio
32.8
%
 
32.9
%
GAAP combined ratio
93.4
%
 
93.8
%
Reinsurance:
 
 
 
Gross premiums written
$
141,450

 
$
166,802

Net premiums written
122,286

 
152,703

Net premiums earned
135,071

 
156,872

Loss ratio
69.9
%
 
75.9
%
Expense ratio
37.5
%
 
37.0
%
GAAP combined ratio
107.4
%
 
112.9
%
Consolidated:
 
 
 
Gross premiums written
$
1,979,421

 
$
1,936,207

Net premiums written
1,665,338

 
1,646,838

Net premiums earned
1,567,408

 
1,570,042

Loss ratio
61.4
%
 
62.4
%
Expense ratio
33.2
%
 
33.3
%
GAAP combined ratio
94.6
%
 
95.7
%
Net Income to Common Stockholders. The following table presents the Company’s net income to common stockholders and net income per diluted share for the three months ended March 31, 2018 and 2017:
(In thousands, except per share data)
2018
 
2017
Net income to common stockholders
$
166,396

 
$
123,447

Weighted average diluted shares
128,125

 
128,453

Net income per diluted share
$
1.30

 
$
0.96

The Company reported net income of $166 million in 2018 compared to $123 million in 2017. The 35% increase in net income was primarily due to an after-tax increase in net investment income of $20 million mainly driven by growth in the fixed income security portfolio and real estate investment funds, an after-tax increase in underwriting income of $13 million, and a $21 million decrease in tax expense due to the reduction of the federal corporate tax rate from 35% to 21%, partially offset by an increase in after-tax foreign currency losses of $6 million, an after-tax reduction in insurance service fee income of $4 million, and a decrease in after-tax net investment gains of $3 million. The number of weighted average diluted shares decreased slightly primarily due to share repurchases.
Premiums. Gross premiums written were $1,979 million in 2018, an increase of 2% from $1,936 million in 2017. The increase was due to an increase in the Insurance segment of $68 million, partially offset by a decrease in the Reinsurance segment of $25 million. Approximately 78.3% of policies expiring in 2018 were renewed, compared with a 78.4% renewal retention rate for policies expiring in 2017.
    Average renewal premium rates for insurance and facultative reinsurance increased 3.5% in 2018 when adjusted for change in exposures.
    

34


A summary of gross premiums written in 2018 compared with 2017 by line of business within each business segment follows:
•
Insurance - gross premiums increased 4% to $1,838 million in 2018 from $1,769 million in 2017. Gross premiums increased $36 million (7%) for other liability, $20 million (11%) for professional liability, $16 million (4%) for short-tail lines, and $12 million (5%) for commercial auto and decreased $15 million (3%) for workers' compensation.
•
Reinsurance - gross premiums decreased 15% to $142 million in 2018 from $167 million in 2017. Gross premiums decreased $14 million (22%) for property lines and $11 million (11%) for casualty lines.
Net premiums written were $1,665 million in 2018, an increase of 1% from $1,647 million in 2017. Ceded reinsurance premiums as a percentage of gross written premiums were 16% in 2018 and 15% in 2017.
Premiums earned decreased less than 1% to $1,567 million in 2018 from $1,570 million in 2017. Insurance premiums (including the impact of rate changes) are generally earned evenly over the policy term, and accordingly, recent rate increases will be earned over the upcoming quarters. Premiums earned in 2018 are related to business written during both 2018 and 2017. Audit premiums were $49 million in 2018 compared with $40 million in 2017.
Net Investment Income. Following is a summary of net investment income for the three months ended March 31, 2018 and 2017: 
 
Amount
 
Average Annualized
Yield
($ in thousands)
2018
 
2017
 
2018
 
2017
Fixed maturity securities, including cash and cash equivalents and loans receivable
$
123,246

 
$
112,346

 
3.5
%
 
3.2
%
Investment funds
40,354

 
26,649

 
13.7

 
8.5

Arbitrage trading account
5,191

 
6,360

 
3.3

 
5.4

Real estate
6,568

 
4,566

 
1.6

 
1.5

Equity securities
646

 
639

 
1.2

 
1.2

Gross investment income
176,005

 
150,560

 
3.9

 
3.5

Investment expenses
(1,487
)
 
(1,702
)
 
—

 
—

Total
$
174,518

 
$
148,858

 
3.9
%
 
3.5
%
Net investment income increased 17% to $175 million in 2018 from $149 million in 2017 due primarily to a $14 million increase in income from investment funds mainly from real estate funds, an $11 million increase in income from fixed maturity securities mainly driven by growth in the fixed income security portfolio and a $2 million increase from real estate, partially offset by a $1 million decrease from the arbitrage trading account. Average invested assets, at cost (including cash and cash equivalents), were $18.1 billion in 2018 and $17.3 billion in 2017.
Insurance Service Fees. The Company earns fees from an insurance distribution business, a third-party administrator and as a servicing carrier of workers' compensation assigned risk plans for certain states. Insurance service fees decreased to $31 million in 2018 from $33 million in 2017.
Net Realized and Unrealized Gains on Investments. The Company buys and sells securities and other investment assets on a regular basis in order to maximize its total return on investments. Decisions to sell securities and other investment assets are based on management’s view of the underlying fundamentals of specific investments as well as management’s expectations regarding interest rates, credit spreads, currency values and general economic conditions. Net realized and unrealized gains on investments were $48 million in 2018 compared with $52 million in 2017. Effective January 1, 2018, the Company adopted new accounting guidance that requires all equity investments with readily determinable fair values to be measured at fair value with changes in the fair value recognized through net income (other than those equity securities accounted for under equity method of accounting or those that result in consolidation of the investee). During the three months ended March 31, 2018, the gains of $48 million include net realized gains on investment sales of $142 million reduced by a change in unrealized gains on equity securities of $94 million.
Other-Than-Temporary Impairments. There were no impairments for the three months ended March 31, 2018 and 2017.
Revenues from Non-Insurance Businesses. Revenues from non-insurance businesses were derived from businesses engaged in the distribution of promotional merchandise, world-wide textile solutions and aviation-related businesses that

35


provide services to aviation markets, including (i) the distribution, manufacturing, repair and overhaul of aircraft parts and components, (ii) the sale of new and used aircraft, and (iii) avionics, fuel, maintenance, storage and charter services. Revenues from non-insurance businesses were $70 million in 2018 and $65 million in 2017. The increase mainly relates to revenues from the textile business purchased in March 2017.
Losses and Loss Expenses. Losses and loss expenses decreased to $963 million in 2018 from $980 million in 2017. The consolidated loss ratio was 61.4% in 2018 and 62.4% in 2017. Catastrophe losses, net of reinsurance recoveries and reinstatement premiums, were $7 million in 2018 and $15 million in 2017. Favorable prior year reserve development (net of premium offsets) was $12 million in 2018 and $2 million in 2017. The loss ratio excluding catastrophe losses and prior year reserve development was 61.7% in both 2018 and 2017.
A summary of loss ratios in 2018 compared with 2017 by business segment follows:
•
Insurance - The loss ratio was 60.6% in 2018 and 60.9% in 2017. Catastrophe losses were $7 million in 2018 compared with $14 million in 2017. Favorable prior year reserve development was $16 million in 2018 and $26 million in 2017. The loss ratio excluding catastrophe losses and prior year reserve development decreased 0.5 points to 61.3% in 2018 from 61.8% in 2017.
•
Reinsurance - The loss ratio of 69.9% in 2018 was 6 points lower than the loss ratio of 75.9% in 2017. Catastrophe losses were $0.3 million in 2018 compared with $0.2 million in 2017. Adverse prior year reserve development was $4 million in 2018 and $24 million in 2017. The 2017 adverse development was largely due to the impact of the change in the Ogden discount rate in the U.K. and adverse development related to U.S. facultative casualty excess of loss business. The loss ratio excluding catastrophe losses and prior year reserve development increased 5.9 points to 66.6% in 2018 from 60.7% in 2017.
Other Operating Costs and Expenses. Following is a summary of other operating costs and expenses:
($ in thousands)
2018
 
2017
Policy acquisition and insurance operating expenses
$
520,231

 
$
523,409

Insurance service expenses
32,712

 
29,933

Net foreign currency losses
13,484

 
5,508

Other costs and expenses
44,012

 
44,850

Total
$
610,439

 
$
603,700


Policy acquisition and insurance operating expenses are comprised of commissions paid to agents and brokers, premium taxes and other assessments and internal underwriting costs. Policy acquisition and insurance operating expenses increased 1% compared with an increase in net premiums earned of less than 1%. The expense ratio (underwriting expenses expressed as a percentage of premiums earned) was 33.2% and 33.3% for the three months ended March 31, 2018 and 2017, respectively.
Service expenses, which represent the costs associated with the fee-based businesses, increased to $33 million in 2018 from $30 million in 2017.
Net foreign currency (gains) losses result from transactions denominated in a currency other than a company's operating functional currency. Net foreign currency losses were $13 million in 2018 compared to losses of $6 million in 2017.
Other costs and expenses represent general and administrative expenses of the parent company and other expenses not allocated to business segments, including the cost of certain long-term incentive plans and new business ventures. Other costs and expenses decreased to $44 million in 2018 from $45 million in 2017.
Expenses from Non-Insurance Businesses. Expenses from non-insurance businesses represent costs associated with businesses engaged in the distribution of promotional merchandise, world-wide textile solutions and aviation-related businesses that include (i) cost of goods sold related to aircraft and products sold and services provided, and (ii) general and administrative expenses. Expenses from non-insurance businesses were $70 million in 2018 compared to $66 million in 2017. The increase mainly relates to expenses from the textile business purchased in March 2017.
Interest Expense. Interest expense was $37 million in both 2018 and 2017. In March 2018, the Company issued $175 million aggregate principal amount of 5.70% subordinated debentures due 2058. Additionally in 2018, the Company issued subsidiary debt of $13 million.

36


Income Taxes. The effective income tax rate was 20.6% in 2018 and 32.4% in 2017. The effective income tax rate differs from the federal income tax rate of 21% primarily because of tax-exempt investment income and tax on income from foreign jurisdictions with different tax rates. The decrease in the effective tax rate in 2018 from 2017 was due, in part, to the Tax Cuts and Jobs Act of 2017, which reduced the federal corporate tax rate from 35% to 21%.
The Company has not provided U.S. deferred income taxes on the undistributed earnings of approximately $23 million of its non-U.S. subsidiaries since these earnings are intended to be permanently reinvested in the non-U.S. subsidiaries. In the future, if such earnings were distributed the Company projects that the incremental tax, if any, will be immaterial.


37


Investments
As part of its investment strategy, the Company establishes a level of cash and highly liquid short-term and intermediate-term securities that, combined with expected cash flow, it believes is adequate to meet its payment obligations. Due to the historically low fixed maturity investment returns, the Company invests in equity securities, merger arbitrage securities, investment funds, private equity, loans and real estate related assets. The Company's investments in investment funds and its other alternative investments have experienced, and the Company expects to continue to experience, greater fluctuations in investment income.
The Company also attempts to maintain an appropriate relationship between the average duration of the investment portfolio and the approximate duration of its liabilities (i.e., policy claims and debt obligations). The average duration of the fixed maturity portfolio, including cash and cash equivalents, was 3.0 years at March 31, 2018 and December 31, 2017. The Company’s fixed maturity investment portfolio and investment-related assets as of March 31, 2018 were as follows:
($ in thousands)
Carrying
Value
 
Percent
of Total
Fixed maturity securities:
 
 
 
U.S. government and government agencies
$
479,909

 
2.6
%
State and municipal:
 
 
 
Special revenue
2,676,724

 
14.4

Pre-refunded (1)
467,758

 
2.5

State general obligation
450,878

 
2.4

Local general obligation
408,745

 
2.2

Corporate backed
373,878

 
2.0

Total state and municipal
4,377,983

 
23.5

Mortgage-backed securities:
 
 
 
Agency
827,309

 
4.4

Commercial
335,284

 
1.8

Residential-Prime
218,183

 
1.2

Residential-Alt A
18,993

 
0.1

Total mortgage-backed securities
1,399,769

 
7.5

Asset-backed securities
2,101,691

 
11.3

Corporate:
 
 
 
Industrial
2,374,121

 
12.8

Financial
1,418,598

 
7.6

Utilities
274,532

 
1.5

Other
43,450

 
0.2

Total corporate
4,110,701

 
22.1

Foreign government and foreign government agencies
873,079

 
4.7

Total fixed maturity securities
13,343,132

 
71.7

Equity securities:
 
 
 
Common stocks
320,435

 
1.7

Preferred stocks
175,599

 
0.9

Total equity securities
496,034

 
2.6

Real estate
1,833,337

 
9.9

Investment funds
1,161,127

 
6.2

Cash and cash equivalents
956,603

 
5.1

Arbitrage trading account
744,859

 
4.0

Loans receivable
75,902

 
0.5

Total investments
$
18,610,994

 
100.0
%
________________________
(1) Pre-refunded securities are securities for which an escrow account has been established to fund the remaining payments of principal and interest through maturity. Such escrow accounts are funded almost exclusively with U.S. Treasury and U.S. government agency securities.
Fixed Maturity Securities. The Company’s investment policy with respect to fixed maturity securities is generally to purchase instruments with the expectation of holding them to their maturity. However, management of the available for sale portfolio is considered necessary to maintain an approximate matching of assets and liabilities as well as to adjust the portfolio

38


as a result of changes in financial market conditions and tax considerations.
The Company’s philosophy related to holding or selling fixed maturity securities is based on its objective of maximizing total return. The key factors that management considers in its investment decisions as to whether to hold or sell fixed maturity securities are its view of the underlying fundamentals of specific securities as well as its expectations regarding interest rates, credit spreads and currency values. In a period in which management expects interest rates to rise, the Company may sell longer duration securities in order to mitigate the impact of an interest rate rise on the fair value of the portfolio. Similarly, in a period in which management expects credit spreads to widen, the Company may sell lower quality securities, and in a period in which management expects certain foreign currencies to decline in value, the Company may sell securities denominated in those foreign currencies. The sale of fixed maturity securities in order to achieve the objective of maximizing total return may result in realized gains; however, there is no reason to expect these gains to continue in future periods.
Equity Securities. Equity securities primarily represent investments in common and preferred stocks in companies with potential growth opportunities in different sectors, including healthcare and financial institutions.
Investment Funds. At March 31, 2018, the carrying value of investment funds was $1,161 million, including investments in real estate funds of $625 million, energy funds of $81 million, and other funds of $455 million. Investment funds are generally reported on a one-quarter lag.
Real Estate. Real estate is directly owned property held for investment. At March 31, 2018, real estate properties in operation included a long-term ground lease in Washington, D.C., a hotel in Memphis, Tennessee, two office complexes in New York City and office buildings in West Palm Beach and Palm Beach, Florida. In addition, there are two properties under development: an office building in London and a mixed-use project in Washington, D.C. The Company expects to fund further development costs for these projects with a combination of its own funds and external financing.
Arbitrage Trading Account. The arbitrage trading account is comprised of direct investments in arbitrage securities. Merger arbitrage is the business of investing in the securities of publicly held companies that are the targets in announced tender offers and mergers.
Loans Receivable. Loans receivable, which are carried at amortized cost, had an aggregate cost of $76 million and an aggregate fair value of $78 million at March 31, 2018. The amortized cost of loans receivable is net of a valuation allowance of $3 million as of March 31, 2018. Loans receivable include real estate loans of $63 million that are secured by commercial real estate located primarily in New York. Real estate loans receivable generally earn interest at floating LIBOR-based interest rates and have maturities (inclusive of extension options) through August 2025. Loans receivable include commercial loans of $13 million that are secured by business assets and have fixed interest rates with varying maturities not exceeding 10 years.
Market Risk. The fair value of the Company’s investments is subject to risks of fluctuations in credit quality and interest rates. The Company uses various models and stress test scenarios to monitor and manage interest rate risk. The Company attempts to manage its interest rate risk by maintaining an appropriate relationship between the effective duration of the investment portfolio and the approximate duration of its liabilities (i.e., policy claims and debt obligations). The effective duration for the fixed maturity portfolio (including cash and cash equivalents) was 3.0 years at March 31, 2018 and December 31, 2017.
In addition, the fair value of the Company’s international investments is subject to currency risk. The Company attempts to manage its currency risk by matching its foreign currency assets and liabilities where considered appropriate.


39


Liquidity and Capital Resources
            Cash Flow. Cash flow used in operating activities was $20 million in the first three months of 2018 as compared to $75 million provided from operating activities in the first three months of 2017, primarily due to the timing of loss and loss expense payments, certain long-term incentive plan payments and payments to taxing authorities.
The Company's insurance subsidiaries' principal sources of cash are premiums, investment income, service fees and proceeds from sales and maturities of portfolio investments. The principal uses of cash are payments for claims, taxes, operating expenses and dividends. The Company expects its insurance subsidiaries to fund the payment of losses with cash received from premiums, investment income and fees. The Company targets an average duration for its investment portfolio that is within one year of the average duration of its liabilities so that portions of its investment portfolio mature throughout the claim cycle and are available for the payment of claims if necessary. In the event operating cash flow and proceeds from maturities and prepayments of fixed income securities are not sufficient to fund claim payments and other cash requirements, the remainder of the Company's cash and investments is available to pay claims and other obligations as they become due. The Company's investment portfolio is highly liquid, with approximately 77% invested in cash, cash equivalents and marketable fixed maturity securities as of March 31, 2018. If the sale of fixed maturity securities were to become necessary, a realized gain or loss equal to the difference between the cost and sales price of securities sold would be recognized.
Debt. At March 31, 2018, the Company had senior notes, subordinated debentures and other debt outstanding with a carrying value of $2,680 million and a face amount of $2,718 million. The maturities of the outstanding debt are $452 million in 2019, $314 million in 2020, $427 million in 2022, $250 million in 2037, $350 million in 2044, $350 million in 2053, $400 million in 2056, and $175 million in 2058.
In March 2018, the Company issued $175 million aggregate principal amount of 5.70% subordinated debentures due 2058. Additionally in 2018, the Company issued subsidiary debt of $13 million.
Equity. At March 31, 2018, total common stockholders’ equity was $5.5 billion, common shares outstanding were 121,543,951 and stockholders’ equity per outstanding share was $44.85. The Company repurchased 101,000 common shares for $6.8 million during the three months ended March 31, 2018. The number of common shares outstanding excludes shares held in a grantor trust established by the Company for delivery upon settlement of vested but mandatorily deferred RSUs.
Total Capital. Total capitalization (equity, debt and subordinated debentures) was $8.1 billion at March 31, 2018. The percentage of the Company’s capital attributable to senior notes, subordinated debentures and other debt was 33% at March 31, 2018 and 32% at December 31, 2017.

Item 3.     Quantitative and Qualitative Disclosure About Market Risk
Reference is made to the information under “Investments - Market Risk” under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Form 10-Q.

Item 4.     Controls and Procedures
              Disclosure Controls and Procedures. The Company’s management, including its Chief Executive Officer and Chief Financial Officer, has conducted an evaluation of the effectiveness of the Company’s disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-14 as of the end of the period covered by this quarterly report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company has in place effective controls and procedures designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Securities Exchange Act of 1934, as amended, and the rules thereunder, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
Changes in Internal Control over Financial Reporting. During the quarter ended March 31, 2018, there were no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.


PART II — OTHER INFORMATION
Item 1. Legal Proceedings
Please see Note 20 to the notes to the interim consolidated financial statements.


Item 1A. Risk Factors

40


There have been no material changes from the risk factors previously disclosed in the Company's annual report on From 10-K for the fiscal year ended December 31, 2017.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds    

Set forth below is a summary of the shares repurchased by the Company during the three months ended March 31, 2018 and the number of shares remaining authorized for purchase by the Company:
 
Total number
of shares purchased
 
Average price
paid per share
 
Total number of shares purchased
as part of publicly announced plans or programs
 
Maximum number of
shares that may yet be purchased under the plans or programs
January 2018
101,000

 
$
67.31

 
101,000

 
9,167,997

February 2018
—

 
—

 
—

 
9,167,997

March 2018
—

 
—

 
—

 
9,167,997


Item 6. Exhibits

Number 
 
 
 
Form of 2018 Performance Unit Award Agreement under the W. R. Berkley Corporation 2014 Long-Term Incentive Plan.
 
 
 
 
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/ 15d-14(a).
 
 
 
 
Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/ 15d-14(a).
 
 
 
 
Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

41


SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
W. R. BERKLEY CORPORATION
 
Date:
May 7, 2018
/s/ W. Robert Berkley, Jr. 
 
 
W. Robert Berkley, Jr.
 
 
President and Chief Executive Officer 
 
 
 
Date:
May 7, 2018
/s/ Richard M. Baio 
 
 
Richard M. Baio
 
 
Senior Vice President - Chief Financial Officer and Treasurer

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