EVEREST REINSURANCE (BERMUDA), LTD. (a wholly owned subsidiary of Everest Re Group, Ltd.) GAAP Financial Statements For the Years Ended December 31,

Transcription

1 EVEREST REINSURANCE (BERMUDA), LTD. (a wholly owned subsidiary of Everest Re Group, Ltd.) GAAP Financial Statements For the 2015 and 2014

2 Independent Auditor's Report To the Shareholder of Everest Reinsurance (Bermuda), Ltd.: We have audited the accompanying financial statements of Everest Reinsurance (Bermuda), Ltd., which comprise the balance sheets as of December 31, 2015 and December 31, 2014, and the related statements of operations and comprehensive income (loss), of changes in shareholder s equity, and of cash flows for the years then ended. Management's Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of the financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor's Responsibility Our responsibility is to express an opinion on the financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the Company's preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Everest Reinsurance (Bermuda), Ltd. as of December 31, 2015 and December 31, 2014, and the results of its operations and its cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. PricewaterhouseCoopers LLP, PricewaterhouseCoopers Center, 300 Madison Avenue, New York, NY T: (646) , F: (646) ,

3 Emphasis of Matter As discussed in Note 13 to the financial statements, the Company has entered into significant transactions with related parties. Our opinion is not modified with respect to this matter. April 26, 2016

4 EVEREST REINSURANCE (BERMUDA), LTD. BALANCE SHEETS December 31, (Dollars in thousands, except par value per share) ASSETS: Fixed maturities - available for sale, at market value $ 6,377,316 $ 6,438,052 (amortized cost: 2015, $6,366,670; 2014, $6,281,747) Equity securities - available for sale, at market value (cost: 2015, $115,299; 2014, $143,627) 101, ,466 Equity securities - available for sale, at fair value - 48,693 Short-term investments 198, ,216 Other invested assets (cost: 2015, $315,614; 2014, $147,447) 315, ,447 Cash 33,538 32,383 Total investments and cash 7,027,018 7,062,257 Accrued investment income 46,966 53,328 Premiums receivable 1,370,227 1,173,640 Reinsurance receivables - unaffiliated 149,380 6,547 Reinsurance receivables - affiliated 433, ,611 Funds held by reinsureds 143, ,582 Deferred acquisition costs 271, ,699 Prepaid reinsurance premiums 36,443 28,988 Other assets 6,141 5,812 TOTAL ASSETS $ 9,485,719 $ 9,165,464 LIABILITIES: Reserve for losses and loss adjustment expenses $ 4,964,200 $ 4,776,224 Future policy benefit reserve 58,910 59,820 Unearned premium reserve 873, ,110 Funds held under reinsurance treaties 21,610 7,915 Losses in course of payment 551, ,240 Income taxes 4,883 11,959 Other net payable to reinsurers 30,389 12,789 Equity index put option liability 40,705 47,022 Deferred gain on retroactive reinsurance 1,172 5,908 Other liabilities 41,743 33,805 Total liabilities 6,588,260 6,147,792 SHAREHOLDER'S EQUITY: Common shares, par value: $1.00; 1.25 million shares authorized, issued and outstanding (2015 and 2014) 1,250 1,250 Additional paid-in capital 1,331,054 1,330,127 Accumulated other comprehensive income (loss), net of deferred income tax expense (benefit) of $9,185 at 2015 and $10,993 at 2014 (125,712) 41,918 Retained earnings 1,690,867 1,644,377 Total shareholder's equity 2,897,459 3,017,672 TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $ 9,485,719 $ 9,165,464 The accompanying notes are an integral part of the financial statements. 3

5 EVEREST REINSURANCE (BERMUDA), LTD. STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) REVENUES: Premiums earned $ 2,818,125 $ 2,681,079 Net investment income 199, ,756 Net realized capital gains (losses): Other-than-temporary impairments on fixed maturity securities (23,366) (590) Other-than-temporary impairments on fixed maturity securities transferred to other comprehensive income (loss) - - Other net realized capital gains (losses) (4,068) 6,747 Total net realized capital gains (losses) (27,434) 6,157 Net derivative gain (loss) 6,317 (11,599) Other income (expense) 23,791 10,428 Total revenues 3,020,688 2,916,821 CLAIMS AND EXPENSES: Incurred losses and loss adjustment expenses 1,554,378 1,416,247 Commission, brokerage, taxes and fees 808, ,011 Other underwriting expenses 27,252 26,922 Total claims and expenses 2,389,711 2,178,180 INCOME (LOSS) BEFORE TAXES 630, ,641 Income tax expense (benefit) 9,487 18,415 NET INCOME (LOSS) $ 621,490 $ 720,226 Other comprehensive income (loss), net of tax: Unrealized appreciation (depreciation) ("URA(D)") on securities arising during the period (170,749) 15,973 Less: reclassification adjustment for realized losses (gains) included in net income (loss) 21,697 (6,030) Total URA(D) on securities arising during the period (149,052) 9,943 Foreign currency translation adjustments (18,578) (21,760) Total other comprehensive income (loss), net of tax (167,630) (11,817) COMPREHENSIVE INCOME (LOSS) $ 453,860 $ 708,409 The accompanying notes are an integral part of the consolidated financial statements. 4

6 EVEREST REINSURANCE (BERMUDA), LTD. STATEMENTS OF CHANGES IN SHAREHOLDER S EQUITY (Dollars in thousands, except share amounts) COMMON SHARES (shares outstanding): Balance, beginning of period 1,250,000 1,250,000 Balance, end of period 1,250,000 1,250,000 COMMON SHARES (par value): Balance, beginning of period $ 1,250 $ 1,250 Balance, end of period 1,250 1,250 ADDITIONAL PAID-IN CAPITAL: Balance, beginning of period 1,330,127 1,329,319 Share-based compensation plans Balance, end of period 1,331,054 1,330,127 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS), NET OF DEFERRED INCOME TAXES: Balance, beginning of period 41,918 53,735 Net increase (decrease) during the period (167,630) (11,817) Balance, end of period (125,712) 41,918 RETAINED EARNINGS: Balance, beginning of period 1,644,377 1,569,151 Net income (loss) 621, ,226 Dividends paid (575,000) (645,000) Balance, end of period 1,690,867 1,644,377 TOTAL SHAREHOLDER'S EQUITY, END OF PERIOD $ 2,897,459 $ 3,017,672 The accompanying notes are an integral part of the financial statements. 5

7 EVEREST REINSURANCE (BERMUDA), LTD. STATEMENTS CASH FLOWS CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 621,490 $ 720,226 Adjustments to reconcile net income to net cash provided by operating activities: Decrease (increase) in premiums receivable (198,306) (4,954) Decrease (increase) in funds held by reinsureds, net 4,797 (6,087) Decrease (increase) in reinsurance receivables (176,652) 28,601 Increase (decrease) in reserve for losses and loss adjustment expenses 236,928 34,521 Increase (decrease) in future policy benefit reserve (910) 308 Increase (decrease) in unearned premiums (54,019) 92,454 Increase (decrease) in losses in course of payment 288, ,116 Increase (decrease) in other net payable to reinsurer 18,316 3,740 Change in equity adjustments in limited partnerships 7,120 (10,059) Distribution of limited partnership income 8,617 9,961 Change in other assets and liabilities, net (21,136) (39,439) Non-cash compensation expense Amortization of bond premium (accrual of bond discount) 25,666 22,633 Net realized capital (gains) losses 27,434 (6,157) Net cash provided by (used in) operating activities 788,768 1,032,673 CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from fixed maturities matured/called - available for sale, at market value 989, ,194 Proceeds from fixed maturities sold - available for sale, at market value 627, ,180 Proceeds from equity securities sold - available for sale, at market value 28,103 16,900 Proceeds from equity securities sold - available for sale, at fair value 45,607 32,000 Distributions from other invested assets 5,728 43,158 Cost of fixed maturities acquired - available for sale, at market value (1,790,370) (1,968,313) Cost of equity securities acquired - available for sale, at market value (7,219) (12,887) Cost of equity securities acquired - available for sale, at fair value (2,908) (4,708) Cost of other invested assets acquired (191,901) (79,873) Net change in short-term investments 59,237 6,216 Net change in unsettled securities transactions 455 (276) Net cash provided by (used in) investing activities (236,125) (433,409) CASH FLOWS FROM FINANCING ACTIVITIES: Dividends paid to shareholder (575,000) (645,000) Net cash provided by (used in) financing activities (575,000) (645,000) EFFECT OF EXCHANGE RATE CHANGES ON CASH 23,512 28,635 Net increase (decrease) in cash 1,155 (17,101) Cash, beginning of period 32,383 49,484 Cash, end of period $ 33,538 $ 32,383 SUPPLEMENTAL CASH FLOW INFORMATION Income taxes paid (recovered) $ 15,127 $ 14,158 The accompanying notes are an integral part of the consolidated financial statements. 6

8 NOTES TO FINANCIAL STATEMENTS 2015 and SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A. Business and Basis of Presentation. Everest Reinsurance (Bermuda) Ltd. (the Company or Bermuda Re ), a Bermuda insurance company and direct wholly owned subsidiary of Everest Re Group, Ltd. ( Group ), is registered as a Class 4 insurer and long-term insurer and underwrites property and casualty reinsurance and insurance and life and annuity business. The Company s U.K. branch writes property and casualty reinsurance for the United Kingdom and European markets. The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America ( GAAP ). All amounts are reported in U.S. dollars. 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 disclosure of contingent assets and liabilities) at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Ultimate actual results could differ, possibly materially, from those estimates. Certain reclassifications and format changes have been made to prior years amounts to conform to the 2015 presentation. B. Investments. Fixed maturity and equity security investments available for sale, at market value, reflect unrealized appreciation and depreciation, as a result of temporary changes in market value during the period, in shareholder s equity, net of income taxes in accumulated other comprehensive income (loss) in the balance sheets. The Company records changes in market value for its fixed maturities available for sale, at market value through shareholders equity, net of taxes in accumulated other comprehensive income (loss) since cash flows from these investments will be primarily used to settle its reserve for losses and loss adjustment expense liabilities. The Company anticipates holding these investments for an extended period as the cash flow from interest and maturities will fund the projected payout of these liabilities. For equity securities, available for sale, at fair value, the Company reflects changes in value as net realized capital gains and losses since these securities may be sold in the near term depending on financial market conditions. Most of the Company s equity securities are mutual fund investments whose underlying investments are comprised of fixed maturity securities. Interest income on all fixed maturities and dividend income on all equity securities are included as part of net investment income in the statements of operations and comprehensive income (loss). Unrealized losses on fixed maturities, which are deemed other-thantemporary and related to the credit quality of a security, are charged to net income (loss) as net realized capital losses. Short-term investments are stated at cost, which approximates market value. Realized gains or losses on sales of investments are determined on the basis of identified cost. For non-publicly traded securities, market prices are determined through the use of pricing models that evaluate securities relative to the U.S. Treasury yield curve, taking into account the issue type, credit quality, and cash flow characteristics of each security. For publicly traded securities, market value is based on quoted market prices or valuation models that use observable market inputs. When a sector of the financial markets is inactive or illiquid, the Company may use its own assumptions about future cash flows and risk-adjusted discount rates to determine fair value. Retrospective adjustments are employed to recalculate the values of asset-backed securities. Each acquisition lot is reviewed to recalculate the effective yield. The recalculated effective yield is used to derive a book value as if the new yield were applied at the time of acquisition. Outstanding principal factors from the time of acquisition to the adjustment date are used to calculate the prepayment history for all applicable securities. Conditional prepayment rates, computed with life to date factor histories and weighted average maturities, are used to effect the calculation of projected and prepayments for pass-through security types. Other invested assets include limited partnerships and rabbi trusts. Limited partnerships are accounted for under the equity method of accounting, which can be recorded on a monthly or quarterly lag. 7

9 C. Uncollectible Receivable Balances. The Company provides reserves for uncollectible reinsurance recoverable and premium receivable balances based on management s assessment of the collectability of the outstanding balances. Such reserves are presented in the table below for the periods indicated. Reinsurance recoverable and premium receivables $ 309 $ 344 D. Deferred Acquisition Costs. Acquisition costs, consisting principally of commissions and brokerage expenses and certain premium taxes and fees incurred at the time a contract or policy is issued and that vary with and are directly related to the Company s reinsurance and insurance business, are deferred and amortized over the period in which the related premiums are earned. Deferred acquisition costs are limited to their estimated realizable value by line of business based on the related unearned premiums, anticipated claims and claim expenses and anticipated investment income. Deferred acquisition costs amortized to income are presented in the table below for the periods indicated. Deferred acquisition costs $ 808,081 $ 735,011 E. Reserve for Losses and Loss Adjustment Expenses. The reserve for losses and loss adjustment expenses ( LAE ) is based on individual case estimates and reports received from ceding companies. A provision is included for losses and LAE incurred but not reported ( IBNR ) based on past experience. A provision is also included for certain potential liabilities relating to asbestos and environmental ( A&E ) exposures, which liabilities cannot be estimated using traditional reserving techniques. See also Note 3. The reserves are reviewed periodically and any changes in estimates are reflected in earnings in the period the adjustment is made. The Company s loss and LAE reserves represent management s best estimate of the ultimate liability. Loss and LAE reserves are presented gross of reinsurance receivables and incurred losses and LAE are presented net of reinsurance. Accruals for commissions are established for reinsurance contracts that provide for the stated commission percentage to increase or decrease based on the loss experience of the contract. Changes in estimates for such arrangements are recorded as commission expense. Commission accruals for contracts with adjustable features are estimated based on expected loss and LAE. F. Future Policy Benefit Reserve. Liabilities for future policy benefits on annuity policies are carried at their accumulated values. Reserves for policy benefits include mortality claims in the process of settlement and IBNR claims. Actual experience in a particular period may fluctuate from expected results. G. Premium Revenues. Written premiums are earned ratably over the periods of the related insurance and reinsurance contracts. Unearned premium reserves are established relative to the unexpired contract period. Such reserves are established based upon reports received from ceding companies or estimated using pro rata methods based on statistical data. Reinstatement premiums represent additional premium received on reinsurance coverages, most prevalently catastrophe related, when limits have been depleted under the original reinsurance contract and additional coverage is granted. Written and earned premiums and the related costs, which have not yet been reported to the Company, are estimated and accrued. Premiums are net of ceded reinsurance. Payout annuity premiums are recognized as revenue over the premium-paying period of the policies. 8

10 H. Prepaid Reinsurance Premiums. Prepaid reinsurance premiums represent unearned premium reserves ceded to other reinsurers. I. Income Taxes. The U.K. branch of Bermuda Re files a U.K. income tax return. Income taxes have been recorded to recognize the tax effect of temporary differences between the financial reporting and income tax bases of assets and liabilities, which arise because of differences between GAAP and U.K. income tax accounting rules. J. Foreign Currency. Assets and liabilities relating to foreign operations are translated into U.S. dollars at the exchange rates in effect at the balance sheet date; revenues and expenses are translated into U.S. dollars using average exchange rates in effect during the reporting period. Gains and losses resulting from translating foreign currency financial statements, net of deferred income taxes, are excluded from net income (loss) and accumulated in shareholder s equity. Gains and losses resulting from foreign currency transactions, other than debt securities available for sale, are recorded through the statements of operations and comprehensive income (loss) in other income (expense). Gains and losses resulting from changes in the foreign currency exchange rates on debt securities, available for sale at market value, are recorded in the balance sheets in accumulated other comprehensive income (loss) as unrealized appreciation (depreciation) and any losses which are deemed other-than-temporary are charged to net income (loss) as net realized capital loss. K. Derivatives. The Company sold seven equity index put option contracts, based on two indices, in 2001 and 2005, which remain outstanding. The Company sold these equity index put options as insurance products with the intent of achieving a profit. These equity index put option contracts meet the definition of a derivative under FASB guidance and the Company s position in these equity index put option contracts is unhedged. Accordingly, these equity index put option contracts are carried at fair value in the balance sheets with changes in fair value recorded in the statements of operations and comprehensive income (loss). The fair value of the equity index put options can be found in the Company s balance sheets as follows: (Dollars in thousands) Derivatives not designated as Location of fair value At December 31, hedging instruments in balance sheet Equity index put option contracts Equity index put option liability $ 40,705 $ 47,022 Total $ 40,705 $ 47,022 The change in fair value of the equity index put option contracts can be found in the Company s statement of operations and comprehensive income (loss) as follows: (Dollars in thousands) Derivatives not designated as Location of gain (loss) in statements of For the hedging instruments operations and comprehensive income (loss) Equity index put option contracts Net derivative gain (loss) $ 6,317 $ (11,599) Total $ 6,317 $ (11,599) 9

11 L. Deposit Assets and Liabilities. In the normal course of its operations, the Company may enter into contracts that do not meet risk transfer provisions. Such contracts are accounted for using the deposit accounting method and are included in other liabilities in the Company s balance sheets. For such contracts, the Company originally records deposit liabilities for an amount equivalent to the assets received. Actuarial studies are used to estimate the final liabilities under such contracts with any change reflected in the statements of operations and comprehensive income (loss). M. Retroactive Reinsurance. The gains on assumed retroactive contracts are deferred and amortized into income based on cash payouts. Losses on assumed retroactive contracts are recognized immediately into income. N. Application of Recently Issued Accounting Standard Changes. Disclosures about Short-Duration Contracts. In May 2015, the FASB issued ASU , authoritative guidance regarding required disclosures associated with short duration insurance contracts. The new disclosure requirements focus on information about initial claim estimates and subsequent claim estimate adjustment, methodologies in estimating claims and the timing, frequency and severity of claims related to short duration insurance contracts. This guidance is effective for annual reporting periods beginning after December 15, 2015 and interim reporting periods beginning after December 15, The Company has chosen not to early adopt and will implement this guidance as of January 1, The Company is still evaluating the impact of the implementation of this guidance but does not anticipate that it will have a significant impact on its financial statements. Debt Issuance Costs. In April 2015, The FASB issued ASU , authoritative guidance on the presentation of debt issuance costs. This guidance requires that debt issuance costs be presented within the balance sheet as a reduction of the carrying value of the debt liability, rather than as a separate asset. This guidance is effective for annual reporting periods beginning after December 15, 2015 and interim reporting periods beginning after December 15, The Company has chosen not to early adopt and will implement this guidance as of January 1, The Company is still evaluating the impact of the implementation of this guidance but does not anticipate that it will have a significant impact on its financial statements. 2. INVESTMENTS The amortized cost, market value and gross unrealized appreciation and depreciation of available for sale, fixed maturity, equity security investments, carried at market value and other-than-temporary impairments ( OTTI ) in accumulated other comprehensive income ( AOCI ) are as follows for the periods indicated: At December 31, 2015 Amortized Unrealized Unrealized Market OTTI in AOCI (Dollars in thousands) Cost Appreciation Depreciation Value (a) Fixed maturity securities U.S. Treasury securities and obligations of U.S. government agencies and corporations $ 75,272 $ 7,079 $ (245) $ 82,106 $ - U.S. Corporate securities 2,487,438 57,265 (32,948) 2,511,755 1,431 Asset-backed securities 261, (2,352) 259,652 - Mortgage-backed securities Commercial 184,528 3,815 (2,647) 185,696 - Agency residential 1,447,259 16,379 (9,989) 1,453,649 - Non-agency residential (1) Foreign government securities 628,804 17,637 (34,697) 611, Foreign corporate securities 1,281,135 36,249 (45,101) 1,272, Total fixed maturity securities $ 6,366,670 $ 138,626 $ (127,980) $ 6,377,316 $ 1,503 Equity securities $ 115,299 $ 3,371 $ (16,732) $ 101,938 $ - 10

12 At December 31, 2014 Amortized Unrealized Unrealized Market OTTI in AOCI (Dollars in thousands) Cost Appreciation Depreciation Value (a) Fixed maturity securities U.S. Treasury securities and obligations of U.S. government agencies and corporations $ 66,627 $ 6,104 $ - $ 72,731 $ - U.S. Corporate securities 2,312,174 93,293 (8,588) 2,396,879 2,689 Asset-backed securities 213, (797) 213,826 - Mortgage-backed securities Commercial 168,997 8,988 (378) 177,607 - Agency residential 1,352,379 24,760 (5,078) 1,372,061 - Non-agency residential 1, ,914 - Foreign government securities 749,294 28,313 (14,504) 763,103 - Foreign corporate securities 1,416,410 45,887 (22,366) 1,439,931 - Total fixed maturity securities $ 6,281,747 $ 208,016 $ (51,711) $ 6,438,052 $ 2,689 Equity securities $ 143,627 $ 3,786 $ (11,947) $ 135,466 $ - (a) Represents the amount of OTTI recognized in AOCI. Amount includes unrealized gains and losses on impaired securities relating to changes in the value of such securities subsequent to the impairment measurement date. The amortized cost and market value of fixed maturity securities are shown in the following table by contractual maturity. Mortgage-backed securities are generally more likely to be prepaid than other fixed maturity securities. As the stated maturity of such securities may not be indicative of actual maturities, the totals for mortgage-backed and asset-backed securities are shown separately. At December 31, 2015 At December 31, 2014 Amortized Market Amortized Market (Dollars in thousands) Cost Value Cost Value Fixed maturity securities available for sale: Due in one year or less $ 516,261 $ 518,650 $ 594,303 $ 599,608 Due after one year through five years 2,809,656 2,814,267 2,638,210 2,709,661 Due after five years through ten years 977, ,558 1,040,218 1,062,742 Due after ten years 169, , , ,633 Asset-backed securities 261, , , ,826 Mortgage-backed securities: Commercial 184, , , ,607 Agency residential 1,447,259 1,453,649 1,352,379 1,372,061 Non-agency residential ,909 1,914 Total fixed maturity securities $ 6,366,670 $ 6,377,316 $ 6,281,747 $ 6,438,052 11

13 The changes in net unrealized appreciation (depreciation) for the Company s investments are derived from the following sources for the periods indicated: Increase during the period between the market value and cost of investments carried at market value, and income taxes thereon: Fixed maturity securities $ (144,474) $ 16,354 Fixed maturity securities, other-than-temporary impairment (1,186) (301) Equity securities (5,200) (3,901) Change in unrealized appreciation (depreciation), pre-tax (150,860) 12,152 Income tax benefit (expense) 1,808 (2,209) Change in unrealized appreciation (depreciation), net of income taxes, included in shareholder's equity $ (149,052) $ 9,943 The Company frequently reviews all of its fixed maturity, available for sale securities for declines in market value and focuses its attention on securities whose fair value has fallen below 80% of their amortized cost at the time of review. The Company then assesses whether the decline in value is temporary or other-thantemporary. In making its assessment, the Company evaluates the current market and interest rate environment as well as specific issuer information. Generally, a change in a security s value caused by a change in the market, interest rate or foreign exchange environment does not constitute an other-thantemporary impairment, but rather a temporary decline in market value. Temporary declines in market value are recorded as unrealized losses in accumulated other comprehensive income (loss). If the Company determines that the decline is other-than-temporary and the Company does not have the intent to sell the security; and it is more likely than not that the Company will not have to sell the security before recovery of its cost basis, the carrying value of the investment is written down to fair value. The fair value adjustment that is credit or foreign exchange related is recorded in net realized capital gains (losses) in the Company s statements of operations and comprehensive income (loss). The fair value adjustment that is non-credit related is recorded as a component of other comprehensive income (loss), net of tax, and is included in accumulated other comprehensive income (loss) in the Company s balance sheets. The Company s assessments are based on the issuers current and expected future financial position, timeliness with respect to interest and/or principal payments, speed of repayments and any applicable credit enhancements or breakeven constant default rates on mortgage-backed and asset-backed securities, as well as relevant information provided by rating agencies, investment advisors and analysts. The majority of the Company s equity securities available for sale at market value are primarily comprised of mutual fund investments whose underlying securities consist of fixed maturity securities. When a fund s value reflects an unrealized loss, the Company assesses whether the decline in value is temporary or otherthan-temporary. In making its assessment, the Company considers the composition of its portfolios and their related markets, reports received from the portfolio managers and discussions with portfolio managers. If the Company determines that the declines are temporary and it has the ability and intent to continue to hold the investments, then the declines are recorded as unrealized losses in accumulated other comprehensive income (loss). If declines are deemed to be other-than-temporary, then the carrying value of the investment is written down to fair value and recorded in net realized capital gains (losses) in the Company s statements of operations and comprehensive income (loss). Retrospective adjustments are employed to recalculate the values of asset-backed securities. All of the Company s asset-backed and mortgage-backed securities have a pass-through structure. Each acquisition lot is reviewed to recalculate the effective yield. The recalculated effective yield is used to derive a book value as if the new yield were applied at the time of acquisition. Outstanding principal factors from the time of acquisition to the adjustment date are used to calculate the prepayment history for all applicable securities. Conditional prepayment rates, computed with life to date factor histories and weighted average maturities, are used in the calculation of projected prepayments for pass-through security types. 12

14 The tables below display the aggregate market value and gross unrealized depreciation of fixed maturity and equity securities, by security type and contractual maturity, in each case subdivided according to length of time that individual securities had been in a continuous unrealized loss position for the period indicated: Duration of Unrealized Loss at December 31, 2015 By Security Type Less than 12 months Greater than 12 months Total Gross Gross Gross Unrealized Unrealized Unrealized (Dollars in thousands) Market Value Depreciation Market Value Depreciation Market Value Depreciation Fixed maturity securities - available for sale U.S. Treasury securities and obligations of U.S. government agencies and corporations $ 24,127 $ (245) $ - $ - $ 24,127 $ (245) U.S. Corporate securities 801,616 (20,792) 122,224 (12,156) 923,840 (32,948) Asset-backed securities 189,093 (1,348) 34,781 (1,004) 223,874 (2,352) Mortgage-backed securities Commercial 102,636 (2,647) ,636 (2,647) Agency residential 614,605 (5,995) 165,058 (3,994) 779,663 (9,989) Non-agency residential 121 (1) (1) Foreign government securities 145,230 (19,570) 87,719 (15,127) 232,949 (34,697) Foreign corporate securities 383,758 (16,229) 168,390 (28,872) 552,148 (45,101) Total fixed maturity securities $ 2,261,186 $ (66,827) $ 578,172 $ (61,153) $ 2,839,358 $ (127,980) Equity Securities ,907 (16,732) 91,907 (16,732) Total $ 2,261,186 $ (66,827) $ 670,079 $ (77,885) $ 2,931,265 $ (144,712) Duration of Unrealized Loss at December 31, 2015 By Maturity Less than 12 months Greater than 12 months Total Gross Gross Gross Unrealized Unrealized Unrealized (Dollars in thousands) Market Value Depreciation Market Value Depreciation Market Value Depreciation Fixed maturity securities Due in one year or less $ 5,695 $ (93) $ 27,490 $ (5,396) $ 33,185 $ (5,489) Due in one year through five years 949,191 (35,003) 239,535 (29,562) 1,188,726 (64,565) Due in five years through ten years 363,804 (17,586) 94,516 (16,675) 458,320 (34,261) Due after ten years 36,041 (4,154) 16,792 (4,522) 52,833 (8,676) Asset-backed securities 189,093 (1,348) 34,781 (1,004) 223,874 (2,352) Mortgage-backed securities 717,362 (8,643) 165,058 (3,994) 882,420 (12,637) Total fixed maturity securities $ 2,261,186 $ (66,827) $ 578,172 $ (61,153) $ 2,839,358 $ (127,980) The aggregate market value and gross unrealized losses related to investments in an unrealized loss position at December 31, 2015 were $2,931,265 thousand and $144,712 thousand, respectively. The market value of securities for the single issuer whose securities comprised the largest unrealized loss position at December 31, 2015, did not exceed 1.1% of the overall market value of the Company s fixed maturity securities. In addition, as indicated on the above table, there was no significant concentration of unrealized losses in any one market sector. The $66,827 thousand of unrealized losses related to fixed maturity securities that have been in an unrealized loss position for less than one year were generally comprised of U.S. corporate securities, foreign government and corporate securities, as well as agency residential and commercial mortgage-backed securities. A significant portion of these unrealized losses are attributable to net unrealized foreign exchange losses, $26,657 thousand, as the U.S. dollar has strengthened against other currencies and unrealized losses in the energy sector, $8,500 thousand, as falling oil prices have disrupted the market values for this sector, particularly for oil exploration, production and servicing companies. The $61,153 thousand of unrealized losses related to fixed maturity securities in an unrealized loss position for more than one year related primarily to foreign corporate and governments securities, U.S. corporate securities and agency residential mortgage-backed securities. The majority of these unrealized losses are attributable to net unrealized foreign exchange losses, $37,498 thousand, as the U.S. dollar has strengthened against other currencies and to unrealized losses in the energy sector, 13

15 $10,811 thousand, as falling oil prices have disrupted the market values for this sector, particularly for oil exploration as well as production and servicing companies. There was no gross unrealized depreciation for mortgage-backed securities related to sub-prime and alt-a loans. In all instances, there were no projected cash flow shortfalls to recover the full book value of the investments and the related interest obligations. The mortgage-backed securities still have excess credit coverage and are current on interest and principal payments. The Company, given the size of its investment portfolio and capital position, does not have the intent to sell these securities; and it is more likely than not that the Company will not have to sell the security before recovery of its cost basis. In addition, all securities currently in an unrealized loss position are current with respect to principal and interest payments. The tables below display the aggregate market value and gross unrealized depreciation of fixed maturity and equity securities, by security type and contractual maturity, in each case subdivided according to length of time that individual securities had been in a continuous unrealized loss position for the period indicated: Duration of Unrealized Loss at December 31, 2014 By Security Type Less than 12 months Greater than 12 months Total Gross Gross Gross Unrealized Unrealized Unrealized (Dollars in thousands) Market Value Depreciation Market Value Depreciation Market Value Depreciation Fixed maturity securities - available for sale U.S. Treasury securities and obligations of U.S. government agencies and corporations $ - $ - $ - $ - $ - $ - U.S. Corporate securities 379,692 (6,000) 158,752 (2,588) 538,444 (8,588) Asset-backed securities 110,351 (797) ,351 (797) Mortgage-backed securities Commercial 16,449 (72) 9,777 (306) 26,226 (378) Agency residential 105,565 (85) 319,838 (4,993) 425,403 (5,078) Non-agency residential Foreign government securities 155,058 (12,387) 47,666 (2,117) 202,724 (14,504) Foreign corporate securities 264,659 (12,062) 149,053 (10,304) 413,712 (22,366) Total fixed maturity securities $ 1,031,774 $ (31,403) $ 685,223 $ (20,308) $ 1,716,997 $ (51,711) Equity Securities 50,285 (4,068) 73,994 (7,879) 124,279 (11,947) Total $ 1,082,059 $ (35,471) $ 759,217 $ (28,187) $ 1,841,276 $ (63,658) 14

16 Duration of Unrealized Loss at December 31, 2014 By Maturity Less than 12 months Greater than 12 months Total Gross Gross Gross Unrealized Unrealized Unrealized (Dollars in thousands) Market Value Depreciation Market Value Depreciation Market Value Depreciation Fixed maturity securities Due in one year or less $ 67,302 $ (3,218) $ 3,092 $ (148) $ 70,394 $ (3,366) Due in one year through five years 516,020 (13,085) 207,364 (3,139) 723,384 (16,224) Due in five years through ten years 180,266 (8,974) 118,950 (8,603) 299,216 (17,577) Due after ten years 35,821 (5,172) 26,065 (3,119) 61,886 (8,291) Asset-backed securities 110,351 (797) ,351 (797) Mortgage-backed securities 122,014 (157) 329,752 (5,299) 451,766 (5,456) Total fixed maturity securities $ 1,031,774 $ (31,403) $ 685,223 $ (20,308) $ 1,716,997 $ (51,711) The aggregate market value and gross unrealized losses related to fixed maturity securities in an unrealized loss position at December 31, 2014 were $1,716,997 thousand and $51,711 thousand, respectively. The market value of securities for the single issuer whose securities comprised the largest unrealized loss position at December 31, 2014, did not exceed 0.2% of the overall market value of the Company s fixed maturity securities. In addition, as indicated on the above table, there was no significant concentration of unrealized losses in any one market sector. The $31,403 thousand of unrealized losses related to fixed maturity securities that have been in an unrealized loss position for less than one year were generally comprised of foreign government and corporate securities and U.S. corporate securities. The majority of these unrealized losses are attributable to unrealized foreign exchange losses, $17,083 thousand, as the U.S. dollar has strengthened against other currencies and unrealized losses in the energy sector, $5,214 thousand, as falling oil prices disrupted the market values for this sector, particularly for oil exploration, production and servicing companies during the fourth quarter of The $20,308 thousand of unrealized losses related to fixed maturity securities in an unrealized loss position for more than one year related primarily to foreign corporate securities, agency residential mortgage-backed securities, U.S. corporate securities and foreign government securities. Of these unrealized losses, $17,224 thousand related to securities that were rated investment grade by at least one nationally recognized statistical rating organization. The gross unrealized depreciation for mortgage-backed securities included less than $1 thousand related to sub-prime and alt-a loans. In all instances, there were no projected cash flow shortfalls to recover the full book value of the investments and the related interest obligations. The mortgage-backed securities still have excess credit coverage and are current on interest and principal payments. The components of net investment income are presented in the table below for the periods indicated: Fixed maturities $ 204,626 $ 216,587 Equity securities 8,758 11,039 Short-term investments and cash Other invested assets Limited partnerships (7,122) 10,059 Gross investment income before adjustments 206, ,951 Funds held interest income (expense) 5,073 3,940 Future policy benefit reserve income (expense) (1,907) (1,687) Gross investment income 209, ,204 Investment expenses (9,688) (9,448) Net investment income $ 199,889 $ 230,756 15

17 The Company records results from limited partnership investments on the equity method of accounting with changes in value reported through net investment income. Due to the timing of receiving financial information from these partnerships, the results are generally reported on a one month or quarter lag. If the Company determines there has been a significant decline in value of a limited partnership during this lag period, a loss will be recorded in the period in which the Company identifies the decline. The Company had contractual commitments to invest up to an additional $168,345 thousand in limited partnerships at December 31, These commitments will be funded when called in accordance with the partnership agreements, which have investment periods that expire, unless extended, through 2020 for new investments. Following the investment period, these capital commitments may be called by the partnerships for follow on investments, management fees and operating expenses. The components of net realized capital gains (losses) are presented in the table below for the periods indicated: Fixed maturity securities, market value: Other-than-temporary impairments $ (23,366) $ (590) Gains (losses) from sales 8,613 7,187 Equity securities, market value: Gains (losses) from sales (6,696) 426 Equity securities, fair value: Gains (losses) from sales (554) 844 Gains (losses from fair value adjustments (5,440) (1,709) Short-term investments gains (losses) 9 (1) Total net realized capital gains (losses) $ (27,434) $ 6,157 The Company recorded as net realized capital gains (losses) in the statements of operations and comprehensive income (loss) write-downs in the value of securities deemed to be impaired on an other-thantemporary basis as displayed in the table above. The Company had no other-than-temporary impaired securities where the impairment had both a credit and non-credit component. The proceeds and split between gross gains and losses, from sales of fixed maturity and equity securities, are presented in the table below for the periods indicated: Proceeds from sales of fixed maturity securities $ 627,754 $ 679,180 Gross gains from sales 19,898 18,231 Gross losses from sales (11,285) (11,044) Proceeds from sales of equity securities $ 73,710 $ 48,900 Gross gains from sales 18 2,508 Gross losses from sales (7,268) (1,238) 16

18 3. RESERVE FOR LOSSES, LAE AND FUTURE POLICY BENEFIT RESERVE Reserves for losses and LAE. Activity in the reserve for losses and LAE is summarized for the periods indicated: At December 31, Gross reserves at January 1 $ 4,776,224 $ 4,806,376 Less reinsurance recoverables (424,361) (475,583) Net reserves at January 1 4,351,863 4,330,793 Incurred related to: Current year 1,598,028 1,469,336 Prior years (43,650) (53,089) Total incurred losses and LAE 1,554,378 1,416,247 Paid related to: Current year 313, ,423 Prior years 1,142,894 1,044,731 Total paid losses and LAE 1,456,519 1,333,154 Foreign exchange/translation adjustment (67,895) (62,023) Net reserves at December 31 4,381,827 4,351,863 Plus reinsurance recoverables 582, ,361 Gross reserves at December 31 $ 4,964,200 $ 4,776,224 (Some amounts may not reconcile due to rounding.) Prior years reserves decreased by $43,650 thousand and $53,089 thousand for the years ended December 31, 2015 and 2014, respectively. The 2015 decrease was attributable to favorable development on worldwide casualty and property business assumed from affiliates. The 2014 decrease was also attributable to favorable development on worldwide casualty and property business assumed from affiliates. The Company continues to receive claims under a loss portfolio transfer agreement with Mt. McKinley Insurance Company ( Mt. McKinley ) asserting injuries and/or damages relating to or resulting from environmental pollution and hazardous substances, including asbestos. Environmental claims typically assert liability for (a) the mitigation or remediation of environmental contamination or (b) bodily injury or property damage caused by the release of hazardous substances into the land, air or water. Asbestos claims typically assert liability for bodily injury from exposure to asbestos or for property damage resulting from asbestos or products containing asbestos. The Company s reserves include an estimate of the Company s ultimate liability for A&E claims. The Company s A&E liabilities emanate from Mt. McKinley s direct insurance business and Everest Re s assumed reinsurance business. All of the contracts of reinsurance under which the Company has received claims during the past two years, expired more than 20 years ago. There are significant uncertainties surrounding the Company s reserves for its A&E losses. 17

19 A&E exposures represent a separate exposure group for monitoring and evaluating reserve adequacy. The following table summarizes incurred losses with respect to A&E reserves on both a gross and net of reinsurance basis for the periods indicated: At December 31, Gross basis: Beginning of period reserves $ 153,925 $ 117,307 Incurred losses 7,562 50,407 Paid losses (118,407) (13,789) End of period reserves $ 43,080 $ 153,925 Net basis: Beginning of period reserves $ 153,925 $ 117,307 Incurred losses 7,562 50,407 Paid losses (118,407) (13,789) End of period reserves $ 43,080 $ 153,925 On July 13, 2015, Everest Reinsurance Holdings, Inc., an affiliate of the Company, sold Mt. McKinley to Clearwater Insurance Company, a Delaware domiciled insurance company. Concurrently with the closing, the Company entered into a retrocession treaty with an affiliate of Clearwater Insurance Company. Per the retrocession treaty, the Company retroceded 100% of the liabilities associated with certain Mt. McKinley policies. As consideration for entering into the retrocession treaty, the Company transferred cash of $140,279 thousand, an amount equal to the net loss reserves as of the closing date. The maximum liability retroceded under the retrocession treaty will be $440,279 thousand, equal to the retrocession payment plus $300,000 thousand. The Company will retain liability for any amounts exceeding the maximum liability retroceded under the retrocession treaty. Reinsurance Receivables. Reinsurance receivables for both paid and unpaid losses were $583,120 thousand and $425,158 thousand at December 31, 2015 and 2014, respectively. At December 31, 2015, $402,509 thousand, or 69.0%, was receivable from Everest International Reinsurance, Ltd. ( Everest International ); $140,279 thousand, or 24.1% was receivable from Resolution Group Reinsurance (Barbados) Limited ( Resolution Group ) and $30,199 thousand, or 5.2%, was receivable from Everest Reinsurance Company ( Everest Re ). No other retrocessionaire accounted for more than 5% of reinsurance receivables. Future Policy Benefit Reserve. Activity in the reserve for future policy benefit is summarized for the periods indicated: At December 31, Balance at beginning of year $ 59,820 $ 59,512 Liabilities assumed Adjustments to reserves 2,310 4,725 Benefits paid in the current year (3,535) (4,667) Balance at end of year $ 58,910 $ 59,820 18

20 4. FAIR VALUE GAAP guidance regarding fair value measurements address how companies should measure fair value when they are required to use fair value measures for recognition or disclosure purposes under GAAP and provides a common definition of fair value to be used throughout GAAP. It defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly fashion between market participants at the measurement date. In addition, it establishes a three-level valuation hierarchy for the disclosure of fair value measurements. The valuation hierarchy is based on the transparency of inputs to the valuation of an asset or liability. The level in the hierarchy within which a given fair value measurement falls is determined based on the lowest level input that is significant to the measurement, with Level 1 being the highest priority and Level 3 being the lowest priority. The levels in the hierarchy are defined as follows: Level 1: Inputs to the valuation methodology are observable inputs that reflect unadjusted quoted prices for identical assets or liabilities in an active market; Level 2: Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument; Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement. The Company s fixed maturity and equity securities are primarily managed by third party investment asset managers. The investment asset managers obtain prices from nationally recognized pricing services. These services seek to utilize market data and observations in their evaluation process. They use pricing applications that vary by asset class and incorporate available market information and when fixed maturity securities do not trade on a daily basis the services will apply available information through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. In addition, they use model processes, such as the Option Adjusted Spread model to develop prepayment and interest rate scenarios for securities that have prepayment features. In limited instances where prices are not provided by pricing services or in rare instances when a manager may not agree with the pricing service, price quotes on a non-binding basis are obtained from investment brokers. The investment asset managers do not make any changes to prices received from either the pricing services or the investment brokers. In addition, the investment asset managers have procedures in place to review the reasonableness of the prices from the service providers and may request verification of the prices. In addition, the Company continually performs analytical reviews of price changes and tests the prices on a random basis to an independent pricing source. No material variances were noted during these price validation procedures. In limited situations, where financial markets are inactive or illiquid, the Company may use its own assumptions about future cash flows and risk-adjusted discount rates to determine fair value. The Company made no such adjustments at December 31, 2015 and Equity securities denominated in U.S. currency with quoted prices in active markets for identical assets are categorized as level 1 since the quoted prices are directly observable. Equity securities traded on foreign exchanges are categorized as level 2 due to the added input of a foreign exchange conversion rate to determine fair or market value. The Company uses foreign currency exchange rates published by nationally recognized sources. All categories of fixed maturity securities listed in the tables below are generally categorized as level 2, since a particular security may not have traded but the pricing services are able to use valuation models with observable market inputs such as interest rate yield curves and prices for similar fixed maturity securities in terms of issuer, maturity and seniority. For foreign government securities and foreign corporate securities, the fair values provided by the third party pricing services in local currencies, and where applicable, are converted to U.S. dollars using currency exchange rates from nationally recognized sources. 19