Response to Barron s Article

Transcription

1 Response to Barron s Article In its June 2, 2014 edition, Barron s published an article by Bill Alpert which is replete with significant factual inaccuracies, which are set forth in Part A below, notwithstanding the Company s cooperation with Mr. Alpert through our written responses to the ten written questions that Mr. Alpert inquired of us. Following receipt of the written responses, Mr. Alpert did not request any clarification and did not have any follow-up inquiries. In the article, Mr. Alpert chose to disregard the Company s responses. Therefore, Mr. Alpert s questions and AmTrust s responses, which address many of the inaccuracies in the Barron s article are set forth in Part B below. A. Significant Inaccuracies 1. Collateral Posted by Maiden. Mr. Alpert incorrectly states that the collateral reported by Maiden appears insufficient by AmTrust s accounting. It is not. Mr. Alpert did not ask the Company any questions regarding the Maiden collateral. However, his faulty analysis fails to consider that Maiden, pursuant to the Reinsurance Agreement, is required to collateralize only AmTrust s U.S. business and does not capture all the components of Maiden s collateral, including a $168 million collateral loan. Consistent with the Reinsurance Agreement, total collateral for the Maiden contract is approximately $1.658 billion. 2. Acquired Reserves. Mr. Alpert incorrectly states that [t]here s also the nearly $50 million difference between the $808 million that AmTrust reports for the total net reserves it picked up in last year s acquisitions and the $761 million sum of gross reserves for each acquisition. He goes on to state that the Company attributes the difference to the activities of an AmTrust reinsurance captive in Luxembourg. Mr. Alpert asked the Company to address this issue. See Part B - Question 9 and the Company s response below. We further note that the Company s response attributed part, but not all, of the difference to our Luxembourg rent-a-captive facility, AmTrust Captive Solutions. AmTrust Captive Solutions manages segregated cells for clients who wish to reinsure their own risks. The reserves assumed by the AmTrust Captive Solutions clients appear on AmTrust s balance sheet and, as the Company advised Mr. Alpert, are offset by cash provided by the client. 3. Accident Year Loss Development for 2007 through Mr. Alpert asserts that AmTrust s 10-K indicates that its reserves remaining after claim payments for all years up through 2007 are $95 million more than the amount for those years plus 2008 which if correct, would indicate that policyholders will pay AmTrust that $95 million on the 2008 incidents. It s not correct. See Part B - Question 2 and the Company s response.

2 4. AmTrust s Paid to Incurred Ratio. Mr. Alpert improperly asserts that [c]ompared with peers in workers compensation insurance, where AmTrust gets half its revenue, the company ended up paying out a higher percentage of its original estimate for losses on accidents in years 2006 through 2012, according to an analysis of the industry s paid to incurred ratios in FBR s April report. Mr. Alpert did not ask the Company to address this point. AmTrust has a higher paid to incurred ratio because we have a faster claim closure rate. Because AmTrust covers small employers in low hazard classes, approximately 76% of our claims are medical only. As disclosed in our 10-K, for Accident Year 2009, only 0.9% of claims remain open; for Accident Year 2010, only 2.8% of claims remain open; for Accident Year 2011, only 5.1% of claims remain open, for Accident Year 2012, only 9.4% of claims remain open and for Accident Year 2013, 32.4% of claims remain open. The percentage of claims which remain open for Accident Years 2009 through 2013 is significantly lower than the industry average. Because of our better than average claim closure rate, there is less risk of adverse development. 5. Consolidated Statutory Capital. Mr. Alpert incorrectly asserts that AmTrust doesn t report its consolidated statutory capital and states we ve attempted to adjust its balance sheet to approximate the rigors of statutory capital by including debt and excludable items such as goodwill, intangibles, prepaid assets, deferred costs and netting for tax effects. With that approach, AmTrust s net written premiums for the 12 months through March exceeded its spendable capital by almost four times. This assertion is wrong. In response to Mr. Alpert s questions we noted that Footnote 22 to our consolidated financial statements sets forth our required statutory capital and actual statutory capital for each insurer in our group. See Part B - Question 3 and the Company s response below. 6. Luxembourg Reinsurance Companies. a. Mr. Alpert incorrectly alleges that AmTrust and its sister company National General have enhanced their operation by making more than $200 million in underwriting losses go unreported to investors. It did that by sending losses to whollyowned Luxembourg reinsurance companies. This is absolutely false. No losses ever have gone unreported to investors. As we have previously reported, the results of our wholly-owned Luxembourg reinsurance companies are fully-consolidated in AmTrust s consolidated financial statements. b. Mr. Alpert then further incorrectly alleges that AmTrust restated its past financials to remove the operating profit boost. This also is completely false. AmTrust did not issue a restatement. There were changes made to AmTrust s financial statement presentation, which had no impact on our net income. Thus, there was no removal of an operating profit boost.

3 7. Cessions to Maiden. Mr. Alpert incorrectly asserts that there is a $400 million variance between AmTrust s and Maiden s accounting for the business AmTrust cedes to Maiden. Mr. Alpert asked for the Company to respond to this assertion. See Part B - Question 10 and the Company s response below. In addition, differences between prepaid premium reported by AmTrust and unearned premium reported by Maiden primarily relates to business written by AmTrust late in the year which was not ceded to Maiden as of year- end. There also are other timing differences and difference arising out of foreign exchange rates. AmTrust s reinsurance recoverable balance include $108 million of losses paid by AmTrust, but not yet reimbursed by Maiden, which Maiden books as paid losses. The balance of the difference relates to valuation differences between AmTrust s ceded ultimate loss estimates and Maiden s assumed ultimate loss estimates. We can confirm that Maiden s net estimates of the ultimate loss ratio for the business we cede to Maiden do not vary significantly from our net ultimate loss ratios. More importantly, AmTrust s and Maiden s loss reserves are and always have been within each company s outside actuaries acceptable ranges. Finally, we note that, across the industry, variances in ceded and assumed losses exist between many insurers and reinsurers. B. Mr. Alpert s Questions and the Company s Responses: Question 1: In light of AmTrust s premium growth, is the company adequately reserved? Company s Response to Question 1: Yes. AmTrust is more than adequately reserved and always maintained within the actuarial range determined by our internal and external actuaries. Our proprietary technology platform enables us to conduct a detailed monthly review of our loss reserves which ensures that our reserves are evaluated for adequacy more often than is typical in the insurance industry. Our reserves also are reviewed for sufficiency regularly by our auditors and outside actuaries. The majority of our premium growth over the past two years has been from workers compensation insurance sold to small, low-hazard businesses. Due to the low-hazard nature of our workers compensation business, approximately 76% of our workers compensation claims is medical-only which is above the industry average. Medical only claims are lower severity and shorter duration than indemnity claims, thus they are more predictable. In addition, writing the same type of business for 15 years provides us with an excellent understanding of the claims trends that occur in our book

4 of workers compensation business. Further, our team of seasoned underwriters and claims staff, many of whom had significant experience in the industry prior to joining us, have successfully managed the workers compensation business even during periods when the competitive environment was more challenging that it is today. The claims experience of our workers compensation insurance business has improved even as our book of business has expanded at an accelerated pace. First, we are writing workers compensation in an improving rate environment. Second, even with the growth, we have observed consistent closure rates on claims. Third, our average hazard level, or riskiness of business underwritten, continues to decline. Fourth, the frequency of claims is down from prior accident years. Fifth, as previously mentioned, we have a higher than industry average level of medical-only claims which are of shorter duration and severity resulting in greater predictability. Finally, we are receiving continued solid rate increases in almost every state. Question 2: I ask, because the loss triangles on pp of its K seem to indicate that AmTrust has paid out claims in excess of its revised estimates of losses for the accident years How can an insurance company have negative reserves for an accident year? Company s Response to Question 2: The loss triangles on pages 19 and 20 of the Company s K show cumulative loss development on a calendar year basis, not on an accident year basis. Our accident year reserves for 2007 through 2009 are not negative and are consistent with our calendar year results. The anomaly that you appear to be referring to results from backing out accident year results from the calendar year triangles. It is the results of that effort, not the loss triangles themselves, which appeared to show negative accident year reserves. Unfortunately, the analysis you have performed does not show the effect of the Company s acquisition in 2007 of $168 million in loss reserves. Therefore the analysis is flawed and we did not have negative reserves in 2008 or Finally, our consolidated actuarial studies underscore that we are squarely within developed actuarial ranges. Question 3: Most every comparable company, including Maiden, reports consolidated statutory capital in their 10-K what is AmTrust s? Company s Response to Question 3: We disclose the surplus/regulatory capital by insurance entity beginning on page F65 of the K in the footnote entitled Statutory Financial Data, Risk Based Capital and Dividend Restrictions the footnote

5 discloses statutory capital and required capital by entity. As of December 31, 2013, AFSI s insurance subsidiaries had $1.7 billion of statutory capital and $676 million of required capital. Therefore, the capital base was 2.54 times the required capital. In addition, our insurance subsidiaries generated $176 million of statutory net income in In fact, as of December 31, 2013, the Company had sufficient capital to dividend $473 million from its subsidiaries without prior regulatory approval. Question 4: When AmTrust tells investors about the ratio of net written premiums to total capital, does total capital include goodwill, intangibles, DAC and pre-paids? Company s Response to Question 4: Total capital referred to in management comments is: shareholders equity+ debt + preferred + trust preferred + convertible debt. The majority of Intangibles/goodwill relate to our service and fee revenue generating companies that we have acquired over the years. In 2013, the Company achieved service and fee revenue of $332 million. The EBITDA margin on this fee revenue is approximately 25% or $83 million. We have been advised by independent financial advisors and industry experts that our Service and Fee generating businesses could be worth in the range of $1.0 billion if we were to recognize the value through a spin-off of the business or other monetization. This valuation is in excess of total goodwill and intangibles. Question 5: Is AmTrust International Insurance, Ltd. ( AII ) adequately capitalized, at 2.14-times the minimum solvency margin at YE2013, compared to its reinsurer Maiden s 4.3-times? Company s Response to Question 5: Yes. AII is more than adequately capitalized at over two times its required statutory capital. Comparison of AmTrust to Maiden or to any other reinsurer for that matter is not an apple to apples comparison. AII assumes business from its affiliates. The premiums AII assumes are very predictable, stable, and non-catastrophe exposed risks. AII s capitalization is not comparable to any other insurance business given that reinsurers may have catastrophe exposure or assume business from unaffiliated cedants that do not perform as well as the AmTrust s book of business. Also, all of AII s reinsurance obligations to its domestic affiliates are completely collateralized. Finally, as we have stated before, evaluating capital only makes sense when it is done on a group basis not on an individual company basis due to the fact that AmTrust has the ability to reallocate capital among individual companies as needed, Question 6: Why does the K show AII s capital and surplus falling from $499 million in 2012 to $416 million in 2013, even though it shows AII earning $2.3 million in 2013?

6 Company s Response to Question 6: The lower statutory capital of AII from 2012 to 2013 was the result of a corporate restructuring in which AII sold its common equity interest in AIUL and IGI. As a consequence, there was an associated reduction in equity income from those entities during In addition, the overall premium growth of AII insurance affiliates resulted in AII assuming more premium in The increase in premium resulted in AII recording a related increase in the DAC asset from 12/31/2012 to 12/31/2013. However, under Bermuda Monetary Authority accounting standards, DAC is a non-admitted asset for the purposes of statutory surplus. AII s Bermuda filing excludes DAC from statutory surplus and therefore shows a net reduction in capital and surplus for AII. In addition, AII s capital and surplus is understated due to the fact that the entity holds the common stock of National General Holding, Corp (NGHC-$14.81). This investment is carried under the equity method of accounting. As of December 31, 2013, the investment in NGHC was carried on All s balance sheet at approximately $92 million. However, the market value of NHGC is approximately $186 million, resulting in $95 million of embedded value for AII which is not reflected in the capital of AmTrust. Further, AII has over $500 million in reinsurance recoverables which are all fully collateralized and not reflected in the entities capital and surplus. Question 7: AmTrust subsidiaries 2013 Schedule Y, Part 1A show AII owning about $300 million worth of affiliates like Rochdale, AIUL (Ireland) and AEL (UK) that all retain some risk, so how accessible is that piece of AII s capital Company s Response to Question 7: Schedule Ypart 1 does not show any capital/surplus amounts. Therefore, Schedule Y part 1 does not show that AII owns about $300 million worth of affiliates. AII owns Amtrust International Management, which owns 50% of Amtrust Equity Solutions, which owns Rochdale, AIUL as well as IGI AII s total indirect ownership of those three companies is $237 million. The capital of Rochdale, AIUL and AEL is very accessible. The total statutory capital of the companies mentioned is $475 million and is 3.7 times those same entities required capital of $128 million. The company could reallocate capital if necessary. In addition, the combined liquid assets of Rochdale, AIUL and AEL is over $1.0 billion. Question 8: The 2013 year Schedule Y Part 2, column 9 show the Luxembourg reinsurance entities with income, after years of losses in that column. What changed and why do AmTrust Holdings Luxembourg s accounts filed in Luxembourg show no profits and (on page 6) downward adjustments of $88 million in book value?

7 Company s Response to Question 8: Luxembourg financials are composed under Luxembourg GAAP accounting standards, not U.S. GAAP accounting standards. AHL s only activity is as the holding company for all of AmTrust s reinsurance companies in Luxembourg. Luxembourg accounting rules exempt AHL from having to provide consolidated accounts. Consequently, AHL prepares non-consolidated financial statements under Luxembourg GAAP which are audited by KPMG and filed with the registrar on an annual basis. AHL holds its investments in its subsidiaries at cost. Value adjustments are made to these investments to recognize permanent reductions in the value of these subsidiaries on an individual basis. A permanent reduction in value is deemed to have happened when the acquisition cost of the participation in the subsidiary is higher than its market value. The market value at December 31, 2013 was the sum of net equity and 90% of the equalization provision (what AmTrust paid for their last captive bought in December 2103) AHL shows a loss in its non-consolidated financial statement at December 31, 2013 because two of its reinsurance subsidiaries were deemed to have a permanent reduction in value. The reduction in value of these subsidiaries resulted from the fact that these subsidiaries recognized underwriting losses under reinsurance treaties with AmTrust International Insurance Ltd (Bermuda) ( AIIL ). AIIL recorded an underwriting gain under these treaties. On consolidation this technical loss in Luxembourg and technical gain in AIIL were eliminated in the group consolidated financial statements. Under Luxembourg GAAP, the subsidiaries released equalization reserves as a result of the losses recorded under the treaties with AII. There was a permanent reduction in the valuation of the subsidiaries due in part to the decrease in equalization reserve in The value of AHL s subsidiaries in its non-consolidated audited financial statements is irrelevant to AFSI because AHL s financial statements are prepared on a nonconsolidated basis under Luxembourg GAAP. In contrast, AFSI s financial statements are prepared on a consolidated basis under US GAAP. If AHL s financial statements had been prepared on a consolidated basis under US GAAP they would show a technical loss. The technical loss would be equal and opposite to the technical gain recorded in AII as a result of the reinsurance treaties between the Luxembourg Reinsurance

8 Companies and AIIL. Under US GAAP these balances are eliminated on consolidation in the group financial statements. Under US GAAP, as a result of the reinsurance treaties between Luxembourg and AIIL, cash has moved from Luxembourg to AIIL. Consequently, the capital base of Luxembourg shrunk and the capital base of AIIL has increased. As the capital base of Luxembourg shrinks, any discount on the purchase of the Luxembourg Reinsurance Captives is released to income in the consolidated group financial statements (initially AmTrust paid 90 cents and received a dollar for a Luxembourg Reinsurance Company with no insurance liabilities) Question 9: Is there a $100 million discrepancy in the K footnote 9 accounting for loss and LAE reserves acquired in 2013? In the K footnote 9 (page F-40), it s reported as $807.6 million. Summing the purchase price allocations in the 10-K footnote 5 (for MIHC, FNIC and Sequoia) and the March Q footnote 12 (for Sagicor), it s $705 million. Subtracting the 2013 cash flow statement Net Loss/LAE of $630 million from the $1,330 million year-over-year increase in the balance sheet Net Loss/LAE (with all these net values resulting from netting the gross numbers for reinsurance recoverable), it s $700 million Company s Response to Question 9: Footnote 9 is correct. There is no discrepancy in footnote 9. Parsing pieces of data and then making assumptions regarding that data, more often than not, leads to incorrect conclusions. The acquired loss reserves for MIHC, FNIC, Sequoia and Sagicor totaled $760.8 million, the reinsurance recoverable associated with those acquisitions totaled $56 million. Your questions assume that the entire amount of the reinsurance recoverable relates to ceded paid loss reserves. That assumption is wrong, thus your assumption that net acquired loss reserves is $705 million is also wrong. There is a portion of the reinsurance recoverable that relates to actual recoveries on paid losses. That portion would not be deducted in arriving at net loss reserves. Additionally, AFSI owns a renta-captive insurance company Amtrust Captive Solutions. As Amtrust Captive Solutions gains additional captive clients, those clients existing balances sheets including loss reserves are transferred to AmTrust Captive Solutions. This transfer results in an increase in loss reserves which are a component of acquired loss reserves as detailed in footnote 9. The loss reserves that transferred/acquired as part of the acquisition of a new captive client are offset by cash sufficient to cover all claim activity. Question 10: As of year-end 2013, the AFSI balance sheet seemed to show $400 million more in assets relating to the Maiden Holdings quota share ($740 million in prepaid premiums plus $1,144 million in reinsurance recoverable) than the corresponding liabilities on Maiden s balance sheet ($687 million in unearned premiums plus $796

9 million in loss and loss adjustment expense reserves)...if that $400 million difference in the corresponding numbers is correct, is AFSI overstating or MHLD understating? Company s Response to Question 10: AmTrust is not overstating reserves or unearned premium ceded to Maiden and there is no basis for concluding that Maiden is understating them. Each quarter AmTrust provides a cession statement to Maiden which shows changes in written premium, changes in unearned premium, ceding commission, and changes in pure incurred losses. Pure incurred losses consist of changes in paid losses and case reserves and do not include IBNR. These cessions are made to Maiden strictly in accordance with the terms of the reinsurance contracts and, in particular, the agreed upon quota share percentages. We do not provide Maiden an IBNR calculation and we do not review Maiden s IBNR calculation. IBNR is determined by insurers and reinsurers on an aggregate basis. In the case of reinsurers, IBNR is developed for the reinsurers business as a whole and then allocated among its cedents. We would not expect the IBNR allocated by Maiden to its AmTrust business to match our IBNR. This is true of all reinsurance relationships, not only AmTrust s relationship with Maiden. Maiden s ultimate losses, which are based, in part, on the premium and pure incurred loss reported by AmTrust, must fall within the actuarial range determined by its actuaries and AmTrust s ultimate losses must fall within the actuarial range developed by its actuaries, but they do not need to match each other. We note that AmTrust has ceded $4.235 billion of written premium and $3.526 billion of earned premium through December 31, AmTrust s reserves are within the range promulgated by the Company s actuaries and therefore are valid Finally, in accordance with the reinsurance contracts, Maiden collateralizes its reinsurance obligations to AmTrust, including IBNR. Quarterly, we report to Maiden the amount of collateral required, which incorporates our calculation of IBNR. Maiden is obligated to fund the collateralization based on our report.