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Section 1: 10-Q (10-Q)

agii-10q_20170930.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

For the quarterly period ended September 30, 2017

or

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

For the transition period from              to             

Commission file number: 1-15259

 

ARGO GROUP INTERNATIONAL HOLDINGS, LTD.

(Exact name of registrant as specified in its charter)

 

 

Bermuda

 

98-0214719

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification Number)

 

110 Pitts Bay Road
Pembroke HM08
Bermuda

 

P.O. Box HM 1282
Hamilton HM FX
Bermuda

(Address of principal executive offices)

 

(Mailing address)

(441) 296-5858

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Security

 

Name of Each Exchange on Which Registered

Common Stock, par value of $1.00 per share

 

NASDAQ Global Select Market

Guarantee of Argo Group US, Inc. 6.500% Senior Notes due 2042

 

NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act:

None

 

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      No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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      No  

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. (Check one):

 

Large accelerated filer  

Accelerated filer  

Non-accelerated filer  

 

Smaller reporting company  

Emerging growth company  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes      No  

If an emerging growth company, indicate by check mark whether 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.    

Indicate the number of shares outstanding (net of treasury shares) of each of the issuer’s classes of common shares as of November 02, 2017.

 

Title

Outstanding

Common Shares, par value $1.00 per share

29,680,863

 

 

 

 


 

ARGO GROUP INTERNATIONAL HOLDINGS, LTD.

INDEX

 

 

 

 

Page

PART I. Financial Information

3

 

Item 1.

 

Condensed Consolidated Financial Statements (unaudited)

3

 

 

Condensed Consolidated Balance Sheets as of September 30, 2017 and December 31, 2016

3

 

 

Condensed Consolidated Statements of (Loss) Income for three and nine months ended September 30, 2017 and 2016

4

 

 

Condensed Consolidated Statements of (Loss) Comprehensive Income for the three and nine months ended September 30, 2017 and 2016

5

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2017 and 2016

6

 

 

Notes to Condensed Consolidated Financial Statements

7

Item 2.

 

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

42

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

53

Item 4.

 

Controls and Procedures

54

PART II. Other Information

54

 

Item 1.

 

Legal Proceedings

54

Item 1A.

 

Risk Factors

54

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

54

Item 3.

 

Defaults Upon Senior Securities

55

Item 4.

 

Mine Safety Disclosures

55

Item 5.

 

Other Information

55

Item 6.

 

Exhibits

55

 

 

Signatures

57

 

 

 

 


 

PART I. FINANCIAL INFORMATION

 

 

Item 1. Condensed Consolidated Financial Statements

ARGO GROUP INTERNATIONAL HOLDINGS, LTD.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in millions, except number of shares and per share amounts)

 

 

 

September 30,

 

 

December 31,

 

 

 

2017

 

 

2016 *

 

 

 

(Unaudited)

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

Investments:

 

 

 

 

 

 

 

 

Fixed maturities available-for-sale, at fair value (cost: 2017 - $3,339.7; 2016 -

   $2,938.8)

 

$

3,378.4

 

 

$

2,932.4

 

Equity securities available-for-sale, at fair value (cost: 2017 - $347.6; 2016 - $335.2)

 

 

480.5

 

 

 

447.4

 

Other investments (cost: 2017 - $553.1; 2016 - $531.6)

 

 

562.6

 

 

 

539.0

 

Short-term investments, at fair value (cost: 2017 - $386.0; 2016 - $405.5)

 

 

386.0

 

 

 

405.5

 

Total investments

 

 

4,807.5

 

 

 

4,324.3

 

Cash

 

 

235.8

 

 

 

86.0

 

Accrued investment income

 

 

23.6

 

 

 

20.7

 

Premiums receivable

 

 

678.8

 

 

 

463.8

 

Reinsurance recoverables

 

 

2,101.9

 

 

 

1,385.6

 

Goodwill

 

 

152.2

 

 

 

152.2

 

Intangible assets, net of accumulated amortization

 

 

108.3

 

 

 

67.7

 

Deferred acquisition costs, net

 

 

168.8

 

 

 

139.1

 

Ceded unearned premiums

 

 

461.4

 

 

 

302.8

 

Other assets

 

 

319.7

 

 

 

262.8

 

Total assets

 

$

9,058.0

 

 

$

7,205.0

 

Liabilities and Shareholders' Equity

 

 

 

 

 

 

 

 

Reserves for losses and loss adjustment expenses

 

$

4,305.9

 

 

$

3,350.8

 

Unearned premiums

 

 

1,286.0

 

 

 

970.0

 

Accrued underwriting expenses

 

 

97.5

 

 

 

115.0

 

Ceded reinsurance payable, net

 

 

822.6

 

 

 

466.6

 

Funds held

 

 

45.0

 

 

 

77.1

 

Senior unsecured fixed rate notes

 

 

139.6

 

 

 

139.5

 

Other indebtedness

 

 

184.7

 

 

 

55.4

 

Junior subordinated debentures

 

 

256.5

 

 

 

172.7

 

Current income taxes payable, net

 

 

11.0

 

 

 

8.1

 

Deferred tax liabilities, net

 

 

41.5

 

 

 

24.1

 

Other liabilities

 

 

59.7

 

 

 

33.0

 

Total liabilities

 

 

7,250.0

 

 

 

5,412.3

 

Commitments and contingencies (Note 16)

 

 

 

 

 

 

 

 

Shareholders' equity:

 

 

 

 

 

 

 

 

Common shares - $1.00 par, 500,000,000 shares authorized; 40,300,433 and

   40,042,330 shares issued at September 30, 2017 and December 31, 2016,

   respectively

 

 

40.3

 

 

 

40.0

 

Additional paid-in capital

 

 

1,129.1

 

 

 

1,123.3

 

Treasury shares (10,640,789 and 10,028,755 shares at September 30, 2017

   and December 31, 2016, respectively)

 

 

(414.8

)

 

 

(378.2

)

Retained earnings

 

 

956.4

 

 

 

959.9

 

Accumulated other comprehensive income, net of taxes

 

 

97.0

 

 

 

47.7

 

Total shareholders' equity

 

 

1,808.0

 

 

 

1,792.7

 

Total liabilities and shareholders' equity

 

$

9,058.0

 

 

$

7,205.0

 

 

*

Derived from audited consolidated financial statements.

See accompanying notes.

 

3


 

ARGO GROUP INTERNATIONAL HOLDINGS, LTD.

CONDENSED CONSOLIDATED STATEMENTS OF (LOSS) INCOME

(in millions, except number of shares and per share amounts)

(Unaudited)

 

 

 

 

For the Three Months Ended September 30,

 

 

For the Nine Months Ended September 30,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Premiums and other revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earned premiums

 

$

389.3

 

 

$

358.7

 

 

$

1,167.8

 

 

$

1,048.5

 

Net investment income

 

 

30.9

 

 

 

32.7

 

 

 

105.0

 

 

 

89.6

 

Fee and other income

 

 

13.0

 

 

 

7.6

 

 

 

20.4

 

 

 

20.2

 

Net realized investment and other gains

 

 

6.0

 

 

 

17.7

 

 

 

25.1

 

 

 

12.8

 

Total revenue

 

 

439.2

 

 

 

416.7

 

 

 

1,318.3

 

 

 

1,171.1

 

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Losses and loss adjustment expenses

 

 

326.4

 

 

 

207.8

 

 

 

779.5

 

 

 

596.0

 

Underwriting, acquisition and insurance expenses

 

 

166.1

 

 

 

137.4

 

 

 

474.4

 

 

 

403.0

 

Interest expense

 

 

7.5

 

 

 

4.9

 

 

 

20.4

 

 

 

14.6

 

Fee and other expense

 

 

5.0

 

 

 

5.9

 

 

 

12.4

 

 

 

18.1

 

Foreign currency exchange losses (gains)

 

 

0.1

 

 

 

(1.5

)

 

 

4.0

 

 

 

4.5

 

Total expenses

 

 

505.1

 

 

 

354.5

 

 

 

1,290.7

 

 

 

1,036.2

 

(Loss) income before income taxes

 

 

(65.9

)

 

 

62.2

 

 

 

27.6

 

 

 

134.9

 

Income tax (benefit) provision

 

 

(4.6

)

 

 

7.0

 

 

 

6.2

 

 

 

21.1

 

Net (loss) income

 

$

(61.3

)

 

$

55.2

 

 

$

21.4

 

 

$

113.8

 

Net (loss) income per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(2.04

)

 

$

1.84

 

 

$

0.71

 

 

$

3.76

 

Diluted

 

$

(2.04

)

 

$

1.80

 

 

$

0.69

 

 

$

3.68

 

Dividend declared per common share

 

$

0.27

 

 

$

0.22

 

 

$

0.81

 

 

$

0.64

 

Weighted average common shares:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

29,978,485

 

 

 

30,018,637

 

 

 

30,075,424

 

 

 

30,227,725

 

Diluted

 

 

29,978,485

 

 

 

30,728,383

 

 

 

30,893,026

 

 

 

30,889,487

 

 

 

 

For the Three Months Ended September 30,

 

 

For the Nine Months Ended September 30,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Net realized investment and other gains before

   other-than-temporary impairment losses

 

$

6.2

 

 

$

20.1

 

 

$

26.8

 

 

$

21.8

 

Other-than-temporary impairment losses recognized in

   earnings:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other-than-temporary impairment losses on fixed

   maturities

 

 

(0.1

)

 

 

(0.6

)

 

 

(0.1

)

 

 

(1.7

)

Other-than-temporary impairment losses on equity

   securities

 

 

(0.1

)

 

 

(1.8

)

 

 

(1.6

)

 

 

(7.3

)

Impairment losses recognized in earnings

 

 

(0.2

)

 

 

(2.4

)

 

 

(1.7

)

 

 

(9.0

)

Net realized investment and other gains

 

$

6.0

 

 

$

17.7

 

 

$

25.1

 

 

$

12.8

 

 

See accompanying notes.

 

 

 

4


 

ARGO GROUP INTERNATIONAL HOLDINGS, LTD.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(in millions)

(Unaudited)

 

 

 

For the Three Months Ended September 30,

 

 

For the Nine Months Ended September 30,

 

 

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Net (loss) income

 

$

(61.3

)

 

$

55.2

 

 

$

21.4

 

 

$

113.8

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

 

0.4

 

 

 

(1.0

)

 

 

(0.2

)

 

 

2.8

 

Unrealized gains on securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gains arising during the year

 

 

38.5

 

 

 

19.8

 

 

 

100.1

 

 

 

97.7

 

Reclassification adjustment for gains included in

   net income

 

 

(17.4

)

 

 

(17.0

)

 

 

(36.3

)

 

 

(25.1

)

Other comprehensive income before tax

 

 

21.5

 

 

 

1.8

 

 

 

63.6

 

 

 

75.4

 

Income tax provision related to other comprehensive

   income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gains on securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gains arising during the year

 

 

10.1

 

 

 

7.6

 

 

 

26.0

 

 

 

27.5

 

Reclassification adjustment for gains included in

   net income

 

 

(5.5

)

 

 

(7.9

)

 

 

(11.7

)

 

 

(11.8

)

Income tax provision (benefit) related to other

   comprehensive income

 

 

4.6

 

 

 

(0.3

)

 

 

14.3

 

 

 

15.7

 

Other comprehensive income, net of tax

 

 

16.9

 

 

 

2.1

 

 

 

49.3

 

 

 

59.7

 

Comprehensive (loss) income

 

$

(44.4

)

 

$

57.3

 

 

$

70.7

 

 

$

173.5

 

 

See accompanying notes.

 

 

 

5


 

ARGO GROUP INTERNATIONAL HOLDINGS, LTD.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions)

(Unaudited)

  

 

 

For the Nine Months Ended September 30,

 

 

 

2017

 

 

2016

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

Net income

 

$

21.4

 

 

$

113.8

 

Adjustments to reconcile net income to net cash provided by (used in)

   operating activities:

 

 

 

 

 

 

 

 

Amortization and depreciation

 

 

24.4

 

 

 

27.4

 

Share-based payments expense

 

 

11.2

 

 

 

11.1

 

Deferred income tax (benefit) provision, net

 

 

(6.4

)

 

 

2.3

 

Net realized investment and other gains

 

 

(25.1

)

 

 

(12.8

)

Undistributed earnings from alternative investment portfolio

 

 

(38.6

)

 

 

(20.8

)

Loss on disposals of fixed assets, net

 

 

1.4

 

 

 

0.2

 

Change in:

 

 

 

 

 

 

 

 

Accrued investment income

 

 

(2.7

)

 

 

(0.3

)

Receivables

 

 

(690.9

)

 

 

(255.5

)

Deferred acquisition costs

 

 

(19.7

)

 

 

(14.9

)

Ceded unearned premiums

 

 

(65.8

)

 

 

(59.8

)

Reserves for losses and loss adjustment expenses

 

 

756.5

 

 

 

154.2

 

Unearned premiums

 

 

162.5

 

 

 

120.3

 

Ceded reinsurance payable and funds held

 

 

179.7

 

 

 

128.3

 

Income taxes

 

 

3.5

 

 

 

19.7

 

Accrued underwriting expenses

 

 

(42.5

)

 

 

(27.4

)

Other, net

 

 

(16.5

)

 

 

(35.0

)

Cash provided by operating activities

 

 

252.4

 

 

 

150.8

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Sales of fixed maturity investments

 

 

1,069.7

 

 

 

761.8

 

Maturities and mandatory calls of fixed maturity investments

 

 

493.2

 

 

 

839.0

 

Sales of equity securities

 

 

140.0

 

 

 

155.3

 

Sales of other investments

 

 

68.3

 

 

 

92.1

 

Purchases of fixed maturity investments

 

 

(1,916.9

)

 

 

(1,650.7

)

Purchases of equity securities

 

 

(118.1

)

 

 

(114.7

)

Purchases of other investments

 

 

(25.2

)

 

 

(90.3

)

Change in foreign regulatory deposits and voluntary pools

 

 

(27.2

)

 

 

4.8

 

Change in short-term investments

 

 

291.4

 

 

 

(78.7

)

Settlements of foreign currency exchange forward contracts

 

 

 

 

 

(7.2

)

Acquisition of subsidiaries, net of cash acquired

 

 

(105.2

)

 

 

 

Purchases of fixed assets

 

 

(20.4

)

 

 

(26.7

)

Other, net

 

 

(15.6

)

 

 

31.9

 

Cash used in investing activities

 

 

(166.0

)

 

 

(83.4

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Additional long-term borrowings

 

 

125.0

 

 

 

 

Activity under stock incentive plans

 

 

0.9

 

 

 

0.6

 

Repurchase of Company's common shares

 

 

(36.6

)

 

 

(45.3

)

Payment of cash dividends to common shareholders

 

 

(24.9

)

 

 

(19.8

)

Cash provided by (used in) financing activities

 

 

64.4

 

 

 

(64.5

)

Effect of exchange rate changes on cash

 

 

(1.0

)

 

 

(1.0

)

Change in cash

 

 

149.8

 

 

 

1.9

 

Cash, beginning of year

 

 

86.0

 

 

 

121.7

 

Cash, end of period

 

$

235.8

 

 

$

123.6

 

 

See accompanying notes.

6


 

ARGO GROUP INTERNATIONAL HOLDINGS, LTD.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

1.

Basis of Presentation

The accompanying consolidated financial statements of Argo Group International Holdings, Ltd. (“Argo Group,” “we” or the “Company”) and its subsidiaries have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. The preparation of interim 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 reported amounts of revenues and expenses during the reporting period. The major estimates reflected in our consolidated financial statements include, but are not limited to, reserves for losses and loss adjustment expenses; reinsurance recoverables, including the reinsurance recoverables allowance for doubtful accounts; estimates of written and earned premiums; reinsurance premium receivable; fair value of investments and assessment of potential impairment; valuation of goodwill and intangibles and our deferred tax asset valuation allowance. Actual results could differ from those estimates. Certain financial information that normally is included in annual financial statements, including certain financial statement footnotes, prepared in accordance with GAAP, is not required for interim reporting purposes and has been condensed or omitted. These statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2016, filed with the Securities and Exchange Commission on February 24, 2017.

Effective February 6, 2017, we completed the acquisition of Maybrooke Holdings, S.A. (“Maybrooke”) and its direct subsidiaries, including Ariel Re. We have accounted for the acquisition in accordance with Accounting Standards Codification (“ASC”) 805, “Business Combinations,” and the purchase price has been preliminarily allocated to the assets acquired and liabilities assumed based on their estimated fair values at the acquisition date. See Note 3, “Acquisition of Maybrooke,” for additional discussion regarding the acquisition and the related financial disclosures. The Consolidated Financial Statements as of and for the three and nine months ended September 30, 2017 and the Notes to the Consolidated Financial Statements reflect the consolidated results of Argo Group and Maybrooke commencing on the date of acquisition.

The interim financial information as of and for the three and nine months ended September 30, 2017 and 2016 is unaudited. However, in the opinion of management, the interim information includes all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of the results presented for the interim periods. The operating results for the interim periods are not necessarily indicative of the results to be expected for the full year. All significant intercompany amounts have been eliminated in consolidation.

During the first quarter of 2017, we evaluated and modified the presentation of our reportable segments to better reflect our new operating framework and management structure. Under this model, Argo Group’s chief operating decision maker – Mark E. Watson III, President and Chief Executive Officer – evaluates performance and allocates resources based on the review of the U.S. Operations and the International Operations. The U.S. Operations includes the former Excess & Surplus and Commercial Specialty reportable segments. The International Operations includes the former Syndicate 1200, International Specialty reportable segments, and the recently acquired Ariel Re business. (See Note 3, “Acquisition of Maybrooke” for details regarding Ariel Re.) The business unit that produces the risk and not the location of the underlying exposure is the primary characteristic in distinguishing operating and reportable segments. For example, a U.S. property exposure underwritten through our Syndicate platform would be included in International Operations. Consistent with prior periods, the Run-off Lines and Corporate segments include all other activity of Argo Group and are included in our consolidated financial results. Segment results for the three and nine months ended September 30, 2016 have been reclassified to conform to the current presentation.

 

 

2.

Recently Issued Accounting Pronouncements

In May 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-09, “Compensation – Stock Compensation” (Topic 718): Scope of Modification Accounting. ASU 2017-09 clarifies when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. The guidance requires entities to apply the modification accounting guidance if the value, vesting conditions or classification of the award changes. In addition to all the disclosures about modifications that are required today, the entities are required to affirmatively disclose when compensation expense has not changed. The ASU will be applied prospectively and is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including in any interim period for which financial statements have not been issued or made available for issuance. We are currently evaluating the impact that the adoption of the ASU will have on our financial results and disclosures.

7


 

In January 2017, the FASB issued ASU 2017-01, “Business Combinations” (Topic 805). ASU 2017-01 clarifies the definition of a business to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The guidance specifies the minimum inputs and processes required to meet the definition of a business. The guidance is effective for annual periods beginning after December 15, 2017, and interim periods within those periods, with early adoption permitted. We do not anticipate that this ASU will have a material impact on our financial results or disclosures.

In January 2017, the FASB issued ASU 2017-04, “Intangibles – Goodwill and Other” (Topic 350). ASU 2017-04 eliminates the requirement to calculate the implied fair value of goodwill that is done in Step 2 of the current goodwill impairment test to measure a goodwill impairment loss. Instead, entities will record an impairment loss based on the excess of a reporting unit’s carrying amount over its fair value. The guidance will be applied prospectively and is effective for annual and interim impairment tests performed in periods beginning after December 15, 2019. We do not anticipate that this ASU will have a material impact on our financial results or disclosures.

In August 2016, the FASB issued ASU 2016-15, “Classification of Certain Cash Receipts and Cash Payments (Topic 230). ASU 2016-15 will reduce diversity in practice on how eight specific cash receipts and payments are classified on the statement of cash flows. The ASU will be effective for fiscal years beginning after December 15, 2017, including interim periods within those years. This ASU will have an impact on how we present the distributions received from equity method investees in our statement of cash flows. We have elected to adopt the cumulative earnings approach to classify distributions received from equity method investees, which we will adopt retrospectively. We anticipate that this ASU will have no net effect on our consolidated statements of cash flows, but will likely have an immaterial impact on the classification of specific cash receipts and payments within the statement.

In June 2016, the FASB issued ASU 2016-13, “Measurement of Credit Losses on Financial Instruments” (Topic 326). ASU 2016-13 requires organizations to estimate credit losses on certain types of financial instruments, including receivables and available-for-sale debt securities, by introducing an approach based on expected losses. The expected loss approach will require entities to incorporate considerations of historical information, current information and reasonable and supportable forecasts. The guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The guidance requires a modified retrospective transition method and early adoption is permitted. We are currently evaluating the impact that the adoption of the ASU will have on our financial results and disclosures, but do not anticipate that any such potential impact would be material.

In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting” (Topic 718). ASU 2016-09 simplifies the accounting for share-based payment award transactions including income tax consequences, classification of awards as either equity or liabilities, classification on the statement of cash flows, and accounting for forfeitures. The ASU is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. We have adopted this ASU as of January 1, 2017, and for presentation purposes, the incremental tax windfall or shortfall associated with these events has been classified as a cash inflow from operating activity as compared with a financing activity, as previously required. The impact to our financial statements was not material. Additionally, we have selected to continue estimating forfeitures based on historical patterns and will true-up the expenses upon vesting.

In February 2016, the FASB issued ASU 2016-02, “Leases” (Topic 842). ASU 2016-02 requires organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. Additionally, the ASU modifies current guidance for lessors' accounting. The ASU is effective for interim and annual reporting periods beginning on or after January 1, 2019, with early adoption permitted. We do not anticipate that this ASU will have a material impact on our results of operations, but we anticipate an increase to the value of our assets and liabilities related to leases, with no material impact to equity.

In January 2016, the FASB issued ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities” (Subtopic 825-10). ASU 2016-01 will require equity investments that are not consolidated or accounted for under the equity method of accounting to be measured at fair value with changes in fair value recognized in net income. This ASU will also require us to assess the ability to realize our deferred tax assets related to an available-for-sale debt security in combination with our other deferred tax assets. The ASU will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. While we continue to evaluate the impact of this ASU, we anticipate the standard will increase the volatility of our consolidated statements of income, resulting from the remeasurement of our equity investments.

8


 

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers” (Topic 606), which replaces most existing GAAP revenue recognition guidance and permits the use of either the retrospective or cumulative effect transition method. In August 2015, “Deferral of the Effective Date” (Topic 606), deferred the effective date of this guidance to interim and annual reporting periods beginning after December 15, 2017. Subsequently, in 2016, the FASB issued implementation guidance related to ASU 2014-09, including:

 

ASU 2016-08, “Principal versus Agent considerations (Reporting Revenue Gross versus Net)” (Topic 606), which is intended to provide further clarification on the application of the principal versus agent implementations;

 

ASU 2016-10, “Identifying Performance Obligations and Licensing” (Topic 606), which is intended to clarify the guidance for identifying promised goods or service in a contract with a customer;

 

ASU 2016-11, “Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting” (Topics 605 & 815);

 

ASU 2016-12, “Narrow-Scope Improvements and Practical Expedients” (Topic 606), provides additional guidance for quantitative and qualitative disclosures in certain cases, and makes 12 additional technical corrections and improvements to the new revenue standard.

While insurance contracts are excluded from this ASU, fee income related to our brokerage operations and management of the third-party capital for our underwriting Syndicate 1200 at Lloyd’s will be subject to this updated guidance. We continue to evaluate what impact this ASU will have on our financial results and disclosures and which adoption method to apply, but do not anticipate such impact being material based on the limited revenue streams subject to the ASU.

 

3.

Acquisition of Maybrooke

Effective February 6, 2017, we completed the acquisition of Maybrooke whereby we acquired all of the issued and outstanding capital stock of Maybrooke. The initial purchase price of $235.3 million was paid in cash from funds on hand and available under our credit facility (see Note 7, “Other Indebtedness”). The initial purchase price was subject to post-closing adjustments based on a final calculation of the purchase price, which we delivered to the seller, as required, within 90 days of closing. As of the date of this filing, we are in discussions with the seller to finalize and agree upon certain changes included in the final purchase price calculation. We anticipate resolving this matter by the end of 2017 and do not expect any material adjustments to the purchase price disclosed below.

Through the acquisition of Maybrooke, we acquired Ariel Re, a global underwriter of specialty insurance and reinsurance business written primarily through its Lloyd’s Syndicate 1910. Ariel Re provides Argo Group with a number of strategic advantages, including enhanced scale in its London- and Bermuda-based platforms.

9


 

The acquisition is being accounted for in accordance with ASC 805, “Business Combinations.” Purchase accounting, as defined by ASC 805, requires that the assets acquired and liabilities assumed be recognized at their fair values as of the acquisition date. We are in the process of finalizing our determination of fair values, including an independent appraisal of certain assets and liabilities, including intangible assets. Therefore, a preliminary allocation of the purchase price to the acquired assets, liabilities, and intangible assets is presented in the table below:

 

(in millions)

 

 

 

 

Assets:

 

 

 

 

Investments

 

$

340.7

 

Cash

 

 

130.1

 

Accrued investment income

 

 

0.2

 

Premiums receivable

 

 

157.6

 

Reinsurance recoverables

 

 

80.2

 

Current income taxes receivable

 

 

0.6

 

Deferred acquisition costs, net

 

 

9.8

 

Ceded unearned premiums

 

 

92.6

 

Other assets

 

 

24.9

 

Total assets

 

 

836.7

 

Liabilities:

 

 

 

 

Reserves for losses and loss adjustment expenses

 

 

197.0

 

Unearned premiums

 

 

152.5

 

Accrued underwriting expenses

 

 

28.8

 

Ceded reinsurance payable, net

 

 

144.2

 

Junior subordinated debentures

 

 

83.6

 

Deferred tax liabilities

 

 

9.0

 

Other liabilities

 

 

30.7

 

Total liabilities

 

 

645.8

 

 

 

 

 

 

Net assets acquired

 

 

190.9

 

Initial purchase price

 

 

235.3

 

Intangible assets

 

$

44.4

 

During the second quarter of 2017, we engaged an independent valuation firm and anticipate completing our valuation analysis and closing the fair value measurement period by the end of 2017. The excess of the purchase price over the fair value of the net assets acquired has been preliminarily allocated to intangible assets, which will be specifically identified and quantified by the end of 2017. We did not record amortization expense related to the $44.4 million intangible assets during the nine months ended September 30, 2017, as the valuation analysis has not yet been completed. We anticipate recording both amortizable and non-amortizable identifiable intangible assets and goodwill upon the completion of the valuation analyses, including intangible assets relating to the Lloyd’s Syndicate 1910 stamp capacity (non-amortizable), distribution networks (amortizable), and the Ariel Re tradename (amortizable). Goodwill is calculated as the excess of the purchase price over the fair value of the net assets recognized, including identifiable intangible assets.

We recognized approximately $2.5 million of acquisition-related transaction costs in our Consolidated Statements of Income, all of which were recorded during the first quarter of 2017. Of these amounts, $2.2 million were reported in “Underwriting, acquisition and insurance expenses” and $0.3 million in “Interest expense” related to the borrowings under our credit facility to help fund the acquisition. No additional transaction costs were incurred during the three months ended September 30, 2017.

Maybrooke’s Contribution to Argo Group’s Revenue and (Loss) Income

The following selected financial information summarizes the results of Maybrooke from the date of acquisition that have been included in our Consolidated Statement of (Loss) Income:

(in millions)

 

For the Three

Months Ended

September 30, 2017

 

 

For the Nine

Months Ended

September 30, 2017

 

Revenues

 

$

27.5

 

 

$

93.7

 

Net loss

 

$

(26.7

)

 

$

(13.7

)

10


 

Unaudited Pro forma Results of Operations

The following unaudited pro forma financial information has been provided to present a summary of the combined results of Argo Group’s operations with Maybrooke’s as if the acquisition had occurred on January 1, 2016. The unaudited pro forma financial information is for informational purposes only and is not necessarily indicative of what the results would have been had the acquisition been completed at the date indicated above, as it may not include all necessary adjustments. Future changes to Maybrooke’s business, such as, but not limited to, the impact from underwriting decisions, changes in risk selection, or retention rates, could result in a material favorable or unfavorable impact on Argo Group’s future results of operations and financial position. The unaudited pro forma results for nine months ended September 30, 2017 include favorable development from prior accident years of $10.5 million, including $6.2 million relating to one specific claim in January 2017. In addition, the $2.5 million of nonrecurring transaction costs directly attributable to the acquisition for nine months ended September 30, 2017, as disclosed above, have also been removed from the unaudited pro forma results in the table below.

 

 

For the Three Months Ended September 30,

 

 

For the Nine Months Ended September 30,

 

(in millions, except per share data)

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Pro forma revenues

 

$

439.2

 

 

$

466.0

 

 

$

1,332.4

 

 

$

1,340.5

 

Pro forma net (loss) income

 

 

(63.4

)

 

 

56.2

 

 

 

29.8

 

 

 

132.9

 

Pro forma net (loss) income per share - basic

 

 

(2.11

)

 

 

1.87

 

 

 

0.99

 

 

 

4.40

 

Pro forma net (loss) income per share - diluted

 

 

(2.11

)

 

 

1.83

 

 

 

0.96

 

 

 

4.30

 

 

 

4.

Investments

Composition of Invested Assets

The amortized cost, gross unrealized gains, gross unrealized losses and fair value of investments were as follows:

 

September 30, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(in millions)

 

Amortized

Cost

 

 

Gross

Unrealized

Gains

 

 

Gross

Unrealized

Losses

 

 

Fair

Value

 

Fixed maturities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Governments

 

$

342.7

 

 

$

0.5

 

 

$

3.2

 

 

$

340.0

 

Foreign Governments

 

 

231.9

 

 

 

7.9

 

 

 

3.5

 

 

 

236.3

 

Obligations of states and political subdivisions

 

 

324.1

 

 

 

11.9

 

 

 

0.8

 

 

 

335.2

 

Corporate bonds

 

 

1,612.7

 

 

 

29.0

 

 

 

9.9

 

 

 

1,631.8

 

Commercial mortgage-backed securities

 

 

147.4

 

 

 

0.4

 

 

 

1.1

 

 

 

146.7

 

Residential mortgage-backed securities

 

 

271.7

 

 

 

3.4

 

 

 

1.6

 

 

 

273.5

 

Asset-backed securities

 

 

156.4

 

 

 

0.7

 

 

 

0.6

 

 

 

156.5

 

Collateralized loan obligations

 

 

252.8

 

 

 

6.6

 

 

 

1.0

 

 

 

258.4

 

Total fixed maturities

 

 

3,339.7

 

 

 

60.4

 

 

 

21.7

 

 

 

3,378.4

 

Equity securities

 

 

347.6

 

 

 

138.2

 

 

 

5.3

 

 

 

480.5

 

Other investments

 

 

553.1

 

 

 

9.5

 

 

 

 

 

 

562.6

 

Short-term investments

 

 

386.0

 

 

 

 

 

 

 

 

 

386.0

 

Total investments

 

$

4,626.4

 

 

$

208.1

 

 

$

27.0

 

 

$

4,807.5

 

11


 

 

December 31, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(in millions)

 

Amortized

Cost

 

 

Gross

Unrealized

Gains

 

 

Gross

Unrealized

Losses

 

 

Fair

Value

 

Fixed maturities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. Governments

 

$

275.1

 

 

$

0.6

 

 

$

4.5

 

 

$

271.2

 

Foreign Governments

 

 

244.2

 

 

 

1.1

 

 

 

8.0

 

 

 

237.3

 

Obligations of states and political subdivisions

 

 

375.7

 

 

 

8.9

 

 

 

1.8

 

 

 

382.8

 

Corporate bonds

 

 

1,316.9

 

 

 

23.3

 

 

 

19.5

 

 

 

1,320.7

 

Commercial mortgage-backed securities

 

 

154.9

 

 

 

0.4

 

 

 

1.6

 

 

 

153.7

 

Residential mortgage-backed securities

 

 

174.8

 

 

 

3.7

 

 

 

1.7

 

 

 

176.8

 

Asset-backed securities

 

 

127.6

 

 

 

0.1

 

 

 

2.1

 

 

 

125.6

 

Collateralized loan obligations

 

 

269.6

 

 

 

3.8

 

 

 

9.1

 

 

 

264.3

 

Total fixed maturities

 

 

2,938.8

 

 

 

41.9

 

 

 

48.3

 

 

 

2,932.4

 

Equity securities

 

 

335.2

 

 

 

117.9

 

 

 

5.7

 

 

 

447.4

 

Other investments

 

 

531.6

 

 

 

7.5

 

 

 

0.1

 

 

 

539.0

 

Short-term investments

 

 

405.5

 

 

 

 

 

 

 

 

 

405.5

 

Total investments

 

$

4,211.1

 

 

$

167.3

 

 

$

54.1

 

 

$

4,324.3

 

 

Included in “Total investments” in our Consolidated Balance Sheets at September 30, 2017 and December 31, 2016 is $154.8 million and $131.9 million, respectively, of assets managed on behalf of the trade capital providers, who are third-party participants that provide underwriting capital to the operations of Syndicate 1200.

Contractual Maturity

The amortized cost and fair values of fixed maturity investments as of September 30, 2017, by contractual maturity, were as follows:

 

(in millions)