In addition to the normal amount of volatility, general liability loss development factors have greater uncertainty due to the complexity of the coverages and the possibly significant periods of time that can elapse between the occurrence of an insured loss, the reporting of the loss to the insurer, and the insurer’s payment of that loss. In our judgment, it is possible that general liability loss development factors could be +/- 5% from those actually selected in our latest reserve analysis. If the loss development assumptions were changed by +/- 5% that would increase/decrease our indicated general liability reserves by approximately $83 million for accident years 2008 and prior.
The elimination of retiree life insurance benefits for current employees amounting to a total benefit of $4.2 million, pre-tax, in the first quarter of 2009.
We are providing 2010 guidance that includes a combined ratio of approximately 101.5% on both a GAAP and statutory basis reflecting catastrophe losses of 1.6 points. These combined ratios do not include any assumptions for reserve development, favorable or unfavorable. Weighted average shares at year-end 2010 are expected to be approximately 54 million.
Reductions in net renewals of $24.5 million, to $1.1 billion, in 2009 including reductions in retention of one point in 2009 from 2008; and
The improvement in the statutory combined ratio in 2009 was driven by a decrease in catastrophe losses of $18.7 million, or 9.5 points, partially offset by an increase in non-catastrophe property losses of $3.0 million, or 1.0 points, compared to 2008. The increased levels of total property losses during 2008 were mainly due to weather-related activity such as water damage and claims resulting from freezing pipes, as well as fire losses.
We believe the various rate increases taken over the last three years illustrated below will help us achieve our goal of being profitable in this line of business.
We have continued to strive to structure our portfolio conservatively with a focus on: (i) asset diversification; (ii) investment quality; (iii) liquidity, particularly to meet the cash obligations of our Insurance Operations segment; (iv) consideration of taxes; and (v) preservation of capital. In an effort to preserve capital and further reduce the risk in our investment portfolio, we took certain actions during 2009, which included the following:
As discussed in Note 3 and Note 5. to the consolidated financial statements, the Company changed its method of evaluating other-than-temporary impairments of fixed maturity securities due to the adoption of new accounting requirements issued by the Financial Accounting Standards Board as of April 1, 2009.
Prior to April 1, 2009, when the decline in fair value below amortized cost of a fixed maturity security was deemed to be other than temporary, the investment was written down to fair value and the amount of the write-down was charged to income as a realized loss. A decline in fair value on a fixed maturity security was deemed to be other than temporary if we did not have the intent and ability to hold the security to its anticipated recovery. Effective April 1, 2009 with the adoption of revised OTTI accounting guidance, see Note 3., unless we have the intent to sell, or it is more likely than not that we may be required to sell, a fixed maturity security, an other-than-temporary impairment is only recognized as a realized loss to the extent it is credit related. If there is a decline in fair value below amortized cost on a fixed maturity security that we intend to sell or, more-likely-than-not, may be required to sell, the impairment is considered other than temporary, and the security is written down to fair value with the amount of the write-down charged to earnings as a component of realized losses.
For structured securities, including CMBS, RMBS, ABS, and CDOs, we project the future cash flows using various expected default, severity, and prepayment assumptions based on security type and vintage, taking into consideration information from credit agencies, historical performance, and other relevant economic and performance factors.
We use a conditional default rate assumption in the present value calculation to estimate future defaults. The conditional default rate is the proportion of all loans outstanding in a security at the beginning of a time period that is expected to default during that period. Our assumption of this rate takes into consideration the uncertainty of future defaults as well as whether or not these securities have experienced significant cumulative losses or delinquencies to date. We use the conditional default rates used during our initial evaluation for each security as a reference point, but we may ultimately use rates at more elevated levels in the discounted cash flow analysis in order to determine our best estimate of the present value of future cash flows.
We estimate an allowance for doubtful accounts on our premiums receivable. This allowance is based on historical write-off percentages adjusted for the effects of current and anticipated trends.
In May 2008, the FASB issued guidance under ASC 470, Debt, which was formerly referred to as FSP No. APB 14-1, Accounting for Convertible Debt Instruments that may be Settled in Cash upon Conversion (Including Partial Cash Settlement). This guidance applies to convertible debt instruments that, by their stated terms, may be completely or partially settled in cash (or other assets) upon conversion, unless the embedded conversion option is required to be separately accounted for as a derivative under FASB ASC 815, Derivatives and Hedging. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The adoption of this guidance did not have a material impact on our financial condition or results of operations for any period presented.
1 U.S. government includes corporate securities fully guaranteed by the FDIC with a fair value of $136.2 million
The discussion that follows will focus on fixed maturity securities in an unrealized loss position for more than 12 months, which amounted to $44.3 million. Specifically, we will focus on the following categories:
Under all scenarios performed, these securities did not indicate that the impairment is other than temporary.
$11.8 million of CMBS credit OTTI charges during 2009. These charges taken during the year related to reductions in the related cash flows of the underlying collateral of these securities. These securities, on average, showed signs of loss at conditional default rates between 2.5 to 3.0 and had declines in fair value of 77% as compared to their amortized cost. As a result, we do not believe it is probable that we will receive all contractual cash flows for these securities.
$1.3 million of corporate debt credit OTTI charges during 2009. In assessing corporate debt securities for OTTI, we evaluate, among other things, the issuer’s ability to meet its debt obligations, the value of the company, and, if applicable, the value of specific collateral securing the position. The charge taken in 2009 was related to a financial institution issuer that was on the verge of bankruptcy at the end of the second quarter of 2009. This security was sold subsequent to the charge at an additional loss of $1.1 million in the third quarter of 2009.
As of December 31, 2009, as the result of our OTTI analysis, we impaired approximately $7.8 million of HTM securities down to fair value, which are typically not carried at fair value. These securities consisted of: (i) one ABS security, fair valued at $2.4 million; and (ii) six CMBS, fair valued at $5.4 million. All of these fair values were determined using Level 2 pricing.
In 2009, we experienced favorable loss development of approximately $29 million, which was primarily driven by favorable loss development in accident years 2007 and prior, which was partially offset by unfavorable loss development in accident year 2008 of $29 million. The main driver of this development was favorable prior year development in our workers compensation, commercial automobile and general liability lines of business. Workers compensation experienced favorable prior year development of approximately $11 million primarily driven by favorable development of $36 million in accident years 2005 to 2007 reflecting the on-going impact from a series of improvement strategies for this line in recent years, partially offset by adverse development of approximately $22 million due to higher than expected severity in accident year 2008. Commercial automobile experienced favorable development of approximately $10 million driven by lower than anticipated severity emergence primarily in accident year 2007. General liability experienced favorable development of approximately $8 million driven by favorable loss emergence for accident years 2004 through 2007, partially offset by adverse development in our products/completed operations business.
(5) In the first quarter of 2009, Selective Insurance Company of the Southeast and Selective Insurance Company of South Carolina (“Indiana Subsidiaries”) joined and invested in the FHLBI, which provides them with access to additional liquidity. The Indiana Subsidiaries’ aggregate investment is $0.7 million and this investment provides the ability to borrow up to 20 times the total amount of the FHLBI common stock purchased with additional collateral, at comparatively low borrowing rates. All borrowings from FHLBI are required to be secured by certain investments. On December 15, 2009, the Indiana Subsidiaries borrowed $9 million and $4 million, respectively, from the FHLBI. The unpaid principal amount accrues interest of 2.9% and is paid on the 15th of every month. The principal amount is due on December 15, 2014.
The Line of Credit agreement contains representations, warranties and covenants that are customary for credit facilities of this type, including, without limitation, financial covenants under which we are obligated to maintain a minimum consolidated net worth, minimum combined statutory surplus, and maximum ratio of consolidated debt to total capitalization, and covenants limiting our ability to: (i) merge or liquidate; (ii) incur debt or liens; (iii) dispose of assets; (iv) make investments and acquisitions; (v) repurchase common stock; and (vi) engage in transactions with affiliates. The Line of Credit permits collateralized borrowings by the Indiana Subsidiaries from the FHLBI so long as the aggregate amount borrowed does not exceed 10% of the respective Indiana Subsidiary’s admitted assets from the preceding calendar year.
SICA offers a nonqualified deferred compensation plan ("Deferred Compensation Plan") to a group of management or highly compensated employees (the "Participants") as a method of recognizing and retaining such employees. The Deferred Compensation Plan provides the Participants the opportunity to elect to defer receipt of specified portions of compensation and to have such deferred amounts deemed to be invested in specified investment options. A Participant in the Deferred Compensation Plan may elect to defer compensation or awards to be received, including up to: (i) 50% of annual base salary; (ii) 100% of annual bonus; and/or (iii) a percentage of other compensation as otherwise designated by the Administrator of the Deferred Compensation Plan.
Our measurement date was December 31, 2009 and our expected return on plan assets was 8.0%, which was based primarily on the Retirement Income Plan's long-term historical returns. Our expected return approximates our actual 7.2% annualized return achieved since plan inception for all plan assets. We have kept our expected return on plan assets at 8.0% after examining recent market conditions and trends. In addition to the plan's historical returns, we consider long-term historical rates of return on the respective asset classes.
At December 31, 2009, the liability recorded in connection with our Cash Incentive Plan was $6.0 million. The fair value of the liability is re-measured at each reporting period through the settlement date of the awards, which is three years from the date of grant based on an amount expected to be paid. A Monte Carlo simulation is performed to determine the fair value of the cash incentive units that, in accordance with the Cash Incentive Plan, are adjusted to reflect our performance on specified indicators as compared to targeted peer companies. The remaining cost associated with the cash incentive units is expected to be recognized over a weighted average period of 1.5 years. During 2009, the cash incentive payment made was $7.0 million. In 2008 and 2007, no cash incentive unit payments were made.
The weighted-average fair value of options and stock, including restricted stock and RSUs granted per share for the Parent's stock plans, during 2009, 2008, and 2007 is as follows:
We paid reinsurance commissions of $0.2 million in 2008 and 2007 to PL, LLC. There were no reinsurance commissions paid to PL, LLC during 2009. PL, LLC is an insurance fund administrator that places reinsurance through an Insurance Subsidiary. As of December 31, 2008, Rue Insurance owned 33.33% of PL, LLC.
In August 1998, certain officers of our company purchased stock on the open market with proceeds advanced by us. These officers gave our company promissory notes totaling $1.8 million. The promissory notes bore interest at 2.5% and were secured by the purchased shares of the Parent's common stock. The promissory notes were full recourse and subject to certain employment requirements. The principal amount outstanding was fully repaid in March 2009 and was $0.1 million at December 31, 2008 and $0.2 million at December 31, 2007.