Combined ratio - We believe our underwriting philosophy and initiatives can drive performance to achieve our underwriting profitability target of a GAAP combined ratio over any five-year period that consistently averages within the range of 95 percent to 100 percent. Our GAAP combined ratio averaged 99.3 percent over the five-year period 2010 through 2014. Performance as measured by the combined ratio is discussed in Consolidated Property Casualty Insurance Results. Our statutory combined ratio averaged 98.8 percent over the five-year period 2010 through 2014 compared with an estimated 100.7 percent for the property casualty industry. The industry’s ratio again excludes its mortgage and financial guaranty lines of business.
Our life insurance segment reported a modest loss in 2014 and a modest profit in 2013, netting to a $4 million profit for both years combined. We discuss results for the segment in Life Insurance Results. Most of this segment’s investment income is included in our investments segment results. In addition to investment income, realized investment gains from the life insurance investment portfolio are also included in our investments segment results.
We discuss in our Item 1A, Risk Factors, many potential risks to our business and our ability to achieve our qualitative and quantitative objectives. These are real risks, but their probability of occurring may not be high. We also believe that our risk management programs generally could mitigate their potential effects, in the event they would occur.
For loss expenses that pertain primarily to salaries and other costs related to our claims department associates, also referred to as adjusting and other expense or AOE, we calculate reserves based on an analysis of the relationship between paid losses and paid AOE. Reserves for AOE are allocated to company, line of business and accident year based on a claim count algorithm.
models and methods for estimating IBNR reserves for our lines of business tends to depend on a line’s tail. Tail refers to the time interval between a typical claim’s occurrence and its settlement. For our long-tail lines such as workers’ compensation and commercial casualty, models from the probabilistic trend family tend to provide superior fits and to validate well compared with models underlying the loss development and Bornhuetter-Ferguson methods. The loss development and Bornhuetter-Ferguson methods, particularly the reported loss variations, tend to produce the more appropriate IBNR reserve estimates for our short-tail lines such as homeowner and commercial property. For our mid-tail lines such as personal and commercial auto liability, all models and methods provide useful insights.
Securities that have previously been other-than-temporarily impaired are evaluated based on their adjusted cost or amortized cost and further written down, if deemed appropriate. We provide detailed information about securities fair valued in a continuous loss position at year-end 2014 in Item 7A, Application of Asset Impairment Policy.
provide us the ability to hold these investments through what we believe to be slightly longer recovery periods during times of historic levels of market volatility.
While our commercial lines new business written premiums were down in 2014, compared with 2013, we continued to increase pricing. That indicates continued improvement in our book of business. We believe that competition increased somewhat in 2014, compared with the previous few years. For 2015, it remains to be seen how that will play out, despite opinions about generally softening pricing in the commercial lines market.
Our excess and surplus lines insurance segment includes results of The Cincinnati Specialty Underwriters Insurance Company and CSU Producer Resources Inc. The year 2014 represented our seventh full year of operations for our excess and surplus lines insurance segment. Performance highlights for this segment include:
Computer software - We expect to spend approximately $16 million over the next three years for current material commitments for computer software, including maintenance contracts on hardware and other known obligations.
Workers’ compensation - We continue to see favorable reserve development, for all prior accident years in aggregate. During 2014, the trend for estimated payments to be made in future calendar years was down slightly. However, we continue to monitor this line closely, as a sudden increase in trend for future payments has a highly leveraged effect. During 2013, paid loss amounts were higher than we expected for several older accident years, and we increased our reserve estimates accordingly. Initiatives to improve profitability of our workers’ compensation line of business are discussed in Commercial Lines Insurance Results, Commercial Lines of Business Analysis.
For the excess and surplus lines insurance segment, the table showing reserves by segment and lines of business in Property Casualty Loss and Loss Expense Obligations and Reserves, shows the components of gross reserves among case, IBNR and loss expense reserves. Total gross reserves were up $45 million from year-end 2013 primarily due to the increase in premiums and exposures for this segment, as we discussed in Excess and Surplus Lines Insurance Results. Favorable development during 2014 of $29 million for excess and surplus lines insurance segment reserves, shown in the table above, illustrates the potential for revisions inherent in estimating reserves. During 2011, we began to rely more heavily on development patterns from our own excess and surplus lines business, contributing to the modest decrease in reserves, especially for the defense and cost containment portion of loss expense reserves.
Included within our other invested assets are $31 million of life policy loans and $37 million of private equity investments. Life policy loans are carried at the receivable value. The private equity investments provide their financial statements to us and generally report investments on their balance sheets at fair value. We use the equity method of accounting for private equity investments.
investments in equity and fixed-maturity securities (including redeemable preferred stock and assets held in separate accounts) on quoted market prices or on prices from a pricing vendor, an outside resource that supplies global securities pricing, dividend, corporate action and descriptive information to support fund pricing, securities operations, research and portfolio management. The company obtains and reviews the pricing service’s valuation methodologies and related inputs and validates these prices by replicating a sample across each asset class using a discounted cash flow model. When a price is not available from these sources, as in the case of securities that are not publicly traded, we determine the fair value using various inputs including quotes from independent brokers. The fair value of investments not priced by a pricing vendor is less than 1 percent of the fair value of our total investment portfolio.
In May 2014, the Financial Accounting Standards Board (FASB) issued ASU 2014-09, Revenue from Contracts with Customers. ASU 2014-09 requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. Insurance contracts do not fall within the scope of this ASU. The effective date of ASU 2014-09 is for annual reporting periods beginning after December 15, 2016. The ASU has not yet been adopted; however, there is not expected to be a material impact on our company’s consolidated financial position, cash flows or results of operations.
Level 3 - Financial assets and liabilities for which values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. Level 3 inputs include the following:
The following tables illustrate the fair value hierarchy for those assets measured at fair value on a recurring basis at December 31, 2014 and 2013. We do not have any material liabilities carried at fair value. There were no transfers between Level 1 and Level 2 for the years ended December 31, 2014 and 2013.
The table below shows beginning and end of year accumulated other comprehensive income or loss for investments, pension obligations, life deferred acquisition costs, life policy reserves and other. The changes from the beginning of year to the end of year are the result of changes to other comprehensive income or loss (OCI).
The provision for federal income taxes is based upon filing a consolidated income tax return for the company and its subsidiaries. As of December 31, 2014 and 2013, we had no operating or capital loss carry forwards.
The statute of limitations for federal tax purposes have closed for tax years 2008 and earlier. Although all issues for tax years 2009 and 2010 have been settled and agreed to, the statute of limitations for these two tax years remains open until December 31, 2015. Our recent settlement with the IRS of tax years 2009 and 2010 resulted in no material changes to the returns as filed.
Options outstanding and exercisable consisted of the following at December 31, 2014:
Risk-free rates are equal to the yield, as of the measurement date, of the zero-coupon U.S. Treasury bill that is commensurate with the performance measurement period. Risk-free rates used were 0.66 percent for 2014 and 0.40 percent for 2013 grants.
For the life insurance segment, we calculate underwriting profit or loss as premiums earned and separate account investment management fees, minus contract holders’ benefits and expenses incurred, plus investment interest credited to contract holders.