Since 2016, the Company's property and casualty insurance subsidiaries and Employers Mutual have been parties to an inter-company reinsurance program. This reinsurance program is intended to reduce the volatility of the Company's quarterly results caused by excessive catastrophe and storm losses, and provide protection from both the frequency and severity of such losses. The reinsurance program consists of two semi-annual aggregate catastrophe excess of loss treaties. The first treaty is effective each year from January 1 through June 30, and has a retention of $20.0 million and a limit of $24.0 million. The total cost of this treaty was approximately $6.0 million in 2017 and $6.3 million in 2016. The second treaty is effective each year from July 1 through December 31, and has a retention of $15.0 million and a limit of $12.0 million. The total cost of this treaty was approximately $1.4 million in 2017 and $1.5 million in 2016. Losses and settlement expenses ceded to Employers Mutual under this program totaled $19.2 million in 2017 and $7.5 million in 2016. All catastrophe and storm losses assumed by the property and casualty insurance subsidiaries (net of applicable reinsurance recoveries from external reinsurance protections purchased by the pool participants) are subject to the terms of these treaties, and there is no co-participation provision.
Similar to the loss reserving process, the Company uses standard actuarial methods to produce estimates of ultimate ratios by accident year and line of business for allocated settlement expenses. Underlying each selection are explicit assumptions regarding the ultimate claim frequency and settlement expense severity associated with the selected estimated ultimate ratio. As the assumptions are based on estimates made at a specific point in time, it is likely that the ultimate allocated settlement expense ratios will vary upwards or downwards from prior estimates. The expected variation will be greater for less mature accident years, and decreases as each accident year ages. This uncertainty is reflected in the unpaid allocated settlement expense estimates underlying the selected estimated ultimate ratios, which produce the carried allocated settlement expense reserves. Assuming the unpaid allocated settlement expense estimates are unbiased, the cumulative impact on the Company's results of operations of a one percent variance in the associated allocated settlement expense reserves over the lifetime of the underlying claims is shown below. A variance in carried allocated settlement expense reserves would also affect the Company’s financial position in that the Company’s equity would be impacted by an amount equivalent to the change in net income. A one percent variance in the unpaid allocated settlement expense estimates underlying the selected estimated ultimate allocated settlement expense ratios is considered reasonably likely based on the range of actuarial indications developed during the analysis of the property and casualty insurance segment’s carried allocated settlement expense reserves. The after tax impact on earnings is calculated using the federal corporate tax rate of 35 percent.
Following is a summary of the carried loss and settlement expense reserves for the reinsurance segment at December 31, 2017 and 2016.
At December 31, 2017, the carried reserves for HORAD and MRB combined were in the upper third of the range of actuarial reserve indications. This selection reflects the fact that there are inherent uncertainties involved in establishing reserves for assumed reinsurance business. Such uncertainties include the fact that a reinsurance company generally has less knowledge than the ceding company about the underlying book of business and the ceding company’s reserving practices. Because of these uncertainties, there is a risk that the reinsurance segment’s reserves for losses and settlement expenses could prove to be inadequate, with a consequential adverse impact on the Company’s future earnings and stockholders’ equity.
Prior to 2008, actual losses paid for asbestos-related claims had been minimal due to the plaintiffs’ failure to identify an exposure to any asbestos-containing products associated with the pool participants’ current and former policyholders. However, paid losses and settlement expenses have increased significantly since 2008 as a result of claims attributed to one former policyholder. During the period 2009 through 2017, the Company's share of paid losses and settlement expenses attributed to this former policyholder, a furnace manufacturer, was $12.5 million (mostly settlement expenses). The asbestos exposure associated with this former policyholder has increased in recent years, and this trend may possibly continue into the future with increased per plaintiff settlements. Settlement expense payments associated with this former policyholder have increased significantly since 2008 and have been a driver behind recent reserve increases. The primary cause of this increase in paid settlement expenses is the retention of a national coordinating counsel in 2008 due to this former policyholder’s exposure in numerous jurisdictions. The national coordinating counsel has provided, and continues to provide, significant services in the areas of document review, discovery, deposition and trial preparation. Approximately 692 asbestos exposure claims associated with this former policyholder remain open. During 2017, a settlement was reached with another former insured, resulting in the Company recognizing $4.5 million (its share) of losses and settlement expenses stemming from the settlement of claims for past and future legal fees and losses on a multi-year asbestos exposure.
The Company has exposure to construction defect claims arising from general liability policies issued by the pool participants to contractors. Most of the pool participants’ construction defect claims are concentrated in a limited number of states, and the pool participants have taken steps to mitigate this exposure. Construction defect is a highly uncertain exposure due to such issues as whether coverage exists, definition of an occurrence, determination of ultimate damages, and allocation of such damages to financially responsible parties. Newly reported construction defect claims numbered 463, 374 and 338 in 2017, 2016 and 2015, respectively, and produced incurred losses and paid settlement expenses of approximately $4.8 million, $3.6 million and $3.2 million in each respective period. Incurred losses and paid settlement expenses on all construction defect claims totaled approximately $6.4 million in 2017. At December 31, 2017, the Company carried case loss reserves of approximately $7.4 million on 427 open construction defect claims.
Results of operations by segment and on a consolidated basis for the three years ended December 31, 2017 are as follows:
2 During 2015, a reallocation of reserves from the current accident year to prior accident years on a two-year contract produced $1.0 million of adverse development that is "mechanical in nature" and had no impact on earnings. This development amount has been excluded from the favorable development amount presented for 2015 to improve comparability.
Because the change in the deferred tax liability was recognized in net income, the amounts contained in the accumulated other comprehensive income line in stockholders' equity continued to reflect deferred income taxes at the previous 35 percent tax rate (commonly referred to as "stranded tax effects"). In February 2018, the Financial Accounting Standards Board issued updated guidance to allow a reclassification to be made from accumulated other comprehensive income to retained earnings for the stranded tax effects resulting from the enactment of the TCJA. The Company adopted this guidance in 2017, and transfered the stranded tax effects in accumulated other comprehensive income to retained earnings. The consolidated balance sheet that was included in the Company's February 8, 2018 earnings release announcing 2017 results did not reflect this reclassification, as it was not permitted at that time.
The loss and settlement expense ratio for the property and casualty insurance segment decreased to 64.1 percent in 2017 from 64.5 percent in 2016. Lower catastrophe and storm losses and an improvement in the underlying loss and settlement expense ratio were the primary drivers of the decline in the loss and settlement expense ratio. Catastrophe and storm losses, net of the amounts ceded to Employers Mutual under the inter-company reinsurance program, accounted for 6.3 percentage points of the loss and settlement expense ratio in 2017, compared to 7.7 percentage points in 2016. The property and casualty insurance subsidiaries ceded $19.2 million of catastrophe and storm losses to Employers Mutual under the inter-company reinsurance program in 2017, compared to $7.5 million in 2016. Taking the loss recoveries and the premiums paid to Employers Mutual into consideration, the inter-company reinsurance program reduced the property and casualty insurance segment's loss and settlement expense ratios by 3.1 and 0.5 percentage points for the years ended December 31, 2017 and 2016, respectively. The inter-company reinsurance program has been renewed for 2018. The only change is a $2 million increase in the retention amount under the treaty covering the first half of the year (from $20.0 million to $22.0 million). The cost of the program will remain at $7.4 million. The underlying loss and settlement expense ratio improved during the second half of 2017, primarily reflecting reductions in the current accident year ultimate loss and settlement expense ratio projections in the commercial property and other liability lines of business. The commercial auto and personal lines of business, which posted loss and settlement expense ratios of 85.4 percent and 72.1 percent, respectively, in 2017, continue to under perform. Management continues to devote a significant amount of time and effort to the initiatives that have been undertaken to improve the performance of these lines of business, including rate increases and more selective risk selection.
Included in other income (loss) are foreign currency exchange gains and losses recognized on the reinsurance segment’s foreign currency denominated reinsurance business. The reinsurance segment had foreign currency exchange losses of $1.6 million in 2017 compared to gains of $356,000 in 2016.
The Company’s cash balance was $347,000 and $307,000 at December 31, 2017 and 2016, respectively.
Fixed maturity securities held by the Company generally have an investment quality rating of “A” or better by independent rating agencies. The following table shows the composition of the Company’s fixed maturity securities, by rating, as of December 31, 2017.