Personal Lines gross and net premiums written declined during 2006 resulting primarily from the rate reductions taken in a number of states in both the personal auto and homeowners product lines, which drove approximately half of the decline in premiums, and lower in-force counts when compared to 2005. This decline is partially offset by a 7.4% increase in new business premium production and slightly improved policy retention ratios when compared to 2005. Both gross and net premiums written declined in 2005 when compared to 2004 due to a decline in new business premium production and rate reductions taken in the latter half of 2005, as well as a lower policy retention ratio.
Accident year 2006 as of December 31, 2006 measures insured events for the twelve months of 2006. Accident year 2005 as of December 31, 2006 measures insured events for the twelve months of 2005 with remaining related liabilities estimated as of December 31, 2006. Accident year 2004 as of December 31, 2006 measures insured events for the twelve months of 2004 with remaining related liabilities estimated as of December 31, 2006. Accident periods may not be comparable due to seasonality, claim reporting and development patterns, claim settlement rates and other factors.
The personal auto including personal umbrella product line combined ratio increased in 2006 due to an 8.2 point increase in the loss and LAE ratios driven by margin compression, higher catastrophe losses, an increase of $5.5 in legal settlement provision for uninsured/underinsured claims handling practices and less favorable prior year reserve development in the current year compared to 2005. The underwriting expense ratio increased 3.4 points primarily the result of an increase in the legal settlement provision discussed above partially offset by lower incentive and contingent commission accruals. The combined ratio improved from 2004 to 2005, due to improvement in the loss and LAE ratios driven by favorable prior year reserve development and a 6.7 point improvement in the underwriting expense ratio due to the same reasons cited above for the Personal Lines segment.
The personal property product line combined ratio increased 10.3 points due to less favorable prior year reserve development in 2006 compared to 2005, higher catastrophe losses and margin compression, partially offset by improvement in the underwriting expense ratio of 1.3 points due to lower incentive and contingent commission accruals. The improvement in the combined ratio from 2004 to 2005 is driven by a 14.4 point improvement in the loss and LAE ratios due primarily to favorable prior year reserve development.
The following tables summarize for all available-for-sale and held-to-maturity securities, the total gross unrealized losses, excluding securities with gross unrealized gains, by investment category and length of time the securities have continuously been in an unrealized loss position as of December 31, 2006 and December 31, 2005:
In 2006, the amortization and impairment costs related to this asset were $12.8 compared with $12.3 in 2005 and $20.6 in 2004. At December 31, 2006, the largest individual agent asset carrying value was $5.0, which represents the maximum future impairment charge for an individual agent, compared to $5.3 at December 31, 2005. Based upon historical performance of this agent, it is unlikely the agent will become impaired or cancelled in the near term. For the approximately 215 individual agents remaining that represent the total agent relationships intangible asset, the average asset carrying value as of December 31, 2006, was $0.5 which compares to approximately 230 agents with an average asset carrying value of $0.5 at December 31, 2005. At December 31, 2006 and 2005, the agent relationships asset balance was $96.9 and $109.7, respectively.
The Group’s largest liabilities are reserves for losses and LAE. Loss and LAE reserves (collectively “loss reserves”) are established for all incurred claims without discounting for the time value of money. Before credit for reinsurance recoverables, these reserves amounted to $2.9 billion at both December 31, 2006 and 2005, respectively. As of December 31, 2006, the loss reserves by operating segment were as follows: $1,897.7 Commercial Lines, $641.9 Specialty Lines and $372.7 Personal Lines. The Group purchases reinsurance to mitigate the impact of large losses and catastrophic events. Loss reserves ceded to reinsurers amounted to $585.7 and $684.6 at December 31, 2006 and 2005, respectively.
Workers’ compensation represents approximately 30% of loss reserves on a net of reinsurance basis. The coverage provided includes indemnity and medical benefits generally defined by state regulation. Indemnity benefits compensate the injured worker for wage replacement, while the medical benefits generally provide unlimited coverage for a work-related accident for the life of the claimant. Many workers’ compensation claims are small and are settled within a year or two of the accident date. However, some of the claims are serious, resulting in costs that can extend for decades. Therefore, this is considered a long-tail coverage. For workers’ compensation loss reserves net of reinsurance at year-end 2006, approximately 60% are related to claims over five years old, and approximately 40% are related to claims over ten years old.
The limits provided by the policy or policies covering the event
Commercial multi-peril provides a combination of property and liability coverage and therefore includes both short and long-tail coverages. For property coverage, it generally takes a relatively short period of time to close claims, and thus there is relatively little reserving risk. The reserving risk for this line is dominated by the liability coverage portion of this product, which is the same as the general liability product described above including asbestos and environmental exposures which are discussed in detail on the following page.
Net cash provided by operations was $147.2 in 2006 compared with $267.9 and $270.6 in 2005 and 2004, respectively. The decline in cash provided by operations is primarily the result of the purchase of company owned life insurance to help offset the increase in future benefit costs, increased income tax payments, incentive plan payments and contributions to the Company’s retirement plan. The reinsurance recoverable asset decreased $108.0, primarily related to a reduction in ceded loss reserves, which declined $98.9 during 2006, a result of favorable development in the commercial umbrella product line and reduced ceded reserve cessions related to increased Group retention levels. The net cash provided by operations was essentially flat from 2005 to 2004 due primarily to continued decline in paid losses and LAE of $50.3 in 2005, a result of improved loss experience and $4.9 received from the settlement of IRS examinations. For more information on the IRS settlement, see Item 15, Note 3 - Income Taxes, in the Notes to the Consolidated Financial Statements on page 76 of this Annual Report on Form 10-K. The impact of these items were offset by a decline in net premiums written in 2005 and a decrease in reinsurance treaty funds held of $44.6. The decrease in the reinsurance treaty funds held is related to withdrawals to pay claims qualified under this contract of reinsurance, which was terminated on December 31, 2004 and is in run-off.
The NAIC has developed a “Risk-Based Capital” formula for property and casualty and life insurers. The formula is intended to measure the adequacy of an insurer’s capital given the asset and liability structure and product mix of the company. As of December 31, 2006 and 2005, all insurance companies in the Group significantly exceeded the necessary capital requirements.