As further described in Note 2 - “Acquisitions and Discontinued Operations” on pages 96 to 98 of the Notes to Consolidated Financial Statements included in Financial Statements and Supplementary Data of this Form 10-K, we acquired Chaucer on July 1, 2011, which has added meaningful business volumes to the six months ended December 31, 2011 and has affected the comparability of our consolidated financial statements and related footnotes. For the year ended December 31, 2011, our discussion of the results of operations reflects Chaucer’s results only for the period from July 1, 2011 through December 31, 2011, while the Commercial Lines, Personal Lines, and Other Property and Casualty segments include results for all of 2011. Results of operations for the comparable periods in 2009 and 2010 do not include any results of Chaucer. Chaucer’s financial results for the six months ended December 31, 2011 will be discussed separately.
Growth in our specialty lines continues to be a significant part of our strategy. The expansion of product offerings in our specialized lines has been supported by several acquisitions over the past several years. Our Commercial Lines segment net written premium grew by 7.5% in 2011, with contributions from both our specialty lines and core segments. Our net earned premium increased by 19.5% in 2011, primarily as a result of fully earning in premiums written previously pursuant to the 2010 renewal rights transaction with OneBeacon Insurance Group (“OneBeacon”).
Segment income was $72.5 million for the year ended December 31, 2011, compared to $227.7 million for the year ended December 31, 2010, a decrease of $155.2 million. Chaucer’s results accounted for $32.3 million of segment income for the year ended December 31, 2011. Catastrophe related activity for our Commercial and Personal Lines businesses was $312.1 million for the year ended December 31, 2011, compared to $160.3 million for the same period in 2010, an increase of $151.8 million. Excluding the impact of catastrophe related activity, earnings for our Commercial and Personal Lines businesses would have decreased by $35.7 million. This decrease was primarily due to higher non-catastrophe weather-related losses and LAE and lower favorable development on prior years’ loss and LAE reserves, partially offset by growth in earned premium and the resulting positive effect on our expense ratio and what we believe is an underlying improvement in our mix of business. Favorable development on prior years’ loss and LAE reserves for the year ended December 31, 2011 was $67.8 million compared to $111.1 million in the prior year, a decrease of $43.3 million.
Segment income was $227.7 million for the year ended December 31, 2010, compared to $270.1 million for the year ended December 31, 2009, a decrease of $42.4 million. Catastrophe related activity for our Commercial and Personal Lines businesses was $160.3 million for the year ended December 31, 2010, compared to $98.9 million for the same period in 2009, an increase of $61.4 million. This increase was primarily related to several severe hail, wind and thunderstorm events, particularly in the first half of 2010. Excluding the impact of catastrophe related activity, segment income would have increased by $19.0 million. This increase was primarily due to more favorable current accident year loss results with improvements in both Commercial and Personal Lines, partially offset by lower favorable development on prior years’ loss and LAE reserves, higher expenses and slightly lower net investment income. Favorable development on prior years’ loss and LAE reserves for the year ended December 31, 2010 was $111.1 million compared to $155.3 million in the prior year, a decrease of $44.2 million.
Our ability to increase Commercial Lines net premiums written while maintaining or improving underwriting results may be affected by competition and the current challenging economic environment.
Some risk factors affect multiple lines of business. Examples include changes in claim department practices, changes in settlement patterns, regulatory and legislative actions, court actions, timeliness of claim reporting, state mix of claimants, and degree of claimant fraud. Additionally, there is also a higher degree of uncertainty due to growth in our newly acquired businesses, with respect to which we have less familiarity and, in some cases, limited historical claims experience. The extent of the impact of a risk factor will also vary by components within a line of business. Individual risk factors are also subject to interactions with other risk factors within line of business components. Thus, risk factors can have offsetting or compounding effects on required reserves.
We are also defendants in various litigation matters, including putative class actions, which may claim punitive damages, bad faith or extra-contractual damages, legal fees and interest, or claim a broader scope of policy coverage than our interpretation. Resolution of these cases are often highly unpredictable and could involve material unanticipated damage awards.
As stated above, numerous factors (both internal and external) contribute to the inherent uncertainty in the process of establishing loss reserves, including changes in the rate of inflation for goods and services related to insured damages (e.g., medical care, home repairs, etc.), changes in the judicial interpretation of policy provisions, changes in the general attitude of juries in determining damage awards, legislative actions, changes in the extent of insured injuries, changes in the trend of expected frequency and/or severity of claims, changes in our book of business (e.g., change in mix due to new product offerings, new geographic areas, etc.), changes in our underwriting practices, and changes in claim handling procedures and/or systems. Regarding our indirect business from voluntary and involuntary pools, we are provided loss estimates by managers of each pool. We adopt reserve estimates for the pools that consider this information and other facts.
For events designated as catastrophes which affect our Chaucer business segment, we initially calculate IBNR reserves using a ground up exposure by exposure analysis based on each cedant or insured. These are supported by broker supplied information, catastrophe modeling and industry event estimates. As more specific claim level data becomes available over time for each catastrophe event, these initial estimates are revised and updated by claim frequency and severity modeling as described above, as appropriate for each event.
Although we attempt to limit our exposures to asbestos and environmental damage liability through specific policy exclusions, we have been and may continue to be subject to claims related to these exposures. Ending loss and LAE reserves for all direct business written by our property and casualty companies related to asbestos and environmental damage liability were $10.0 million, $10.1 million and $11.3 million, net of reinsurance of $18.7 million for 2011 and $19.9 million for both 2010 and 2009. During 2011, there was minimal activity for our asbestos and environmental
Our municipal bond portfolio constitutes approximately 14% of invested assets at December 31, 2011 and is 99% investment grade, without regard to any insurance enhancement. Currently, approximately 29% of the municipal bond portfolio has an insurance enhancement. The portfolio is well diversified by geography, sector and source of payment, and consists primarily of taxable securities. Approximately 61% of the portfolio is invested in revenue bonds and 39% in general obligation bonds. Revenue bonds are backed by the revenue stream generated by the services provided by the issuer, while general obligation bonds are backed by the authority that issued the debt and are secured by the taxing powers of those authorities.
We believe the remaining deferred tax asset from other temporary differences will be fully realizable based on our projected future taxable income and recent financial operations. Although we believe that these assets are fully recoverable, there can be no certainty that future events will not affect their recoverability. Future economic conditions and debt market volatility, including increase in interest rates, can adversely impact our tax planning strategies.
Corporate member - A company admitted to membership of Lloyd’s and which provides capital in support of a Lloyd’s syndicate to enable the syndicate to undertake underwriting risks.
The foregoing allocation of the purchase price is based on information that was available to management at the time the consolidated financial statements were prepared. The allocation may change as additional information becomes available; the impact of such changes, if any, may be material. Transaction costs associated with the acquisition, which included advisory, legal, and accounting costs, were expensed as incurred. Allowances for uncollectible accounts related to reinsurance recoverables are not significant at July 1, 2011.
The Company holds overseas deposits of $135.1 million at December 31, 2011 which are investments held in overseas funds and managed exclusively by Lloyd’s. These investments are reflected in other investments in the Consolidated Balance Sheet.
The Company’s Series B 8.207% Subordinated Deferrable Interest Debentures (“Junior Debentures”) have a face value of $59.7 million and $129.2 million as of December 31, 2011 and 2010, respectively.
The Company or its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state jurisdictions, as well as foreign jurisdictions. With few exceptions, the Company and its subsidiaries are no longer subject to U.S. federal income tax examinations by tax authorities for years before 2007. The IRS audits of the years 2007 and 2008 commenced in April 2010. In 2011, the Company received a RAR for the 2007 and 2008 IRS audit. The Company has agreed to all proposed adjustments other than a disallowance of deduction for certain loss reserves, for which it has filed a formal protest and requested an IRS Appeals Conference. The Company believes it will ultimately prevail and has not recorded any liabilities for uncertain tax positions. The effect of the proposed disallowance of deductions for certain reserves, if sustained, only impacts the timing of such deduction and does not materially affect the Company’s financial position. The Company and its subsidiaries are still subject to U.S. state income tax examinations by tax authorities for years after 2001 and foreign examinations for years after 2008.
On January 4, 2010 the Company made a discretionary contribution of $100 million to the qualified defined benefit pension plan. With this contribution, and based on current estimates of plan liabilities and other assumptions, including future returns of plan assets, its qualified defined benefit pension plan is essentially fully funded.
ASC 715 requires that employers measure the funded status of their plans as of the date of their year-end statement of financial position. As such, the Company has utilized a measurement date of December 31, 2011 and 2010, to determine its postretirement benefit obligations, consistent with the date of its Consolidated Balance Sheets. Weighted-average discount rate assumptions used to determine postretirement benefit obligations and periodic postretirement costs are as follows:
The favorable loss and LAE reserve development during the year ended December 31, 2010 is primarily the result of lower than expected losses in the personal automobile line across all coverages, primarily related to the 2009 accident year, and lower than expected losses in the workers’ compensation line, primarily related to the 2008 and 2009 accident years. In addition, lower than expected losses in the commercial multiple peril line in liability coverages, primarily related to the 2007 through 2009 accident years and in the commercial umbrella line related to the 2007 through 2009 accident years contributed to the favorable development, partially offset by unfavorable development in the surety business, primarily related to the 2009 accident year. The 2010 amount includes $9.8 million of favorable development resulting from a change in the cost factors used for establishing unallocated loss adjustment expense reserves.
The Plaintiff filed an Amended Complaint adding two new named plaintiffs and additional claims on December 11, 2009. In response, the Company filed a Motion to Dismiss on January 30, 2010. In addition to the pending claim challenging the calculation of lump sum distributions, the Amended Complaint includes: (a) a claim that the Plan failed to calculate participants’ account balances and lump sum payments properly because interest credits were based solely upon the performance of each participant’s selection from among various hypothetical investment options (as the Plan provided) rather than crediting the greater of that performance or the 30 year Treasury rate; (b) a claim that the 2004 Plan amendment, which changed interest crediting for all participants from the performance of participant’s investment selections to the 30 year Treasury rate, reduced benefits in violation of the Employee Retirement Income Security Act of 1974 (“ERISA”) for participants who had account balances as of the amendment date by not continuing to provide them performance-based interest crediting on those balances; and (c) claims for breach of fiduciary duty and ERISA notice requirements arising from the various interest crediting and lump sum distribution matters of which Plaintiffs complain. The District Court granted the Company’s Motion to Dismiss the additional claims on statute of limitations grounds by a Memorandum Opinion dated March 31, 2011, leaving the claims substantially as set forth in the original March 12, 2007 complaint. Plaintiffs filed a Motion for Reconsideration of the District Court’s decision to dismiss the additional claims. Recently, the District Court denied the Plaintiff’s Motion for Reconsideration with respect to the claims set forth in (a) and (b) above; however, the Court did allow the fiduciary duty claims to stand.