We also lease offices throughout the United States for branch sales, underwriting and claims processing functions, and the operations of acquired subsidiaries.
- MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of operations include the accounts of The Hanover Insurance Company (“Hanover Insurance”) and Citizens Insurance Company of America (“Citizens”), our principal property and casualty companies; and certain other insurance and non-insurance subsidiaries. Our results of operations also include the results of our discontinued operations, consisting primarily of our former Chaucer international business, Chaucer Holdings Limited (“Chaucer”), a United Kingdom (“U.K.”) domiciled specialist insurance underwriting group which operates through the Society and Corporation of Lloyd’s (“Lloyd’s”), and the international insurance and non-insurance subsidiaries, which collectively constituted our former Chaucer segment. On December 28, 2018, we completed the sale of Chaucer Holdings Limited, the major portion of our Lloyd's international specialty business. As of December 31, 2018 and for all prior periods presented in this Annual Report on Form 10-K, operations from Chaucer and the related assets and liabilities are presented as discontinued operations. Results of operations also include the discontinued operations of our accident and health and former life insurance businesses.
Operating income before interest expense and income taxes (a non-GAAP financial measure; see also “Results of Operations - Consolidated - Non-GAAP Financial Measures”) was $406.5 million in 2018 compared to $327.3 million in 2017, an increase of $79.2 million. This increase is primarily due to lower catastrophe losses, higher net investment income, a reduction in reinsurance reinstatement premiums, earned premium growth and lower expenses, partially offset by higher non-catastrophe current accident year losses. Pre-tax catastrophe losses were $219.2 million in 2018, compared to $251.5 million in 2017, a decrease of $32.3 million. Reinsurance reinstatement premium, net of ceding commissions, was a favorable change of $21.5 million. Net unfavorable development on prior years’ loss and loss adjustment expense (“LAE”) reserves (“prior years’ loss reserves”) was $0.4 million in 2018, compared to $1.2 million in 2017.
Net premiums written grew by 7.7% in 2018, primarily due to higher renewal premium, driven by rate increases and strong retention, as well as new business growth. Underwriting results declined in 2018, as compared to 2017, primarily due to higher unfavorable development on prior years’ loss reserves and higher non-catastrophe current accident year losses, partially offset by earned premium growth, lower catastrophe losses, and lower expenses. We continue to seek rate increases that meet or exceed underlying loss cost trends, subject to regulatory and competitive considerations.
Primary business operations include insurance products and services currently provided through three operating segments: Commercial Lines, Personal Lines, and Other. Commercial Lines includes commercial multiple peril, commercial automobile, workers’ compensation, and other commercial coverages, such as inland marine, specialty program business, management and professional liability, surety, and specialty property. Personal Lines includes personal automobile, homeowners, and other personal coverages, such as umbrella. Included in the “Other” segment are Opus Investment Management, Inc., which markets investment management services to institutions, pension funds, and other organizations; earnings on holding company assets; holding company and other expenses, including certain costs associated with retirement benefits due to our former life insurance employees and agents; and a run-off voluntary pools business. Due to the sale of Chaucer on December 28, 2018, the operations of Chaucer have been classified as Discontinued Operations for the period ending December 31, 2018. Periods prior to 2018 have also been restated to present Chaucer as a discontinued operation. We present the separate financial information of each segment consistent with the manner in which our chief operating decision maker evaluates results in deciding how to allocate resources and in assessing performance.
Net premiums written increased by $226.4 million for the year ended December 31, 2017, compared to the year ended December 31, 2016, due to growth in both our Personal and Commercial Lines segments.
We are continuing our efforts to improve underwriting results through increased rates, pricing segmentation, specific underwriting actions and targeted new business growth. Our ability to achieve overall rate increases is affected by the current competitive pricing
Net premiums written in the personal automobile line of business for the year ended December 31, 2018 were $1,127.5 million, compared to $1,041.6 million for the year ended December 31, 2017, an increase of $85.9 million. This increase was primarily due to rate increases and an increase in policies in force of 2.5%. Net premiums written in the homeowners line of business for the year ended December 31, 2018 were $604.0 million, compared to $566.9 million for the year ended December 31, 2017, an increase of $37.1 million. This is attributable to rate increases and an increase in policies in force of 3.0%.
Commercial Lines net premiums written were $2,462.0 million for the year ended December 31, 2017, compared to $2,361.5 million for the year ended December 31, 2016. This $100.5 million increase was due to growth of $117.4 million, primarily driven by pricing increases, strong retention, and targeted new business expansion, partially offset by a $16.9 million increase in reinsurance reinstatement premiums driven by large property losses in our inland marine and commercial multiple peril lines.
Commercial Lines underwriting profit for the year ended December 31, 2017 was $12.2 million, compared to underwriting loss of $123.2 million for the year ended December 31, 2016, a change of $135.4 million. Favorable development on prior years’ loss reserves for the year ended December 31, 2017 was $9.4 million, compared to unfavorable development of $223.0 million for the year ended December 31, 2016, a favorable change of $232.4 million, primarily due to the aforementioned reserve charge following our 2016 fourth quarter reserve review. Catastrophe-related losses for the year ended December 31, 2017 were $170.6 million, compared to $70.1 million for the year ended December 31, 2016, an increase of $100.5 million. This increase is primarily due to hurricanes Harvey and Irma that occurred in the third quarter, the California wildfires that occurred in the fourth quarter, and a large Midwest hail event that occurred in the second quarter.
Commercial Lines current accident year underwriting profit, excluding catastrophes, was $173.4 million for the year ended December 31, 2017, compared to $169.9 million for the year ended December 31, 2016. This $3.5 million improvement was primarily due to lower losses in our workers’ compensation line, lower expenses and premium growth, partially offset by higher large losses and the increase in reinstatement premiums. The impact of additional reinstatement premiums, net of ceding commissions, decreased 2017 current accident year underwriting profit by $12.0 million from 2016 levels.
Personal Lines net premiums written were $1,647.1 million for the year ended December 31, 2017, compared to $1,521.2 million for the year ended December 31, 2016, an increase of $125.9 million. This was primarily due to higher renewal premium driven by rate increases and improved retention, as well as new business growth.
Net premiums written in the personal automobile line of business for the year ended December 31, 2017 were $1,041.6 million, compared to $953.6 million for the year ended December 31, 2016, an increase of $88.0 million. This increase was primarily due to rate increases and an increase in policies in force of 3.8%. Net premiums written in the homeowners line of business for the year ended December 31, 2017 were $566.9 million, compared to $529.7 million for the year ended December 31, 2016, an increase of $37.2 million. This is attributable to rate increases and an increase in policies in force of 4.0%.
Personal Lines underwriting profit for the year ended December 31, 2017 was $83.7 million, compared to $103.1 million for the year ended December 31, 2016, a decline of $19.4 million. Catastrophe losses for the year ended December 31, 2017 were $80.9 million, compared to $47.0 million for the year ended December 31, 2016, an increase of $33.9 million. This increase is primarily due to a large Midwest wind event that occurred in the first quarter of 2017. Unfavorable development on prior years’ loss reserves for the year ended December 31, 2017 was $9.4 million, compared to $4.3 million for the year ended December 31, 2016, an increase of $5.1 million.
Personal Lines current accident year underwriting profit, excluding catastrophes, was $174.0 million in the year ended December 31, 2017, compared to $154.4 million for the year ended December 31, 2016. This $19.6 million increase was primarily a result of earned premium growth and lower expenses. Also, higher current accident year losses in our homeowners line were substantially offset by lower losses in our personal automobile line.
We determine the amount of our loss reserves based on an estimation process that is complex and considers information from both company specific and industry data, as well as general economic and other information. The estimation process utilizes a combination of objective and subjective information, the blending of which requires significant professional judgment. There are various assumptions required, including future trends in frequency and severity of claims, operational changes in claim handling and case reserving practices, and trends related to general economic and social conditions. Informed judgments as to our ultimate exposure to losses are an integral component of our loss reserve estimation process.
There is greater inherent uncertainty in estimating insurance reserves for certain types of property and casualty insurance lines, particularly liability lines, where a longer period of time may elapse before a definitive determination of ultimate liability and losses may be made. In addition, the technological, judicial, regulatory and political climates involving these types of claims are continuously evolving. There is also greater uncertainty in establishing reserves with respect to business that is new to us, particularly new business which is generated with respect to newly introduced product lines, by newly appointed agents or in geographies in which we have less experience in conducting business. In such cases, there is less historical experience or knowledge and less data upon which we can rely. A combination of business that is both new to us and has longer development periods provides even greater uncertainty in estimating insurance reserves. In our management and professional liability lines, we are modestly increasing, and expect to continue to increase, our exposure to longer-tailed liability lines, including directors and officers liability, errors and omissions liability and product liability coverages. In addition, in recent periods we have experienced extensions of the “tails” in certain lines of business as the full value of claims are presented later than had been our historical experience.
We regularly review our reserving techniques, our overall reserving position and our reinsurance. Based on (i) our review of historical data, legislative enactments, judicial decisions, legal developments in impositions of damages and policy coverage, political attitudes and trends in general economic conditions, (ii) our review of per claim information, (iii) our historical loss experience and that of the industry, (iv) the nature of policies written by us, and (v) our internal estimates of required reserves, we believe that adequate provision has been made for loss reserves. However, establishment of appropriate reserves is an inherently uncertain process, and there can be no certainty that current established reserves will prove adequate in light of subsequent actual experience. A significant change to the estimated reserves could have a material impact on our results of operations and financial position. An increase or decrease in reserve estimates would result in a corresponding decrease or increase in financial results. For example, each one percentage point change in the aggregate loss and LAE ratio resulting from a change in reserve estimation is currently projected to have an approximate $43 million impact on operating income, based on 2018 full year premiums.
Most of our indirect business from our run-off voluntary and ongoing involuntary pools is assumed long-tailed casualty reinsurance. Reserve estimates for this business are therefore subject to the variability caused by extended loss emergence periods. The estimation of loss reserves for this business is further complicated by delays between the time the claim is reported to the ceding insurer and when it is reported by the ceding insurer to the pool manager and then to us, and by our dependence on the quality and consistency of the loss reporting by the ceding company and actuarial estimates by the pool manager. These reserving factors also apply to our discontinued assumed accident and health reinsurance pools and arrangements that are included in our liabilities of discontinued life business (See “Risk Factors” in Part I - Item 1A for further discussion).
accident year can be predictive of the expected future patterns that are applied to current paid and reported losses to generate estimated ultimate losses by accident year.
In completing the loss reserve analysis, a variety of assumptions must be made for each line of business, coverage and accident year. Each estimation method has its own pattern, parameter and/or judgmental dependencies, with no estimation method being better than the others in all situations. The relative strengths and weaknesses of the various estimation methods, when applied to a particular class of business, can also change over time, depending on the underlying circumstances. In many cases, multiple estimation methods will be valid for the particular facts and circumstances of the relevant class of business. The manner of application and the degree of reliance on a given method will vary by line of business and coverage, and by accident year based on an evaluation of the above dependencies and the potential volatility of the loss frequency and severity patterns. The estimation methods selected or given weight at a particular valuation date are those that are believed to produce the most reliable indication for the loss reserves being evaluated. Selections incorporate input from claims personnel, pricing actuaries, and underwriting management on loss cost trends and other factors that could affect ultimate losses.
For most classes of shorter-tailed business in our Commercial and Personal Lines segments, the emergence of paid and incurred losses generally exhibits a relatively stable pattern of loss development from one accident year to the next. Thus, for these classes, the loss development factor method is generally appropriate. For many of the classes of shorter-tailed business, the emergence of paid and incurred losses may exhibit a relatively volatile pattern of loss development from one accident year to the next. In certain cases where there is a relatively low level of reliability placed on the available paid and incurred loss data, expected loss methods or adjusted loss methods are considered appropriate for the most recent accident year.
Our carried reserves for each line of business and coverage are determined based on the quarterly loss reserving process. In making the determination, we consider numerous quantitative and qualitative factors. Quantitative factors include changes in reserve estimates in the period, the maturity of the accident year, trends observed over the recent past, the level of volatility within a particular class of business, the estimated effects of reinsurance, including reinstatement premiums, general economic trends, and other factors. Qualitative factors may include legal and regulatory developments, changes in claim handling and case reserving practices, recent
example, for hurricanes and other severe wind storms, complications often include the inability of insureds to promptly report losses, delays in the ability of claims adjusting staff to inspect losses, difficulties in determining whether losses are covered by our homeowners policy (generally for damage caused by wind or wind driven rain) or are specifically excluded from coverage caused by flood, and challenges in estimating additional living expenses, assessing the impact of demand surge, exposure to mold damage, and the effects of numerous other considerations. Another example is the complication of estimating the cost of business interruption coverage on commercial lines policies. Estimates for catastrophes which occur at or near the end of a financial reporting period may be even less reliable since we will have less claims data available and little time to complete our estimation process. In such situations, we may adapt our practices to accommodate the circumstances.
The following discussion presents disclosure related to possible variation in net reserve estimates due to changes in key assumptions. This information is provided for illustrative purposes only. Many other assumptions may also lead to material reserve adjustments. If any such variations do occur, then they would likely occur over a period of several years and therefore their impact on our results of operations would be recognized during the same periods. It is important to note, however, that there is the potential for future variations greater than the amounts described below and for any such variations to be recognized in a single quarterly or annual period. No consideration has been given to potential correlation or lack of correlation among key assumptions or among lines of business and coverage as described below. As a result and because there are so many other factors which affect our net reserve estimate, it would be inappropriate to take the amounts described below and simply add them together in an attempt to estimate volatility in total. While we believe these are reasonably possible scenarios, the reader should not consider the following sensitivity analysis as illustrative of a net reserve range.
Personal and Commercial Automobile Bodily Injury - loss reserves recorded for bodily injury on U.S. voluntary business were $635.7 million as of December 31, 2018. A key assumption for bodily injury is the inflation rate underlying the estimated reserve. A five point change (e.g., 4% changed to 9% or -1%) in the embedded inflation rate would have changed total reserves by approximately $79 million, either positive or negative, respectively, at December 31, 2018.
Personal Automobile Personal Injury Protection Medical Payment - loss reserves recorded for personal injury protection medical payment on U.S. voluntary business were $150.1 million as of December 31, 2018. A key assumption for this coverage is the inflation rate underlying the estimated reserve. Given the long reporting pattern for this line of business, an additional key assumption is the amount of additional development required to reach full maturity, thereby reflecting ultimate costs, as represented by the tail factor. A five point change in the embedded inflation rate and a one point change to the tail factor assumption (e.g., 2% changed to 1% or 3%) would have changed total reserves by approximately $47 million, either positive or negative, at December 31, 2018.
Workers’ Compensation - loss reserves recorded for workers’ compensation on U.S. voluntary business were $420.6 million as of December 31, 2018. A key assumption for workers’ compensation is the inflation rate underlying the estimated reserve. Given the long reporting pattern for this line of business, an additional key assumption is the amount of additional development required to reach full maturity, thereby reflecting ultimate costs, as represented by the tail factor. A five point change in the embedded inflation rate and a one point change to the tail factor assumption would have changed total reserves by approximately $123 million, either positive or negative, at December 31, 2018.
Conditions and trends that have affected reserve development in the past will not necessarily recur in the future. As discussed under “Reserving Process Overview” in the preceding section, our historical loss experience and loss development patterns are important factors in estimating loss reserves, however, they are not the only factors we evaluate to establish reserves. Therefore, a mechanical application of standard actuarial methodologies in projecting ultimate claims could result in materially different reserves to those held. Accordingly, it is not appropriate to extrapolate future favorable or unfavorable development based on amounts experienced in prior periods.
In 2018, favorable catastrophe development was $9.3 million, primarily due to lower than expected losses related to the 2017 hurricanes Harvey, Irma and Maria and California wildfires. In 2017, favorable catastrophe development was $1.4 million, primarily due to lower than expected losses related to the 2016 hurricane Matthew. In 2016, unfavorable catastrophe development was $2.6 million, primarily due to higher than expected losses related to 2015 severe summer hail and wind storms.
development of $33.3 million was primarily due to higher than expected losses of $15.8 million within the homeowners line in accident years 2015 through 2017, and $15.0 million in the personal automobile line, driven by bodily injury severity in the 2016 accident year and, to a lesser extent, the 2015 accident year. In addition, Other segment unfavorable development of $1.2 million was due to higher than expected losses in our runoff voluntary pools business.
In 2017, net unfavorable loss and LAE development, excluding catastrophes, was $1.2 million. Commercial Lines favorable development of $9.4 million was primarily due to lower than expected losses within the workers’ compensation line in accident years 2012 through 2016. Personal Lines unfavorable development of $9.4 million was primarily due to higher than expected losses in homeowners for accident year 2016. In addition, Other segment unfavorable development of $1.2 million was due to higher than expected losses in our runoff voluntary pools business.
In 2016, net unfavorable loss and LAE development was $235.6 million, primarily as a result of net unfavorable development of $223.0 million for Commercial Lines. The net unfavorable Commercial Lines development primarily resulted from higher than expected losses in other commercial lines of $168.0 million, which includes the AIX program business. This was primarily driven by AIX programs, general liability coverages in accident years 2012 through 2015, and surety bonds in accident years 2012 through 2015. We also experienced higher than expected losses within the commercial multiple peril line of $74.2 million for accident years 2012 through 2015 and the commercial automobile line of $27.5 million in accident years 2012 through 2014, both primarily within liability coverages. Partially offsetting the unfavorable development was lower than expected losses of $46.7 million within the workers’ compensation line, primarily related to accident years 2013 through 2015 and, to a lesser extent, our commercial umbrella line related to accident year 2015.
As a result of our 2016 fourth quarter reserve review, carried reserves for prior accident years, excluding catastrophes, were increased by $174.1 million in the fourth quarter, of which $161.5 million related to Commercial Lines. The majority of this adjustment was attributed to our long-tailed commercial liability coverages, including our AIX program business and was largely driven by worsening trends in the number and nature of high severity losses and higher than anticipated legal defense costs. We reacted to this adverse emergence by updating our assumptions about loss severity, loss development patterns, expected loss ratios and loss adjustment expenses for the most recent accident years, placing greater weight on the adverse severity trends experienced in the most recent calendar years. The adverse prior year development for our Other segment was due to our run-off voluntary assumed reinsurance pools business. The reserve increase was based on an updated third-party actuarial study received in the fourth quarter for the Excess and Casualty Reinsurance Association (“ECRA”) pool that primarily consists of asbestos and environmental exposures.
Nevertheless, the asbestos, environmental and toxic tort liability reserves could be revised, and any such revisions could have a material adverse effect on our results of operations for a particular quarterly or annual period or on our financial position.
The investments discussion below excludes amounts relating to the operations of Chaucer.
The increase in net investment income in both 2018 and 2017 was primarily due to the investment of higher operational cash flows, partially offset by the impact of lower fixed income new money yields that, while increasing from recent lower levels, were below that of average embedded investments. Also, net investment income included higher limited partnership and commercial mortgage loan income in both years.
Total cash and investments increased $1,122.0 million, or 15.6%, for the year ended December 31, 2018. This increase was primarily attributable to the proceeds from the sale of Chaucer and the pre-signing dividend. Excluding the impact from the sale of Chaucer, the investment portfolio increased by 3.8% for the year, primarily due to operational cashflows, partially offset by market value depreciation and the funding of financing activities, including dividend payments and stock repurchases.
For the years ended December 31, 2018, 2017 and 2016, we recognized in earnings $4.6 million, $5.6 million and $27.4 million, respectively, of other-than-temporary impairments (“OTTI”). In 2018, OTTI consisted of $2.6 million on fixed maturities and $2.0 million on other invested assets. In 2017, OTTI consisted of $2.0 million on other invested assets, $1.8 million on fixed maturities and $1.8 million on equity securities. In 2016, OTTI consisted primarily of $16.1 million on fixed maturities we intended to sell, $8.3 million related to estimated credit losses on fixed maturities and $2.7 million on equity securities. OTTI in 2016 that related to the energy sector was $16.4 million.
Gross unrealized losses on fixed maturities as of December 31, 2018 were $134.2 million, an increase of $95.8 million compared to December 31, 2017, primarily attributable to higher prevailing interest rates and wider credit spreads. At December 31, 2018, gross unrealized losses consisted primarily of $92.0 million of corporate fixed maturities, $24.5 million of residential and commercial mortgage-backed securities and $9.8 million on municipal securities. See also Note 3 - “Investments” in the Notes to Consolidated Financial Statements.
The following table sets forth gross unrealized losses for fixed maturities by maturity period at December 31, 2018 and 2017. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations, with or without call or prepayment penalties, or we may have the right to put or sell the obligations back to the issuers.
Most developed economies’ central banks have now ended their extraordinary measures and begun to tighten monetary policy or signal potential tightening, but inflation remains below target in several large economies. Fundamental conditions in the corporate sector generally remain sound. While we may experience defaults on fixed income securities, particularly with respect to non-investment grade debt securities, it is difficult to foresee which issuers, industries or markets will be affected. As a result, the value of our fixed maturity portfolio could change rapidly in ways we cannot currently anticipate, and we could incur additional realized and unrealized losses in future periods.
The following table, which excludes assets relating to Chaucer, illustrates the estimated impact on the fair value of our fixed maturity portfolio at December 31, 2018 and 2017 of hypothetical changes in prevailing interest rates, defined as changes in interest rates on U.S. Treasury debt. It does not reflect changes in credit spreads, liquidity spreads and other factors that also affect the value of securities. Since changes in prevailing interest rates are often accompanied by changes in these other factors, the reader should not assume that an actual change in interest rates would result in the values illustrated.
We manage investment assets for our Commercial Lines, Personal Lines, and Other segments based on the requirements of our combined property and casualty companies. We allocate the investment income, expenses, and realized gains and losses to our Commercial Lines, Personal Lines, and Other segments based on actuarial information related to the underlying businesses. We manage investment assets separately for our Chaucer business.
At December 31, 2018, we had informed the FHLB of our intent to repay a $125 million FHLB note due 2029 with a coupon of 5.5%, with settlement to occur on January 2, 2019. In the fourth quarter of 2018, we recorded a non-operating charge of $20.8 million after-taxes related to the pre-payment provision. Additionally, in 2018 we repurchased subordinated debentures with a net carrying value of $9.6 million at a cost of $11.5 million, resulting in a loss of $1.9 million. In 2016, we redeemed senior debentures with a net carrying value of $375.2 million at a cost of $461.3 million, resulting in a loss of $86.1 million. Additionally, in 2016 we repurchased senior debentures with a net carrying value of $11.9 million at a cost of $14.1 million, resulting in a loss of $2.2 million.
On December 28, 2018, we completed the sale of Chaucer Holdings Limited to China Re. Total consideration payable by China Re for this portion of the transaction is expected to total approximately $793.7 million(1) and is subject to adjustment based upon 2018 accident year catastrophe losses in excess of 10% of Chaucer’s 2018 net earned premium. The pre-tax gain on the sale is estimated to be $174.4 million. THG paid customary transaction costs along with providing certain representations and warranties and agreeing to indemnify China Re for certain pre-sale contingent liabilities.
Initial consideration for Chaucer Holdings Limited as determined in the sales and purchase agreement was $779 million. This amount, along with $28 million in cash proceeds received from the sale of the Irish entity on February 14, 2019, $13 million in cash proceeds to be received upon the closing of the sale of the Australian entities, estimated contingent consideration of $31.7 million, and an $85 million pre-signing dividend from Chaucer that was received in the second quarter of 2018, results in expected total proceeds from the entire transaction of $936.7 million. These amounts were partially offset by $17.0 million paid to China Re to adjust the purchase price for amounts received by the Company from Chaucer prior to December 28, 2018.
Contingent proceeds, as reflected in the sales and purchase agreement, may be up to $45 million and is determined based upon 2018 catastrophe losses. Based upon our best estimate of Chaucer’s 2018 catastrophe losses, expected contingent consideration is $31.7 million.
Chaucer’s income before income taxes for the year ended December 31, 2018 was $24.7 million, compared to $8.6 million for the year ended December 31, 2017, an improvement of $16.1 million. This increase is primarily due to lower catastrophe losses. Catastrophe losses for the year ended December 31, 2018 were $85.8 million, compared to $131.1 million for the year ended December 31, 2017, a decrease of $45.3 million. Chaucer’s income before taxes, excluding catastrophes, was $110.5 million in the year ended December 31, 2018, compared to $139.7 million for the year ended December 31, 2017. This $29.2 million decline was primarily due to higher non-catastrophe current accident year large losses and higher expenses, primarily driven by higher brokerage costs due to a change in business mix.
Chaucer’s net premiums earned were $853.0 million for the year ended December 31, 2017, compared to $838.6 million for the year ended December 31, 2016, an increase of $14.4 million, or 1.7%. This was primarily due to new business growth in the treaty, property and casualty lines, partially offset by a planned increase in the use of ceded reinsurance, as a result of current market conditions.
In 2018, the favorable catastrophe development ratio was 2.0% primarily driven by lower than expected losses related to hurricane Harvey. In 2017, the favorable catastrophe development ratio was 2.8% primarily due to lower than expected property losses in the treaty line. In 2016, the favorable catastrophe development ratio was 4.5% primarily due to lower than expected property losses in the treaty line and, to a lesser extent, in the property line.
Total cash and investments decreased $2.2 billion, or 98.8%, for the year ended December 31, 2018, primarily due to the sale of the U.K. subsidiaries, which included cash and investments of approximately $2.0 billion. Also, prior to the sale, Chaucer’s investment assets were reduced by a pre-signing dividend of $85.0 million from Chaucer to THG and an approximate $65 million repayment of intercompany debt. Assets remaining at December 31, 2018 relate to the Chaucer-related Irish and Australian subsidiaries which, as discussed elsewhere, have been or are expected to be sold in the first quarter of 2019.
Prior to the sale of Chaucer, we had a Standby Letter of Credit Facility Agreement (the “Facility Agreement”) which was not to exceed £220.0 million outstanding at any one time, and included an option to increase the amount available for issuances of letters of credit to £300.0 million. The Facility Agreement provided regulatory capital supporting Chaucer’s underwriting activities for the 2018 and 2019 years of account and each prior open year of account. Supporting the Facility Agreement, we had entered into a Guaranty Agreement (the “Guaranty Agreement”) with Lloyds Bank plc, as Facility Agent and Security Agent, pursuant to which we unconditionally guaranteed the obligations of Chaucer under the Facility Agreement. On December 28, 2018, in connection with the completion of the Chaucer sale, this Facility Agreement and the related Guaranty Agreement were terminated.
The provision for income taxes from continuing operations was an expense of $43.5 million, $76.8 million, and a benefit of $1.0 million in 2018, 2017 and 2016, respectively. These amounts resulted in consolidated effective tax rates of 15.4% and 26.2% on pre-tax income for 2018 and 2017, respectively, and a benefit of 1.5% on pre-tax income for 2016. The provision for 2018 reflects a tax benefit related to prior years of $4.3 million, primarily due to a $40.0 million contribution to our U.S. pension plan made in September 2018 and reflected as a deduction in our 2017 U.S. income tax return at the then higher statutory tax rate. The provision for the 2017 tax year further reflects a tax benefit of $3.9 million related to the revaluation of our net deferred tax liabilities as a result of the enactment of the Tax Cuts and Jobs Act (“TCJA”,”U.S. Tax Reform” or “the Act”). See the discussion of the new tax law, “U.S. Tax Reform”, below. The provisions in 2018 and 2017 also included excess tax benefits related to stock-based compensation of $2.3 million and $5.3 million, respectively. The adoption of ASC Update No. 2016-09 on January 1, 2017 required the inclusion of excess tax benefits from stock-based compensation in the income statement, whereas prior to the adoption, these excess tax benefits were recognized in additional paid-in capital. Lastly, the provisions in 2018, 2017, and 2016 reflect benefits related to tax planning strategies implemented in prior years of $9.2 million, $12.7 million, and $20.7 million, respectively. Absent these items, the provision for income taxes for 2018, 2017, and 2016 would have been expenses of $59.3 million, or 21.0%, $98.7 million, or 33.7%, and $19.7 million, or 29.8%, respectively. The lower effective tax rate in 2018 is primarily due to the aforementioned decrease in the U.S. statutory rate and the lower effective tax rate in 2016 is primarily due to lower underwriting income.
During 2017, we recorded an increase to our uncertain tax positions of $0.9 million related to the recognition of federal income taxes on previously untaxed earnings from foreign operations. This amount is partially offset by a decrease in our uncertain tax positions of $0.6 million due to the expiration of a statute of limitation, for a net change of $0.3 million. We are subject to U.S. federal and state examinations and foreign examinations for years after 2014. There are no ongoing audits on our open tax years.
In prior years, we completed several transactions which resulted in the realization, for tax purposes only, of unrealized gains in our investment portfolio. As a result of these transactions, we were able to realize capital losses carried forward and release the valuation allowance recorded against the deferred tax asset related to those losses. The releases of valuation allowances were recorded as a benefit in accumulated other comprehensive income. Previously unrealized benefits of $9.2 million, $12.7 million and $20.7 million attributable to non-operating income, are recognized as part of our income from continuing operations during 2018, 2017 and 2016, respectively. The remaining amount of $35.6 million in accumulated other comprehensive income will be released into income from continuing operations in future years, as the investment securities subject to these transactions are sold or mature.
See “Reinsurance Recoverables” in Part I - Item 1 for information on our reinsurance recoverable balances.
Two significant assumptions used in the determination of benefit plan obligations and expenses that are dependent on market factors, which have been subject to a greater level of volatility in recent years, are the discount rate and the return on plan asset assumptions. The discount rate enables us to state expected future benefit payments as a present value on the measurement date. We also use this discount rate in the determination of our pre-tax pension expense or benefit. A lower discount rate increases the present value of benefit obligations and increases pension expense. We determined our discount rate for the domestic plan utilizing independent yield curves which provide for a portfolio of high quality bonds that are expected to match the cash flows of our pension plans. Bond information used in the yield curve included only those rated Aa or better as of December 31, 2018 and 2017, respectively, and had been rated by at least two well-known rating agencies. The following provides the discount rates for our qualified pension plan.
Net actuarial losses related to the domestic qualified plan of $19.9 million and gains of $11.4 million were reflected as changes to accumulated other comprehensive income in 2018 and 2017, respectively. Net actuarial losses in 2018 resulted primarily from investment losses experienced during the year, partially offset by increases in the discount rate. Net actuarial gains in 2017 resulted primarily from benefits from investment gains experienced during the year, partially offset by decreases in the discount rate. The change in these actuarial gains and losses is amortized into earnings in future periods. In 2018 and 2017, amortization of actuarial losses from prior years was $8.6 million and $12.5 million, respectively.
Holding all other assumptions constant, sensitivity to changes in our key assumptions related to our qualified defined pension plan is as follows:
We employ a systematic methodology to evaluate declines in fair values below amortized cost for all fixed maturity investments. The methodology utilizes a quantitative and qualitative process that seeks to ensure that available evidence concerning the declines in fair value below amortized cost is evaluated in a disciplined manner. In determining whether a decline in fair value below amortized cost is other-than-temporary, we evaluate several factors and circumstances, including the issuer’s overall financial condition; the issuer’s credit and financial strength ratings; the issuer’s financial performance, including earnings trends, dividend payments and asset quality; any specific events which may influence the operations of the issuer; the general outlook for market conditions in the industry or geographic region in which the issuer operates; and the length of time and the degree to which the fair value of an issuer’s securities remains below our cost. We consider factors that might raise doubt about the issuer’s ability to make contractual payments as they become due and whether we expect to recover the entire amortized cost basis of the security.
We monitor corporate fixed maturity securities with unrealized losses on a quarterly basis and more frequently when necessary to identify potential credit deterioration, as evidenced by ratings downgrades, unexpected price variances, and/or company or industry specific concerns. We apply consistent standards of credit analysis which includes determining whether the issuer is current on its contractual payments, and we consider past events, current conditions and reasonable forecasts to evaluate whether we expect to recover the entire amortized cost basis of the security. We utilize valuation declines as a potential indicator of credit deterioration and apply additional levels of scrutiny in our analysis as the severity of the decline increases or duration persists.
Temporary declines in market value are recorded as unrealized losses, which do not affect net income and earnings per share, but reduce accumulated other comprehensive income, which is reflected in our Consolidated Balance Sheets. We cannot provide assurance that the OTTIs will be adequate to cover future losses or that we will not have substantial additional impairments in the future. See “Investments” for further discussion regarding OTTIs and securities in an unrealized loss position.
As of December 31, 2018, we had $0.2 million of valuation allowance related to our employee benefit plan. We believe it is more likely than not that the remaining deferred tax assets will be realized.
The statutory capital and surplus for our insurance subsidiaries increased $95.4 million during 2018, primarily due to approximately $290 million of income, partially offset by a $140.0 million dividend paid by Hanover Insurance to THG in the second quarter and increases in unrealized losses on investments.
The NAIC prescribes an annual calculation regarding risk based capital (“RBC”). RBC ratios for regulatory purposes, as described in the glossary, are expressed as a percentage of the capital required to be above the Authorized Control Level (the “Regulatory Scale”); however, in the insurance industry, RBC ratios are widely expressed as a percentage of the Company Action Level. The following table reflects the Company Action Level, the Authorized Control Level and RBC ratios for Hanover Insurance (which includes Citizens and other insurance subsidiaries), as of December 31, 2018 and 2017, expressed both on the Industry Scale (Total Adjusted Capital divided by the Company Action Level) and Regulatory Scale (Total Adjusted Capital divided by Authorized Control Level):
Dividend payments previously made to the holding company by Chaucer were regulated by U.K. law. Chaucer paid dividends of $85.0 million and $79.5 million to the holding company in 2018 and 2016, respectively, and did not pay any dividend in 2017. Additionally, in connection with an intercompany borrowing arrangement between Chaucer and a wholly-owned non-insurance subsidiary of the holding company, interest on a $300 million note was paid by Chaucer on a quarterly basis to this affiliate, which is ultimately available to provide dividends to the holding company. During 2018 and 2017, Chaucer made payments of $22.5 million and $20.7 million, respectively, related to this agreement of which $22.1 million and $20.2 million, respectively, were then dividended to the holding company. In 2016, Chaucer made a payment of $22.4 million directly to the holding company. This agreement was terminated as part of the sale of Chaucer.
Net cash provided by investing activities was $271.3 million during 2018, as compared to net cash used of $506.3 million during 2017 and $495.4 million in 2016. During 2018, cash provided by investing activities primarily related to net proceeds received from the sale of Chaucer. These proceeds were partially offset by net purchases of fixed maturities, commercial mortgage loan participations, and other investments. During 2017, cash used in investing activities primarily related to net purchases of fixed maturities, commercial mortgage loan participations, and other investments. During 2016, cash used in investing activities primarily related to net purchases of fixed maturities, commercial mortgage loan participations, and other investments. These cash outflows were partially offset by proceeds from net sales of equity securities.
Net cash used in financing activities was $171.0 million during 2018, as compared to $111.7 million during 2017 and $300.8 million in 2016. During 2018, cash used in financing activities primarily resulted from the payment of dividends to shareholders and repurchases of common stock. During 2017, cash used in financing activities primarily resulted from the payment of dividends to shareholders and repurchases of common stock, partially offset by cash inflows related to option exercises. During 2016, cash used in financing activities primarily resulted from the repayment of debt, repurchases of common stock, and payment of dividends to shareholders. These cash outflows were partially offset by cash inflows related to the issuance of $375 million of senior unsecured debentures.
At December 31, 2018, THG, as a holding company, held approximately $1.2 billion of fixed maturities and cash. This amount includes deployable capital primarily generated through the sale of Chaucer which provided approximately $779 million of proceeds to the holding company upon closing the sale of the U.K. subsidiaries in December 2018. On January 2, 2019, we paid cash of $250.0 million as part of an accelerated share repurchase (“ASR”) agreement (described below). Additionally, in January 2019, we paid the aforementioned special dividend of $4.75 per share with total cash payments of approximately $193 million. We believe our holding company assets will be sufficient to meet other 2019 obligations, which consist primarily of quarterly dividends to our shareholders (as and to the extent declared), interest on our senior and subordinated debentures, certain costs associated with benefits due to our former life employees and agents, and, to the extent required, payments related to indemnification of liabilities associated with the sale of various subsidiaries. As discussed below, we have, and opportunistically may continue to, repurchase our common stock and debt. We do not expect that it will be necessary to dividend additional funds from our insurance subsidiaries in order to fund 2019 holding company obligations; however, we may decide to do so.
We expect to continue to generate sufficient positive operating cash to meet all short-term and long-term cash requirements relating to current operations, including the funding of our qualified defined benefit pension plan. Based upon the current estimate of liabilities and certain assumptions regarding investment returns and other factors, our qualified defined benefit pension plan has plan liabilities in excess of plan assets of approximately $19 million. The ultimate payment amounts for our benefit plan is based on several assumptions, including but not limited to, the rate of return on plan assets, the discount rate for benefit obligations, mortality experience, interest crediting rates, inflation and the ultimate valuation and determination of benefit obligations. Since differences between actual plan experience and our assumptions are almost certain, changes, both positive and negative, to our current funding status and ultimately our obligations in future periods are likely.
Our insurance subsidiaries maintain a high degree of liquidity within their respective investment portfolios in fixed maturity and short-term investments. We believe that the quality of the assets we hold will allow us to realize the long-term economic value of our portfolio, including securities that are currently in an unrealized loss position. We do not anticipate the need to sell these securities to meet our insurance subsidiaries’ cash requirements since we expect our insurance subsidiaries to generate sufficient operating cash to meet all short-term and long-term cash requirements relating to current operations. However, there can be no assurance that unforeseen business needs or other items will not occur causing us to have to sell those securities in a loss position before their values fully recover, thereby causing us to recognize impairment charges in that time period.
On December 30, 2018, the Board of Directors authorized a new stock repurchase program which provides for aggregate repurchases of our common stock of up to $600 million. Under the repurchase authorization, the Company may repurchase, from time to time, common shares in amounts, at prices and at such times as the Company deems appropriate, subject to market conditions and other considerations. Repurchases may be executed using open market purchases, privately negotiated transactions, accelerated repurchase programs or other transactions. We are not required to purchase any specific number of shares or to make purchases by any certain date under this program. On January 2, 2019, pursuant to the terms of an ASR agreement, we paid $250.0 million and received an initial delivery of approximately 1.8 million shares of our common stock, which is approximately 80% of the total number of shares expected to be repurchased under this agreement. Additionally, under the prior repurchase program, during 2018, we repurchased 0.5 million shares at a cost of $57.7 million.
Additionally, on January 2, 2019, we repaid $125 million of our FHLB advances due 2029 with a coupon of 5.5%. In the fourth quarter of 2018, we recorded a non-operating charge of approximately $26.3 million for related pre-payment fees. Membership in the FHLB provides us with access to additional liquidity based on our stock holdings and pledged collateral. At December 31, 2018, we had additional borrowing capacity of $90.1 million. There were no borrowings outstanding under this short-term facility at December 31, 2018; however, we have borrowed and may continue to borrow, from time to time, through this facility to provide short-term liquidity.
We have a $200.0 million credit agreement which expires in May 2019. Borrowings, if any, under the agreement are unsecured and incur interest at a rate per annum equal to, the higher of (a) the prime commercial lending rate of the administrative agent, (b) the Federal Funds Rate plus half a percent, or (c) the one month Adjusted LIBOR plus one percent and any applicable margin. The agreement contains financial covenants including, but not limited to, maintaining at least specified levels of consolidated equity and leverage ratios, and requires certain of our subsidiaries to maintain minimum RBC ratios. We had no borrowings under this agreement during 2018.
At December 31, 2018, we were in compliance with the covenants of our debt and credit agreements.
Financing obligations generally include repayment of our senior debentures, subordinated debentures, borrowings from the FHLB, and operating lease payments. The following table represents our annual payments related to the contractual principal and interest payments of these financing obligations as of December 31, 2018, unless otherwise noted, and operating lease payments reflect expected cash payments based upon lease terms. In addition, we also have included our estimated payments related to our loss and LAE obligations and our current expectation of payments to be made to support the obligations of our benefit plans. The following table also includes commitments to purchase investment securities at a future date. Actual payments may differ from the contractual and/or estimated payments in the table.
Amounts represent non-qualified defined benefit pension and postretirement benefit obligations and reflect estimated payments to be made through plan year 2028 for pension, postretirement, and postemployment benefits, although it is likely that payments will be made beyond 2028. Estimates of these payments and the payment patterns are based upon historical experience. We do not expect to make any significant contributions to our qualified plan in order to meet our minimum funding requirements for the next several years; therefore, no contributions for this plan are included in this schedule. However, additional contributions may be required in the future based on the level of pension assets and liabilities in future periods. The ultimate payment amount for our pension plan is based on several assumptions, including, but not limited to, the rate of return on plan assets, the discount rate for benefit obligations, mortality experience, interest crediting rates and the ultimate valuation of benefit obligations. Differences between actual plan experience and our assumptions are likely and will likely result in changes to our funding obligations in future periods.
Insurance companies are rated by rating agencies to provide both industry participants and insurance consumers information on specific insurance companies. Higher ratings generally indicate the rating agencies’ opinion regarding financial stability and a stronger ability to pay claims.
Catastrophe - A severe loss, resulting from natural or manmade events, including, among others, hurricanes, tornadoes and other windstorms, earthquakes, hail, severe winter weather, fire, explosions, and terrorism.
Catastrophe loss - Loss and directly identified loss adjustment expenses from catastrophes, including development on prior years’ catastrophe loss reserves. The Insurance Services Office (“ISO”) Property Claim Services (“PCS”) defines a catastrophe loss as an event that causes $25 million or more in insured property losses from U.S. direct writers and affects a significant number of property and casualty policyholders and insurers. In limited instances where the impact of an event extends across multiple geographic areas or time periods, but is not within the specific parameters established by PCS, the Company may determine that certain losses are better included within the same catastrophe event. In addition to those catastrophe events declared by ISO, claims management also generally includes within the definition of a “catastrophe loss”, a property loss event that causes approximately $5 million or more in Company insured losses and affects in excess of one hundred policy holders.
Price(ing) increase or decrease (Commercial Lines) - Represents the average change in premium on renewed policies caused by the estimated net effect of base rate changes, discretionary pricing, inflation or changes in policy level exposure or insured risk.
Price(ing) increase or decrease (Personal Lines) - The estimated cumulative premium effect of approved rate actions applied to policies available for renewal, regardless of whether or not policies are actually renewed. Pricing changes do not represent actual increases or decreases realized by the Company.
Rate - The estimated pure pricing factor upon which the policyholder’s premium is based excluding changes in exposure or risk.
Expense Ratio - The ratio of underwriting expenses (including the amortization of deferred acquisition costs), less premium installment fee income and premium charge offs, to premiums earned for a given period.
Statutory accounting practices - Recording transactions and preparing financial statements in accordance with the rules and procedures prescribed or permitted by insurance regulatory authorities including the National Association of Insurance Commissioners, which in general reflect a liquidating, rather than going concern, concept of accounting.
Written premium - The premium assessed for the entire coverage period of an insurance policy or contract without regard to how much of the premium has been earned. See also “Earned premium” above. Net premium written is written premium net of reinsurance.
Equity securities are carried at fair value. Effective January 1, 2018, in accordance with the provisions of Accounting Standards Codification (“ASC”) Update No. 2016-01, (Subtopic 825-10) Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU No. 2016-01”), increases and decreases in fair value are reported in net income. Previously, equity securities were classified as available-for-sale and unrealized gains and losses, net of taxes, were reported in AOCI. See Section O - “New Accounting Pronouncements” below.
Other investments consist primarily of mortgage participations and limited partnerships. Mortgage participations represent interests in commercial mortgage loans originated and serviced by a third-party of which the Company shares, on a pro-rata basis, in all related cash flows of the underlying mortgage loans. Prior to May 2018, certain reacquisition rights, which are no longer in effect, and which were previously retained by the third-party in the loan participations required that these investments be accounted for as secured borrowings under ASC 860, Transfers and Servicing (“ASC 860”). Mortgage participations are stated at unpaid principal balances adjusted for deferred fees or expenses, net of reserves. Reserves on mortgages are established and are collectively evaluated based on losses expected by the Company for loans that may not be collectible in full. In establishing reserves, the Company considers, among other things, the estimated fair value of the underlying collateral.
The Company shares certain insurance risks it has underwritten, through the use of reinsurance contracts, with various insurance entities. Reinsurance accounting is followed for ceded transactions when the risk transfer provisions of ASC 944, Financial Services - Insurance (“ASC 944”), have been met. As a result, when the Company experiences loss or claims events that are subject to a reinsurance contract, reinsurance recoverables are recorded. The amount of the reinsurance recoverable can vary based on the terms of the reinsurance contract, the size of the individual loss or claim, or the aggregate amount of all losses or claims in a particular line or book of business or an aggregate amount associated with a particular accident year. The valuation of losses or claims recoverable depends on whether the underlying loss or claim is a reported loss or claim, or an incurred but not reported loss. For reported losses and claims, the Company values reinsurance recoverables at the time the underlying loss or claim is recognized, in accordance with contract terms. For incurred but not reported losses, the Company estimates the amount of reinsurance recoverables based on the terms of the reinsurance contracts and historical reinsurance recovery information and applies that information to the gross loss reserve. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured
The Company’s debt at December 31, 2018 includes senior debentures, subordinated debentures, and collateralized borrowings with the Federal Home Loan Bank (“FHLB”). Debt instruments are carried at principal amount borrowed, net of any applicable unamortized discounts and issuance costs. See Note 6 - “Debt and Credit Arrangements”.
Insurance premiums written are generally recorded at the policy inception and are primarily earned on a pro-rata basis over the terms of the policies for all products. Premiums written may also include estimates that are derived from multiple sources, which include the historical experience of the underlying business, similar businesses and available industry information. These estimates are regularly reviewed and updated, and any resulting adjustments are included in the current year’s results. Unearned premium reserves represent
the portion of premiums written that relates to the unexpired terms of the underlying in-force insurance policies and reinsurance contracts. Premium receivables reflect the unpaid balance of premium written as of the balance sheet date. Premium receivables are generally short-term in nature and are reported net of an allowance for estimated uncollectible premium accounts. The Company reviews its receivables for collectability at the balance sheet date. The allowance for uncollectible accounts was not material as of December 31, 2018 and 2017. Ceded premiums are charged to income over the applicable term of the various reinsurance contracts with third-party reinsurers. Reinsurance reinstatement premiums, when required, are recognized in the same period as the loss event that gave rise to the reinstatement premiums. Losses and related expenses are matched with premiums, resulting in their recognition over the lives of the contracts. This matching is accomplished through estimated and unpaid losses and amortization of deferred acquisition costs.
Options to purchase shares of common stock whose exercise prices are greater than the average market price of the common shares are not included in the computation of diluted earnings per share because the effect would be antidilutive.
In March 2017, the FASB issued ASC Update No. 2017-07, (Topic 715) Compensation - Retirement Benefits: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. This guidance requires that an employer report in its income statement the service cost component of both net periodic pension and net periodic postretirement benefit cost in the same line item or items as other compensation costs arising from services rendered by pertinent employees during the period, and present in the income statement separately from the other components of benefit cost, if appropriate under the company’s current presentation of its income statement. Additionally, the guidance allows only the service cost component to be eligible for capitalization when applicable. The updated guidance is effective for annual and interim periods beginning after December 15, 2017, and should be applied retrospectively for the presentation of the service cost component and other components of net periodic pension cost and net periodic postretirement benefit cost in the income statement, and prospectively for the capitalization of the service cost component of net periodic cost in assets. The Company implemented this guidance effective January 1, 2018. The effect of implementing this guidance was not material to the Company’s financial position or results of operations as the Company does not have any service cost remaining related to its pension and postretirement plans.
In August 2018, the FASB issued ASC Update No. 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASC Update No. 2018-15”). This ASC update requires the capitalization of implementation costs incurred in a hosting arrangement that is a service contract consistent with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The guidance also requires an entity to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting agreement, and apply impairment guidance consistent with long-lived assets. ASC Update No. 2018-15 also provides specific guidelines related to the presentation of these capitalized implementation costs and related expenses in the financial statements. The updated guidance is effective for interim and annual periods beginning after December 15, 2019, and should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. Early adoption is permitted, including interim periods. The Company does not expect the adoption of ASC Update No. 2018-15 to have a material impact on its financial position or results of operations.
In August 2018, the FASB issued ASC Update No. 2018-14 (Topic 715-20) Compensation - Retirement Benefits - Defined Benefit Plans - General - Disclosure Framework - Changes to the Disclosure Requirements for the Defined Benefit Plans. This ASC update modifies disclosures related to defined benefit pension or other postretirement plans. This ASC update removes the disclosure of amounts in accumulated other comprehensive income expected to be recognized over the next fiscal year and the effects of a one percentage point change of health care cost trends on net periodic benefit costs and postretirement benefit obligations and clarifies the specific requirements of disclosures related to the project benefit obligation and accumulated benefit obligation. This ASC Update also adds disclosures related to weighted average crediting rates for cash balance plans and requires disclosure of an explanation of any significant gains and losses related to changes in benefit obligations for the period. The amendments in this ASC update are effective for fiscal years ending after December 15, 2020, and should be applied on a retrospective basis to all periods presented. Early adoption is permitted. Implementing this guidance is not expected to have an impact on the Company’s financial position or results of operations as the update is disclosure related.
In March 2017, the FASB issued ASC Update No. 2017-08, (Subtopic 310-20) Receivables - Nonrefundable Fees and Other Costs: Premium Amortization on Purchased Callable Debt Securities. This guidance shortens the amortization period of premiums on certain purchased callable debt securities to the earliest call date. The updated guidance is effective for annual and interim periods beginning after December 15, 2018, and should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to
retained earnings as of the beginning of the period of adoption. Early adoption is permitted, including adoption in an interim period. The Company does not expect the adoption of ASC Update No. 2017-08 will have a material effect on its financial position or results of operations.
In January 2017, the FASB issued ASC Update No. 2017-04, (Topic 350) Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment. This guidance eliminates step 2 from the goodwill impairment test. Instead, an entity should perform its goodwill impairment test by comparing the fair value of the reporting unit with its carrying amount, including any applicable income tax effects, and recognize an impairment for the amount by which the carrying amount exceeds the reporting unit’s fair value. However, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The updated guidance is effective for annual or interim goodwill impairment tests performed in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not expect the adoption of ASC Update No. 2017-04 to have a material impact on its financial position or results of operations.
In February 2016, the FASB issued ASC Update No. 2016-02, (Topic 842) Leases. This ASC update requires a lessee to recognize a right-of-use asset, which represents the lessee’s right to use a specified asset for the lease term, and a corresponding lease liability, which represents a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis, for all leases that extend beyond 12 months. For finance or capital leases, interest on the lease liability will be recognized separately from amortization of the right-of-use asset in the statements of income and comprehensive income. In addition, the repayment of the principal portion of the lease liability will be classified as a financing activity while the interest component will be included in the operating section of the statement of cash flows. For operating leases, the asset and liability will be amortized as a single lease cost, such that the cost of the lease is allocated over the lease term, on a generally straight-line basis, with all cash flows included within operating activities in the statement of cash flows. ASC Update No. 2016-02 requires that implementation of this guidance be through a modified retrospective transition approach. In July 2018, the FASB issued ASC Update No. 2018-11, (Topic 842) Leases Targeted Improvements, which provides entities with an additional transition method to adopt ASC Update No. 2016-02. Under this optional transition method, an entity can initially apply the new guidance at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The Company will implement this guidance effective January 1, 2019 using the optional transition method provided in ASC Update No. 2018-11 and will elect to utilize the practical expedient package available in ASC Update 2016-02. The effect of implementing this guidance is expected to increase total assets and liabilities each by approximately $35 million on January 1, 2019, which is not material to the Company’s financial position. Furthermore, implementation of this guidance is not expected to have a material impact on the Company’s results of operations.
On December 28, 2018, the Company completed the sale of Chaucer Holdings Limited to China Re. Total cash proceeds payable by China Re for this portion of the transaction is expected to total approximately $793.7 million(1) and is subject to adjustment based upon 2018 accident year catastrophe losses in excess of 10% of 2018 net earned premium. The pre-tax gain on the sale is estimated to be $174.4 million. THG paid customary transaction costs along with providing certain representations and warranties and agreeing to indemnify China Re for certain pre-sale contingent liabilities.
million of additional consideration for the Irish entity, and it expects to receive $13 million of additional consideration related to the Australian entities.
Contingent proceeds, as reflected in the sales and purchase agreement, may be up to $45 million and is determined based upon 2018 catastrophe losses. Based upon the Company’s best estimate of Chaucer’s 2018 catastrophe losses, expected contingent consideration is $31.7 million.
The Company recognized $0.8 million, $1.1 million and $22.3 million in foreign currency transaction losses in net income in 2018, 2017 and 2016, respectively.
The following table details the cash flows associated with the Chaucer business:
Discontinued operations for the years ended December 31, 2018, 2017 and 2016 resulted in gains of $0.1 million, losses of $16.8 million and losses of $1.0 million, respectively, net of income tax benefits of $9.3 million and $2.8 million in 2017 and 2016, respectively. The increased losses in 2017 primarily relate to additional losses in the Company’s long-term care pool, which is included in the portion of the discontinued accident and health business that was directly assumed.
The Company participates in a security lending program for the purpose of enhancing income. Securities on loan to various counterparties had a fair value of $4.8 million and $23.4 million at December 31, 2018 and 2017, respectively, and were fully collateralized by cash. The fair value of the loaned securities is monitored on a daily basis, and the collateral is maintained at a level of at least 102% of the fair value of the loaned securities. Securities lending collateral is recorded by the Company in cash and cash equivalents, with an offsetting liability included in expenses and taxes payable.
The Company enters into various agreements that may require its fixed maturities to be held as collateral by others. At December 31, 2018 and 2017, fixed maturities with fair values of $234.9 million and $225.7 million, respectively, were held as collateral for the FHLB collateralized borrowing program. See Note 6-“Debt and Credit Arrangements” for additional information related to the Company’s FHLB program.
Effective January 1, 2018, increases or decreases in fair value of equity securities are no longer reported as unrealized gains and losses in accumulated other comprehensive income. Instead, they are reported in net realized and unrealized investment gains (losses) in the Consolidated Statements of Income (see “Equity Securities” below).
The Company views gross unrealized losses on fixed maturities as being temporary since it is its assessment that these securities will recover in the near term, allowing the Company to realize the anticipated long-term economic value. The Company employs a systematic methodology to evaluate declines in fair value below amortized cost for fixed maturity securities. In determining OTTI, the Company evaluates several factors and circumstances, including the issuer’s overall financial condition; the issuer’s credit and financial strength ratings; the issuer’s financial performance, including earnings trends and asset quality; any specific events which may influence the operations of the issuer; the general outlook for market conditions in the industry or geographic region in which the issuer operates; and the length of time and the degree to which the fair value of an issuer’s securities remains below the Company’s amortized cost. The Company also considers any factors that might raise doubt about the issuer’s ability to make contractual payments as they come due and whether the Company expects to recover the entire amortized cost basis of the security.
The Company’s mortgage participations and other mortgage loans were $405.7 million and $365.8 million at December 31, 2018 and 2017, respectively. Participating interests in commercial mortgage loans are originated and serviced by a third-party. For these investments, the Company shares, on a pro-rata basis, in all related cash flows of the underlying mortgages. Mortgage participations and other mortgage loans were comprised of the following property types and geographic locations.
The following table provides pre-tax net realized and unrealized losses on equity securities from continuing operations:
For 2018, total OTTI from continuing operations was $5.4 million. Of this amount, $4.6 million was recognized in earnings and the remaining $0.8 million was recorded as unrealized losses in AOCI. The $4.6 million of OTTI recognized in earnings relates to $2.6 million of fixed maturity securities and $2.0 million of other invested assets.
The proceeds from sales of available-for-sale securities and the gross realized gains and gross realized losses on those sales, were as follows:
Beginning in 2018, equity securities are no longer classified as available-for-sale. Proceeds from the sale of equity securities for the years ended December 31, 2017 and 2016 were $128.8 million and $245.0 million, respectively, resulting primarily in gross realized gains of $18.8 million and $31.1 million, respectively.
Level 1 securities generally include U.S. Treasury issues and other securities that are highly liquid and for which quoted market prices are available. Level 2 securities are valued using pricing for similar securities and pricing models that incorporate observable inputs including, but not limited to yield curves and issuer spreads. Level 3 securities include issues for which little observable data can be obtained, primarily due to the illiquid nature of the securities, and for which significant inputs used to determine fair value are based on the Company’s own assumptions.
Foreign government - estimates of appropriate market spread versus underlying related sovereign treasury curve(s) dependent on liquidity and direct or contingent support.
Other investments primarily include mortgage participations and limited partnerships not subject to the equity method of accounting. The fair values of limited partnerships not subject to the equity method of accounting are based on the net asset value provided by the general partner adjusted for recent financial information and are excluded from the fair value hierarchy.
The following tables provide, for each hierarchy level, the Company’s assets that were measured at fair value on a recurring basis.
Limited partnerships measured at fair value using NAV based on an ownership interest in partners’ capital have not been included in the hierarchy tables. At December 31, 2018 and 2017, the fair values of these investments were $171.5 million and $149.4 million, respectively, approximately 2% of total investment assets, excluding assets-held-for-sale.
There were no Level 3 held-for-sale securities (Chaucer) at December 31, 2018.
The following table provides quantitative information about the significant unobservable inputs used by the Company in the fair value measurements of Level 3 assets, excluding amounts relating to the Chaucer business held-for-sale. Where discounted cash flows were used in the valuation of fixed maturities, the internally-developed discount rate was adjusted by the significant unobservable inputs shown in the table.
During the third quarter of 2018, the Company repurchased subordinated debentures maturing February 3, 2027 with a net carrying value of $9.6 million at a cost of $11.5 million, resulting in a loss of $1.9 million.
The income tax expense attributable to the consolidated results of continuing operations is different from the amount determined by multiplying income from continuing operations before income taxes by the U.S. statutory federal income tax rate of 21% in 2018 and 35% in both 2017 and 2016. The sources of the difference and the tax effects of each were as follows:
There are no tax positions at December 31, 2018, 2017 and 2016 for which the ultimate deductibility is highly certain, but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred tax accounting, other than interest and penalties, a change in the timing of deductions would not impact the annual effective tax rate.
The Company recognizes interest and penalties related to unrecognized tax benefits in federal income tax expense. For the years ended December 31, 2018, 2017 and 2016 the Company recognized a de minimis amount of net interest and has not recognized any penalties associated with unrecognized tax benefits.
On December 22, 2017, the Tax Cuts and Jobs Act (“TCJA”, “U.S. Tax Reform”, or “the Act”) was enacted in the U.S. The Act substantially changed many aspects of the U.S. Tax code, including a reduction in the U.S. corporate income tax rate from 35% to 21%. While the new corporate rate is effective on January 1, 2018, the Company has recognized the impact of the rate change on its deferred tax balances as of the enactment date. The effect of this re-measurement of the Company’s deferred tax balances was a provision of $9.4 million for the year ended December 31, 2017. This provision was recorded as a component of income tax expense in continuing operations and as a component of the Chaucer business and reflected a tax benefit of $4.1 million and an expense of $13.5 million, respectively. This amount included the revaluation of deferred taxes initially recorded through other comprehensive income and recorded through discontinued operations, such as unrealized appreciation on investments, employee benefit plan-related items, foreign currency translation adjustments and reserve adjustments for discontinued business. Deferred taxes related to the revaluation of the Company’s pension plans at December 31, 2017, as well as changes in unrealized gains and losses occurring after the Act’s enactment date, were recorded at 21% in other comprehensive income.
In addition, the Act limited various existing deductions such as executive compensation and introduced new income taxes on certain low-taxed non-U.S. income. Under the Act, the exemption from the $1 million limitation on certain executive compensation has been eliminated. As a result, the Company recognized a provision of $0.2 million for the year ended December 31, 2017.
The cumulative effect of the enactment of TCJA was an expense of $22.3 million for the year ended December 31, 2017, comprising the aforementioned three components. The Company’s estimates were not based upon provisional amounts, as defined in the SEC’s Staff Accounting Bulletin No. 118.
As of January 1, 2005, the defined benefit pension plans were frozen and since that date, no further cash balance allocations have been credited to participants. Participants’ accounts are credited with interest daily, based upon the General Agreement of Trades and Tariffs rate (the 30-year Treasury Bond interest rate). In addition, the grandfathered benefits for the transition group were also frozen at January 1, 2005 levels with an annual transition pension adjustment calculated at an interest rate equal to 5% per year up to 35 years of completed service, and 3% thereafter. As of December 31, 2018, based on current estimates of plan liabilities and other assumptions, the projected benefit obligation of the qualified defined benefit pension plan exceeds plan assets by approximately $18.8 million.
The expected rates of return were determined by using historical mean returns for each asset class, adjusted for certain factors believed to have an impact on future returns. These returns are generally weighted to the plan’s actual asset allocation, and are net of administrative expenses. For the U.S. defined benefit plans, the expected return on plan assets for 2018 of 4.75% reflects long-term expectations and remains generally consistent with 2017. The Company reviews and updates, at least annually, its expected return on plan assets based on changes in the actual assets held by the plans and market conditions.
The Company utilizes a target allocation approach, which focuses on creating a mix of assets that will generate modest growth from equity securities while minimizing volatility in the Company’s earnings from changes in the markets and economic environment. Various factors are taken into consideration in determining the appropriate asset mix, such as census data, actuarial valuation information and capital market assumptions. The Company reviews and updates, at least annually, the target allocation and makes changes periodically.
Securities classified as Level 1 at December 31, 2018 and 2017 include actively traded mutual funds and publicly traded securities, which are valued at quoted market prices. Securities classified as Level 3 at December 31, 2018 and 2017 include assets held in a fixed account of an insurance company. The fair value of the investment is estimated using a comparable public market financial institution derived fair value curve that uses non-observable inputs for market liquidity and unique credit characteristics of its underlying securities.
The Plan also holds investments measured at fair value using NAV based on the value of the underlying investments, which is determined independently by the investment manager and have not been included in the table above. These include investments in commingled pools and investment-grade fixed income securities held in a custom fund, and other commingled pools that primarily invest in publicly traded common stocks and international equity securities. The daily NAV, which is not published as a quoted market price for these investments, is used as the basis for transactions. Redemption of these funds is not subject to restriction. The fair values of these investments are as follows:
The following table reflects the benefit obligations, fair value of plan assets and funded status of the U.S. plans at December 31, 2018 and 2017.
The following table reflects the benefit obligations and fair value for the Chaucer plan as of December 31, 2017 and related changes in those balances, as well as the changes to those balances during 2018 prior to the plan’s disposition in conjunction with the sale of Chaucer on December 28, 2018.
The accumulated benefit obligation for the plan is equal to the projected benefit obligation.
Net periodic pension benefit for Chaucer’s pension plan of $2.3 million, $0.3 million and $0.9 million in 2018, 2017 and 2016, respectively, have been reported in discontinued operations and are not included in the amounts disclosed above.
The following table reflects the total amounts recognized in accumulated other comprehensive income relating to the U.S. defined benefit pension plans as of December 31, 2018 and 2017.
The unrecognized net actuarial gains (losses) which exceed 10% of the greater of the projected benefit obligation or the fair value of plan assets are amortized as a component of net periodic pension cost over the next five years. The total estimated amount of actuarial losses that will be amortized from accumulated other comprehensive income into net periodic pension cost in 2019 is $11.9 million.
In accordance with ERISA guidelines, the Company is not required to fund its U.S. qualified benefit plan in 2019. The Company expects to contribute $3.1 million to its U.S. non-qualified pension plans to fund 2019 benefit payments. During 2018, the Company made a discretionary contribution of $40.0 million to its qualified benefit plan. At this time, no additional discretionary contributions are expected to be made into any of the U.S. plans during 2019, and the Company does not expect that any funds will be returned from the plans to the Company during 2019.
The benefit payments are based on the same assumptions used to measure the Company’s benefit obligations at the end of 2018. Benefit payments related to the qualified plan will be made from plan assets held in trust and not included with Company assets, whereas those payments related to the non-qualified plans will be provided for by the Company.
The Company has recognized the funded status of its postretirement benefit plans in its Consolidated Balance Sheets. Since the plans are unfunded, the amount recognized in the Consolidated Balance Sheets is equal to the accumulated benefit obligation of the plans. The components of accumulated other comprehensive income or loss are reflected as either a net actuarial gain or loss or a net prior service cost.
The benefit payments are based on the same assumptions used to measure the Company’s benefit obligation at the end of 2018 and reflect benefits attributable to estimated future service.
Employers are required to 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, 2018 and 2017, 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:
Additionally, on May 20, 2014, shareholders approved The Hanover Insurance Group 2014 Employee Stock Purchase Plan (the “ESPP Plan”) and the Chaucer Share Incentive Plan (the “SIP Plan”), authorizing the issuance of 2,500,000 and 750,000 shares, respectively, under such plans. As of December 31, 2018, 2,371,060 shares were available for grant under the ESPP Plan. As a result of the sale of the Chaucer business in 2018, new grants of stock to the SIP Plan were terminated and the SIP Plan was transferred as part of the sale on December 28, 2018. Total shares awarded under this SIP Plan since 2014 were 74,189.
Cash received for options exercised for the years ended December 31, 2018, 2017 and 2016 was $14.3 million, $20.5 million and $15.8 million, respectively. The intrinsic value of options exercised for the years ended December 31, 2018, 2017 and 2016 was $9.6 million, $15.6 million and $21.1 million, respectively.
The excess tax expense realized from options exercised for the years ended December 31, 2018, 2017 and 2016 was $1.6 million, $4.0 million, and $5.6 million, respectively. The aggregate intrinsic value at December 31, 2018 for shares outstanding and shares exercisable was $34.1 million and $24.2 million, respectively. At December 31, 2018, the weighted average remaining contractual life for shares outstanding and shares exercisable was 7.5 years and 6.2 years, respectively. Additional information about employee options outstanding and exercisable at December 31, 2018 is included in the following table:
The fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model. For all options granted through December 31, 2018, the exercise price equaled the market price on the grant date. Compensation cost related to options is based upon the grant date fair value and expensed on a straight-line basis over the service period for each separately vesting portion of the option as if the option was, in substance, multiple awards.
The Company granted market-based restricted share units in 2018, 2017 and 2016. These units generally vest after 3 years of continued employment and after the achievement of certain stock performance targets. The Company also granted time-based restricted stock units to eligible employees in 2018, 2017 and 2016 that generally vest after 3 years of continued employment.
At December 31, 2018, the aggregate intrinsic value of restricted stock units was $39.1 million and the weighted average remaining contractual life was 1.3 years. The aggregate intrinsic value of market-based restricted stock units was $8.2 million and the weighted average remaining contractual life was 1.4 years. As of December 31, 2018, there was $19.7 million of total unrecognized compensation cost related to unvested restricted stock units and performance and market-based restricted stock units. The cost is expected to be recognized over a weighted average period of 1.8 years. Compensation cost associated with restricted stock, restricted stock units and performance and market-based restricted stock units is generally calculated based upon grant date fair value, which is determined using current market prices.
Prior to December 30, 2018, the Board of Directors had authorized a stock repurchase program, which, including subsequent amendments to increase the number of shares subject to repurchase, provided for aggregate repurchases of up to $900 million. This program was terminated on December 30, 2018 in conjunction with the establishment of the new program discussed below. Prior to termination, the Company purchased 0.5 million shares of its common stock at a cost of $57.7 million during 2018. Total repurchases under this program were 14.9 million at a cost of $811.2 million. On December 30, 2018, the Board of Directors authorized a new stock repurchase program which provides for aggregate repurchases of up to $600 million. Under the repurchase authorization, the Company may repurchase, from time to time, common shares in amounts, at prices and at such times as the Company deems appropriate, subject to market conditions and other considerations. Repurchases may be executed using open market purchases, privately negotiated transactions, accelerated repurchase programs or other transactions. The Company is not required to purchase any specific number of shares or to make purchases by any certain date under this program. As of December 31, 2018, the Company had $600.0 million available for repurchases under this repurchase authorization. On January 2, 2019, pursuant to the terms of an accelerated share repurchase (“ASR”) agreement executed on December 30, 2018, the Company paid $250.0 million and received an initial delivery of approximately 1.8 million shares of common stock, which is approximately 80% of the total number of shares expected to be repurchased under this agreement.
Pursuant to New Hampshire’s statute, the maximum dividends and other distributions that an insurer may pay in any twelve month period, without prior approval of the New Hampshire Insurance Commissioner, is limited to the lesser of 10% of such insurer’s statutory policyholder surplus as of the preceding December 31, or statutory net income less net realized gains. Hanover Insurance declared and paid dividends to its parent totaling $140.0 million, $296.8 million and $218.8 million in 2018, 2017 and 2016, respectively. In 2017, the $296.8 million dividend included $80.0 million of extra ordinary dividends. At January 1, 2019, the maximum dividend payable without prior approval is $76.7 million. In May 2019, the maximum dividend declared payable without prior approval will increase by $140.0 million to a total amount of $216.7 million.
Summarized below is financial information with respect to the Company’s business segments.
Rental expenses for operating leases from continuing operations amounted to $16.7 million, $14.8 million and $15.6 million in 2018, 2017 and 2016, respectively. These expenses relate primarily to building leases of the Company. At December 31, 2018, future minimum rental payments under non-cancelable operating leases were $41.1 million, payable as follows: 2019 - $13.5 million; 2020 - $11.0 million; 2021 - $8.3 million and 2022 - $4.5 million and 2023 and thereafter - $3.8 million. It is expected that in the normal course of business, leases that expire will generally be renewed or replaced by leases on similar property and equipment.
Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company; consequently, allowances are established for amounts deemed uncollectible. The Company determines the appropriate amount of reinsurance based on evaluations of the risks accepted and analyses prepared by consultants and on market conditions (including the availability and pricing of reinsurance). The Company also believes that the terms of its reinsurance contracts are consistent with industry practice in that they contain standard terms with respect to lines of business covered, limit and retention, arbitration and occurrence. The Company believes that its reinsurers are financially sound, based upon an ongoing review of financial strength ratings assigned to them by rating agencies, their reputations in the reinsurance marketplace, collections history, advice from third parties and the analysis and guidance of THG’s reinsurance advisors.
The higher level of ceded losses and LAE in 2017 as compared to 2016 and 2018 is primarily due to higher non-catastrophe large loss activity occurring in certain domestic lines.
The loss reserve estimation process relies on the basic assumption that past experience, adjusted for the effects of current developments and likely trends, is an appropriate basis for predicting future outcomes. As part of this process, the Company uses a variety of analytical methods that consider experience, trends and other relevant factors. Incurred but not reported (“IBNR”) reserves are generally calculated by first projecting the ultimate cost of all claims that have been reported or expected to be reported in the future and then subtracting reported losses and loss adjustment expenses. IBNR reserves include both incurred-but-not-reported liabilities plus expected development on reported claims included in the liability for unpaid claims and claim adjustment expenses. Reported losses include cumulative paid losses and loss adjustment expenses plus outstanding case reserves. The Company’s ultimate IBNR reserves are estimated by management and reserving actuaries on an aggregate basis for each line of business or coverage for loss and loss expense liabilities not reflected within the case reserves. Case reserves are established by claim personnel individually on a claim by claim basis and based on information specific to the occurrence and terms of the underlying policy. Case reserves are periodically reviewed and modified based on new or additional information pertaining to the claim.
For events designated as catastrophes, the Company generally calculates IBNR reserves directly as a result of an estimated IBNR claim count and an estimated average claim amount for each event. Such an assessment involves a comprehensive analysis of the nature of the event, of policyholder exposures within the affected geographic area and of available claims intelligence.
Within other commercial lines, general liability is comprised of both monoline general liability and certain management and professional liability coverages and other lines is primarily comprised of lawyers professional liability, fidelity, marine, miscellaneous property, and healthcare lines. Loss and LAE reserve development in the Other segment is related to run-off voluntary assumed reinsurance pools business.
As a result of continuing trends in the Company’s business, reserves including catastrophes have been re-estimated for all prior accident years and were decreased by $8.9 million in 2018, decreased by $0.2 million in 2017 and increased by $238.2 million in 2016.
In 2018, net favorable loss and LAE development was $8.9 million, primarily as a result of net favorable Commercial Lines development of $40.9 million, partially offset by unfavorable Personal Lines development of $30.8 million. Commercial Lines favorable development was primarily due to lower than expected losses of $31.0 million within the workers’ compensation line in accident years 2015 through 2017, $29.1 million in other commercial lines, primarily in our professional and management liability and monoline general liability lines, related to the 2014 through 2016 accident years, and our surety line in accident years 2015 and 2017, partially offset by higher than expected losses in AIX programs and business classes which have since been terminated. Also partially offsetting the favorable Commercial Lines development was higher than expected losses of $23.2 million in the commercial automobile line, driven by higher bodily injury severity in the 2014, 2016, and 2017 accident years. Personal Lines unfavorable development was primarily due to higher than expected losses of $14.3 million in the personal automobile line, driven by bodily injury severity in the 2015 and 2016 accident years and $13.8 million in homeowners in accident years 2015 through 2017. In addition, Other segment unfavorable development of $1.2 million was due to higher than expected losses in our runoff voluntary pools business.
General liability and umbrella - occurrence is primarily comprised of our commercial monoline general liability and umbrella coverages. General liability - claims made is primarily comprised of our commercial professional and management liability lines. Within total Commercial Lines and other, other lines is primarily comprised of marine, surety, miscellaneous commercial property, product liability, voluntary pools, healthcare and fidelity lines. Included in the above table, primarily in other lines, are $57.6 million and $59.4 million of gross asbestos and environmental reserves as of December 31, 2018 and 2017, respectively.
For the following net reserve components, commercial multiple peril, workers’ compensation, commercial automobile liability, general liability and umbrella - occurrence, general liability - claims made, personal automobile liability and homeowners, the Company is presenting incurred claims development tables by accident year. The commercial multiple peril, workers’ compensation, commercial automobile liability and general liability and umbrella - occurrence lines presentation includes AIX program business. In each of these tables, the Company is presenting the number of years for which claims are typically outstanding, which is consistent with the period at which substantially all of the reserve development has emerged based on past history. The tables presented below include cumulative incurred loss and allocated loss adjustment expenses (“ALAE”), cumulative paid loss and ALAE and IBNR balances at December 31, 2018. IBNR includes both incurred but not reported liabilities and expected development on reported claims. In addition, cumulative incurred claim counts are presented as of December 31, 2018 and claim duration is presented in a separate table disclosing the average annual percentage payout of incurred claims by age, net of reinsurance. Claim duration is calculated as an average of paid loss and ALAE divided by incurred loss and ALAE by elapsed year. The incurred claims development tables presented are reconciled to the net carried reserves in the preceding table as of December 31, 2018.
The following table is information about average historical claims duration as of December 31, 2018. The table is computed based on the paid and incurred claims data, net of reinsurance, for the accident years presented in the preceding claims development tables.
The plaintiff filed an Amended Complaint adding two new named plaintiffs and additional claims on December 11, 2009. Two of the three new claims set forth in the Amended Complaint were dismissed by the District Court, which action was upheld in November 2015 by the U.S. Court of Appeals, Sixth Circuit. The District Court, however, did allow to stand the new claim in the Amended Complaint for breach of fiduciary duty and failure to meet notice requirements arising under the Employee Retirement Income Security Act of 1974 (“ERISA”) from the various interest crediting and lump sum distribution matters of which plaintiffs complain, but only as to plaintiffs’ “whipsaw” claim that remained in the case. On December 17, 2013, the Court entered an order certifying a class to bring “whipsaw” and related breach of fiduciary duty claims consisting of all persons who received a lump sum distribution between March 1, 1997 and December 31, 2003.
The Company’s insurance subsidiaries are required to file annual statements with state regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities (statutory basis), as codified by the National Association of Insurance Commissioners (“NAIC”). Permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices differ from state to state, may differ from company to company within a state, and may change in the future. The Company’s U.S. insurance subsidiaries did not have any permitted practices as of or for the years ended December 31, 2018, 2017, and 2016.
The minimum statutory capital and surplus necessary to satisfy the Company’s regulatory requirements was $518.4 million, $500.7 million and $460.1 million, which equals the Authorized Control Level at December 31, 2018, 2017, and 2016, respectively. Beginning in 2017, the NAIC modified the RBC formula to require the inclusion of catastrophe risk. Accordingly, the Authorized Control Level for 2016 has been restated to reflect this change.
The quarterly results of operations for 2018 and 2017 are summarized below.
In accordance with ASU No. 2016-01, changes in fair value of equity securities are now reflected in income from continuing operations; whereas previously these changes were captured in AOCI. The fourth quarter of 2018 reflects $50.1 million of losses related to such changes in fair value.
Additionally, during the fourth quarter of 2018, the Company recognized $26.3 million of prepayment fees related to its FHLB advance (see Note 6 - “Debt and Credit Arrangements”).
On February 14, 2019, the Company completed the sale of its Chaucer-related Irish entity for proceeds of $28 million.