We also own office space located in a three-building complex located at 808 North Highlander Way, Howell, Michigan, with approximately 176,000 square feet, where various business operations are conducted, and office space located at Thanet Way, Whitstable, United Kingdom, with approximately 40,000 square feet, where we operate our U.K. motor line of business. In 2013, we consolidated the business operations in Howell, Michigan. Accordingly, approximately 108,000 square feet of owned office space located at 645 W. Grand River in Howell, Michigan is no longer required for our business operations. Certain of our properties have been leased to unrelated third parties or are available for lease.
Results of operations include the accounts of The Hanover Insurance Company (“Hanover Insurance”) and Citizens Insurance Company of America (“Citizens”), our principal U.S. domiciled property and casualty companies; Chaucer Holdings plc (“Chaucer”), our United Kingdom (U.K.) domiciled specialist insurance underwriting group which operates through the Society and Corporation of Lloyd’s (“Lloyd’s”); and certain other insurance and non-insurance subsidiaries. The acquisition of Chaucer on July 1, 2011, which has added meaningful business volumes to our results, has affected the comparability of our results of operations for the years ended December 31, 2013, 2012 and 2011. Results of operations for the years ended December 31, 2013 and 2012 include results from all of our business segments, while results of operations for the year ended December 31, 2011 include Chaucer’s results for only the period from July 1, 2011 through December 31, 2011. Additionally, results of operations include our discontinued operations, consisting primarily of our former life insurance businesses, accident and health business and prior to April 30, 2012, our third party administration business.
Operating income (formally referred to as segment income) before interest expense and income taxes was $393.4 million in 2013 compared to $75.1 million in 2012, an increase of $318.3. This increase was primarily due to lower catastrophe and non-catastrophe related losses, and higher favorable development on prior years’ loss and loss adjustment expense (“LAE”) reserves (“prior years’ loss reserves”). Pre-tax catastrophe losses were $140.0 million, compared to $369.9 million during 2012. Catastrophe losses in 2012 were primarily the result of $198.1 million of pre-tax losses related to Superstorm Sandy during the fourth quarter, and from several tornadoes during the first six months of the year. There was favorable development on prior years’ loss reserves of $76.3 million in 2013, compared to $15.8 million in 2012.
Underwriting results improved in 2013, as compared to 2012, primarily due to lower catastrophe losses, improved non-catastrophe current accident year results and lower unfavorable development on prior years’ loss reserves. The competitive nature of the Commercial Lines market requires us to be highly disciplined in our underwriting process to ensure that we write business at acceptable margins and we continue to seek rate increases across our lines of business.
Personal Lines focuses on partnering with high quality, value-oriented agencies that deliver consultative selling and stress the importance of account rounding (the conversion of single policy customers to accounts with multiple policies and additional coverages). Approximately 75% of our policies in force are account business. We are focused on making investments that help maintain profitability, build a distinctive position in the market, help diversify us geographically from our historical core states of Michigan, Massachusetts, New York and New Jersey, and provide us with profitable growth opportunities.
Underwriting results improved in 2013, as compared to 2012, primarily due to lower catastrophe losses, improved non-catastrophe current accident year results and lower net unfavorable development on prior years’ loss reserves. We continue to seek additional rate increases, subject to regulatory and competitive considerations, in our personal automobile line, particularly as a result of recent trends of higher loss severity in bodily injury and personal injury protection claims. We also continue to seek rate increases in our homeowners lines as a result of the catastrophe and non-catastrophe weather-related losses that the industry experienced in the past several years.
Consolidated net income was $55.9 million in 2012, compared to $36.7 million in 2011. The $19.2 million increase is primarily due to income from our Chaucer segment and lower costs in 2012 related to the Chaucer acquisition. Additionally, we recognized a $10.8 million gain from the sale of our third party administration business, Citizens Management, Inc. (“CMI”), which was completed on April 30, 2012 (see also “Discontinued Operations”). These increases were partially offset by a decrease in operating results in our domestic operations.
In addition to consolidated net income, we assess our financial performance based upon pre-tax “operating income (loss),” and we assess the operating performance of each of our four operating segments based upon the pre-tax operating income (loss) generated by each segment. We formerly referred to these pre-tax measures as “segment income (loss).” Operating income (loss) before taxes excludes interest expense on debt and certain other items which we believe are not indicative of our core operations, such as net realized investment gains and losses (including net gains and losses on certain derivative instruments). Such gains and losses are excluded since they are determined by interest rates, financial markets and the timing of sales. Also, operating income (loss) before taxes excludes net gains and losses on disposals of businesses, gains and losses related to the repayment of debt, discontinued operations, costs to acquire businesses, restructuring costs, extraordinary items, the cumulative effect of accounting changes and certain other items. Although the items excluded from operating income (loss) before taxes may be important components in understanding and assessing our overall financial performance, we believe a discussion of operating income before taxes enhances an investor’s understanding of our results of operations by segregating income attributable to the core operations of the business. However, operating income (loss) before taxes should not be construed as a substitute for income (loss) before income taxes and operating income (loss) should not be construed as a substitute for net income (loss).
Catastrophe losses and prior years’ reserve development are significant components in understanding and assessing the financial performance of our business. Management reviews and evaluates catastrophes and prior years’ reserve development separately from the other components of earnings. Catastrophes and prior years’ reserve development are not predictable as to timing or the amount that will affect the results of our operations and have affected our results in the past few years. Management believes that providing certain financial metrics and trends excluding the effects of catastrophes and prior years’ reserve development helps investors to understand the variability in periodic earnings and to evaluate the underlying performance of our operations.
The following is our discussion and analysis of the results of operations by business segment. The operating results are presented before interest expense, taxes and other items which management believes are not indicative of our core operations, including realized gains and losses. Results for Chaucer include activity since the July 1, 2011 acquisition.
Our consolidated catastrophe related activity for the year ended December 31, 2013 was $140.0 million, compared to $369.9 million for the year ended December 31, 2012, a decrease of $229.9 million. Our 2012 catastrophe losses included $198.1 million of pre-tax losses related to Superstorm Sandy.
Favorable development on prior years’ loss reserves was $76.3 million for the year ended December 31, 2013, compared to $15.8 million for the year ended December 31, 2012, an increase of $60.5 million. For 2013, $94.6 million of favorable development related to our Chaucer segment was partially offset by $18.3 million of unfavorable development related to our domestic operations. For the year ended December 31, 2012, $72.6 million of favorable development related to our Chaucer segment was partially offset by $56.8 million of unfavorable development related to our domestic operations.
The following table summarizes premiums written on a gross and net basis and net premiums earned by line of business for the Chaucer segment.
Commercial Lines underwriting loss for the year ended December 31, 2013 was $11.0 million, compared to $224.2 million for the year ended December 31, 2012, a decrease of $213.2 million. This improvement reflects decreased catastrophe losses and lower
Pricing in Commercial Lines continued to be favorable in 2013 due to recent years’ weather-related losses, as well as to reduced investment income as a result of low interest rates, and other factors. We are continuing efforts to improve our underwriting results, including through increased rates; however, our ability to increase Commercial Lines net premiums written while maintaining or improving underwriting results may be affected by price competition and the current challenging economic environment. We also expect to continue our efforts to reduce our property exposures in certain geographic areas and classes of business, with a goal of improving our longer-term profitability and reducing earnings volatility. Also, in the past several years, weather-related catastrophe and non-catastrophe losses have been in excess of longer term averages. We continue to monitor these trends and consider them in our rate actions.
Personal Lines net premiums written were $1,428.0 million in the year ended December 31, 2013, compared to $1,475.6 million in the year ended December 31, 2012, a decrease of $47.6 million. The primary factors contributing to this decrease were our continued property-focused exposure management actions and actions to improve underwriting results in all lines of business. These decreases were partially offset by higher rates in both our homeowners and personal automobile lines.
Personal Lines underwriting profit for the year ended December 31, 2013 was $37.6 million, compared to a loss of $67.3 million for the year ended December 31, 2012, an improvement of $104.9 million. This was primarily due to decreased catastrophe losses and improved non-catastrophe current accident year results. Catastrophe losses for the year ended December 31, 2013 were $66.9 million, compared to $134.8 million for the year ended December 31, 2012, a decrease of $67.9 million. Catastrophe losses in 2012 included $45.2 million of pre-tax losses related to Superstorm Sandy. Unfavorable development on prior years’ loss reserves for the year ended December 31, 2013 was $13.7 million, compared to unfavorable development of $26.5 million for the year ended December 31, 2012, a change of $12.8 million.
Chaucer’s economic interests in Syndicate 1084. Written premium growth was also driven by growth in our marine, casualty, and property lines, due to favorable pricing and specific underwriting opportunities in these markets. Partially offsetting this growth was a reduction in net premiums written in our energy line, primarily due to a reduction of estimated premiums for the exploration and production coverage class, specifically control of well business, and the construction coverage class. This change was based on a reduced volume in actual well footage drilled, following tighter safety regulations worldwide and a reduction of offshore gas exploration in the U.S., and a reduced number and size of new construction projects worldwide. Additionally, strong market competition decreased net premiums in our aviation line.
After a profitable year in our international insurance business and against a very competitive market background, we expect few rate increases in 2014. Current pricing conditions for international energy, marine and aviation and both direct and assumed property reinsurance markets continue to be affected by an absence of major losses, excess capacity and high levels of competition. Overall, we expect rates to remain flat in these markets, with any increases in these areas to be negligible and restricted to local market conditions in specific classes. Also, a reduction in worldwide energy industry projects is lowering the demand and pricing for exploration, production and construction coverages. Casualty market rates are flat overall, although after several years of continued rate decline, there are now signs of potential modest rate increases in certain classes. We will seek rate increases in the U.K. motor market in 2014 to maintain margins at acceptable overall levels. There can be no assurance that we will be able to maintain adequate rates in light of economic and regulatory conditions in our markets.
Commercial Lines net premiums written were $1,902.0 million in the year ended December 31, 2012, compared to $1,703.1 million in the year ended December 31, 2011. This $198.9 million increase was primarily driven by rate increases, strong retention, and targeted new business expansion, including growth in the AIX program business, which grew by approximately $69 million. These factors were partially offset by the effects of exposure management actions and business mix improvement initiatives.
Commercial Lines current accident year underwriting loss, excluding catastrophes, was $1.8 million for the year ended December 31, 2012, compared to $9.3 million for the year ended December 31, 2011. This $7.5 million improvement was primarily due to growth in earned premium and the resulting positive effect on our expense ratio, partially offset by higher current accident year losses. There were higher non-catastrophe losses in our commercial automobile lines, including automobile coverages in our AIX program business, partially offset by lower non-catastrophe losses in our commercial multiple peril and inland marine lines.
Other operating loss was $6.9 million for the year ended December 31, 2012, compared to $0.5 million for the year ended December 31, 2011. The $6.4 million increased loss is primarily due to lower net investment income in our holding company.
The IBNR reserve includes a provision for claims that have occurred but have not yet been reported to us, some of which may not yet be known to the insured, as well as a provision for future development on reported claims. IBNR represents a significant proportion of our total net loss reserves, particularly for long-tail liability classes. In fact, approximately 46% of our aggregate net loss reserves at December 31, 2013 were for IBNR losses and loss expenses.
We regularly update our reserve estimates as new information becomes available and additional events occur which may impact the resolution of unsettled claims. Reserve adjustments are reflected in the results of operations as adjustments to losses and LAE. Often, these adjustments are recognized in periods subsequent to the period in which the underlying policy was written and the loss event occurred. When these types of subsequent adjustments affect prior years, they are described separately as “prior year reserve development”. Such development can be either favorable or unfavorable to our financial results and may vary by line of business. As discussed below, estimated loss and LAE reserves for claims occurring in prior years developed favorably by $76.3 million, $15.8 million, and $103.3 million for the years ended December 31, 2013, 2012, and 2011, respectively. However, we have experienced unfavorable development and there can be no assurance that current loss and LAE reserves will be sufficient.
Inflation generally increases the cost of losses covered by insurance contracts. The effect of inflation varies by product. Our property and casualty insurance premiums are established before the amount of losses and LAE and the extent to which inflation may affect such expenses are known. Consequently, we attempt, in establishing rates and reserves, to anticipate the potential impact of inflation in the projection of ultimate costs. For example, we have experienced increasing medical and attendant care costs, including those associated with automobile personal injury protection claims, particularly in Michigan, as well as in our workers’ compensation line in most states. Also, the U.K. motor business written by Chaucer recently has experienced high levels of claims inflation and increases in potential fraud-type claims. Increases are reflected in our current reserve estimates, but continued increases could contribute to increased losses and LAE in the future.
In addition, we must consider the uncertain effects of emerging or potential claims and coverage issues that arise as legal, judicial, social conditions, political risks, and economic conditions change. For example, claims which we consider closed may be re-opened as additional damages surface or new liability or damage theories are presented. These and other issues could have a negative effect on our loss reserves by either extending coverage beyond the original underwriting intent or by increasing the number or size of claims. Additionally, the effect of the recent U.K. legislation (the Legal Aid, Sentencing and Punishment of Offenders Act) on our U.K. motor business is unclear. Effective April 2013, key changes introduced by this legislation are limiting the level of success fees paid to lawyers, banning referral fees and increasing general damages by 10% for all bodily injury claims. As a result, the uncertainties inherent in estimating ultimate claim costs on the basis of past experience further complicate the already complex loss reserving process.
The Chaucer segment contains run-off business comprised of liability lines, notably financial institutions and professional liability business written by Lloyd’s Syndicate 4000. There is particular uncertainty around the reserve estimates in respect of business written in 2007 and 2008 which have been subject to claims arising out of the financial turmoil in that time period, particularly in the financial institutions book. These claims are unlikely to be settled for some time since they contain numerous coverage issues and in many
cases involve class action lawsuits that are likely to take several years to resolve. We have utilized substantially all of our available reinsurance with respect to losses and LAE related to Syndicate 4000 business written in 2008. Effective January 1, 2014, Syndicate 1084 accepted the reinsurance to close of the unpaid liabilities of Syndicate 4000 for the 2008 year of account and prior. This transaction resulted in the closure of the Syndicate 4000 and has no impact on a consolidated basis.
Monoline and Multi-Peril General Liability - reserves recorded for general liability on U.S. voluntary business were $402.0 million as of December 31, 2013. A key assumption for general liability is the implied adequacy of the underlying case reserves. A ten point change in case adequacy (e.g. 10% deficiency changed to 0% or 20% deficiency) would have changed estimated IBNR by approximately $32 million, either positive or negative, at December 31, 2013.
New classes of business - reserves recorded for new classes of Chaucer business (primarily within energy, engineering and international liability lines) were $292 million as of December 31, 2013. An increase in the ultimate loss by 5%, 10%, and 15% in the 2011 and prior, 2012, and 2013 years of account, respectively, on these classes would have increased estimated IBNR by approximately $49 million at December 31, 2013.
Catastrophe events - a 25% increase in estimated gross ultimate claim deterioration for the 2011 Japan earthquakes and Thailand floods and Superstorm Sandy, would have reduced underwriting income by approximately $14 million, including reinstatement premiums.
The table below summarizes the gross reserve for losses and LAE by line of business.
Other lines are primarily comprised of our general liability, umbrella, professional and management liability, marine, voluntary pools, surety, and healthcare lines. Included in the above table, primarily in other lines, are $61.9 million, $60.5 million and $59.8 million of asbestos and environmental reserves as of December 31, 2013, 2012 and 2011, respectively. Included in the Chaucer segment in the above table are $230.6 million, $272.4 million and $302.8 million of reserves as of December 31, 2013, 2012 and 2011, respectively, related to Chaucer’s Syndicate 4000, which consists of financial and professional liability lines written in 2008 and prior.
The primary drivers of reserve development for the year ended December 31, 2011 were as follows:
It is not possible to know whether the factors that affected loss reserves in the year ended December 31, 2013 will also occur in future periods. As discussed in detail in this Form 10-K, there are inherent uncertainties in estimating reserves for losses and loss adjustment expenses and we encourage you to read this Form 10-K for more information about our reserving process and the judgments, uncertainties and risks associated therewith.
Activity for our asbestos and environmental reserves was not significant to our 2013, 2012 or 2011 financial results. In recent years, average asbestos and environmental payments have declined modestly. As a result of our historical direct underwriting mix of Commercial Lines policies toward smaller and middle market risks, past asbestos and environmental damage liability loss experience has remained minimal in relation to our total loss and LAE incurred experience.
In addition, we have established gross loss and LAE reserves for assumed reinsurance pool business with asbestos and environmental damage liability of $29.8 million, $30.3 million and $31.1 million at December 31, 2013, 2012 and 2011, respectively. These reserves relate to pools in which we have terminated our participation; however, we continue to be subject to claims related to years in which we were a participant. Results of operations from these pools are included in our Other segment. A significant part of our pool reserves relates to our participation in the Excess and Casualty Reinsurance Association (“ECRA”) voluntary pool from 1950 to 1982. In 1982, the pool was dissolved and since that time, the business has been in run-off. Our percentage of the total pool liabilities varied from 1% to 6% during these years. Our participation in this pool has resulted in average paid losses of approximately $2 million annually over the past ten years.
Net investment income before taxes was $269.0 million, $276.6 million and $258.2 million for the years ended December 31, 2013, 2012 and 2011, respectively. The decrease in net investment income in 2013 compared to 2012 was primarily due to the impact of lower new money yields. This decrease was partially offset by additional income resulting from our investments in higher yielding investment grade mortgage-backed securities and the investment of operational cash flows, lower investment expenses and the investment of cash balances into fixed maturities beginning in the second quarter of 2012. The increase in net investment income in 2012 compared to 2011 was primarily due to the acquisition of Chaucer on July 1, 2011 and its related assets and investment income. Also, the increase resulted from our investments in dividend-yielding equity securities, various higher yielding investment grade fixed maturities and the investment of cash balances into fixed maturities, partially offset by the impact of lower new money yields. Average pre-tax earned yields on fixed maturities were 3.95%, 4.26% and 4.84% for the years ended December 31, 2013, 2012 and 2011, respectively. We expect average investment yields to continue to decline as new money rates remain lower than embedded book yields.
Total cash and investments increased $36.4 million, or 0.5%, for the year ended December 31, 2013, of which equities increased $114.4 million, fixed maturities increased $18.4 million, cash and cash equivalents decreased $78.6 million and other investments decreased $17.8 million. Equity securities increased primarily from purchases of dividend yielding stocks and exchange traded funds, as well as market value appreciation, partially offset by sales of mutual funds. Fixed maturities increased due to the investment of positive operational cash flows and available cash, partially offset by market value depreciation of $267.3 million for the year. Cash and cash equivalents decreased due to funding net investments and financing activities. Cash used in financing activities in 2013 included repayment of debt, common stock repurchases and external dividend payments, partially offset by cash provided by net proceeds from the issuance of subordinated debentures.
Our fixed maturity portfolio is comprised of corporate securities, taxable and tax-exempt municipal securities, residential mortgage-backed securities, commercial mortgage-backed securities, U.S. governmental securities, foreign government securities and asset-backed securities. Equity securities primarily consist of common stocks, exchange traded funds and non-redeemable preferred stocks.
Based on ratings by the National Association of Insurance Commissioners (“NAIC”), approximately 94% of the fixed maturity portfolio consisted of investment grade securities at December 31, 2013, compared to 95% at December 31, 2012. The quality of our fixed maturity portfolio remains strong based on ratings, capital structure position, support through guarantees, underlying security, issuer diversification and yield curve position.
We actively manage our credit exposure and seek securities with the best combination of credit strength and valuation. As we invest new capital, we consider expectations for the strength and duration of economic recovery in Europe and the possibility of additional volatility. Accordingly, we focus on providers of essential services or products best positioned to navigate the period of weak growth; industrials with greater international exposure, either locally or via exports, particularly to the developing world, which we view favorably based on higher growth assumptions for emerging market economies; and financial institutions best positioned regarding asset quality, liquidity and capital adequacy.
Overall economic growth remains weak throughout Europe but modestly improved versus the prior year. Volatility, while currently suppressed, could increase suddenly as officials in Europe continue to address the twin objectives of stimulating economic growth while balancing fiscal budgets. We believe that leaders remain committed to protecting the currency union and improving financial stability. Although the timing and degree of success toward achieving these goals remains uncertain, we do not anticipate that future developments related to our European sovereign and non-sovereign debt exposure will have a material effect on our financial condition, results of operations or liquidity.
For the year ended December 31, 2013, we recognized in earnings $6.0 million of other-than-temporary impairments (“OTTI”), of which $4.1 million related to equity securities and $1.9 million related to debt securities. OTTI on equity securities consisted of $2.5 million from an emerging markets exchange-traded fund and $1.6 million of common stocks. OTTI on debt securities consisted of $1.4 million of estimated credit losses, including $0.8 million of corporate securities in the industrial sector and $0.6 million on residential mortgage-backed securities, and $0.5 million on below investment grade corporate securities that we intended to sell. For the year ended December 31, 2012, we recognized in earnings $7.8 million of OTTI, of which $6.6 million related to debt securities and $1.2 million related to equity securities. OTTI on debt securities consisted of $4.6 million of below investment grade corporate bonds in the utilities and industrial sectors that we intended to sell and $2.0 million related to estimated credit losses, consisting of $0.9 million on municipal bonds, $0.7 million on residential mortgage-backed securities and $0.4 million on corporate bonds. For the year ended December 31, 2011, we recognized in earnings $6.9 million of OTTI, of which $5.5 million related to debt securities and $1.4 million related to equity securities. OTTI on debt securities consisted of $4.6 million of primarily below investment grade corporate and municipal bonds that we intended to sell and $0.9 million related to estimated credit losses on residential mortgage-backed securities.
The following table provides information about our fixed maturities and equity securities that were in an unrealized loss position. (See also Note 3 - “Investments” in the Notes to Consolidated Financial Statements included in Financial Statements and Supplementary Data of this Form 10-K).
The carrying values of defaulted fixed maturity securities on non-accrual status at December 31, 2013 and 2012 were not material. The effects of non-accruals compared with amounts that would have been recognized in accordance with the original terms of the fixed maturities, were reductions in net investment income of $2.3 million, $2.5 million and $2.3 million for the years ended December 31, 2013, 2012 and 2011, respectively. Any defaults in the fixed maturities portfolio in future periods may negatively affect investment income.
Monetary policies in the developed economies, particularly in the United States, Europe and Japan, are supportive of moderate economic growth, while fiscal policies are more divergent and subject to change. During 2014 in the United States, the Federal Reserve (the “Fed”) began tapering its $85 billion of monthly bond purchases, known as quantitative easing, which has put upward pressure on investment yields. However, the Fed’s balance sheet of more than $4 trillion is expected to keep rates low. The Fed has indicated that it does not plan to begin raising short-term rates in the near future and is expected to continue to provide forward guidance to keep rates relatively stable even as the economy strengthens. As a result, we anticipate marginally higher new money yields and lower fixed maturity market values in 2014.
We maintain an overall risk management strategy that incorporates the use of derivative instruments, as necessary, to manage significant unplanned fluctuations in earnings caused by foreign currency and interest rate volatility.
In 2011, we realized losses on derivative instruments of $7.1 million. In April 2011, we entered into a foreign currency forward contract to hedge the foreign currency exchange risk embedded in the purchase price of Chaucer, which was denominated in GBP, resulting in the recognition of a loss of $11.3 million in income from continuing operations. In May 2011, we entered into a treasury lock forward agreement to hedge the interest rate risk associated with our planned issuance of senior debt, resulting in a loss of $1.9 million, which was recorded in accumulated other comprehensive income and will be recognized in earnings over the term of the senior notes. Additionally in 2011, Chaucer held foreign currency forward contracts utilized to mitigate changes in fair value caused by foreign currency fluctuation in converting the fair value of GBP and Euro denominated investment portfolios into their U.S. dollar denominated equivalent. These portfolios supported U.S. dollar denominated claim reserve liabilities. For the year ended December 31, 2011, we recognized a gain of $6.1 million related to these instruments, which were terminated in October 2011.
Net realized gains on investments were $33.5 million, $23.6 million, and $28.1 million for 2013, 2012, and 2011, respectively. Net realized gains in 2013 were primarily due to $41.3 million of gains recognized from the sale of equities and fixed maturities, partially offset by $6.0 million of other-than-temporary impairments. Net realized gains in 2012 were primarily due to $31.8 million of gains recognized from the sale of equities and fixed maturities, partially offset by $7.8 million of other-than-temporary impairments. Net realized gains in 2011 were primarily due to $27.7 million of gains recognized from the sale of fixed maturities and equity securities and $6.1 million of gains on foreign currency hedges, partially offset by $6.9 million of other-than-temporary impairments.
In 2013, we consolidated our operations in Howell, Michigan from two buildings into one building. This resulted in a plan to relocate the employees and pursue the sale of one of the buildings. In conjunction with the planned relocation, we recognized a loss of $4.7 million. This is included in other operating expenses in the Consolidated Statements of Income during the year ended December 31, 2013.
Acquisition costs were $0.1 million and $2.6 million in 2013 and 2012, respectively, and $16.4 million in 2011, which primarily consisted of advisory, legal, and accounting costs associated with the acquisition of Chaucer on July 1, 2011. For information on the loss on derivative instruments and net foreign exchange gains recognized during 2011, see Note 2 - “Acquisitions and Discontinued Operations” of the Notes to Consolidated Financial Statements included in Financial Statements and Supplementary Data of this Form 10-K.
The following table illustrates the estimated impact on the fair value of our investment portfolio at December 31, 2013 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 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.
Our overall investment strategy is intended to balance investment income with credit and interest rate risk, while maintaining sufficient liquidity and the opportunity for capital growth. The asset allocation process takes into consideration the types of business written, the level of surplus required to support our different businesses and the risk return profiles of the underlying asset classes. We look to balance the goals of capital preservation, net investment income stability, liquidity and total return.
Our equity securities portfolio is exposed to equity price risk arising from potential volatility in equity market prices. Portfolio characteristics are analyzed regularly and price risk is actively managed through a variety of techniques. A hypothetical increase or decrease of 10% in the market price of our equity securities would have resulted in an increase or decrease in the fair value of the equity securities portfolio of approximately $43 million at December 31, 2013 and approximately $32 million at December 31, 2012.
Chaucer has exposure to foreign currency risk, most notably in insurance contracts and invested assets. Some of the insurance contracts provide that ultimate losses may be payable in foreign currencies depending on the country of original loss. Foreign currency exchange rate risk exists to the extent that there is an increase in the exchange rate of the foreign currency in which losses are ultimately owed. Thus, Chaucer attempts to manage foreign currency risk by seeking to match liabilities under insurance and reinsurance policies that are payable in foreign currencies with cash and investments that are denominated in such currencies. We may also utilize foreign currency forward contracts as part of our investment strategy. The principal currency creating foreign exchange risk for us is the U.K. pound sterling, and to a lesser extent, the Euro and the Canadian dollar. A hypothetical 10% reduction in the value of foreign denominated investments would be expected to produce a loss in fair value of approximately $112 million at December 31, 2013 and approximately $124 million at December 31, 2012.
Discontinued operations primarily consist of our former life insurance businesses which were sold prior to 2009, our Discontinued Accident and Health Business and our former third party administration business, CMI, which was sold in 2012.
The provision for income taxes from continuing operations was an expense of $83.4 million in 2013, compared to benefits of $17.4 million and $9.9 million in 2012 and 2011, respectively. These amounts resulted in consolidated effective tax rates of 25.3%, (60.6)%, and (45.8)% on pre-tax income for 2013, 2012, and 2011, respectively. These provisions reflect benefits related to tax planning strategies implemented in prior years of $17.5 million, $14.3 million and $9.7 million in 2013, 2012 and 2011, respectively. The provisions in 2012 and 2011 also reflect decreases in our valuation allowance related to capital loss carryforwards of $7.7 million and $7.5 million, respectively. Absent these benefits, the provision for income taxes for 2013, 2012, and 2011 would have been expenses of $100.9 million or 30.7%, $4.6 million, or 16.0%, and $7.3 million, or 33.8%, respectively. The increase in 2013 effective tax rate is primarily due to higher underwriting income.
The income tax provision on operating income was an expense of $100.9 million for 2013, compared to a benefit of $1.9 million for 2012 and an expense of $2.6 million in 2011. These provisions resulted in effective tax rates for operating income of 30.8%, (14.4)% and 15.5% in 2013, 2012 and 2011, respectively. The increase in expense for 2013 is primarily due to higher underwriting income. The tax benefit in 2012 is primarily due to income from foreign operations not subject to U.S. tax and lower domestic underwriting income.
The IRS audits of the years 2007 and 2008 commenced in April 2010. In 2011, we received a Revenue Agent Report for the 2007 and 2008 IRS audit. We agreed to all proposed adjustments other than the disallowance of deduction for certain loss reserves, for which we filed a formal protest. In December 2013, we reached a tentative settlement on the disallowance of deduction for certain loss reserves and as a result a liability for uncertain tax positions was established for $4.8 million, with an offsetting deferred tax asset. The net impact is a decrease to income from continuing operations of $0.5 million. We expect to reach a final settlement of this issue during 2014.
In prior years, we completed several transactions which resulted in the realization, for tax purposes only, of unrealized gains in our investment portfolio. We realized $69.6 million and $98.4 million, respectively, in 2012 and 2011 as a result of such transactions. These transactions enabled us to realize capital loss carryforwards to offset these gains, and resulted in the release of the valuation allowance we held against the deferred tax asset related to these capital loss carryforwards. In 2012, we released $24.4 million of our valuation allowance which was recorded as a benefit in accumulated other comprehensive income. In 2011, we released $29.0 million of our valuation allowance which $0.2 million was reflected in income from continuing operations and the remaining $28.8 million was reflected as a benefit in accumulated other comprehensive income. During 2013, 2012 and 2011, we recognized in income from continuing operations, related to non-operating income, $17.5 million, $14.3 million and $9.7 million, respectively. The remaining amount of $107.7 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.
Reinsurance recoverables recorded on insurance losses ceded under reinsurance contracts are subject to judgments and uncertainties similar to those involved in estimating gross loss reserves, as disclosed above. In addition to these uncertainties, our reinsurance recoverables may prove uncollectible if the reinsurers are unable or unwilling to perform under the reinsurance contracts. In establishing our reinsurance allowance for amounts deemed uncollectible, we evaluate the financial condition of our reinsurers and monitor concentration of credit risk arising from our exposure to individual reinsurers. To determine if an allowance is necessary, we consider, among other factors, published financial information, reports from rating agencies, payment history, collateral held and our legal right to offset balances recoverable against balances we may owe. Our reinsurance allowance for doubtful accounts is subject to uncertainty and volatility due to the time lag involved in collecting amounts recoverable from reinsurers. Over the period of time that losses occur, reinsurers are billed and amounts are ultimately collected, economic conditions, as well as the operational and financial performance of particular reinsurers, may change and these changes may affect the reinsurers’ willingness and ability to meet their contractual obligation to us. It is also difficult to fully evaluate the impact of major catastrophic events on the financial stability of reinsurers, as well as the access to capital that reinsurers may have when such events occur. The ceding of insurance does not legally discharge us from our primary liability for the full amount of the policies, and we will be required to pay the loss and bear collection risk even if the reinsurers fail to meet their obligations under the reinsurance contracts.
We currently have a U.S. qualified defined benefit plan, a defined benefit pension plan for our international subsidiary, Chaucer, and several smaller qualified and non-qualified benefit plans. In order to measure the liabilities and expense associated with these plans, we must make various estimates and key assumptions, including discount rates used to value liabilities, assumed rates of return on plan assets, employee turnover rates and anticipated mortality rates. Additionally, our Chaucer pension plan also must take into consideration inflation rates, specifically related to participant salary increases. These estimates and assumptions are reviewed at least annually and are based on our historical experience, as well as current facts and circumstances. In addition, we use outside actuaries to assist in measuring the expenses and liabilities associated with our defined benefit pension plans.
Expenses related to these plans are generally calculated based upon information available at the beginning of the plan year. Our pre-tax expense related to our defined benefit plans was $12.6 million and $11.0 million for 2013 and 2012, respectively.
Discount Rate - A 25 basis point increase in the discount rate would decrease our pension expense in 2014 by $1.6 million and decrease our projected benefit obligation by $11.9 million. A 25 basis point reduction in the discount rate would increase our pension expense by $1.5 million and increase our projected benefit obligation by $12.4 million.
Expected Return on Plan Assets - A 25 basis point increase or decrease in the expected return on plan assets would decrease or increase our pension expense in 2014 by $1.3 million.
For the years ended December 31, 2013 and 2012, the expected rate of return on plan assets was 6.70% and 7.50%, respectively. The composition of Chaucer’s plan assets are 74% equities, 19% fixed maturities, and 7% real estate funds at December 31, 2013. Actual returns of the plan investments generated approximately $17 million and $10 million of gains during the years ended December 31, 2013 and 2012, respectively, as compared to expected returns of approximately $6 million in each year.
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 U.S. insurance subsidiaries), as of December 31, 2013 and 2012, 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):
Chaucer corporate members operate in the Lloyd’s market, which requires that these members deposit funds, referred to as “Funds at Lloyd’s”, to support their underwriting interests. Lloyd’s sets required capital annually for all participating syndicates based on each syndicate’s business plans, the rating and reserving environment, and discussions with regulatory and rating agencies. Although the minimum capital levels are set by Lloyd’s, it is the responsibility of Chaucer to continually monitor the risk profiles of its managed syndicates to ensure that the level of funding remains appropriate. Such capital is comprised of cash and cash equivalents, investments, undrawn letters of credit provided by various banks and other assets. At December 31, 2013, we are in compliance with
In connection with an intercompany borrowing arrangement between Chaucer and the holding company, interest on a $300 million note is paid by Chaucer on a quarterly basis to the holding company. This interest may be deferred at the election of the holding company. If deferred, the interest is added to the principal. Chaucer paid $28.1 million and $27.4 million of interest during 2013 and 2012, respectively.
At December 31, 2013, THG, as a holding company, held approximately $122.4 million of fixed maturities and cash. We believe our holding company assets are sufficient to meet our future obligations, which consist primarily of dividends to our shareholders (as and to the extent declared), the interest on our senior and subordinated debentures, certain costs associated with benefits due to our former life employees and agents, additional funds relating to the purchase of Chaucer, and, to the extent required, payments related to indemnification of liabilities associated with the sale of various subsidiaries. We do not expect that it will be necessary to dividend additional funds from our insurance subsidiaries in order to fund 2014 holding company obligations; however, we may decide to do so.
Net cash provided by operating activities was $383.9 million during 2013, as compared to $408.2 million in 2012 and $221.7 million in 2011. The $24.3 million decrease in 2013 compared to 2012 is primarily due to the timing of reimbursements made to Lloyd’s related to claim payments made on our behalf, partially offset by lower claims payments in 2013. The $186.5 million increase in 2012 compared to 2011 primarily resulted from an increase in premiums, partially offset by an increase in loss and LAE payments.
Dividends to common shareholders are subject to quarterly board approval and declaration. During 2013, as declared by the Board, we paid three quarterly dividends of $0.33 per share and one quarterly dividend of $0.37 per share to our shareholders totaling $60.0 million. We believe that our holding company assets are sufficient to provide for future shareholder dividends should the Board of Directors declare them.
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 and the Chaucer pension plan. Based upon the current estimate of liabilities and certain assumptions regarding investment returns and other factors, our qualified defined benefit pension plans and Chaucer pension plan collectively have plan liabilities in excess of plan assets by approximately $15 million. The ultimate payment amounts for our benefit plans are 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.
Since October 2007 and through December 2013, our Board of Directors has authorized aggregate repurchases of our common stock of up to $600 million, including a $100 million increase in the program in 2013. 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. During 2013, we repurchased 1.6 million shares of our common stock at a cost of $78.2 million.
Additionally, from time to time, we may also repurchase our debt on an opportunistic basis. During 2013, we repurchased senior debentures with a net carrying value of $73.8 million at a cost of $93.7 million, resulting in a loss of $19.9 million. Additionally in 2013, we repaid $46.3 million of our FHLBB advances plus prepayment fees of $7.8 million for a total payment of $54.1 million. We expect these repurchases will reduce our annual pre-tax interest costs by approximately $7 million. In 2012, we called $65.4 million of our subordinated unsecured notes related to Chaucer at par value. These notes had a carrying value of $60.3 million, resulting in a net loss of $5.1 million on the repayment. Additional information related to all borrowings is in Note 6 - “Debt and Credit Arrangements” in the Notes to Consolidated Financial Statements included in Financial Statements and Supplementary Data of this Form 10-K.
In November 2013, we amended and restated our existing Standby Letter of Credit Facility (the “Amended Facility Agreement”) not to exceed £130.0 million (or $215.8 million) outstanding at any one time, with the option to increase the amount available for issuances of letters of credit to £195.0 million (or $323.7 million) in the aggregate on one occasion only during the term of the Amended Facility Agreement (subject to the consent of all lenders and assuming no default and satisfaction of other specified conditions). Amounts in U.S. dollars were converted based on the foreign currency exchange rate of 1.66 at December 31, 2013. Prior to the amendment, we had a Standby Letter of Credit Facility Agreement in place not to exceed $180.0 million outstanding at any one time, with a similar option to increase the amount available for issuances of letters of credit to $270.0 million. The amended agreement provides certain covenants including, but not limited to, the syndicates’ financial condition which were also in place prior to the amendment of the agreement. The Amended Facility Agreement provides regulatory capital supporting Chaucer’s underwriting activities for the 2014 and 2015 years of account and each prior open year of account and is generally renewed biennially to support new underwriting years. A letter of credit commission fee on outstanding letters of credit is payable quarterly, and ranges from 1.375% to 1.75% per annum, depending on our credit ratings for portions that are not cash collateralized, and 0.275% per annum for portions that are cash collateralized. We may, from time to time, collateralize a portion of the outstanding letter of credit. In addition to the commission fee on the uncollateralized outstanding letter of credit, a commitment fee in respect of the unutilized commitments under the Amended Facility Agreement is payable quarterly, and ranges from 0.55% to 0.70% per annum, depending on our credit ratings. Chaucer is also required to pay customary agency fees. Under the previous agreement we paid $2.7 million in interest in 2013. We expect lower interest payments under the new agreement based on current prevailing interest rates.
Simultaneous with the Amended Facility Agreement, we entered into a Guaranty Agreement (the “Guaranty Agreement”) with Lloyds Bank plc, as Facility Agent and Security Agent, pursuant to which, we unconditionally guarantee the obligations of Chaucer under the Amended Facility Agreement. The Guaranty Agreement contains certain financial covenants that require us to maintain a minimum net worth, a minimum risk-based capital ratio at our primary U.S. domiciled property and casualty companies and a maximum leverage ratio, and certain negative covenants that limit our ability, among other things, to incur or assume certain debt, grant liens on our property, merge or consolidate, dispose of assets, materially change the nature or conduct of our business and make restricted payments (except, in each case, as provided by certain exceptions). The Guaranty Agreement also contains certain customary representations and warranties. The current Guaranty Agreement contains terms and conditions substantially similar to the previous guaranty agreement we had in place with Lloyds Bank plc in connection with Chaucer’s previous Facility Agreement.
At December 31, 2013, we were in compliance with the covenants of the aforementioned debt agreements.
Catastrophe - A severe loss, resulting from natural and manmade events, including risks such as hurricane, fire, earthquake, windstorm, tornado, hailstorm, severe winter weather, drought, explosion, terrorism, riots and other similar events.
Economic interest- The share of syndicate underwriting capacity supported by capital from Chaucer Holdings plc.
Loss ratio, GAAP- The ratio of losses to premiums earned for a given period.
Underwriting expenses - Expenses incurred in connection with the acquisition, pricing and administration of a policy or contract.
In the normal course of business, the Company may enter into transactions involving various types of financial instruments, including debt, investments such as fixed maturities, equity securities and mortgage loans, investment and loan commitments, swap contracts, option contracts, forward contracts and futures contracts. These instruments involve credit risk and could also be subject to risk of loss due to interest rate and foreign currency fluctuation. The Company evaluates and monitors each financial instrument individually and, when appropriate, obtains collateral or other security to minimize losses.
Other investments consist primarily of overseas deposits, which are investments maintained in overseas funds and managed exclusively by Lloyd’s. These funds are required in order to protect policyholders in overseas markets and enable the Company to operate in those markets. Overseas deposits are carried at fair value. Realized and unrealized gains and losses on overseas deposits, including the impact of foreign currency movements, are reflected in the income statement in the period the gain or loss was generated.
Acquisition costs consist of commissions, underwriting costs and other costs, which vary with, and are primarily related to, the successful production of premiums. Acquisition costs are deferred and amortized over the terms of the insurance policies.
In 2013, the Company consolidated its operations in Howell, Michigan from two buildings into one building. This resulted in a plan to relocate the employees and pursue the sale of one of the buildings. In conjunction with the planned relocation, the Company recognized a loss of $4.7 million. This is included in other operating expenses in the Consolidated Statements of Income for the year ended December 31, 2013.
Liabilities for outstanding claims, losses and loss adjustment expenses (“LAE”) are estimates of payments to be made for reported losses and LAE and estimates of losses and LAE incurred but not reported. These liabilities are determined using case basis evaluations and statistical analyses of historical loss patterns and represent estimates of the ultimate cost of all losses incurred but not paid. These estimates are continually reviewed and adjusted as necessary; adjustments are reflected in current operations. Estimated amounts of salvage and subrogation on unpaid losses are deducted from the liability for unpaid claims.
The Company’s debt at December 31, 2013 includes senior debentures, subordinated debentures, and collateralized borrowings with the Federal Home Loan Bank of Boston (“FHLBB”). The senior debentures are carried at principal amount borrowed, net of any applicable unamortized discounts. The subordinated debentures and borrowings under the FHLBB program are carried at principal amount borrowed (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 include estimates, primarily in the Chaucer segment, 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, 2013 and 2012. 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.
In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (“ASC”) Update No. 2013-02 (Topic 220) Comprehensive Income Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (“ASC Update No. 2013-02”). This guidance requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income (“AOCI”) either on the face of the Statement of Income or in the Notes to the Consolidated Financial Statements. Significant amounts reclassified out of AOCI should be provided by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified in its entirety to net income in the same reporting period. For amounts not required to be reclassified in their entirety to net income, a cross-reference to other disclosures provided for in accordance with U.S. GAAP is required. This guidance was applicable for reporting periods beginning after December 15, 2012. The Company implemented the guidance effective January 1, 2013. The effect of implementing the guidance relates to financial statement presentation and disclosures. (See disclosures in Note 10 - Other Comprehensive Income.)
In July 2012, the FASB issued ASC Update No. 2012-02 (Topic 350) Testing Indefinite - Lived Intangible Assets for Impairment. This ASC update allows an entity to first assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite - lived intangible asset is impaired. This assessment should be used as a basis for determining whether it is necessary to perform the quantitative impairment test. An entity would not be required to calculate the fair value of the intangible asset and perform the quantitative test unless the entity determines, based upon its qualitative assessment, that it is more likely than not that its fair value is less than its carrying value. The update further improves previous guidance by expanding upon the examples of events and circumstances that an entity should consider in determining whether it is more likely than not that the fair value of an indefinite - lived intangible asset is less than its carrying amount. The update also allows an entity the option to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test. An entity will be able to resume performing the qualitative assessment in any subsequent period. This ASC update was effective for annual and interim periods beginning after September 15, 2012, with early adoption permitted. The Company implemented this guidance effective October 1, 2012. The effect of implementing this guidance was not material to the Company’s financial position or results of operations.
In September 2011, the FASB issued ASC Update No. 2011-08 (Topic 350) Testing Goodwill for Impairment. This ASC update allows an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. The update provides that an entity would not be required to calculate the fair value of a reporting unit unless the entity determines, based on its qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. The update further improves previous guidance by expanding upon the examples of events and circumstances that an entity should consider in determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Also, the update improves the examples of events and circumstances that should be considered by an entity that has a reporting unit with a zero or negative carrying amount in determining whether to measure an impairment loss, if any, under the second step of the goodwill impairment test. This ASC update was effective for annual and interim periods beginning after December 15, 2011, with early adoption permitted. The Company implemented this guidance effective January 1, 2012. The effect of implementing this guidance was not material to the Company’s financial position or results of operations.
In October 2010, the FASB issued ASC Update No. 2010-26 (Topic 944), Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts (a consensus of the FASB Emerging Issues Task Force). This ASC update provides clarity in defining which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral, commonly known as deferred acquisition costs. Additionally, this update specifies that only costs associated with the successful acquisition of a policy or contract may be deferred, whereas industry practice historically included costs relating to unsuccessful contract acquisition. This ASC was effective for fiscal years beginning after December 15, 2011. Retrospective application to all prior periods upon the date of adoption was permitted. The Company implemented this guidance effective January 1, 2012 and elected to apply this guidance retrospectively. Retrospective application required that the new accounting principle be reflected in the earliest period presented as if the accounting principle had always been used. Upon adoption in 2012, the Company applied this guidance to the then earliest period, which was January 1, 2010. Additionally, since the Company purchased Chaucer July 1, 2011, it has reflected the impact of the retrospective application for Chaucer through equity, as a cumulative effect of a change in accounting principle, during 2011. The implementation of this ASC resulted in an after-tax reduction to our shareholders’ equity as of January 1, 2012 of $25.8 million, or 1%. The effect of implementing this guidance was not material to our results of operations or cash flows on either a historical basis or a prospective basis.
On July 1, 2011, the Company acquired Chaucer, a U.K. insurance business. Shareholders of Chaucer received 53.3 pence for each Chaucer share, which was paid in either cash or loan notes to those shareholders who elected to receive such notes in lieu of cash. The following table summarizes the transaction in both GBP and U.S. dollars:
(1) Weighted average shares outstanding and per diluted share amounts in 2011 exclude common stock equivalents, since the impact of these instruments would be antidilutive.
Discontinued operations primarily consist of the Company’s former life insurance businesses, which were sold prior to 2009, its Discontinued Accident and Health Business and its former third party administration business, Citizens Management, Inc. (“CMI”), which was sold in 2012.
The accident and health business had no significant financial results that impacted 2013, 2012 or 2011. At December 31, 2013 and 2012, the portion of the discontinued accident and health business that was directly assumed had assets of $66.6 million and $72.9 million, respectively, consisting primarily of invested assets, and liabilities of $51.3 million and $52.5 million, respectively, consisting primarily of policy liabilities. At December 31, 2013 and 2012, the assets and liabilities of this business, as well as those of the reinsured portion of the accident and health business are classified as assets and liabilities of discontinued operations in the Consolidated Balance Sheets.
At December 31, 2013 and 2012, fixed maturities with fair values of $142.4 million and $115.7 million, respectively, and amortized cost of $135.2 million and $106.2 million, respectively, were on deposit with various state and governmental authorities.
The Company enters into various agreements that may require its fixed maturities to be held as collateral by others. At December 31, 2013 and 2012, fixed maturities with a fair value of $160.9 million and $213.8 million, respectively, were held as collateral for collateralized borrowings and other arrangements. Of these amounts, $148.1 million and $200.8 million related to the FHLBB collateralized borrowing program at December 31, 2013 and 2012, respectively. See Note 6-“Debt and Credit Arrangements” for additional information related to the Company’s FHLBB program.
In 2011, the Company realized losses on derivative instruments of $7.1 million. In April 2011, the Company entered into a foreign currency forward contract as an economic hedge of the foreign currency exchange risk embedded in the purchase price of Chaucer, which was denominated in GBP resulting in a loss of $11.3 million, reflected in other operating expenses in the Consolidated Statements of Income. In May 2011, the Company entered into a treasury lock forward agreement to hedge the interest rate risk associated with the planned issuance of senior debt resulting in a loss of $1.9 million which was recorded in accumulated other comprehensive income and is being recognized as an expense over the term of the senior notes. This hedge qualified as a cash flow hedge. Additionally in 2011, Chaucer held foreign currency forward contracts utilized to mitigate changes in fair value caused by foreign currency fluctuation in converting the fair value of GBP and Euro denominated investment portfolios into their U.S. dollar denominated equivalent. During the year ended December 31, 2011, the Company recognized a net gain of $6.1 million, reflected in net realized investment gains in the Consolidated Statements of Income, related to these instruments, which were terminated in October 2011.
The following tables provide information about the Company’s fixed maturities and equity securities that were in an unrealized loss position at December 31, 2013 and 2012:
The Company had no concentration of investments in a single investee that exceeded 10% of shareholders’ equity except for fixed maturities invested in Federal Home Loan Mortgage Corp., which had a fair value of $341.8 million and $415.7 million as of December 31, 2013 and 2012, respectively.
The Company held overseas deposits of $149.6 million and $169.2 million at December 31, 2013 and 2012, respectively, which are investments held in overseas funds and managed exclusively by Lloyd’s. These investments are reflected in other investments in the Consolidated Balance Sheets.
Included in the net realized investment gains (losses) were other-than-temporary impairments of investment securities recognized in earnings totaling $6.0 million, $7.8 million and $6.9 million in 2013, 2012 and 2011, respectively.
Level 2 - Quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data, including model-derived valuations.
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
Level 1 consists of publicly traded securities, including exchange traded funds, valued at quoted market prices. Level 2 includes securities that are valued using pricing for similar securities and pricing models that incorporate observable inputs. Level 2 also
includes fair values obtained from net asset values provided by mutual fund investment managers, upon which subscriptions and redemptions can be executed. Level 3 consists of common or preferred stock of private companies for which observable inputs are not available. Non-binding broker quotes are also included in Level 3.
Other investments consist primarily of overseas trust funds, for which fair values are provided by the investment manager based on quoted prices for similar instruments in active markets and are reported as Level 2. Also included in other investments are cost basis limited partnerships and mortgage loans. Cost basis limited partnerships’ fair values are based on the net asset value provided by the general partner and recent financial information and are reported as Level 3. Mortgage loans’ fair values are estimated by discounting the future contractual cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and are reported as Level 2.
The Company has processes designed to ensure that the values received from its third party pricing service are accurately recorded, that the data inputs and valuation techniques utilized are appropriate and consistently applied and that the assumptions are reasonable and consistent with the objective of determining fair value. The Company performs a review of the fair value hierarchy classifications and of prices received from its pricing service on a quarterly basis. The Company reviews the pricing services’ policies describing its methodology, processes, practices and inputs, including various financial models used to value securities. Also, the Company reviews the portfolio pricing, including securities with changes in prices that exceed a defined threshold are verified to independent sources, if available. If upon review, the Company is not satisfied with the validity of a given price, a pricing challenge would be submitted to the pricing service along with supporting documentation for its review. The Company does not adjust quotes or prices obtained from the pricing service unless the pricing service agrees with the Company’s challenge. During 2013 and 2012, the Company did not adjust any prices received from brokers or its pricing service.
The tables below provide a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3).
The following table summarizes gains and losses due to changes in fair value that are recorded in net income for Level 3 assets.
There were no Level 3 liabilities held by the Company for years ended December 31, 2013 and 2012.
Interest expense was $65.3 million, $61.9 million, and $55.0 million in 2013, 2012 and 2011, respectively. At December 31, 2013, the Company was in compliance with the covenants associated with all of its debt indentures and credit arrangements.
Included in the Company’s deferred tax asset as of December 31, 2013 are assets of $42.1 million related to U.S. net operating loss carryforwards and a deferred tax asset of $22.4 million related to foreign net operating carryforwards. The pre-tax U.S. operating loss carryforwards of $120.3 million will expire beginning in 2031. The pre-tax foreign operating loss carryforwards of $66.2 million were generated in the U.K. and have no expiration date. It is the Company’s opinion that there will be sufficient future U.S. and U.K. taxable income to utilize these loss carryforwards. The Company’s estimate of the gross amount and likely realization of loss carryforwards may change over time.
Included in the Company’s deferred tax asset as of December 31, 2013 are assets of $110.3 million related to alternative minimum tax credit carryforwards and $12.8 million related to foreign tax credit carryforwards. The alternative minimum tax credit carryforwards have no expiration date and the foreign tax credit carryforwards will expire beginning in 2022. The Company may utilize the credits to offset regular federal income taxes due from future income, and although the Company believes that these assets are fully recoverable, there can be no certainty that future events will not affect their recoverability. The Company believes, based on objective evidence, it is more likely than not that the remaining deferred tax assets will be realized.
During 2013, the Company recorded a valuation allowance of $2.9 million related to its deferred tax asset on the unrealized depreciation in its investment portfolio. It is the Company’s opinion that it is more likely than not that this asset will not be realized and accordingly, the Company recorded this valuation allowance as an adjustment to other comprehensive income.
The ultimate deductibility of the aforementioned $4.8 million payable is highly certain, but 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. There are no tax positions at December 31, 2012 and 2011 for which the ultimate deductibility is highly certain, but for which there is uncertainty about the timing of such deductibility.
The Company recognizes interest and penalties related to unrecognized tax benefits in federal income tax expense. The Company had accrued interest of $1.2 million and $0.4 million as of December 31, 2013 and 2012, respectively. The Company has not recognized any penalties associated with unrecognized tax benefits.
The Company or its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state jurisdictions, as well as foreign jurisdictions. With few exceptions, the Company and its subsidiaries are no longer subject to U.S. federal income tax examinations by tax authorities for years before 2007. The IRS audits of the years 2009 and 2010 commenced in June 2012. The Company and its subsidiaries are still subject to U.S. state income tax examinations by tax authorities for years after 2006 and foreign examinations for years after 2010.
Prior to 2002, the Chaucer segment provided defined benefit pension retirement benefits to certain of its employees. As of December 31, 2001, the defined benefit pension plan was closed to new members. The defined benefit obligation for this plan is based on the employees’ years of service and final pensionable salary. Contributions are made at least annually to this plan by both the Company and by employees. As of December 31, 2013, 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 $8 million.
The Company utilizes a measurement date of January 1st to determine its periodic pension costs. Weighted-average assumptions used to determine net periodic pension costs for the defined benefit plans are as follows:
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. Specifically, for the U.S. defined benefit plans, because the allocation of assets between fixed maturities and equities has changed over time, the historical mean returns were adjusted downward slightly to reflect the plan’s asset mix. The adjusted mean returns were weighted to the plan’s expected target asset allocation at December 31, 2013, resulting in an expected rate of return on plan assets for 2013 of 5.25%. 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.
The Company utilizes a target allocation strategy, 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. During 2013 and 2012, the plan assets were invested 84% in fixed income securities and 16% in equity securities. The Company reviews and updates, at least annually, the target allocation and makes changes periodically.
Securities classified as Level 1 at December 31, 2013 and 2012 include actively traded mutual funds and publicly traded securities, which are valued at quoted market prices. Securities classified as Level 2 at December 31, 2013 and 2012 include a separate investment account, which is invested entirely in the Vanguard Total Bond Market Index Fund, a mutual fund that in turn invests in investment grade fixed maturities, as well as commingled pools and investment grade fixed income securities that are held in a custom fund. The fair value of each of the Level 2 investments is determined daily as the Net Asset Value (“NAV”) based on the value of the underlying investments, which is determined independently by the investment manager. 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 investment strategy of the Chaucer defined benefit pension plan is to invest primarily in growth assets in the form of equity funds which are expected to provide a positive return that exceeds inflation over the longer term in order to protect the existing and future liabilities of the pension plan. In order to reduce volatility and diversify the portfolio, the target allocation includes an exposure to corporate bond and commercial property funds. In 2013, the Company modified its investment allocation strategy and began shifting assets from equity securities into fixed maturities. The Company will continue shifting assets until it reaches its current ultimate target level of 60% equities, 30% fixed maturities and 10% real estate funds. This allocation plan will be reviewed annually and target allocation changes will be made as appropriate. The following table provides 2013 target allocations and actual invested asset allocations for 2013 and 2012.
Included in total plan assets of $120.2 million at December 31, 2013 were $119.9 million of invested assets carried at fair value and $0.3 million of cash and equivalents. Total plan assets at December 31, 2012 of $90.9 million included $90.7 million of invested assets carried at fair value and $0.2 million of cash and equivalents.
The following table presents for each hierarchy level the Chaucer defined benefit plan’s investment assets that are measured at fair value at December 31, 2013 and 2012.
Securities classified as Level 2 at December 31, 2013 and 2012 include pooled funds which are valued at the close of business using a third party pricing service. These values are adjusted by the fund manager to reflect outstanding dividends, taxes and investment fees and other expenses to calculate the NAV.
The Company recognizes the current net underfunded status of its plans in its Consolidated Balance Sheets. Changes in the funded status of the plans are reflected as components of accumulated other comprehensive loss or income. The components of accumulated other comprehensive loss or income are reflected as either a net actuarial gain or loss or a net prior service cost. The following table reflects the benefit obligations, fair value of plan assets and funded status of the plans at December 31, 2013 and 2012.
The following table reflects the total amounts recognized in accumulated other comprehensive income relating to both the U.S.
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 in future years. The following table reflects the total estimated amount of actuarial losses that will be amortized from accumulated other comprehensive income into net periodic pension cost in 2014:
In addition to the defined benefit plans, THG provides a defined contribution 401(k) plan for its U.S. employees, whereby the Company matches employee elective 401(k) contributions, up to a maximum percentage of 6% in 2013, 2012, and 2011. The Company’s expense for this matching provision was $18.3 million, $17.9 million and $17.8 million for 2013, 2012 and 2011, respectively. In addition to this matching provision, the Company can elect to make an annual contribution to employees’ accounts. Additional contributions amounted to $2.8 million for the 2013 plan year. There were no additional contributions in 2012 and 2011.
A one-percentage point change in assumed health care cost trend rates in each year would have an immaterial effect on net periodic
benefit cost during 2013 and accumulated postretirement benefit obligation at December 31, 2013.
On May 16, 2006, the shareholders approved the adoption of The Hanover Insurance Group, Inc. 2006 Long-Term Incentive Plan (the “Plan”). Key employees, directors and certain consultants of the Company and its subsidiaries are eligible for awards pursuant to the Plan, which is administered by the Compensation Committee of the Board of Directors (the “Committee”) of the Company. Under the Plan, awards may be granted in the form of non-qualified or incentive stock options, stock appreciation rights, performance awards, restricted stock, unrestricted stock, stock units, or any other award that is convertible into or otherwise based on the Company’s stock, subject to certain limits. The Plan authorized the issuance of 3,000,000 new shares that may be used for awards. In addition, shares of stock underlying any award granted and outstanding under the Company’s Amended Long-Term Stock Incentive Plan (the “1996 Plan”) as of the adoption date of the Plan that are forfeited, cancelled, expire or terminate without the issuance of stock become available for future grants under the Plan. As of December 31, 2013, there were 1,033,786 shares available for grants under the Plan. The Company utilizes shares of stock held in the treasury account for option exercises and other awards granted under both plans.
Compensation cost for the years ended December 31, 2013, 2012, and 2011 totaled $12.4 million, $12.8 million and $12.2 million, respectively. Related tax benefits were $4.3 million, $4.5 million and $4.3 million, respectively.
Under the Plan, options may be granted to eligible employees, directors or consultants at an exercise price equal to the market price of the Company’s common stock on the date of grant. Option shares may be exercised subject to the terms prescribed by the Committee at the time of grant. Options granted in 2013 generally vest over 3 years with 33 1/3% vesting in each year, whereas options granted in 2012, and 2011 generally vest over 4 years with a 50% vesting rate in the third year and a 50% vesting rate in the fourth year. Options must be exercised not later than ten years from the date of grant.
The excess tax expense realized from options exercised for the years ended December 31, 2013, 2012, and 2011 was $9.0 million, $0.4 million, and $1.5 million, respectively. The aggregate intrinsic value at December 31, 2013 for shares outstanding and shares exercisable was $38.0 million and $14.5 million, respectively. At December 31, 2013, the weighted average remaining contractual life for shares outstanding and shares exercisable was 6.4 years and 3.6 years, respectively. Additional information about employee options outstanding and exercisable at December 31, 2013 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, 2013, 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 weighted average grant date fair value of options granted during the years ended December 31, 2013, 2012 and 2011 was $7.69, $8.87 and $12.23, respectively.
The Company granted market-based restricted share units in 2013 and 2012 and performance-based restricted share units in 2011 to certain employees. Share units granted in 2013 generally vest after 3 years of continued employment and after the achievement of certain stock performance targets and share units granted in 2012 and 2011 vest after the achievement of certain performance targets at a rate of 50% after 3 years and the remaining 50% after 4 years of continued employment. The Company also granted restricted stock units to eligible employees that for awards granted in 2013 generally vest after 3 years of continued employment and for those granted in 2012 and 2011 generally vest at a rate of 50% after 3 years and the remaining 50% after 4 years of continued employment. The following table summarizes information about employee restricted stock units;
In 2013 and 2012, the Company granted market-based awards totaling 76,175 and 92,400, respectively, to certain members of senior management, which are included in the table above as performance and market-based restricted stock activity. The vesting of these stock units is based on the relative total shareholder return (“TSR”) of the Company. This metric is generally based on relative TSR for a three year period as compared to a Property and Casualty Index of peer companies. The fair value of market based awards was estimated at the date of grant using a valuation model. These units have the potential to range from 0% to 150% of the shares disclosed.
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 10% of such insurer’s statutory policyholder surplus as of the preceding December 31. No dividends were declared by Hanover Insurance in 2013 or 2012. In 2011, Hanover Insurance declared dividends to its parent totaling $99.0 million. During 2014, the maximum dividend payable without prior approval is $183.0 million.
Pursuant to Michigan’s statute, the maximum dividends and other distributions that an insurer may pay in any twelve month period, without prior approval of the Michigan Insurance Commissioner, is limited to the greater of 10% of policyholders’ surplus as of December 31 of the immediately preceding year or the statutory net income less net realized gains, for the immediately preceding calendar year. Citizens declared dividends to its parent, Hanover Insurance, totaling $68.0 million, $70.0 million and $69.0 million in 2013, 2012 and 2011, respectively. Citizens cannot pay a further dividend to its parent without prior approval until December 2014, at which time the maximum dividend payable without prior approval would be $66.2 million.
Dividend payments from Chaucer to its parent are regulated by U.K. law. Dividends from Chaucer are dependent on dividends from its subsidiaries. Annual dividend payments from Chaucer are limited to retained earnings that are not restricted by capital and other requirements for business at Lloyd’s. Also, Chaucer must provide advance notice to the U.K.’s Prudential Regulation Authority (“PRA”), one of the successors to the Financial Services Authority, of certain proposed dividends or other payments from PRA regulated entities. Dividend payments to THG from Chaucer entities totaled $13.9 million in 2013. No dividends were declared by Chaucer in 2012 or 2011.
Summarized below is financial information with respect to the Company’s business segments. Amounts reflect activity of Chaucer since the July 1, 2011 acquisition date.
The Company reviews the assets of its U.S. Companies collectively and does not allocate them between the Commercial Lines, Personal Lines and Other segments.
Rental expenses for operating leases amounted to $21.6 million, $22.4 million and $21.1 million in 2013, 2012 and 2011, respectively. These expenses relate primarily to building leases of the Company. At December 31, 2013, future minimum rental payments under non-cancelable operating leases, were $47.2 million, payable as follows: 2014 - $17.0 million; 2015 - $14.2 million; 2016 - $8.4 million; 2017 - $4.3 million and 2018 and thereafter - $3.3 million. It is expected that in the normal course of business, leases that expire may be renewed or replaced by leases on other property and equipment.
The table below provides a reconciliation of the gross beginning and ending reserve for unpaid losses and loss adjustment expenses (results for Chaucer for the year ended December 31, 2011 reflect the period from July 1, 2011 to December 31, 2011).
As part of an ongoing process, reserves have been re-estimated for all prior accident years and were decreased by $76.3 million, $15.8 million and $103.3 million in 2013, 2012 and 2011, respectively. For the years ended December 31, 2013, 2012 and the six months ended December 31, 2011, these amounts include favorable loss and LAE reserve development of $94.6 million, $72.6 million and $35.5 million, respectively for Chaucer. Chaucer’s favorable development during 2013 was primarily the result of lower than expected losses in the energy line, primarily in the 2009 through 2012 accident years, property line, primarily in the 2011 and 2012 accident years, within casualty and other lines, specialty liability lines, primarily in the 2008 accident year, and the marine and aviation line, primarily in the 2010 through 2012 accident years. For Commercial and Personal Lines, the unfavorable loss and LAE development during 2013 was primarily the result of higher than expected losses within the personal automobile line, due to severity in bodily injury coverage in the 2010 through 2012 accident years, higher than expected large losses in the commercial automobile line, primarily related to liability coverage in the 2009 through 2011 accident years, and higher than expected losses within other commercial lines, primarily in the 2010 through 2012 accident years. Partially offsetting the unfavorable development was lower than expected losses within the workers’ compensation line, primarily in the 2006 through 2011 accident years and lower involuntary pool losses, including a $3.2 million benefit from the settlement of a legal proceeding, and lower than expected losses within the commercial multi-peril line, primarily in the 2012 accident year.
The $15.8 million favorable loss and LAE reserve development during the year ended December 31, 2012 includes favorable loss and LAE reserve development of $72.6 million for Chaucer. Chaucer’s favorable development during 2012 was primarily the result of lower than expected losses in the energy line, primarily in the 2008 through 2011 accident years, marine and aviation lines, primarily in the 2007 through 2011 accident years, casualty lines, primarily in the 2010 and 2011 accident years, and the property lines, primarily in the 2009 through 2011 accident years. For Commercial and Personal Lines, the unfavorable loss and LAE development during 2012 was primarily the result of higher than expected losses within other commercial lines, primarily in the contract surety line due to the challenging macroeconomic environment for contractors, and to a lesser extent, the AIX program business, primarily related unexpected severity in commercial automobile liability, commercial multiple peril and general liability in a limited number of programs, and from higher than expected large losses within the commercial automobile line, primarily related to liability coverage in the 2011 accident year. In addition, the Company experienced higher than expected losses within the personal automobile line,
The $103.3 million favorable loss and LAE reserve development during 2011 includes favorable loss and LAE reserve development of $35.5 million for Chaucer. Chaucer’s favorable development was primarily the result of lower than expected losses in the energy, property and U.K. motor lines, primarily related to the 2009 and 2010 accident years. For Commercial and Personal Lines, the favorable loss and LAE reserve development during 2011 was primarily the result of lower than expected losses in the personal automobile line, primarily related to bodily injury coverage in the 2008 through 2010 accident years, the commercial multiple peril line related to the 2007 through 2010 accident years and lower than expected losses in the 2007 through 2010 accident years in the workers’ compensation line. In addition, within other commercial lines, unfavorable development in the professional liability and surety lines were partially offset by favorable development in the healthcare and other commercial property lines.
The plaintiff filed an Amended Complaint adding two new named plaintiffs and additional claims on December 11, 2009. In response, the Company filed a Motion to Dismiss on January 30, 2010. In addition to the pending claim challenging the calculation of lump sum distributions, the Amended Complaint included: (a) a claim that the Plan failed to calculate participants’ account balances and lump sum payments properly because interest credits were based solely upon the performance of each participant’s selection from among various hypothetical investment options (as the Plan provided) rather than crediting the greater of that performance or the 30 year Treasury rate; (b) a claim that the 2004 Plan amendment, which changed interest crediting for all participants from the performance of participant’s investment selections to the 30 year Treasury rate, reduced benefits in violation of the Employee Retirement Income Security Act of 1974 (“ERISA”) for participants who had account balances as of the amendment date by not continuing to provide them performance-based interest crediting on those balances; and (c) claims against the Company for breach of fiduciary duty and ERISA notice requirements arising from the various interest crediting and lump sum distribution matters of which plaintiffs complain. On March 31, 2011, the District Court granted the Company and the Plan’s Motion to Dismiss on statute of limitations grounds the
additional claims set forth in (a) and (b) above, however, in response to a motion for reconsideration, the Court allowed the new breach of fiduciary duty claim to stand, but only as to plaintiffs’ “whipsaw” claim that remained in the case. On June 22, 2012, the Company and the Plan filed a Partial Motion for Summary Judgment to dismiss the “whipsaw” claim of one of the named plaintiffs who received his lump sum distribution after December 31, 2003. On October 2, 2013, the Court granted the Company and the Plan’s Partial Motion for Summary Judgment and dismissed with prejudice the “whipsaw” claim of the named plaintiff who received a lump sum distribution after December 31, 2003 and the similar claims of the putative class members he sought to represent. 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, and a subclass to bring such claims consisting of all persons who received lump sum distributions between March 1, 1997 and March 12, 2002. On December 17, 2013, the Court also granted plaintiffs’ motion for entry of a final order allowing an immediate appeal by the two named plaintiffs added in the Amended Complaint of their dismissed claims that the 2004 Plan amendment reduced benefits in violation of ERISA, and for one of them, that his post-2003 lump sum distribution should have been greater. On January 14, 2014, the Company filed a Motion to Alter or Amend the Court’s December 17, 2013 Order requesting that the Court reverse its order making the dismissed claims final and appealable or, in the alternative, stay merits discovery on the claims remaining in the district court pending resolution of the dismissed plaintiffs’ appeal. The Court has not yet ruled on that motion.
Statutory capital and surplus differs from shareholders’ equity reported in accordance with generally accepted accounting principles primarily because under the statutory basis of accounting, deferred acquisition costs are expensed when incurred, the recognition of deferred tax assets is based on different recoverability assumptions and prior to 2013, postretirement benefit costs were based on different participant assumptions.
(1) Per diluted share amounts in the fourth quarter of 2012 exclude common stock equivalents, since the impact of these instruments was antidilutive.