The Company leases its principal executive offices in New York, New York, as well as approximately 164 field and claim offices throughout the United States under leases or subleases with third parties. The Company also leases offices outside the United States, including in Canada, the United Kingdom and the Republic of Ireland. The Company owns six buildings in Hartford, Connecticut. The Company also owns buildings located in other areas of Connecticut; Norcross, Georgia; St. Paul, Minnesota; and Omaha, Nebraska.
The following is a discussion and analysis of the Company’s financial condition and results of operations for the years ended December 31, 2020 and 2019, including year-to-year comparisons between 2020 and 2019. Year-to-year comparisons between 2019 and 2018 have been omitted from this Form 10-K, but may be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the year ended December 31, 2019.
•Total debt of $6.55 billion, resulting in a debt-to-total capital ratio of 18.3% (20.7% excluding net unrealized investment gains, net of tax, included in shareholders' equity)
•Repurchased 5.2 million common shares for total cost of $672 million and paid $861 million of dividends to shareholders
Beginning in March 2020 and continuing through the end of 2020, the global pandemic caused by the novel coronavirus COVID-19 (“COVID-19”) and related economic conditions impacted the Company's results of operations. The Company's underwriting margins were impacted as follows:
•Earned premiums were negatively impacted by premium refunds in Personal Insurance provided to personal automobile customers. In Business Insurance, earned premiums were negatively impacted by a modest reduction in exposures and reduced levels of new business. Additionally, Business Insurance earned premiums were negatively impacted by reductions in the Company's estimate of ultimate audit premiums receivable. Earned premiums in Bond & Specialty Insurance were not materially impacted by COVID-19 and related economic conditions.
•Net investment income from the Company's other investments of $209 million was impacted by continued volatility in global financial markets. Other investments include private equity, hedge fund and real estate partnerships that are accounted for under the equity method of accounting and typically report their financial statement information to the Company one month to three months following the end of the reporting period. Accordingly, the impact of any volatility in global financial markets on net investment income from these other investments is generally reflected in the Company's financial statements on a quarter lag basis.
The Company has insurance operations in Canada, the United Kingdom, the Republic of Ireland and throughout other parts of the world as a corporate member of Lloyd’s, as well as in Brazil and Colombia, primarily through joint ventures. Because these operations are conducted in local currencies other than the U.S. dollar, the Company is subject to changes in foreign currency exchange rates. For the years ended December 31, 2020 and 2019, changes in foreign currency exchange rates impacted reported line items in the statement of income by insignificant amounts. The impact of these changes was not material to the Company’s net income or segment income for the periods reported.
Net investment income in 2020 was $2.23 billion, $241 million or 10% lower than in 2019. Net investment income from fixed maturity investments in 2020 was $2.01 billion, $59 million lower than in 2019. The decrease primarily resulted from lower long-term interest rates, partially offset by a higher average level of fixed maturity investments. Net investment income from short-term securities in 2020 was $44 million, $61 million lower than in 2019. The decrease primarily resulted from lower short-term interest rates. Net investment income generated by the Company's remaining investment portfolios in 2020 was $209 million, $124 million lower than in 2019. The decline in net investment income from these portfolios in 2020 compared with 2019 primarily reflected the impact of the disruption in global financial markets associated with COVID-19. Included in other investments are private equity, hedge fund and real estate partnerships that are accounted for under the equity method of accounting and typically report their financial statement information to the Company one month to three months following the end of the reporting period. Accordingly, the impact of any volatility in global financial markets, including the impact of COVID-19 during 2020, on net investment income from these other investments is generally reflected in the Company's financial statements on a quarter lag basis.
In the second quarter of 2020, the Company recorded a $40 million credit impairment loss from the other-than-temporary impairment of the carrying value of a joint venture investment included in other investments.
Net favorable prior year reserve development in 2020 included subrogation recoveries related to wildfires in California in 2017 and 2018, which are discussed in more detail in note 8 of notes to the consolidated financial statements. Factors contributing to net prior year reserve development during the years ended December 31, 2020, 2019 and 2018 are discussed in more detail in note 8 of notes to the consolidated financial statements.
(2) Favorable prior year reserve development in 2020 included the benefit of PG&E subrogation recoveries applicable to this event, which are discussed in more detail in note 8 of notes to the consolidated financial statements.
(3) In addition to the Glass fire, there were 16 other PCS-designated wildfires in 2020. While none of the 16 wildfires were individually large enough to meet the Company's threshold for disclosure as a significant catastrophe in this table, total losses from those wildfires were $169 million, of which two wildfires totaling $73 million met the Company's threshold for disclosure as catastrophes.
Amortization of deferred acquisition costs in 2020 was $4.77 billion, $172 million or 4% higher than in 2019. The increase in 2020 was generally consistent with the increase in earned premium before the impact of premium refunds referred to above. Amortization of deferred acquisition costs is discussed in more detail in the segment discussions that follow.
General and administrative expenses in 2020 were $4.51 billion, $144 million or 3% higher than in 2019, primarily reflecting the impact of costs associated with higher business volumes. General and administrative expenses are discussed in more detail in the segment discussions that follow.
Income tax expense in 2020 was $540 million, $24 million or 5% higher than in 2019, primarily reflecting the impact of the $99 million increase in income before income taxes in 2020.
The combined ratio of 95.0% in 2020 was 1.5 points lower than the combined ratio of 96.5% in 2019. The loss and loss adjustment expense ratio of 65.1% in 2020 was 1.8 points lower than the loss and loss adjustment expense ratio of 66.9% in 2019. The underwriting expense ratio of 29.9% in 2020 was 0.3 points higher than the underwriting expense ratio of 29.6% in 2019.
Earned premiums of $15.29 billion in 2020 were comparable with 2019. Earned premiums in 2020 were negatively impacted by a modest reduction in exposures and a decrease in new business volume, as well as reductions in the Company's estimate of ultimate audit premiums receivable, in each case impacted by COVID-19 and related economic conditions.
Net investment income in 2020 was $1.63 billion, $183 million or 10% lower than in 2019. Refer to the “Net Investment Income” section of the “Consolidated Results of Operations” discussion for a description of the factors contributing to the decrease in the Company’s consolidated net investment income in 2020 compared with 2019. In addition, refer to note 2 of notes to the consolidated financial statements for a discussion of the Company’s net investment income allocation methodology.
National Accounts is the primary source of fee income due to revenue from its large deductible policies and service businesses, which include risk management, claims administration, loss control and risk management information services provided to third parties, as well as policy issuance and claims management services to workers’ compensation residual market pools. Fee income in 2020 was $405 million, $32 million or 7% lower than in 2019, primarily reflecting lower claim volume under administration associated with its service businesses.
Net unfavorable prior year reserve development in 2020 included the favorable impact of subrogation recoveries related to wildfires in California in 2017 and 2018. Factors contributing to net prior year reserve development during the years ended December 31, 2020, 2019 and 2018 are discussed in more detail in note 8 of notes to the consolidated financial statements.
Amortization of deferred acquisition costs in 2020 was $2.52 billion, $15 million or 1% higher than in 2019, generally consistent with the change in earned premiums.
Catastrophe losses in 2020 and 2019 accounted for 4.2 points and 3.0 points, respectively, of the combined ratio. Net unfavorable prior year reserve development in 2020 and 2019 accounted for 0.6 points and 1.7 points, respectively, of the combined ratio. The underlying combined ratio in 2020 was 0.7 points lower than the 2019 ratio on the same basis, impacted by earned pricing that exceeded loss cost trends. COVID-19 and related economic conditions had a modest net unfavorable impact on the underlying combined ratio.
Business Insurance’s gross and net written premiums by market were as follows:
Gross and net written premiums in 2020 both decreased by 1% from 2019. Gross and net written premiums in 2020 were negatively impacted by a modest reduction in exposures and a decrease in new business volume, both impacted by COVID-19 and related economic conditions.
Middle Market. Net written premiums of $8.51 billion in 2020 decreased by 1% from 2019. Retention rates remained strong in 2020. Renewal premium changes in 2020 remained positive and were higher than in 2019. New business premiums in 2020 decreased from 2019.
National Property and Other. Net written premiums of $2.09 billion in 2020 increased by 6% over 2019. Retention rates declined in 2020. Renewal premium changes in 2020 remained positive and were higher than in 2019. New business premiums in 2020 increased over 2019.
Net investment income in 2020 was $213 million, $20 million or 9% lower than in 2019. Included in Bond & Specialty Insurance are certain legal entities whose invested assets and related net investment income are reported exclusively in this
The combined ratio of 87.4% in 2020 was 7.9 points higher than the combined ratio of 79.5% in 2019. The loss and loss adjustment expense ratio of 51.5% in 2020 was 9.3 points higher than the loss and loss adjustment expense ratio of 42.2% in 2019. The underwriting expense ratio of 35.9% in 2020 was 1.4 points lower than the underwriting expense ratio of 37.3% in 2019.
Net unfavorable prior year reserve development had no impact on the combined ratio in 2020. Net favorable prior year reserve development in 2019 provided 2.5 points of benefit to the combined ratio. Catastrophe losses in 2020 and 2019 accounted for 0.4 points and 0.2 points, respectively, of the combined ratio. The underlying combined ratio in 2020 was 5.2 points higher than the 2019 ratio on the same basis, reflecting the impact of higher loss estimates for management liability coverages, primarily due to the impact of COVID-19 and related economic conditions.
Bond & Specialty Insurance’s gross and net written premiums were as follows:
Gross written premiums in 2020 increased by 9% over 2019. Net written premiums in 2020 increased by 8% over 2019. Gross and net written premiums in 2020 were negatively impacted by lower surety volumes, primarily due to COVID-19 and related economic conditions.
International. Net written premiums in 2020 were $337 million, $69 million or 26% higher than in 2019, primarily driven by increases in the United Kingdom.
Segment income in 2020 was $1.20 billion, $371 million or 45% higher than segment income of $824 million in 2019. The increase in segment income before income taxes primarily reflected the pre-tax impacts of (i) higher underlying underwriting margins and (ii) higher net favorable prior year reserve development, partially offset by (iii) higher catastrophe losses and (iv) lower net investment income. Catastrophe losses in 2020 and 2019 were $957 million and $411 million, respectively. Net favorable prior year reserve development in 2020 and 2019 was $443 million and $133 million, respectively. The higher underlying underwriting margins primarily reflected the impacts of lower losses in the automobile product line due to a decrease in miles driven attributable to COVID-19 and related economic conditions (net of premium refunds provided to personal automobile customers), lower non-catastrophe weather-related losses in the homeowners and other product line and higher business volumes. Income tax expense in 2020 was higher than in 2019, primarily reflecting the impact of the increase in segment income before income taxes.
Claims and claim adjustment expenses in 2020 were $6.86 billion, $221 million or 3% lower than in 2019, primarily reflecting the impacts of (i) lower losses in the automobile product line due to a decrease in miles driven attributable to COVID-19 and related economic conditions, (ii) higher net favorable prior year reserve development and (iii) lower non-catastrophe weather-related losses in the homeowners and other product line, partially offset by (iv) higher catastrophe losses, (v) higher business volumes and (vi) loss cost trends.
Amortization of deferred acquisition costs in 2020 was $1.74 billion, $116 million or 7% higher than in 2019, generally consistent with the increase in earned premiums before the impact of premium refunds referred to above.
Income tax expense in 2020 was $308 million, $113 million or 58% higher than in 2019, primarily reflecting the impact of the $484 million increase in income before income taxes in 2020.
For its domestic Agency business, Personal Insurance had approximately 8.0 million and 7.5 million active policies at December 31, 2020 and 2019, respectively.
(for the year ended December 31, in millions) 2020 2019 2018
The Income (loss) for Interest Expense and Other in 2020 was $6 million lower than in 2019. Pre-tax interest expense in 2020 and 2019 was $339 million and $344 million, respectively. After-tax interest expense in 2020 and 2019 was $268 million and $272 million, respectively.
The Company believes that the property and casualty insurance industry has suffered from court decisions and other trends that have expanded insurance coverage for asbestos claims far beyond the original intent of insurers and policyholders. The Company has received and continues to receive a significant number of asbestos claims. Factors underlying these claim filings include continued intensive advertising by lawyers seeking asbestos claimants and the focus by plaintiffs on defendants, such as manufacturers of talcum powder, who were not traditionally primary targets of asbestos litigation. The focus on these defendants is primarily the result of the number of traditional asbestos defendants who have sought bankruptcy protection in previous years. The bankruptcy of many traditional defendants has also caused increased settlement demands against those policyholders who are not in bankruptcy but remain in the tort system. Currently, in many jurisdictions, those who allege very serious injury and who can present credible medical evidence of their injuries are receiving priority trial settings in the courts, while those who have not shown any credible disease manifestation are having their hearing dates delayed or placed on an inactive docket. Prioritizing claims involving credible evidence of injuries, along with the focus on defendants who were not traditionally primary targets of asbestos litigation, contributes to the claims and claim adjustment expense payment patterns experienced by the Company. The Company’s asbestos-related claims and claim adjustment expense experience also has been impacted by the unavailability of other insurance sources potentially available to policyholders, whether through exhaustion of policy limits or through the insolvency of other participating insurers.
In addition to claims against policyholders, proceedings have been launched directly against insurers, including the Company, by individuals challenging insurers’ conduct with respect to the handling of past asbestos claims and by individuals seeking damages arising from alleged asbestos-related bodily injuries. It is possible that other direct actions against insurers, including the Company, could be filed in the future. It is difficult to predict the outcome of these proceedings, including whether the plaintiffs would be able to sustain these actions against insurers based on novel legal theories of liability. The Company believes it has meritorious defenses to any such claims and has received favorable rulings in certain jurisdictions.
The Company conducts an annual review of domestic policyholders with open asbestos claims. Policyholders are identified for this review based upon, among other factors: a combination of past payments and current case reserves in excess of a specified threshold (currently $100,000), perceived level of exposure, number of reported claims, products/completed operations and potential “non-product” exposures, size of policyholder and geographic distribution of products or services sold by the policyholder.
The number of policyholders with open asbestos claims declined slightly while gross asbestos-related payments increased slightly, in each case when compared to 2019. Payments on behalf of these policyholders continue to be influenced by a high level of litigation activity in a limited number of jurisdictions where individuals alleging serious asbestos-related injury, primarily mesothelioma, continue to target defendants who were not traditionally primary targets of asbestos litigation.
The Company’s quarterly asbestos reserve reviews include an analysis of exposure and claim payment patterns by policyholder, as well as recent settlements, policyholder bankruptcies, judicial rulings and legislative actions. The Company also analyzes developing payment patterns among policyholders and the assumed reinsurance component of reserves, as well as projected reinsurance billings and recoveries. In addition, the Company reviews its historical gross and net loss and expense paid experience, year-by-year, to assess any emerging trends, fluctuations, or characteristics suggested by the aggregate paid activity. Conventional actuarial methods are not utilized to establish asbestos reserves, and the Company’s evaluations have not resulted in a reliable method to determine a meaningful average asbestos defense or indemnity payment.
The completion of these reviews and analyses in 2020, 2019 and 2018 resulted in $295 million, $220 million and $225 million increases, respectively, to the Company’s net asbestos reserves. In each year, the reserve increases were primarily driven by increases in the Company’s estimate of projected settlement and defense costs related to a broad number of policyholders. The increase in the estimate of projected settlement and defense costs primarily resulted from payment trends that continue to be higher than previously anticipated due to the continued high level of mesothelioma claim filings and the impact of the current litigation environment surrounding those claims discussed above. Over the past decade, the property and casualty insurance industry, including the Company, has experienced net unfavorable prior year reserve development with regard to asbestos reserves, but the Company believes that over that period there has been a reduction in the volatility associated with the Company’s overall asbestos exposure as the overall asbestos environment has evolved from one dominated by exposure to significant litigation risks, particularly coverage disputes relating to policyholders in bankruptcy who were asserting that their claims were not subject to the aggregate limits contained in their policies, to an environment primarily driven by a frequency of litigation related to individuals with mesothelioma. The Company’s overall view of the current underlying asbestos environment is essentially unchanged from recent periods, and there remains a high degree of uncertainty with respect to future exposure to asbestos claims.
The Company has received and continues to receive claims from policyholders who allege that they are liable for injury or damage arising out of their alleged disposition of toxic substances, frequently under policies issued prior to the mid-1980s. These claims are mainly brought pursuant to various state or federal statutes that require a liable party to undertake or pay for environmental remediation. For example, the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) enables private parties as well as federal and state governments to take action with respect to releases and threatened releases of hazardous substances. This federal statute permits the recovery of response costs from some liable parties and may require liable parties to undertake their own remedial action. Liability under these statutes may be joint and several with other responsible parties. The Company has also been, and continues to be, involved in litigation involving insurance coverage issues pertaining to environmental claims. The Company believes that some court decisions pertaining to environmental claims have interpreted the insurance coverage to be broader than the original intent of the insurers and policyholders. For more information regarding environmental claims and litigation, see note 8 of notes to the consolidated financial statements.
•a further increase in the cost to resolve, and/or the number of, asbestos and environmental claims beyond that which is anticipated;
•the emergence of a greater number of asbestos claims than anticipated as a result of extended life expectancies resulting from medical advances and lifestyle improvements;
•future developments pertaining to our ability to recover reinsurance for asbestos and environmental claims;
•any impact on asbestos defendants we insure due to the bankruptcy of other asbestos defendants;
•the unavailability of other insurance sources potentially available to policyholders, whether through exhaustion of policy limits or through the insolvency of other participating insurers; and
Changes in the legal, regulatory and legislative environment may impact the future resolution of asbestos and environmental claims and result in adverse loss reserve development. The emergence of a greater number of asbestos or environmental claims beyond that which is anticipated may result in adverse loss reserve development. Changes in applicable legislation and future court and regulatory decisions and interpretations, including the outcome of legal challenges to legislative and/or judicial reforms establishing medical criteria for the pursuit of asbestos claims, could affect the settlement of asbestos and environmental claims. It is also difficult to predict the ultimate outcome of complex coverage disputes until settlement negotiations near completion and significant legal questions are resolved or, failing settlement, until the dispute is adjudicated. This is particularly the case with policyholders in bankruptcy where negotiations often involve a large number of claimants and other parties and require court approval to be effective. As part of its continuing analysis of asbestos and environmental reserves, the Company continues to study the implications of these and other developments.
Because of the uncertainties set forth above, additional liabilities may arise for amounts in excess of the Company’s current reserves. In addition, the Company’s estimate of claims and claim adjustment expenses may change. These additional liabilities or increases in estimates, or a range of either, cannot now be reasonably estimated and could result in income statement charges that could be material to the Company’s operating results in future periods.
(3)Included in commercial mortgage-backed securities and project loans at December 31, 2020 and 2019 were $392 million and $557 million of securities guaranteed by the U.S. government, respectively, and $0 million and $2 million of securities guaranteed by government-sponsored enterprises at December 31, 2020 and 2019, respectively.
The Company’s fixed maturity investment portfolio at December 31, 2020 and 2019 included $36.36 billion and $29.92 billion, respectively, of securities which are obligations of states, municipalities and political subdivisions (collectively referred to as the municipal bond portfolio). The municipal bond portfolio is diversified across the United States, the District of Columbia and Puerto Rico and includes general obligation and revenue bonds issued by states, cities, counties, school districts and similar issuers. Included in the municipal bond portfolio at December 31, 2020 and 2019 were $3.54 billion and $2.06 billion, respectively, of pre-refunded bonds, which are bonds for which states or municipalities have established irrevocable trusts, almost exclusively comprised of U.S. Treasury securities and obligations of U.S. government and government agencies and authorities. These trusts were created to fund the payment of principal and interest due under the bonds. The irrevocable trusts are verified as to their sufficiency by an independent verification agent of the underwriter, issuer or trustee. All of the Company’s holdings of securities issued by Puerto Rico and related entities have either been pre-refunded and therefore are defeased by U.S. Treasury securities or have FHA guarantees subject to federal appropriation.
The following table displays the funding sources for the $12.72 billion of municipal bonds identified as revenue bonds in the foregoing table at December 31, 2020:
The following table shows the geographic distribution of the Company’s long-term fixed maturity investments in debt securities issued by foreign governments at December 31, 2020:
The following table shows the Company’s Eurozone exposure at December 31, 2020 to all debt securities issued by foreign governments, financial companies, sovereign corporations (including sovereign banks) whose securities are backed by the respective country’s government and all other corporate securities (comprised of industrial corporations and utility companies) which could be affected if economic conditions deteriorated due to a prolonged recession:
(1)Rated using external rating agencies or by the Company when a public rating does not exist. The table includes $1.09 billion of short-term securities which have high ratings issued by external rating agencies for short-term issuances. For purposes of this table, the short-term securities, which are rated “A-1+” and/or “P-1,” are included as “Aaa” rated securities.
In addition to fixed maturities noted in the foregoing table, the Company has exposure totaling $147 million to private equity limited partnerships and real estate partnerships (both of which are included in other investments in the Company’s consolidated balance sheet) whose primary investing focus is across Europe. The Company has unfunded commitments totaling $121 million to these partnerships. The Company has no non-redeemable preferred stock issued by companies in the Eurozone.
The Company’s fixed maturity investment portfolio at December 31, 2020 and 2019 included $2.36 billion and $3.28 billion, respectively, of residential mortgage-backed securities, including pass-through-securities and collateralized mortgage obligations (CMOs), all of which are subject to prepayment risk (either shortening or lengthening of duration). While prepayment risk for securities and its effect on income cannot be fully controlled, particularly when interest rates move dramatically, the Company’s investment strategy generally favors securities that reduce this risk within expected interest rate ranges. The Company makes investments in residential CMOs that are either guaranteed by GNMA, FNMA or FHLMC, or if not guaranteed, are senior or super-senior positions within their respective securitizations. Both guaranteed and non-guaranteed residential CMOs allocate the distribution of payments from the underlying mortgages among different classes of bondholders. In addition, non-guaranteed residential CMOs provide structures that allocate the impact of credit losses to different classes of bondholders. Senior and super-senior CMOs are protected, to varying degrees, from credit losses as those losses are initially allocated to subordinated bondholders. The Company’s investment strategy is to purchase CMO tranches that are expected to offer the most favorable return given the Company’s assessment of associated risks. The Company does not purchase residual interests in CMOs. For more information regarding the Company’s investments in residential mortgage-backed securities, see note 3 of notes to the consolidated financial statements.
See note 1 of notes to the consolidated financial statements for further information about these invested asset classes.
The Company also invests in private equity limited partnerships, hedge funds and real estate partnerships. Also included in other investments are non-public common and preferred equities and derivatives. These asset classes have historically provided a higher return than fixed maturities but are subject to more volatility. At December 31, 2020 and 2019, the carrying value of the Company's other investments was $3.43 billion and $3.42 billion, respectively. The Company has unfunded commitments to private equity limited partnerships, real estate partnerships and others in which it invests. These commitments totaled $1.72 billion and $1.66 billion at December 31, 2020 and 2019, respectively. It is the opinion of the Company’s management that the Company has adequate liquidity to meet these commitments.
Impairment charges included in net realized investment gains in the consolidated statement of income were $55 million and $4 million for the years ended December 31, 2020 and 2019, respectively. The total in 2020 included a $40 million other-than-temporary impairment of the carrying value of an equity method investment included in other investments. See note 3 of notes to the consolidated financial statements for further information.
Purchases and sales of investments are based on cash requirements, the characteristics of the insurance liabilities and current market conditions. The Company identifies investments to be sold to achieve its primary investment goals of assuring the Company’s ability to meet policyholder obligations as well as to optimize investment returns, given these obligations.
During the year ended December 31, 2020, the Company incurred pre-tax realized losses of $3 million on the sale of fixed maturity investments having a fair value of $97 million.
The Company actively monitors and evaluates changes in third-party models and, when necessary, calibrates the catastrophe risk model estimates delivered via its own proprietary modeling processes. The Company considers historical loss experience, recent events, underwriting practices, market share analyses, external scientific analysis and various other factors, including non-modeled losses, to refine its proprietary view of catastrophe risk. These proprietary models are updated regularly as new information and techniques emerge.
The tables below set forth the probabilities that estimated losses, comprising claims and allocated claim adjustment expenses (but excluding unallocated claim adjustment expenses), from a single event occurring in a one-year timeframe will equal or exceed the indicated loss amounts (expressed in dollars, net of tax, and as a percentage of the Company’s common equity), based on the proprietary and third-party computer models utilized by the Company at December 31, 2020. For example, on the basis described below the tables, the Company estimates that there is a one percent chance that the Company’s loss from a single U.S. and Canadian hurricane in a one-year timeframe would equal or exceed $1.7 billion, or 7% of the Company’s common equity at December 31, 2020.
(1) An event that has, for example, a 2% likelihood of exceedance is sometimes described as a “1-in-50 year event.” As noted above, however, the probabilities in the table represent the likelihood of losses from a single event equaling or exceeding the indicated threshold loss amount in a one-year timeframe, not over a multi-year timeframe. Also, because the probabilities relate to a single event, the probabilities do not address the likelihood of more than one event occurring in a particular period, and, therefore, the amounts do not address potential aggregate catastrophe losses occurring in a one-year timeframe.
The threshold loss amounts in the tables above, which are based on the Company’s in-force portfolio at December 31, 2020 and catastrophe reinsurance program at January 1, 2021, are net of reinsurance, after-tax and exclude unallocated claim adjustment expenses, which historically have been less than 10% of loss estimates. For further information regarding the Company’s reinsurance, see “Item 1 - Business-Reinsurance.” The amounts for hurricanes reflect U.S. and Canadian exposures and include property exposures, property residual market exposures and an adjustment for certain non-property exposures. The hurricane loss amounts are based on the Company’s catastrophe risk model estimates and include losses from the hurricane hazards of wind and storm surge. The amounts for earthquakes reflect U.S. and Canadian property and workers’ compensation exposures. The Company does not believe that the inclusion of hurricane or earthquake losses arising from other geographical areas or other exposures would materially change the estimated threshold loss amounts.
Moreover, the Company is exposed to the risk of material losses from other than property and workers’ compensation coverages arising out of hurricanes and earthquakes, and it is exposed to catastrophe losses from perils other than hurricanes and earthquakes, such as tornadoes and other windstorms, hail, wildfires, severe winter weather, floods, tsunamis, volcanic eruptions, solar flares and other naturally-occurring events, as well as acts of terrorism and cyber events.
In addition, compared to models for hurricanes, models for earthquakes are less reliable due to there being a more limited number of significant historical events to analyze, while models for tornadoes, hail storms wildfires and winter storms are newer and may be less reliable due to the highly random geographic nature and size of these events. Accordingly, these models may be less accurate in predicting risks and estimating losses. Further, changes in climate conditions could cause our underlying modeling data to be less predictive, thus limiting our ability to effectively evaluate and manage catastrophe risk. As compared to natural catastrophes, modeling for man-made catastrophes, such as terrorism and cyber events, is even more difficult and less reliable, and for some events (both natural and man-made), models are either in early stages of development and, therefore, not widely adopted, or are not available.
The Company discusses how changing climate conditions may present other issues for its business under “Item 1A - Risk Factors.” and “Outlook.” For example, among other things:
•Increasingly unpredictable and severe weather conditions could result in increased frequency and severity of claims under policies issued by the Company. See “Item 1A - Risk Factors-High levels of catastrophe losses, including as a result of factors such as increased concentrations of insured exposures in catastrophe-prone areas, could materially and adversely affect our results of operations, our financial position and/or liquidity, and could adversely impact our ratings, our ability to raise capital and the availability and cost of reinsurance” and “-Outlook-Underwriting Gain/Loss.”
•The full range of potential liability exposures related to changing climate conditions continues to evolve. For example, from time to time third parties sue our policyholders alleging that they caused or contributed to changing climate conditions. Through the Company’s Emerging Issues Committee and its Committee on Climate, Energy and the Environment, the Company works with its business units and corporate groups, as appropriate, to identify and try to assess climate change-related liability issues, which are continually evolving and often hard to fully evaluate. The Company regularly reviews emerging issues, including changing climate conditions, to consider potential changes to its modeling and the use of such modeling, as well as to help determine the need for new underwriting strategies, coverage modifications or new products. See “Item 1A - Risk Factors-The effects of emerging claim and coverage issues on our business are uncertain, and court decisions or legislative changes that take place after we issue our policies can result in an unexpected increase in the number of claims and have a material adverse impact on our results of operations.”
The Company reinsures a portion of the risks it underwrites in order to control its exposure to losses. For additional discussion regarding the Company’s reinsurance coverage, see “Part I-Item 1 - Business-Reinsurance.”
pay, the Company would recognize an impairment of the related reinsurance recoverable if, and to the extent, the purchased annuities are not covered by state guaranty associations. In the event that the life insurance company fails to make the required annuity payments, the Company would be required to make such payments. The following table presents the Company’s top five groups by structured settlements at December 31, 2020 (in millions). Also included is the A.M. Best rating of the Company’s predominant insurer from each such insurer group at February 11, 2021:
The Company’s retention levels (the amount of expiring premium that renews, before the impact of renewal premium changes) have remained strong by historical standards in recent periods; however, retention levels, particularly in the near term, may be impacted by COVID-19 and related economic conditions. For example, retention may improve due to lower levels of business being marketed as a result of operational disruptions impacting businesses. On the other hand, business failures or customers choosing not to renew coverages due to financial distress would result in lapses of policies and lower levels of retention. In addition, as risk profiles of insureds change, the Company may determine to non-renew certain policies.
Catastrophe losses and non-catastrophe weather-related losses are inherently unpredictable from period to period. The Company’s results of operations could be adversely impacted if significant catastrophe and non-catastrophe weather-related losses were to occur.
On average for the ten-year period ended December 31, 2020, the Company experienced approximately 44% of its annual catastrophe losses during the second quarter, primarily arising out of severe wind and hail storms, including tornadoes. Hurricanes, wildfires and winter storms tend to happen at other times of the year and can also have a material impact on the Company's results of operations. Catastrophe losses incurred in a particular quarter in any given year may differ materially from historical experience. In addition, most of the Company's reinsurance programs renew on January 1 or July 1 of each year, and, therefore, any changes to the cost or coverage terms of such programs will be effective after such dates.
Over much of the past decade, the Company’s results have included significant amounts of net favorable prior year reserve development driven by better than expected loss experience. However, given the inherent uncertainty in estimating claims and claim adjustment expense reserves, loss experience could develop such that the Company recognizes in future periods higher or lower levels of favorable prior year reserve development, no favorable prior year reserve development or, as was the case in 2019, unfavorable prior year reserve development. In addition, the ongoing review of prior year claims and claim adjustment expense reserves, or other changes in current period circumstances, may result in the Company revising current year loss estimates upward or downward in future periods of the current year.
portfolio of high-quality, liquid, taxable U.S. government, tax-exempt and taxable U.S. municipal and taxable corporate and U.S. agency mortgage-backed bonds.
Approximately 31% of the fixed maturity portfolio is expected to mature over the next three years (including the early redemption of bonds, assuming interest rates (including credit spreads) do not rise significantly by applicable call dates). As a result, the overall yield on and composition of its portfolio could be meaningfully impacted by the types of investments available for reinvestment with the proceeds of maturing bonds.
Net investment income is a material contributor to the Company’s results of operations. Based on the impact of expected lower reinvestment yields on fixed income investments, partially offset by our current expectations for slightly higher levels of fixed income investments, the Company expects that after-tax net investment income from that portfolio will be approximately $420 million to $430 million for each quarter of 2021. This expectation could be impacted by further disruptions in global financial markets associated with the continuing impact of COVID-19. Included in other investments are private equity, hedge fund and real estate partnerships that are accounted for under the equity method of accounting and typically report their financial statement information to the Company one month to three months following the end of the reporting period. Accordingly, the impact of any volatility in global financial markets on net investment income from these other investments is generally reflected in the Company's financial statements on a quarter lag basis. Further changes in global financial markets could impact the Company’s net investment income in future periods from its non-fixed income investment portfolio, positively or negatively.
The Company had a net pre-tax unrealized investment gain of $5.18 billion ($4.07 billion after-tax) in its fixed maturity investment portfolio at December 31, 2020. While the Company does not attempt to predict future interest rate movements, a rising interest rate environment would reduce the market value of fixed maturity investments and, therefore, reduce shareholders’ equity, and a declining interest rate environment would have the opposite effects. Additionally, further disruptions in global financial markets associated with the continuing impact of COVID-19 could also impact the market value of the Company’s investment portfolio. The Company's investment portfolio has benefited from certain tax exemptions (primarily those related to interest from municipal bonds) and certain other tax laws, including, but not limited to, those governing dividends-received deductions and tax credits (such as foreign tax credits). Changes in these laws could adversely impact the value of the Company's investment portfolio. See "Our businesses are heavily regulated by the states and countries in which we conduct business, including licensing, market conduct and financial supervision, and changes in regulation, including higher tax rates, may reduce our profitability and limit our growth" included in “Part I-Item 1A - Risk Factors.”
For further discussion of the Company’s investment portfolio, see “Investment Portfolio.” For a discussion of the risks to the Company’s business during or following a financial market disruption and risks to the Company’s investment portfolio, see the risk factors entitled “During or following a period of financial market disruption or an economic downturn, our business could be materially and adversely affected” and “Our investment portfolio is subject to credit and interest rate risk, and may suffer reduced or low returns or material realized or unrealized losses” included in “Part I-Item 1A - Risk Factors.” For a discussion of the risks to the Company’s investments from foreign currency exchange rate fluctuations, see the risk factor entitled “We are subject to additional risks associated with our business outside the United States” included in “Part I-Item 1A - Risk Factors” and see “Part II-
Statement of Changes in Shareholders’ Equity for the years ended December 31, 2020, 2019 and 2018
Statement of Cash Flows for the years ended December 31, 2020, 2019 and 2018
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 11, 2021 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
•Assessing the assumptions and methodologies underlying the Company’s claims and claim adjustment expense reserve estimate;
•Developing an overall range of reserve estimates and assessing the position of the Company’s recorded reserve relative to the range.
The Company adopted the updated guidance for leases for the quarter ended March 31, 2019 and elected to utilize a cumulative-effect adjustment to the opening balance of retained earnings for the year of adoption. Accordingly, the Company’s reporting for the comparative periods prior to adoption continue to be presented in the financial statements in accordance with
previous lease accounting guidance. The Company also elected to apply all practical expedients applicable to the Company in the updated guidance for transition for leases in effect at adoption, including using hindsight to determine the lease term of existing leases, the option to not reassess whether an existing contract is a lease or contains a lease and whether the lease is an operating or finance lease. The adoption of the updated guidance resulted in the Company recognizing a right-of-use asset of $320 million as part of other assets and a lease liability of $384 million as part of other liabilities in the consolidated balance sheet, as well as de-recognizing the liability for deferred rent that was required under the previous guidance, for its corporate real estate agreements at March 31, 2019. The cumulative effect adjustment to the opening balance of retained earnings at January 1, 2019 was zero. The adoption of the updated guidance did not have a material effect on the Company’s results of operations or liquidity.
In June 2016, the FASB issued updated guidance for the accounting for credit losses for financial instruments. The updated guidance applies a new credit loss model (current expected credit losses or CECL) for determining credit-related impairments for financial instruments measured at amortized cost (including reinsurance recoverables and structured settlements that are recorded as part of reinsurance recoverables) and requires an entity to estimate the credit losses expected over the life of an exposure or pool of exposures. The estimate of expected credit losses should consider historical information, current information, as well as reasonable and supportable forecasts, including estimates of prepayments. The expected credit losses, and subsequent adjustments to such losses, are recorded through an allowance account that is deducted from the amortized cost basis of the financial asset, with the net carrying value of the financial asset presented on the consolidated balance sheet at the amount expected to be collected.
The updated guidance also amends the previous other-than-temporary impairment model for available-for-sale debt securities by requiring the recognition of impairments relating to credit losses through an allowance account and limits the amount of credit loss to the difference between a security’s amortized cost basis and its fair value. In addition, the length of time a security has been in an unrealized loss position will no longer impact the determination of whether a credit loss exists.
The Company adopted the updated guidance for the quarter ended March 31, 2020. For available-for-sale debt securities, the updated guidance was applied prospectively. For financial instruments measured at amortized cost, the updated guidance was applied by a cumulative effect adjustment to the opening balance of retained earnings as of January 1, 2020, the beginning of the period of adoption. The adoption of this guidance resulted in the recognition of an after-tax cumulative effect adjustment of $43 million to reflect the impact of recognizing expected credit losses, as compared to incurred credit losses recognized under the previous guidance. This adjustment is primarily associated with structured settlements that are recorded as part of reinsurance recoverables. The cumulative effect adjustment decreased retained earnings as of January 1, 2020 and increased the allowance for estimated uncollectible reinsurance.
In January 2017, the FASB issued updated guidance that eliminates the requirement to calculate the implied fair value of goodwill (i.e., Step 2 of the current goodwill impairment test) to measure a goodwill impairment charge. Instead, entities will record an impairment charge by comparing a reporting unit’s fair value with its carrying amount and recognizing an impairment charge for the excess of the carrying amount over estimated fair value (i.e., Step 1 of current guidance). The implied fair value of goodwill is currently determined in Step 2 by deducting the fair value of all assets and liabilities of the reporting unit (determined in the same manner as a business combination) from the reporting unit’s fair value as determined in Step 1 (including any corporate-level assets or liabilities that were included in the determination of the carrying amount and fair value of the reporting unit in Step 1). The updated guidance requires an entity to perform its annual, or interim, impairment test by either: (1) an initial qualitative assessment of factors (such as changes in management, key personnel, strategy, key technology or customers) that may impact a reporting unit’s fair value and lead to the determination that it is more likely than not that the reporting unit’s fair value is less than its carrying value, including goodwill (consistent with current guidance), or (2) applying Step 1.
Beginning on January 1, 2020, credit losses are recognized through an allowance account. See note 1 - Adoption of Accounting Standards - Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments for additional information.
For fixed maturity investments that the Company does not intend to sell or for which it is more likely than not that the Company would not be required to sell before an anticipated recovery in value, the Company separates the credit loss component of the impairment from the amount related to all other factors and reports the credit loss component in net realized investment gains (losses). The impairment related to all other factors (non-credit factors) is reported in other comprehensive income. The allowance is adjusted for any additional credit losses and subsequent recoveries. Upon recognizing a credit loss, the cost basis is not adjusted.
For fixed maturity investments where the Company records a credit loss, a determination is made as to the cause of the impairment and whether the Company expects a recovery in the value. For fixed maturity investments where the Company expects a recovery in value, the constant effective yield method is utilized, and the investment is amortized to par.
The Company reports investment income accrued separately from fixed maturity investments, available for sale, and has elected not to measure an allowance for credit losses for investment income accrued. Investment income accrued is written off through net realized investment gains (losses) at the time the issuer of the bond defaults or is expected to default on payments.
Uncollectible available-for-sale debt securities are written-off when the Company determines that no additional payments of principal or interest will be received.
The Company may, from time to time, sell invested assets subsequent to the balance sheet date that it did not intend to sell at the balance sheet date. Conversely, the Company may not sell invested assets that it asserted that it intended to sell at the balance sheet date. Such changes in intent are due to events occurring subsequent to the balance sheet date. The types of events that may result in a change in intent include, but are not limited to, significant changes in the economic facts and
circumstances related to the invested asset (e.g., a downgrade or upgrade from a rating agency), significant unforeseen changes in liquidity needs, or changes in tax laws or the regulatory environment.
Amounts recoverable from reinsurers are estimated in a manner consistent with the associated claim liability. Included in reinsurance recoverables are amounts related to certain structured settlements. The Company reports its reinsurance recoverables net of an allowance for amounts that are estimated to be uncollectible. The allowance is based upon the Company’s ongoing review of amounts outstanding, length of collection periods, changes in reinsurer credit standing, disputes, applicable coverage defenses and other relevant factors. For structured settlements, the allowance is also based upon the Company’s ongoing review of life insurers’ creditworthiness and estimated amounts of coverage that would be available from state guaranty funds if a life insurer defaults. A probability-of-default methodology which reflects current and forecasted economic conditions is used to estimate the amount of uncollectible reinsurance due to credit-related factors and the estimate is reported in an allowance for estimated uncollectible reinsurance. The allowance also includes estimated uncollectible amounts related to dispute risk with reinsurers. Amounts deemed to be uncollectible, including amounts due from known insolvent reinsurers, are written off against the allowance. Changes in the allowance, as well as any subsequent collections of amounts previously written off, are reported as part of claims and claim adjustment expenses. The Company evaluates and monitors the financial condition of its reinsurers under voluntary reinsurance arrangements to minimize its exposure to significant losses from reinsurer insolvencies.
Under certain workers’ compensation insurance contracts with deductible features, the Company is obligated to pay the claimant for the full amount of the claim. The Company is subsequently reimbursed by the policyholder for the deductible amount. These amounts are included on a gross basis in the consolidated balance sheet in both contractholder payables and contractholder receivables. Contractholder receivables are reported net of an allowance for expected credit losses. The allowance is based upon the Company’s ongoing review of amounts outstanding, changes in policyholder credit standing, and other relevant factors. A probability-of-default methodology, which reflects current and forecasted economic conditions, is used to estimate the allowance for expected credit losses.
The Company performs a review, on at least an annual basis, of goodwill held by the reporting units which are the Company’s three operating and reportable segments: Business Insurance; Bond & Specialty Insurance; and Personal Insurance. The
Company estimates the fair value of its reporting units and compares it to their carrying value, including goodwill. If the carrying values of the reporting units were to exceed their fair value, the amount of the impairment would be calculated and goodwill adjusted accordingly.
Claims and claim adjustment expense reserves represent management's estimate of the ultimate liability for unpaid losses and loss adjustment expenses for claims that have been reported and claims that have been incurred but not yet reported (IBNR) as of the balance sheet date. The reserves are adjusted regularly based upon experience. Included in the claims and claim adjustment expense reserves in the consolidated balance sheet are reserves for long-term disability and annuity claim payments, primarily arising from workers’ compensation insurance and workers’ compensation excess insurance policies, that are discounted to the present value of estimated future payments.
Also included in other liabilities is an accrual for policyholder dividends. Certain insurance contracts, primarily workers’ compensation, are participating whereby dividends are paid to policyholders in accordance with contract provisions. Net written
premiums for participating dividend policies were approximately 1% of total net written premiums for each of the years ended December 31, 2020, 2019 and 2018. Policyholder dividends are accrued against earnings using best available estimates of amounts to be paid. The liability accrued for policyholder dividends totaled $69 million and $71 million at December 31, 2020 and 2019, respectively.
The Company’s non-U.S. insurance subsidiaries file financial statements prepared in accordance with the regulatory reporting requirements of their respective local jurisdiction.
Fee income includes revenues from risk and claims management services provided to the Company’s insureds and third-party non-insureds, as well as policy issuance and claims management services to workers' compensation residual market pools. Fee income is earned over the policy period for the services provided to the Company’s insureds, and either over the contract period or as the Company completes its service obligations for the services provided to third-party non-insureds.
Other revenues include revenues from premium installment charges, which are recognized as collected, gains and losses on dispositions of assets and redemption of debt, and other miscellaneous revenues, including gains recognized as a result of settlements of reinsurance disputes and claim-related legal matters.
The Company has an employee stock incentive compensation plan that permits grants of nonqualified stock options, incentive stock options, stock appreciation rights, restricted stock, deferred stock, stock units, performance awards and other share-based or share-denominated awards with respect to the Company’s common stock.
•Middle Market provides mid-sized businesses with property and casualty insurance products and services, including workers’ compensation, general liability, commercial multi-peril, commercial automobile and commercial property, as
well as risk management, claims handling and other services. Middle Market generally provides these products to mid-sized businesses through Commercial Accounts, as well as to targeted industries through Construction, Technology, Public Sector Services and Oil & Gas, and additionally, provides mono-line umbrella and excess coverage insurance through Excess Casualty. Middle Market also provides insurance for goods in transit and movable objects, as well as builders’ risk insurance, through Inland Marine; insurance for the marine transportation industry and related services, as well as other businesses involved in international trade, through Ocean Marine; and comprehensive breakdown for equipment, including property and business interruption, through Boiler & Machinery.
The Company does not have revenue from transactions with a single customer amounting to 10 percent or more of its revenues.
Pre-refunded bonds of $3.54 billion and $2.06 billion at December 31, 2020 and 2019, respectively, were bonds for which states or municipalities have established irrevocable trusts, almost exclusively comprised of U.S. Treasury securities and obligations of U.S. government and government agencies and authorities. These trusts were created to fund the payment of principal and interest due under the bonds.
At December 31, 2020 and 2019, the Company held commercial mortgage-backed securities (CMBS, including FHA project loans) of $1.42 billion and $1.51 billion, respectively, which are included in “All other corporate bonds” in the tables above. At December 31, 2020 and 2019, approximately $392 million and $559 million of these securities, respectively, or the loans backing such securities, contained guarantees by the U.S. government or a government-sponsored enterprise. The weighted average credit rating of the $1.03 billion and $950 million of non-guaranteed securities at December 31, 2020 and 2019, respectively, was “Aaa” at both dates. The CMBS portfolio is supported by loans that are diversified across economic sectors and geographical areas. The weighted average credit rating of the CMBS portfolio was “Aaa” at both December 31, 2020 and 2019.
At December 31, 2020 and 2019, the Company had $139 million and $404 million, respectively, of securities on loan as part of a tri-party lending agreement.
Proceeds from sales of fixed maturities classified as available for sale were $3.06 billion, $2.19 billion and $3.55 billion in 2020, 2019 and 2018, respectively. Gross gains of $70 million, $67 million and $51 million and gross losses of $3 million, $8 million and $18 million were realized on those sales in 2020, 2019 and 2018, respectively.
At December 31, 2020 and 2019, the Company’s insurance subsidiaries had $4.45 billion and $4.34 billion, respectively, of securities on deposit at financial institutions in certain states pursuant to the respective states’ insurance regulatory requirements. Funds deposited with third parties to be used as collateral to secure various liabilities on behalf of insureds, cedants and other creditors had a fair value of $52 million and $54 million at December 31, 2020 and 2019, respectively. Other
investments pledged as collateral securing outstanding letters of credit had a fair value of $1 million at both December 31, 2020 and 2019. In addition, the Company utilizes Lloyd’s trust deposits, whereby owned securities with a fair value of approximately $119 million and $173 million held by a wholly-owned subsidiary at December 31, 2020 and 2019, respectively, and $35 million and $34 million held by TRV at December 31, 2020 and 2019, respectively, were pledged into Lloyd’s trust accounts to provide a portion of the capital needed to support the Company’s obligations at Lloyd’s.
The Company recognized $25 million and $61 million of net gains on equity securities still held as of December 31, 2020 and 2019, respectively.
Proceeds from the sale of real estate investments were not material in 2020, $0 in 2019 and $74 million in 2018. Gross gains of $23 million and gross losses of $0 million were realized on those sales in 2018. Accumulated depreciation on real estate held for investment purposes was $462 million and $422 million at December 31, 2020 and 2019, respectively.
Entities which do not have sufficient equity at risk to allow the entity to finance its activities without additional financial support or in which the equity investors, as a group, do not have the characteristic of a controlling financial interest are referred to as variable interest entities (VIE). A VIE is consolidated by the variable interest holder that is determined to have the controlling financial interest (primary beneficiary) as a result of having both the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and the obligation to absorb losses or right to receive benefits from the VIE that could potentially be significant to the VIE. The Company determines whether it is the primary beneficiary of an entity subject to consolidation based on a qualitative assessment of the VIE’s capital structure, contractual terms, nature of the VIE’s operations and purpose and the Company’s relative exposure to the related risks of the VIE on the date it becomes initially involved in the VIE. The Company reassesses its VIE determination with respect to an entity on an ongoing basis.
At December 31, 2020, the amount of gross unrealized losses for all fixed maturity investments reported at fair value for which fair value was less than 80% of amortized cost was not significant.
Net realized investment gains in 2020 included $40 million of realized losses related to the other-than-temporary impairment of the carrying value of an equity method investment included in other investments.
Credit losses related to the fixed maturity portfolio for 2020 and 2019 represented less than 1% of the fixed maturity portfolio on a pre-tax basis and less than 1% of shareholders' equity on an after-tax basis at both December 31, 2020 and 2019.
From time to time, the Company enters into U.S. Treasury note futures contracts to modify the effective duration of specific assets within the investment portfolio. U.S. Treasury futures contracts require a daily mark-to-market and settlement with the broker. At December 31, 2020 and 2019, the Company had no open U.S. Treasury futures contracts. Net realized investment gains and losses related to U.S. Treasury futures contracts in 2020, 2019 and 2018 were not significant.
The Company has a put/call option that was entered into in connection with a business acquisition that allows the Company to acquire the remaining shares of the acquired company at a future date. Net realized investment gains and losses related to this put/call option in 2020 and 2019 were not significant.
•Level 2 - Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in inactive markets; or valuations based on models where the significant inputs are observable (e.g., interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.
The Company utilized a pricing service to estimate fair value measurements for approximately 99% of its fixed maturities at both December 31, 2020 and 2019. The pricing service utilizes market quotations for fixed maturity securities that have quoted prices in active markets. Since fixed maturities other than U.S. Treasury securities generally do not trade on a daily basis, the pricing service prepares estimates of fair value measurements for these securities using its proprietary pricing applications, which include available relevant market information, benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. Additionally, the pricing service uses an Option Adjusted Spread model to develop prepayment and interest rate scenarios.
The Company holds investments in various publicly-traded securities which are reported in other investments. These investments include mutual funds and other small holdings. The $17 million and $16 million fair value of these investments at December 31, 2020 and 2019, respectively, was disclosed in Level 1. At December 31, 2020 and 2019, the Company held investments in non-public common and preferred equity securities, with fair value estimates of $35 million and $20 million, respectively, reported in other investments, where the fair value estimate is determined either internally or by an external fund manager based on recent filings, operating results, balance sheet stability, growth and other business and market sector fundamentals. Due to the significant unobservable inputs in these valuations, the Company includes the total fair value estimate for all of these investments at December 31, 2020 and 2019 in the amount disclosed in Level 3.
The Company also includes in Level 3 the put/call option entered into in connection with a business acquisition that is reported in other liabilities and had a fair value of $5 million at December 31, 2020.
The Company also includes in Level 3 the put/call option entered into in connection with a business acquisition that is reported in other liabilities and had a fair value of $8 million at December 31, 2019.
The following table presents the balances of premiums receivable, net of the allowance for expected credit losses, at January 1, 2020 and December 31, 2020, and the changes in the allowance for expected credit losses for the twelve months ended December 31, 2020.
Of the total reinsurance recoverables at December 31, 2020, after deducting mandatory pools and associations and before allowances for estimated uncollectible reinsurance, $5.85 billion, or 87%, were rated by A.M. Best Company. The Company utilizes updated A.M. Best credit ratings on a quarterly basis when determining the allowance. Of the total rated by A.M. Best Company, 94% were rated A- or better. The remaining 13% of reinsurance recoverables were comprised of the following: 6% related to captive insurance companies, 1% related to the Company’s participation in voluntary pools, and 6% were balances from other companies not rated by A.M. Best Company. Certain of the Company's reinsurance recoverables are collateralized by letters of credit, funds held or trust agreements.
The following table presents the balances of contractholder receivables, net of the allowance for expected credit losses, at January 1, 2020 and December 31, 2020, and the changes in the allowance for expected credit losses for the twelve months ended December 31, 2020.
The Company monitors the financial condition of its reinsurers under voluntary reinsurance arrangements to evaluate the collectability of amounts due from reinsurers and as a basis for determining the reinsurers with which the Company conducts ongoing business. In addition, in the ordinary course of business, the Company may become involved in coverage disputes with its reinsurers. Some of these disputes could result in lawsuits and arbitrations brought by or against the reinsurers to determine the Company’s rights and obligations under the various reinsurance agreements. The Company employs dedicated specialists and strategies to manage reinsurance collections and disputes.
Ceded premiums include the premiums paid for coverage provided by the Company’s catastrophe bonds.
The Terrorism Risk Insurance Program is a Federal program administered by the Department of the Treasury authorized through December 31, 2027 that provides for a system of shared public and private compensation for certain insured losses resulting from certified acts of terrorism.
In order for a loss to be covered under the program (subject losses), the loss must meet certain aggregate industry loss minimums and must be the result of an event that is certified as an act of terrorism by the U.S. Secretary of the Treasury, in consultation with the Secretary of Homeland Security and the Attorney General of the United States. The annual aggregate
(1)Contract-based intangible assets subject to amortization are comprised of fair value adjustments on claims and claim adjustment expense reserves, reinsurance recoverables and other contract-related intangible assets. Fair value adjustments recorded in connection with insurance acquisitions were based on management’s estimate of nominal claims and claim adjustment expense reserves and reinsurance recoverables. The method used calculated a risk adjustment to a risk-free discounted reserve that would, if reserves ran off as expected, produce results that yielded the assumed cost-of-capital on the capital supporting the loss reserves. The fair value adjustments are reported as other intangible assets on the consolidated balance sheet, and the amounts measured in accordance with the acquirer’s accounting policies for insurance contracts have been reported as part of the claims and claim adjustment expense reserves and reinsurance recoverables. The intangible assets are being recognized into income over the expected payment pattern. Because the time value of money and the risk adjustment (cost of capital) components of the intangible assets run off at different rates, the amount recognized in income may be a net benefit in some periods and a net expense in other periods.
Amortization expense of intangible assets was $14 million, $15 million and $17 million for the years ended December 31, 2020, 2019 and 2018, respectively. Amortization expense for all intangible assets subject to amortization is estimated to be $14 million in 2021, $13 million in 2022, $13 million in 2023, $12 million in 2024 and $12 million in 2025. Amortization expense for intangible assets arising from insurance contracts acquired in a business combination is estimated to be $4 million in 2021, $3 million in 2022, $3 million in 2023, $2 million in 2024 and $2 million in 2025.
PG&E Corporation and Pacific Gas and Electric Company (together, PG&E) emerged from bankruptcy on July 1, 2020, the date the Debtors' and Shareholder Proponents' Joint Chapter 11 Plan of Reorganization Dated June 19, 2020 (the Plan) became effective. In accordance with the terms of the Plan, PG&E funded a trust from which the Company and other subrogation claimants have received, and/or will receive, recoveries related to the 2017 and 2018 California wildfires. In 2020, the Company recognized a subrogation benefit related to these claims of $403 million (the Company's estimate of its total recoveries from the trust prior to its expiration in 2025, pre-tax and net of expenses and amounts that inure to the benefit of the Company's reinsurers) and received payments from the trust of $380 million.
Business Insurance. Net unfavorable prior year reserve development in 2020 totaled $91 million, primarily driven by the following:
•General liability (excluding asbestos and environmental) - higher than expected loss experience in the segment's domestic operations for primary and excess coverages for recent accident years, as well as an increase to general liability reserves in the Company's run-off operations related to policies issued more than 20 years ago;
•Commercial multi-peril (excluding PG&E subrogation recoveries and asbestos and environmental) - higher than expected loss experience in the segment's domestic operations for recent accident years.
Personal Insurance. Net favorable prior year reserve development in 2020 totaled $443 million, primarily driven by $322 million of PG&E subrogation recoveries described above and better than expected loss experience in the segment's domestic operations in the automobile product line for recent accident years.
•Commercial automobile - higher than expected loss experience in the segment's domestic operations for recent accident years;
•Asbestos reserves - an increase of $220 million, primarily in the segment's domestic general liability product line;
•Workers' compensation - better than expected loss experience in the segment's domestic operations for multiple accident years; and
Personal Insurance. Net favorable prior year reserve development in 2019 totaled $133 million, primarily driven by better than expected loss experience in the segment's domestic operations in the automobile and homeowners and other product lines for recent accident years.
•Asbestos reserves - an increase of $225 million, primarily in the segment's domestic general liability product line;
(4)Total reinsurance recoverables (on paid and unpaid losses) at December 31, 2020 were $8.35 billion.
The claim development tables that follow present, by accident year, incurred and cumulative paid claims and allocated claim adjustment expense on a historical basis. This claim development information is presented on an undiscounted, net of reinsurance basis for ten years, or the number of years for which claims incurred typically remain outstanding if less than ten years. The claim development tables also provide the historical average annual percentage payout of incurred claims (including the impact of subrogation recoveries from PG&E for accident years 2017 and 2018 in the commercial property, commercial multi-peril and homeowners and other product lines) by age, net of reinsurance, as supplementary information (identified as unaudited in the tables below). For Personal Insurance - International - Canada, the claim development information reflects the acquisition of The Dominion of Canada General Insurance Company (Dominion) in November 2013 on a retrospective basis (includes Dominion data for years prior to the Company’s acquisition of Dominion).
The incurred and paid amounts have been translated from the local currency to U.S. dollars using the December 31, 2020 spot rate for all years presented in the table above in order to isolate changes in foreign exchange rates from loss development.
•The paid loss development method assumes that the future change (positive or negative) in cumulative paid losses for a given cohort of claims will occur in a stable, predictable pattern from year-to-year, consistent with the pattern observed in past cohorts.
•The Bornhuetter-Ferguson method uses an initial estimate of ultimate losses for a given product line reserve component, typically expressed as a ratio to earned premium. The method assumes that the ratio of additional claim activity to earned premium for that component is relatively stable and predictable over time and that actual claim activity to date is not a credible predictor of further activity for that component. The method is used most often for more recent accident years where claim data is sparse and/or volatile, with a transition to other methods as the underlying claim data becomes more voluminous and therefore more credible.
•The average value analysis combined with the reported claim development method assumes that average claim values are stable and predictable over time for a particular cohort of claims. It is typically limited to analysis at more granular levels, such as coverage or hazard/peril, where a more homogeneous subset of claims produce a more stable and fairly predictable average value. The reported claim development method is the same as the paid loss development method but uses changes in cumulative claim counts to produce estimates of ultimate claim counts rather than ultimate dollars. The resulting estimate of ultimate claim counts by cohort is multiplied by an average value per claim from an average value analysis to obtain estimated ultimate claims and claim adjustment expenses.
While these are the principal methods utilized, the Company’s actuaries have available to them the full range of actuarial methods developed by the casualty actuarial profession. The Company’s actuaries are also continually monitoring developments within the profession for advances in existing techniques or the creation of new techniques that might improve current and future estimates. Most actuarial methods assume that past patterns demonstrated in the data will repeat themselves
In the third quarter of 2020, the Company completed its annual in-depth asbestos claim review, including a review of policyholders with open claims and litigation cases for potential product and “non-product” liability, and noted the continuation of the following trends:
Net asbestos paid loss and loss expenses in 2020, 2019 and 2018 were $237 million, $224 million and $225 million, respectively. Approximately 1%, 4% and 9% of total net paid losses in 2020, 2019 and 2018, respectively, related to policyholders with whom the Company entered into settlement agreements that limit those policyholders' ability to present future claims to the Company.
events; infrastructure disruption; fraud; the effect of mold damage and business income interruption costs; and reinsurance collectibility. The timing of a catastrophe’s occurrence, such as at or near the end of a reporting period, can also affect the information available to the Company in estimating reserves for that reporting period. The estimates related to catastrophes are adjusted as actual claims emerge.
2020 Debt Repayment. On November 1, 2020, the Company's $500 million, 3.90% notes matured and were fully paid.
The Company is party to a five-year, $1.0 billion revolving credit agreement with a syndicate of financial institutions that expires on June 4, 2023. Pursuant to the credit agreement covenants, the Company must maintain a minimum consolidated net worth, defined as shareholders’ equity determined in accordance with GAAP (excluding accumulated other comprehensive income (loss)) plus (a) trust preferred securities (not to exceed 15% of total capital) and (b) mandatorily convertible securities (combined with trust preferred securities, not to exceed 25% of total capital) less goodwill and other intangible assets, of $12.494 billion. In addition, the credit agreement contains other customary restrictive covenants as well as certain customary events of default, including with respect to a change in control, which is defined to include the acquisition of 35% or more of the Company’s voting stock and certain changes in the composition of the Company’s Board of Directors. At December 31, 2020, the Company was in compliance with these covenants. Generally, the cost of borrowing under this agreement will range from LIBOR plus 75 basis points to LIBOR plus 137.5 basis points, depending on the Company’s credit ratings. At December 31, 2020, that cost would have been LIBOR plus 100 basis points, had there been any amounts outstanding under the credit agreement. In the event that LIBOR is no longer available, the credit agreement provides that the Company and the syndicate of financial institutions use commercially reasonable efforts to jointly agree upon an alternate rate of interest.
The Company’s Amended and Restated 2004 Stock Incentive Plan and the Amended and Restated 2014 Stock Incentive Plan provide settlement alternatives to employees in which the Company retains shares to cover payroll withholding taxes in connection with the vesting of restricted stock unit awards and performance share awards, and shares used by employees to cover the price of certain stock options that were exercised. During the years ended December 31, 2020 and 2019, the Company acquired $47 million and $48 million, respectively, of its common stock under these plans.
The Company’s U.S. insurance subsidiaries, domiciled principally in the State of Connecticut, are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid by each insurance subsidiary to its respective parent company without prior approval of insurance regulatory authorities. A maximum of $2.73 billion is available by the end of 2021 for such dividends to the holding company, TRV, without prior approval of the Connecticut Insurance Department. The Company may choose to accelerate the timing within 2021 and/or increase the amount of dividends from its insurance subsidiaries in 2021, which could result in certain dividends being subject to approval by the Connecticut Insurance Department.
TRV and its two non-insurance holding company subsidiaries received dividends of $2.00 billion, $2.50 billion and $2.30 billion from their U.S. insurance subsidiaries in 2020, 2019 and 2018, respectively.
The following is a reconciliation of the income and share data used in the basic and diluted earnings per share computations:
If the Company determines that any of its deferred tax assets will not result in future tax benefits, a valuation allowance must be established for the portion of these assets that are not expected to be realized. The net change in the valuation allowance for deferred tax assets was a decrease of $6 million in 2020, primarily driven by a $10 million decrease resulting from the sale of the Company's consolidated Brazilian subsidiary, partially offset by increases of $2 million in each of the Company's Canadian subsidiary and Republic of Ireland subsidiary. Based upon a review of the Company’s anticipated future taxable income, and also including all other available evidence, both positive and negative, the Company’s management concluded that it is more likely than not that the net deferred tax assets will be realized.
U.S. income taxes have not been recognized on any undistributed earnings that are intended to be permanently reinvested. Any potential U.S. income tax on these amounts is immaterial.
The following is a reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2020 and 2019:
The Company also has a compensation program for non-employee directors (the Director Compensation Program). Under the Director Compensation Program, non-employee directors’ compensation consists of an annual retainer, a deferred stock award, committee chair fees and a lead director fee. Each non-employee director may choose to receive all or a portion of his or her annual retainer, committee chair fee and lead director fee, as applicable, in the form of cash or deferred stock units which vest upon grant. The annual deferred stock awards vest in full one day prior to the date of the Company’s annual meeting of shareholders occurring in the year following the year of the grant date, subject to continued service. The annual deferred stock awards, including dividend equivalents, accumulate until distribution either in a lump sum six months after termination of service as a director or, if the director so elects, in annual installments beginning at least six months following termination of service as a director. The deferred stock units issued under the Director Compensation Program are awarded under the 2014 Incentive Plan.
The fair value of each option award is estimated on the date of grant by application of a variation of the Black-Scholes option pricing model using the assumptions noted in the following table. The expected term of newly granted stock options is the time to vest plus half the remaining time to expiration. This considers the vesting restriction and represents an even pattern of exercise behavior over the remaining term. The expected volatility assumption is based on the historical volatility of the Company’s common stock for the same period as the estimated option term generally using the volatility of the week prior to the stock option grant. The expected dividend is based upon the Company’s current quarter dividend annualized and assumed to be constant over the expected option term. The risk-free interest rate for each option is the interpolated market yield of a U.S. Treasury bill with a term comparable to the expected option term for the same week used for measuring volatility. The following table provides information about options granted:
A summary of stock option activity under the 2014 Incentive Plan and the legacy plans as of and for the year ended December 31, 2020 is as follows:
(3)Represents the current year change in estimated performance shares to reflect the attainment of performance goals for the awards that were granted in each of the years 2018 through 2020.
The Company has discretion regarding whether to provide additional funding and when to provide such funding to its qualified domestic pension plan. In 2020, 2019 and 2018, there were no required contributions to the qualified domestic pension plan. In 2020 and 2019, the Company made no voluntary contributions to the qualified domestic pension plan. In 2018, the Company voluntarily made contributions totaling $200 million to the qualified domestic pension plan. There is no required contribution to the qualified domestic pension plan during 2021, and the Company has not determined whether or not additional
The following table summarizes the components of net periodic benefit cost (benefit) and other amounts recognized in other comprehensive income related to the benefit plans.
The Company’s overall investment strategy for the qualified domestic pension plan is to achieve a mix of approximately 85% to 90% of investments for long-term growth and 10% to 15% for near-term benefit payments with a diversification of asset types, fund strategies and fund managers. The current target allocations for plan assets are 55% to 65% equity securities and 20% to 40% fixed income securities, with the remainder allocated to short-term securities. Equity securities primarily include investments in large, medium and small-cap companies primarily located in the United States. Fixed income securities include corporate bonds of companies from diversified industries, mortgage-backed securities, U.S. Treasury securities and debt securities issued by foreign governments.
For a discussion of the methods employed by the Company to measure the fair value of invested assets, see note 4. The following discussion of fair value measurements applies exclusively to the Company’s pension plans and other postretirement benefit assets.
The Company enters into lease agreements for real estate that is primarily used for office space in the ordinary course of business. These leases are accounted for as operating leases, whereby lease expense is recognized on a straight-line basis over the term of the lease, and a right-of-use asset and lease liability is recognized as part of other assets and other liabilities, respectively, in the consolidated balance sheet. See note 1 - Adoption of Accounting Standards - Leases for additional information regarding the accounting for leases.
Most leases include an option to extend or renew the lease term. The exercise of the renewal option is at the Company's discretion. The operating lease liability includes lease payments related to options to extend or renew the lease term if the Company is reasonably certain of exercising those options. The Company, in determining the present value of lease payments, utilizes either the rate implicit in the lease, if that rate is readily determinable, or the Company’s incremental secured borrowing rate commensurate with the term of the underlying lease.
(1) Leases with a term of twelve months or less are not recorded on the consolidated balance sheet.
In the ordinary course of its insurance business, the Company has received and continues to receive claims for insurance arising under policies issued by the Company asserting alleged injuries and damages from asbestos- and environmental-related exposures that are the subject of related coverage litigation. The Company is defending asbestos- and environmental-related litigation vigorously and believes that it has meritorious defenses; however, the outcomes of these disputes are uncertain. In
The Company is involved in other lawsuits, including lawsuits alleging extra-contractual damages relating to insurance contracts or reinsurance agreements, that do not arise under insurance contracts or reinsurance agreements. The legal costs associated with such lawsuits are expensed in the period in which the costs are incurred. Based upon currently available information, the Company does not believe it is reasonably possible that any such lawsuit or related lawsuits would be material to the Company’s results of operations or would have a material adverse effect on the Company’s financial position or liquidity.
Investment Commitments - The Company has unfunded commitments to private equity limited partnerships, real estate partnerships and others. These commitments totaled $1.76 billion and $1.66 billion at December 31, 2020 and 2019, respectively.
In the ordinary course of selling businesses to third parties, the Company has agreed to indemnify purchasers for losses arising out of breaches of representations and warranties, obligations arising from certain liabilities and any breach or failure to perform certain covenants with respect to the businesses being sold. Such indemnification provisions generally are applicable from the closing date to the expiration of the relevant statutes of limitations, although, in some cases, there may be agreed upon term limitations or no term limitations. Certain of these contingent obligations are subject to deductibles which have to be incurred by the obligee before the Company is obligated to make payments. The maximum amount of the Company’s contingent obligation for indemnifications related to the sale of businesses that are quantifiable was $351 million at December 31, 2020.
There were no material noncash financing or investing activities during the years ended December 31, 2020, 2019 and 2018.