Through The Cincinnati Insurance Company, Cincinnati Financial Corporation is one of the 25 largest property casualty insurers in the nation, based on net written premium volume for the first nine months of 2019, among approximately 2,000 U.S. stock and mutual insurer groups. We market our insurance products through a select group of independent insurance agencies in 45 states as discussed in Item 1, Our Business and Our Strategy.
The table below shows the primary components of our value creation ratio on a percentage basis. Analysis of the components aids understanding of our financial performance. Our financial results are further analyzed in the Corporate Financial Highlights section below.
The 2019 value creation ratio improved by 30.6 percentage points, compared with 2018, primarily due to a higher valuation for our investment portfolio, as shown in the table above. The decrease in 2018, compared with 2017, was primarily due to a lower valuation for our investment portfolio. Operating results in 2019 contributed to VCR more than in 2018, despite a 0.7% contribution from certain non-recurring items in the 2018 ratio, including the impact of various tax accounting method changes. VCR in 2017 included a 7.0% contribution from a tax benefit due to net deferred income tax liability revaluation related to U.S. tax reform.
** Change in book value divided by the beginning of year book value
*** Dividend declared to shareholders divided by beginning of year book value
Premium growth - We believe over any five-year period our agency relationships and initiatives can lead to a property casualty written premium growth rate that exceeds the industry average. The compound annual growth rate of our net written premiums was 5.9% over the five-year period 2015 through 2019, exceeding the 4.3% estimated growth rate for the property casualty insurance industry, with 2019 representing industry data reported through the first nine months of 2019. The industry’s growth rate excludes its mortgage and financial guaranty lines of business.
Combined ratio - We believe our underwriting philosophy and initiatives can drive performance to achieve our underwriting profitability target of a GAAP combined ratio over any five-year period that consistently averages within the range of 95% to 100%. Our GAAP combined ratio averaged 94.7% over the five-year period 2015 through 2019, slightly better than the performance target range. Performance as measured by the combined ratio is discussed in Consolidated Property Casualty Insurance Results. Our statutory combined ratio averaged 94.3% over the five-year period 2015 through 2019, compared with an estimated 100.1% for the property casualty industry, with 2019 representing industry data reported through the first nine months of 2019. The industry’s ratio again excludes its mortgage and financial guaranty lines of business.
The board of directors is committed to rewarding shareholders directly through cash dividends and share repurchase authorizations. Through 2019, the company has increased the annual cash dividend rate for 59 consecutive years, a record we believe is matched by only seven other publicly traded U.S. companies. In addition to regular dividends, strong capital and excellent company performance has provided opportunities to further reward shareholders, including a special dividend paid in December 2017. The board regularly evaluates relevant factors in dividend-related decisions, and the 2019 increase to the regular dividend reflected confidence in our strong capital, liquidity and financial flexibility, as well as progress through our initiatives to improve earnings performance while growing insurance premium revenues. We discuss our financial position in more detail in Liquidity and Capital Resources.
Total investments increased by 18% during 2019 on a fair value basis, with an increase in our securities portfolio valuation that added to a 6% increase in its cost basis. Entering 2020, we believe the portfolio continues to be well diversified and is well positioned to withstand short-term fluctuations. We discuss our investment strategy in Item 1, Investments Segment, and results for the segment in Investments Results. Total assets rose 16%. Shareholders’ equity increased by 26% and book value per share also increased by 26%, for reasons discussed in the preceding Executive Summary.
Net income rose $1.710 billion or 596% in 2019, compared with 2018, including a $1.621 billion increase for 2019 net investment gains after taxes. The improved 2019 net income also included an increase in property casualty underwriting income of $122 million after taxes, as discussed below, and a $21 million increase in investment income after taxes. Our investment operation’s performance is discussed further in Investments Results. Net income in 2018 included a $56 million benefit from certain other non-recurring items, primarily the impact of various tax accounting method changes as disclosed in Item 8, Note 11 of the Consolidated Financial Statements.
As discussed in Investments Results, we reported a net investment gain in 2019, primarily due to a $1.626 billion net favorable change in fair value for equity securities still held. In 2018, we reported a net investment loss, primarily due to unfavorable changes in fair values of equity securities even though we continued to hold the securities. For 2017 we reported investment gains, largely due to investment sales that were discretionary in timing and amount.
We measure property casualty underwriting profitability primarily by the combined ratio. Our combined ratio measures the percentage of each earned premium dollar spent on claims plus all expenses related to our property casualty operations, all on a pretax basis. A lower ratio indicates more favorable results and better underlying performance. A ratio below 100% represents an underwriting profit. Initiatives to improve our combined ratio are discussed in Item 1, Our Business and Our Strategy, Strategic Initiatives. In 2019, 2018 and 2017, favorable development on reserves for claims that occurred in prior accident years helped offset other incurred losses and loss expenses. Reserve development is discussed further in Property Casualty Loss and Loss Expense Obligations and Reserves. Losses from weather-related catastrophes are another important item influencing the combined ratio and are discussed along with other factors in Financial Results for our property casualty business and related segments.
Our life insurance segment reported profit of $1 million in 2019 and $8 million in 2018. We discuss results for the segment in Life Insurance Results. Most of this segment’s investment income is included in our investments segment results. In addition to investment income, investment gains from the life insurance investment portfolio are also included in our investments segment results.
Manage insurance profitability - Implementation of these initiatives is intended to enhance underwriting expertise and knowledge, thereby increasing our ability to manage our business while also gaining efficiency. Better profit margins can arise from additional information and more focused action on underperforming product lines, plus pricing capabilities we are expanding through the use of technology and analytics. In addition to enhancing company efficiency, improving internal processes also supports the ability of the independent agencies that represent us to grow profitably by allowing them to serve clients faster and to more efficiently manage agency expenses.
The significant accounting policies used in the preparation of the financial statements are discussed in Item 8, Note 1 of the Consolidated Financial Statements. In conjunction with that discussion, material implications of uncertainties associated with the methods, assumptions and estimates underlying the company’s critical accounting policies are discussed below. The audit committee of the board of directors reviews the annual financial statements with management and the independent registered public accounting firm. These discussions cover the quality of earnings, review of reserves and accruals, reconsideration of the suitability of accounting principles, review of highly judgmental areas including critical accounting estimates, audit adjustments and such other inquiries as may be appropriate.
For events designated as natural catastrophes resulting in losses incurred related to premiums written on a direct basis by The Cincinnati Insurance Companies, we calculate IBNR reserves directly as a result of an estimated IBNR claim count and an estimated average claim amount for each event. Once case reserves are established for a catastrophe event, we reduce the IBNR reserves. Our claims department management coordinates the assessment of these events and prepares the related IBNR reserve estimates. Such an assessment involves a comprehensive analysis of the nature of the event, of policyholder exposures within the affected geographic area and of available claims intelligence. Depending on the nature of the event, available claims intelligence could include surveys of field claims associates within the affected geographic area, feedback from a catastrophe claims team sent into the area, as well as data on claims reported as of the financial statement date.
For asbestos and environmental claims, we calculate IBNR reserves by deriving an actuarially-based estimate of total unpaid loss and loss expenses. We then reduce the estimate by total case reserves. We discuss the reserve analysis that applies to asbestos and environmental reserves in Liquidity and Capital Resources, Asbestos and Environmental Loss and Loss Expense Reserves.
Our investment portfolio is our largest asset. We monitor the fixed-maturity portfolio and all other assets for signs of other-than-temporary or permanent impairment. We monitor decreases in the fair value of invested assets; an accumulation of company costs in excess of the amount originally expected to acquire or construct an asset; uncollectability of all receivable assets; or other factors such as bankruptcy, deterioration of creditworthiness, failure to pay interest; signs indicating that the receivable carrying amount may not be recoverable; and changes in legal factors or in the business climate.
The application of our impairment policy resulted in other-than-temporary impairment (OTTI) charges that reduced our income before income taxes by $9 million in 2019, $5 million in 2018 and $9 million in 2017. OTTI losses represent noncash charges to income and are reported as investment losses.
All fixed-maturity securities valued below 100% of amortized cost are reported to the asset impairment committee for evaluation. When evaluating for OTTI, the committee considers the company’s intent and ability to retain a security for a period adequate to recover its cost.
Fixed-maturity securities considered to have a temporary decline would be expected to recover their amortized cost, which may be at maturity. Under the same accounting treatment as fair value gains, temporary declines (changes in the fair value of these fixed-maturity securities) are reflected in shareholders’ equity on our Consolidated Balance Sheets in accumulated other comprehensive income (AOCI), net of tax, and have no impact on net income.
Fair value is defined as the exit price or the amount that would be (1) received to sell an asset or (2) paid to transfer a liability in an orderly transaction between marketplace participants at the measurement date. When determining an exit price, we must, whenever possible, rely upon observable market data.
We report as Other the noninvestment operations of the parent company and its noninsurer subsidiary, CFC Investment Company. In addition, Other includes the financial results of our reinsurance assumed operations, known as Cincinnati ReSM, and our London-based global specialty underwriter Cincinnati Global Underwriting Ltd.SM, known as Cincinnati Global.
The calculations of segment data are described in more detail in Item 8, Note 18, of the Consolidated Financial Statements. The following sections provide analysis and discussion of results of operations for each of the five segments.
Expansion of Cincinnati Re produced $228 million of 2019 net written premiums and contributed $70 million of the growth in other written premiums, compared with 2018. Cincinnati Re assumes risks through reinsurance treaties and in some cases cedes part of the risk and related premiums to one or more unaffiliated reinsurance companies through transactions known as retrocessions. In 2019, earned premiums for Cincinnati Re totaled $184 million.
Cincinnati Global also contributed to the increase in other written premiums, following its acquisition on February 28, 2019. Net written premiums were $140 million since the acquisition, while earned premiums were $149 million.
Other written premiums also include premiums ceded to reinsurers as part of our ceded reinsurance program. An increase in ceded premiums, other than Cincinnati Re and Cincinnati Global premiums, reduced net written premium growth by $12 million more in 2019, compared with 2018.
Our statutory combined ratio was 93.4% in 2019 compared with 96.0% in 2018 and 97.2% in 2017. The estimated statutory combined ratio for the property casualty industry, with the industry’s ratio excluding its mortgage and financial guaranty lines of business and based on industry data reported through the first nine months of 2019, was 98.0% in 2019, 99.3% in 2018 and 104.0% in 2017. The contribution of catastrophe losses to our statutory combined ratio was 6.0 percentage points in 2019, 7.1 percentage points in 2018 and 7.2 percentage points in 2017, compared with industry estimates of 4.4, 5.9 and 9.7 percentage points, respectively, with 2019 representing industry data reported through the first nine months of 2019. Components of the combined ratio are discussed below.
For our property catastrophe occurrence and aggregate excess of loss treaty that we renewed for a period of one year effective July 1, 2019, there is a total limit of $50 million for all coverages combined. The combined coverage noted below applies to business written on a direct basis and by Cincinnati Re. Cincinnati Global catastrophe losses are not applicable to the treaty. Key coverages are summarized below.
Direct business-only in certain Western states - Aggregate net recovery up to $31 million for:
There was no recovery from reinsurers for losses during 2019 pertaining to the treaty effective July 1, 2019. For the treaty effective in July 2018, the aggregate recovery from reinsurers totaled $14 million for incurred losses in 2019, after considering all applicable deductibles, due to adverse reserve development in our personal lines insurance
Loss and loss expenses include both net paid losses and reserve changes for unpaid losses as well as the associated loss expenses. For all property casualty lines of business in aggregate, net loss and loss expense reserves at December 31, 2019, were $92 million higher than at year-end 2018, including $131 million for incurred but not reported (IBNR) reserves. The $92 million reserve increase raised year-end 2018 net loss and loss expense reserves by 2%.
Most of the incurred losses and loss expenses shown in the consolidated property casualty insurance results three-year highlights table are for the respective current accident years, with reserve development on prior accident years shown separately. Since less than half of our consolidated property casualty current accident year incurred losses and loss expenses represents net paid amounts, the majority represents reserves for our estimate of ultimate losses and loss expenses. These reserves develop over time, and we re-estimate previously reported reserves as we learn more about the development of the related claims. The table below illustrates that development. For example, the 68.9% accident year 2018 loss and loss expense ratio reported as of December 31, 2018, developed favorably by 1.8 percentage points to 67.1% due to claims settling for less than previously estimated, or due to updated reserve estimates for unpaid claims, as of December 31, 2019. Accident years 2018 and 2017 have both developed favorably, as indicated by the progression over time for the ratios in the table.
Catastrophe loss trends, discussed above, accounted for some of the movement in the current accident year loss and loss expense ratio for 2019, compared with 2018. Catastrophe losses added 6.6 percentage points in 2019, 7.4 points in 2018 and 7.8 points in 2017 to the respective consolidated property casualty current accident year loss and loss expense ratios in the table above.
The 60.9% ratio for current accident year loss and loss expenses before catastrophe losses for 2019 decreased 0.6 percentage points compared with the 61.5% accident year 2018 ratio measured as of December 31, 2018. Contributors to the decrease included a 0.2 percentage-point reduction in the ratio for current accident year losses of $1 million or more per claim, shown in the table below.
Reserve development on prior accident years continued to net to a favorable amount in 2019, and was primarily due to less-than-anticipated loss emergence on known claims. We recognized $248 million of favorable development in 2019, compared with $167 million in 2018 and $119 million in 2017. Of the $81 million increase in 2019, compared with 2018, $50 million was attributable to our commercial casualty and workers' compensation lines of business. Approximately 83% of our net favorable reserve development on prior accident years recognized during 2019 occurred in our commercial casualty, commercial property, workers’ compensation and personal auto lines of business. In 2018, our commercial casualty, commercial property and workers' compensation lines of business were responsible for approximately 91% of the favorable reserve development. As discussed in Liquidity and Capital Resources, Property Casualty Loss and Loss Expense Obligations and Reserves, Property Casualty Insurance Development of Estimated Reserves by Accident Year, commercial casualty and workers' compensation are considered long-tail lines with the potential for revisions inherent in estimating reserves. Favorable development recognized during 2017 was primarily from our commercial property and workers’ compensation lines of business. Development by accident year is further discussed in Liquidity and Capital Resources, Property Casualty Insurance Development of Estimated Reserves by Accident Year.
In 2019, total large losses incurred decreased by $10 million, or 3%, net of reinsurance, primarily due to a decrease for our commercial lines insurance segment. The corresponding ratio decreased 0.7 percentage points. The large loss data included in the table above does not include Cincinnati Re and Cincinnati Global. Our analysis of large losses incurred indicated no unexpected concentration of these losses and reserve increases by geographic region, policy inception, agency or field marketing territory. We believe the inherent volatility of aggregate loss experience for our portfolio of larger policies is greater than that of our portfolio of smaller policies, and we continue to monitor the volatility in addition to general inflationary trends in loss costs.
Premiums - Earned premiums and net written premiums rose in 2019, including a $73 million increase in renewal written premiums that continued to include higher average pricing. New business written premiums in 2019 increased $93 million, or 22%, compared with 2018. Approximately one-third of the increase was from agencies appointed since the beginning of 2018.
As discussed in Critical Accounting Estimates, Property Casualty Insurance Loss and Loss Expense Reserves, stable historical paid loss patterns are a key assumption used to make projections necessary for estimating IBNR reserves. During 2017, we observed paid losses or re-estimates of case reserves emerging at levels higher than expected for commercial casualty. Considering that new data at December 31, 2017, we estimated commercial casualty IBNR reserves for accident year 2017 at levels more likely to be adequate. During 2019 and 2018, commercial casualty reserve development on prior accident years was favorable, as discussed below. In 2018, our estimate for commercial casualty IBNR reserves for accident year 2018 contributed an increase of 0.5 percentage points to the 2018 commercial lines segment ratio for current accident year losses and loss expenses before catastrophes, compared with its contribution to accident year 2017 as of December 31, 2017. Our commercial casualty 2019 total loss and loss expense ratio was 2.3 percentage points better than in 2018.
Our commercial lines statutory combined ratio was 92.3% in 2019, compared with 95.1% in 2018 and 96.2% in 2017. The contribution of catastrophe losses to our commercial lines statutory combined ratio was 4.5 percentage points in 2019, 5.8 percentage points in 2018 and 5.0 percentage points in 2017.
Our 2% increase in 2019 agency renewal written premiums included higher average pricing. We measure average changes in commercial lines renewal pricing as the rate of change in renewal premium for the new policy period compared with the premium for the expiring policy period, assuming no change in the level of insured exposures or policy coverage between those periods for respective policies. In 2019, our standard commercial lines policies averaged an estimated pricing change at a percentage in the low-single-digit range, slightly higher than in 2018. Our average commercial lines pricing change includes the flat pricing effect of certain coverages within package policies written for a three-year term that were in force but did not expire during the period being measured. Therefore, the average commercial lines pricing change we report reflects a blend of policies that did not expire and other policies that did expire during the measurement period.
Premiums resulting from audits of actual sales or payrolls that confirmed or adjusted initial premium estimates are part of net written premiums and earned premiums. The contribution to our commercial lines earned premiums was $65 million, $70 million and $69 million in 2019, 2018 and 2017, respectively.
In 2019, our commercial lines new business premiums written by our agencies increased $93 million, or 22%, compared with 2018. New business premium volume in recent years has been significantly influenced by new agency appointments. Agencies appointed since the beginning of 2018 produced commercial lines new business written premiums of $45 million, in aggregate, during 2019, up $33 million from what they produced during 2018. All other agencies contributed the remaining $465 million, up $60 million from the $405 million they produced in 2018.
The 61.7% ratio for current accident year loss and loss expenses before catastrophe losses for 2019 decreased 0.4 percentage points compared with the 62.1% accident year 2018 ratio measured as of December 31, 2018. Contributors to the decrease included less large losses incurred, described below, and the corresponding ratios for new losses above $1 million, with a 0.4 percentage-point decrease to the 2019 ratio. Other contributions included favorable effects from various initiatives, such as those to improve pricing precision and loss experience related to claims and loss control practices.
In 2019, total large losses incurred decreased by $23 million, or 8%, net of reinsurance. The corresponding ratio decreased 0.9 percentage points. The 2019 decreases on both a dollar and ratio basis were largely due to lower amounts for our commercial casualty line of business. In 2018, total large losses incurred and the corresponding ratio were higher than in 2017, largely due to higher amounts of large losses for our commercial casualty and commercial property lines of business. Our analysis indicated no unexpected concentration of these losses and reserve increases by geographic region, policy inception, agency or field marketing territory. We believe the inherent volatility of aggregate loss experience for our portfolio of larger policies is greater than that of our portfolio of smaller policies, and we continue to monitor the volatility in addition to general inflationary trends in loss costs.
Renewal and new business pricing for commercial risks continues to experience significant competitive pressure, reinforcing the need for enhanced pricing analytics and careful risk selection. Commentary regarding the commercial lines market within the property casualty insurance industry indicates commercial lines pricing in 2020 may be generally higher than in 2019. Despite challenging market conditions from strong competition, we believe we can manage our business and execute strategic initiatives to offset market pressures to some extent and profitably grow our commercial lines insurance segment.
We intend to keep marketing our products to a broad range of business classes with a package approach, while also continuing to improve our pricing precision and further segmenting among commercial lines policies. We intend to maintain our underwriting discipline and carefully manage our rate levels as well as our programs that seek to accurately match exposures with appropriate premiums. We will continue to evaluate each risk individually and to make decisions about rates, the use of three-year commercial policies and other policy conditions on a case-by-case basis, even in lines and classes of business that are under competitive pressure. For our commercial auto line of business, we will continue to improve premium rate classification and the use of other rating variables in risk selection and pricing. We believe that our initiatives to improve pricing precision and lower loss costs will continue to benefit commercial lines profitability during 2020, and that recent-year premium growth initiatives will continue to grow commercial lines premiums at a healthy pace.
Combined ratio - The 2019 combined ratio improved 2.1 percentage points, compared with 2018, despite a 0.5 percentage-point increase in the ratio for 2019 natural catastrophe losses. Development on prior accident years’ loss and loss expense reserves before catastrophes during 2019 was 2.7 percentage points more favorable than in 2018.
Our personal lines statutory combined ratio was 99.3% in 2019, compared with 101.2% in 2018 and 102.4% in 2017. The contribution of catastrophe losses to our personal lines statutory combined ratio was 9.9 percentage points in 2019, 9.4 percentage points in 2018 and 10.9 percentage points in 2017.
Personal lines insurance is a strategic component of our overall relationship with most of our agencies and is an important component of our agencies’ relationships with their clients. We believe agents recommend our personal insurance products to their clients who seek to balance quality and price and who are attracted by our superior claims service and the benefits of our package approach. We also believe our continuing efforts to improve pricing precision are helping us attract and retain more of our agencies’ preferred business, while also obtaining higher rates for more thinly priced business. Our progress toward broader geographic diversification is reflected in part through premium growth trends. Personal lines earned premiums in our five highest volume states increased in aggregate by 1% in 2019, while premiums for the remaining states, including our newer areas of operation, increased 9% in aggregate.
The 6% increase in agency renewal written premiums in 2019 reflected various rate changes. We estimate that premium rates for our personal auto line of business increased at average percentages in the high-single-digit range during 2019, with some individual policies experiencing lower or higher rate changes based on enhanced pricing precision enabled by predictive models that consider characteristics of specific risks. For our homeowner line of business, we estimate that rate increases during 2019 averaged in the mid-single-digit range, higher than in 2018. Similar to our personal auto line of business, that average varied widely by state, and some individual policies experienced lower or higher rate changes based on pricing precision and current rate level indications that helped determine appropriate premium rates.
In 2019, personal lines total large losses incurred increased by $8 million, or 19%, net of reinsurance. The ratio for 2019 large losses as a percent of earned premiums increased 0.3 percentage points. The 2019 increases on both a dollar and ratio basis were primarily due to higher amounts for our homeowner line of business. In 2018, total large losses decreased, compared with 2017, largely due to lower amounts for personal umbrella claims related to auto accidents. Our analysis indicated no unexpected concentration of these losses and reserve increases by risk category, geographic region, policy inception, agency or field marketing territory. We believe the inherent volatility of aggregate loss experience for our portfolio of larger policies is greater than that of our portfolio of smaller policies, and we continue to monitor the volatility in addition to general inflationary trends in loss costs.
Our high net worth initiative, along with various other actions to improve performance in our personal lines insurance segment, is discussed in greater detail in Personal Lines Insurance Results and also in Item 1, Our Business and Our Strategy, Strategic Initiatives and Our Segments, Personal Lines Insurance Segment.
Premiums - Earned premiums and net written premiums continued to grow during 2019, including an increase in new business written premiums and higher renewal written premiums that included average renewal estimated price increases in the low-single-digit range. New business written premiums grew 57% in 2019, reflecting opportunities to write larger policies and our additional marketing efforts.
Combined ratio - The combined ratio rose 8.0 percentage points in 2019, primarily due to less favorable reserve development on prior accident years.
The $17 million increase in 2019 renewal premiums reflected the opportunity to renew many policies for the first time as well as higher renewal pricing. Average renewal estimated price increases were in the low-single-digit range during 2019. We measure average changes in excess and surplus lines renewal pricing as the rate of change in renewal premium for the new policy period compared with the premium for the expiring policy period, assuming no change in the level of insured exposures or policy coverage between those periods for respective policies.
New business written premiums rose $40 million, primarily due to more opportunities in the marketplace to write policies with annual premiums of $10,000 or more, plus higher premium rates and our additional marketing efforts. Other written premiums in 2019 reduced net written premium growth by $3 million more than in 2018. Other written premiums are primarily premiums that are ceded to reinsurers and lower our net written premiums.
Loss and loss expenses include both net paid losses and reserve changes for unpaid losses, as well as the associated loss expenses. The majority of the total incurred losses and loss expenses shown above in the three-year highlights table are for the respective current accident years, with reserve development on prior accident years shown separately. Since less than 20% of our excess and surplus lines current accident year incurred losses and loss expenses represents net paid amounts, a large majority represents reserves for our estimate of unpaid losses and loss expenses. These reserves develop over time, and we update our estimates of previously reported reserves as we learn more about the development of the related claims. The table below illustrates that development. For example, the 55.0% accident year 2018 loss and loss expense ratio reported as of December 31, 2018, developed favorably by 2.6 percentage points to 52.4% due to claims settling for less than previously estimated, or due to updated reserve estimates for unpaid claims, as of December 31, 2019. Accident years 2018 and 2017 for this segment have both developed favorably, as indicated by the progression over time of the ratios in the table.
Catastrophe losses, as discussed in Consolidated Property Casualty Insurance Results, explain some of the movement among components of the current accident year loss and loss expense ratio for accident year 2019, compared with 2018. Catastrophe losses added 0.4 percentage points in 2019, 1.1 percentage points in 2018 and 1.1 percentage points in 2017 to the respective excess and surplus lines current accident year loss and loss expense ratios in the table above.
We believe the loss and loss expense reserves for our excess and surplus lines business are adequate. The amount of outstanding reserves for our excess and surplus lines operation can be seen in a table in Liquidity and Capital Resources, Property Casualty Loss and Loss Expense Obligations and Reserves. One indication of how long it takes for most of the outstanding reserves to be settled is to measure outstanding reserves by accident year at different points in time, using Item 8, Note 4 of the Consolidated Financial Statements. For example, for accident years 2013, 2012 and 2011, in aggregate, after subtracting cumulative paid amounts from incurred amounts at December 31, 2013, reserves for estimated unpaid losses, plus the portion of loss expenses known as ALAE, equaled $129 million. For those same accident years, at December 31, 2019, the reserve estimate for the remaining unpaid amount equaled $8 million. The inherent uncertainty in estimating reserves is discussed in Liquidity and Capital Resources, Property Casualty Insurance Loss and Loss Expense Obligations and Reserves. Development trends by accident year are further discussed in Property Casualty Insurance Development of Estimated Reserves by Accident Year.
In 2019, total large losses incurred of $9 million, net of reinsurance, more than doubled the amount in 2018. The ratio for 2019 large losses as a percent of earned premiums increased by 1.4 percentage points. That ratio for 2018 decreased by 0.2 points, compared with 2017. Our analysis indicated no unexpected concentration of these losses and reserve increases by risk category, geographic region, policy inception, agency or field marketing territory. We believe the inherent volatility of aggregate loss experience for our portfolio of larger policies is greater than that of our portfolio of smaller policies, and we continue to monitor the volatility in addition to general inflationary trends in loss costs.
Excess and surplus lines commission expense as a percent of earned premiums for 2019 decreased compared with 2018, largely due to a decrease in the ratio for profit-sharing commissions for agencies. The ratio for other underwriting expenses increased in 2019, primarily due to higher internal expense allocations that offset higher earned premiums and ongoing expense management efforts. In 2018, the ratio decreased, reflecting higher earned premiums and ongoing expense management efforts.
Industry reports suggest that there are opportunities for profitability and growth through greater use of technology. Technology and data are also being used by excess and surplus lines insurance companies to identify new exposures in emerging businesses that need insurance protection or other value-added services.
Revenues - Earned premiums rose 8% for the year 2019, as shown in the table below that includes details by major line of business. Our largest life insurance product line, term life insurance, rose 8%. Net in-force policy face amounts rose 6% to $69.984 billion at year-end 2019 from $66.142 billion at year-end 2018 and $61.177 billion at year-end 2017.
Profitability - The life insurance segment frequently reports only a small profit or loss because most of its investment income is included in the investments segment results. We include only investment income credited to contract holders (interest assumed in life insurance policy reserve calculations) in life insurance segment results. The segment reported a $1 million profit in 2019, following profit of $8 million in 2018 and a loss of $1 million in 2017. It has averaged an annual profit of $1 million over the past five years.
Earned premiums rose $20 million in 2019, primarily due to growth in our term life insurance business, as shown in the table below. Growth in 2018 was also primarily due to term life insurance.
Contract holders’ benefits incurred, related to traditional life and interest-sensitive products, accounted for 76.9% of 2019 total benefits and expenses compared with 78.1% in 2018 and 76.1% in 2017. Total contract holders’ benefits increased as net death claims were higher in 2019, compared with 2018. Net death claims increased in 2019 and were above our mortality projections while remaining within our range of pricing expectations.
We recognize that assets under management, capital appreciation and investment income are integral to evaluation of the success of the life insurance segment because of the long duration of life products. On a basis that includes investment income and investment gains or losses from life insurance-related invested assets, our life insurance subsidiary reported net income of $39 million in 2019, compared with net income of $48 million in 2018 and $155 million in 2017. Net income in 2017 included a nonrecurring item, a $111 million benefit from net deferred income tax liability revaluation due to U.S. tax reform. The life insurance subsidiary portfolio had after-tax net investment losses of $4 million in 2019 and $4 million in 2018 and an after-tax net investment gain of $4 million in 2017. Investment gains and losses are discussed under Investments Results. We exclude most of our life insurance company investment income from investments segment results.
The persistently low interest rate environment presents a challenge to all life companies. We are better positioned than most due to our focus on term insurance, a line that is not as sensitive to interest rates.
Regulatory action on best interest standards and genetic testing information could lead to a need to increase rates to cover additional expenses and potential anti-selection. We are keeping an eye on these and other matters but remain confident that the state-based regulatory system is preferable to federal oversight.
Investment income - Pretax investment income grew $27 million, or 4%, in 2019, primarily due to an increase from dividends. Dividend income reflected rising dividend rates and net purchases of equity securities from available funds. Interest income increased by $1 million in 2019, compared with 2018, as net purchases of fixed-maturity securities offset the continuing effects on bond yields of the low interest rate environment. Pretax investment income rose 2% in 2018, primarily due to an increase in dividend income. Average yields in the investment income table below are based on the average invested asset and cash amounts indicated in the table using fixed-maturity securities valued at amortized cost and all other securities at fair value.
Investment gains and losses - We reported an investment gain in 2019, primarily due to favorable changes in fair values of equity securities even though we continue to hold the securities or as otherwise required by GAAP. For 2018, we reported an investment loss, primarily due to unfavorable changes in fair values of equity securities we continued to hold. For 2017, we reported an investment gain largely due to investment sales that were discretionary in timing and amount. Those gains were reduced by other-than-temporary impairment (OTTI) charges.
Total investment return of 16.6% in 2019 was significantly more than in 2018. The 2019 contribution from the investment income component was enhanced by the net favorable effect of the investment gains and losses components. Comparing contributions for 2019 with 2018, investment income rose $27 million, investment gains increased by $2.052 billion and the invested assets net change in unrealized gains and losses increased by $883 million. The base component of the return calculation, annual average invested assets, was down 1% in 2019. For 2018 compared with 2017, total investment return decreased by 11.2 percentage points, reflecting net unfavorable effect of the investment gains and losses. The base component of the return calculation, annual average invested assets, increased 9% in 2018.
Dividend income rose $20 million, or 11%, in 2019, after rising 6% in 2018. Increases in dividend payment rates for most of the holdings in our common stock portfolio during both 2019 and 2018 drove the increases in dividend income. An increase in funds invested in that portfolio during both 2019 and 2018 also favorably affected dividend income.
Investment gains and losses are recognized on the sales of investments, for certain changes in fair values of securities even though we continue to hold the securities or as otherwise required by GAAP. New accounting requirements adopted in 2018 resulted in reporting, through net income, the change in fair value for equity securities still held, as disclosed in Note 1, Summary of Significant Accounting Policies. Total investment gains and losses included $1.626 billion of gains in 2019, from the recognition of fair value changes of equity securities still held that prior to 2018 would have been reported in other comprehensive income instead of net income. Change in unrealized gains or losses for fixed-maturity securities are included as a component of other comprehensive income (OCI). Accounting requirements for OTTI charges for the fixed-maturity portfolio are disclosed in Item 8, Note 1, Summary of Significant Accounting Policies. The factors we consider when evaluating impairments are also discussed in Critical Accounting Estimates, Asset Impairment.
The timing of gains or losses from sales can have a material effect on results in any given period. However, such gains or losses usually have little, if any, effect on total shareholders’ equity because most equity and fixed-maturity investments are carried at fair value.
As appropriate, we buy, hold or sell both fixed-maturity and equity securities on an ongoing basis to help achieve our portfolio objectives. We generally purchase fixed-maturity securities with the intention to hold until maturity. If they no longer meet our investment criteria, they are divested. Sales of fixed-maturity securities are usually due to a change in credit fundamentals. Pretax total investment gains in 2019 were largely due to favorable changes in fair values of equity securities even though we continue to hold the securities. In 2018, total investment losses reflected unfavorable changes in fair values of fixed-maturity and equity securities we continued to hold, and total gains in 2017 were largely due to rising fair values or sales of equity holdings. Additional information about investment gains or losses is included in Item 8, Note 2 of the Consolidated Financial Statements.
The table below summarizes total investment gains and losses, before taxes.
We continue to focus on portfolio strategies to balance near-term income generation and long-term book value growth. In 2020, we expect to continue to allocate a portion of cash available for investment to equity securities, taking into consideration corporate liquidity and income requirements, as well as insurance department regulations and rating agency comments. We discuss our portfolio strategies in Item 1, Our Segments, Investments Segment.
The change in our effective tax rate between periods were due to changes in our net investment gains and losses, changes in our underwriting income as well as changes in investment income. As a result of adoption of ASU 2016-01, effective January 1, 2018, the change in our 2018 effective tax rate was impacted due to large net unrealized losses included in 2018 income versus only net realized gains included in income for the prior-year periods. In addition, our change in the 2018 effective tax rate included a reduction by 19.9% as a result of Internal Revenue Service (IRS) approved changes to our tax accounting methods, primarily related to the valuation of our tax basis unpaid losses. The change in our 2017 effective tax rate is largely driven by the significant non-recurring income tax benefit recorded as a result of the enactment of the Tax Cuts and Jobs Act (Tax Act) on December 22, 2017. The effective tax rate for that year was reduced as a result of the revaluation of our net deferred tax liability to account for the decrease in the federal tax rate from 35% to 21%.
Historically, we have pursued a strategy of investing some portion of cash flow in tax-advantaged, fixed-maturity and equity securities to minimize our overall tax liability and maximize after-tax earnings. See Item 1, Our Segments, Fixed-Maturity Security Investments, for further discussion on municipal bond purchases in our fixed-maturity investment portfolio. For tax years 2017 and earlier, for our property casualty insurance subsidiaries, approximately 85% of interest from tax-advantaged fixed-maturity investments and approximately 60% of dividends from qualified equities were exempt from federal tax after applying proration from the 1986 Tax Reform Act. Our noninsurance companies own an immaterial amount of tax-advantaged, fixed-maturity investments. For our noninsurance companies, the dividend received deduction exempted 70% of dividends from qualified equities. Our life insurance company does not own tax-advantaged, fixed maturity investments or equities subject to the dividend received deduction.
The Tax Act, which took effect on January 1, 2018, lowered the U.S. corporate income tax rate from a top marginal rate of 35% to a flat rate of 21% and changed the amount of dividends received deduction and proration. For tax years after 2017, for our property casualty insurance subsidiaries, approximately 75% of interest from tax-advantaged, fixed-maturity investments and approximately 40% of dividends from qualified equities are exempt from federal tax after applying proration. For our noninsurance companies, the dividend received deduction exempts 50% of dividends from qualified equities.
The parent company’s primary sources of cash inflows are dividends from our lead insurance subsidiary, investment income and sale proceeds from investments. The parent company’s cash outflows are primarily interest and principal payments on long- and short-term debt, dividends to shareholders, common stock repurchases and general operating expenses. The table below shows a summary, by the direct cash flow method, of the major sources and uses of cash flow of the parent company.
Cash in excess of operating requirements is invested in fixed-maturity and equity securities. Cash generated from investment income provides an important investment contribution to cash flow and liquidity. The sale of investments could provide an additional source of liquidity at either the parent company or insurance subsidiary level, if required. In addition to possible sales of investments, proceeds of call or maturities of fixed-maturity securities also can provide liquidity. During the five-year period beginning in 2020, fair value of $3.761 billion, or 32.1%, of our fixed-maturity portfolio is scheduled to mature. At December 31, 2019, we had $7.518 billion of common stock securities, with $3.068 billion, or 40.8%, held by the parent company.
Financial resources of the parent company also could be made available to our insurance subsidiaries, if circumstances required it. This flexibility would include our ability to access the capital markets and short-term bank borrowings. We generally have minimized our reliance on debt financing, although we may use the line of credit to fund short-term cash needs.
The company’s senior debt is rated investment grade by four independent rating agencies. None of the rating agencies made changes to our debt ratings in 2019. On January 30, 2020, A.M. Best upgraded our debt rating from a- to a. At February 24, 2020, our debt ratings from the other rating agencies were: A- from Fitch, A3 from Moody’s and BBB+ from S&P.
At December 31, 2019, we had a $300 million line of credit with commercial banks, with $39 million borrowed. The amount borrowed was $32 million at December 31, 2018, and during 2019 we borrowed a net $7 million as part of routine cash management. That unsecured revolving line of credit has an accordion feature giving us the option to double the $300 million amount, under the same terms and conditions. Terms and conditions of the agreement include a debt-to-total capital maximum of 35% and the agreement has no net worth covenant. It was due to expire on February 4, 2024, with the option of two one-year extensions. On December 6, 2019, we exercised our option to extend the term of the line of credit one year to February 4, 2025.
restricted stock units of equity awards granted in the past. The amount of future repurchases may be more, or less, than the past, depending on circumstances and discretion exercised by management. Our corporate Code of Conduct restricts repurchases during certain time periods. The details of the repurchase authorizations and activity are described in Item 5, Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
At December 31, 2019, we estimated our future contractual obligations as follows:
Other operating expenses - Many of our operating expenses are not contractual obligations but reflect the ongoing expenses of our business.
Funds at Lloyd's - From time to time, we may be required to meet certain cash funding requirements on behalf of Cincinnati Global. During 2019, the parent company deposited $67 million with Lloyd's to meet these funding requirements.
At December 31, 2019, we had $767 million in cash and cash equivalents. During 2020, our lead insurance subsidiary may pay $562 million in dividends to our parent company without regulatory approval. That strong liquidity and our consistent cash flows give us the flexibility to meet current obligations and commitments while building value by prudently investing where we see potential for both current income and long-term return. Our cash and cash equivalents provide adequate financial cushion when short-term operating results do not meet our objectives.
In any year, we consider the most likely source of pressure on liquidity would be an unusually high level of catastrophe loss payments within a short period of time. There could be additional obligations for our insurance operations due to increasing severity or frequency of noncatastrophe claims. To address the risk of unusually large insurance loss obligations, including catastrophe events, we maintain property casualty reinsurance contracts with highly rated reinsurers, as discussed under 2020 Reinsurance Ceded Programs. We also monitor the financial condition of our reinsurers because their insolvency could jeopardize a portion of our $610 million reinsurance recoverable asset at December 31, 2019. Parent-company liquidity could also be constrained by Ohio regulatory requirements that restrict the dividends insurance subsidiaries can pay.
Economic weakness also has the potential to affect our liquidity and capital resources in a number of different ways, including delinquent payments from agencies, defaults on interest payments by fixed-maturity holdings in our portfolio, dividend reductions by holdings in our equity portfolio or declines in the market value of holdings in our portfolio.
While we believe that historical performance of property casualty and life loss payment patterns is a reasonable source for projecting future claim payments, there is inherent uncertainty in this estimate of contractual obligations. We believe that we could meet our obligations under a significant and unexpected change in the timing of these payments because of the liquidity of our invested assets, strong financial position and access to lines of credit.
The historical pattern of using premium receipts for the payment of loss and loss expenses has enabled us to extend slightly the maturities of our investment portfolio beyond the estimated settlement date of the loss reserves. The effective duration of our consolidated property casualty fixed-maturity portfolio was 4.8 years at year-end 2019. By contrast, the duration of our loss and loss expense reserves was approximately 3.5 years. We believe this difference in duration does not affect our ability to meet current obligations because cash flow from operations is sufficient to meet these obligations. In addition, investment holdings could be sold, if necessary, to meet higher than anticipated loss and loss expenses.
The ranges reflect our assessment of the most likely unpaid loss and loss expenses at year-end 2019 and 2018. However, actual unpaid loss and loss expenses could nonetheless fall outside of the indicated ranges.
Favorable reserve development was $78 million for our commercial casualty line of business and $77 million for our workers’ compensation line of business, together accounting for approximately 63% of the overall total. Drivers of significant reserve development typically reflect loss emergence on known claims that was more favorable or less favorable than previously anticipated for various lines of business and are discussed below.
Commercial casualty - During 2019 and 2018, we experienced favorable development on prior accident years after seeing adverse development in 2017 for this line of business. We continue to watch this line so we can detect unfavorable trends should they reoccur.
Workers’ compensation - We continue to see favorable reserve development, for all prior accident years in aggregate. During 2019 and 2018, the trend for estimated payments to be made in future calendar years was stable compared to 2017. However, we continue to monitor this line closely, as a sudden increase in trend for future payments has a highly leveraged effect.
Commercial auto - Loss emergence continued to develop unfavorably during parts of 2019. This line of business has been troublesome for the industry in recent years. As part of the U.S. economic recession of a few years ago, slowing business activity influenced our estimates of reserves for ultimate losses and loss expenses during that period. As the economy slowly recovered, we believe we were slow to recognize some of the higher loss cost effects in current accident year reserve estimates for at least part of that period. As claims that occurred during that period have become more mature, paid and reported loss cost trends resulted in us increasing our estimated ultimate losses. Initiatives to improve profitability of our commercial auto line of business are discussed in Commercial Lines Insurance Results.
For the excess and surplus lines insurance segment, the table showing reserves by segment and lines of business in Property Casualty Loss and Loss Expense Obligations and Reserves, shows the components of gross reserves among case, IBNR and loss expense reserves. Total gross reserves were up $53 million from year-end 2018 primarily due to the increase in premiums and exposures for this segment, as we discussed in Excess and Surplus Lines Insurance Results. Favorable development during 2019 of $11 million for excess and surplus lines insurance segment reserves, shown in the table above, illustrates the potential for revisions inherent in estimating reserves.
These estimated cash outflows are undiscounted with respect to interest. As a result, the sum of the cash outflows for all years of $5.426 billion (total of life insurance obligations) exceeds the liabilities recorded in life policy and investment contract reserves and separate accounts for future policy benefits and claims of $3.704 billion (total of life insurance policy reserves and separate account policy reserves). A significant portion of the difference can be attributed to the time value of money and changes in mortality, morbidity and lapse assumptions between the date the liabilities were originally established and the current date.
Gross life policy reserves were $2.835 billion at year-end 2019, compared with $2.779 billion at year-end 2018. The increase was primarily due to reserves for traditional life insurance contracts. We establish reserves for traditional life insurance policies based on expected expenses, mortality, morbidity, withdrawal rates and investment yields, including a provision for uncertainty. Once these assumptions are established, they generally are maintained throughout the lives of the contracts. We use both our own experience and industry experience adjusted for historical trends in arriving at our assumptions for expected mortality and morbidity. We use our own experience and historical trends for setting our assumptions for expected withdrawal rates and expenses. We base our assumptions for expected investment income on our own experience adjusted for current and future expected economic conditions.
A single large loss or an unexpected rise in claims severity or frequency due to a catastrophic event is a risk to the company's liquidity and financial strength. In an effort to control such losses, we limit marketing property casualty insurance in specific geographic areas and monitor our exposure in certain coastal regions. An example of this is the reduction in recent years of our homeowner policies in the southeastern U.S. coastal region. Loss exposures in that area had been identified as a major contributor to our catastrophe probable maximum loss estimates shown in the table below. Those estimates were subsequently reduced, in large part due to less exposure from southeastern U.S. homeowner policies. We also continually review aggregate exposures to huge disasters and purchase reinsurance protection to cover these exposures. For business other than Cincinnati Re and Cincinnati Global, we use the Risk Management Solutions (RMS) and Applied Insurance Research (AIR) models to evaluate exposures to a once-in-a-100-year and a once-in-a-250-year event to help determine appropriate reinsurance coverage programs. In conjunction with these activities, we also continue to evaluate information provided by our reinsurance broker. Examples include deterministic modeling of probable maximum loss contribution from growth in new geographic territories.
The modeled losses according to RMS in the table are based on its RiskLink version 18.1 catastrophe model and use a long-term storm catalog methodology. The modeled losses according to AIR in the table are based on its AIR Touchstone® version 6.0 catastrophe model and use a long-term methodology. The AIR and RMS storm catalogs include decades of documented weather events used in simulations for probable maximum loss projections.
Casualty per occurrence treaty - The casualty treaty provides capacity up to $25 million. Similar to the property treaty, it provides sufficient capacity to cover the vast majority of casualty accounts we insure and also includes protection for extra-contractual liability coverage losses. We retain the first $10 million of each loss. Losses between $10 million and $25 million are reinsured at 100%. The 2020 ceded premium estimate was $12 million, essentially unchanged from the 2019 estimate.
After reinsurance, our maximum exposure to a catastrophic event that causes $800 million in covered losses in 2020 would be $249 million, compared with our retention of $125 million for 2019 for a $600 million event. The largest catastrophe loss event in our history occurred during 2011 from a May 20-27 storm system that included a tornado in Joplin, Missouri, and that also included significant losses from hail in the Dayton, Ohio, area. Our losses from that storm were estimated to be $226 million before reinsurance, based on updated estimates as of December 31, 2017.
A form of reinsurance is also provided through The Terrorism Risk Insurance Act of 2002 (TRIA). TRIA was originally signed into law on November 26, 2002, and extended on several occasions, including the most recent extension on December 20, 2019. TRIA provides a temporary federal backstop for losses related to the writing of the terrorism peril in property casualty insurance policies. Under regulations promulgated under this statute, insurers are required to offer terrorism coverage for certain lines of property casualty insurance, including property, commercial multi-peril, fire, ocean marine, inland marine, liability, aircraft and workers’ compensation. In the event of a terrorism event defined by TRIA, the federal government would reimburse terrorism claim payments subject to the insurer’s deductible. The deductible is calculated as a percentage of subject written premiums for the preceding calendar year. Our deductible in 2019 was $551 million (20% of 2018 subject premiums), and we estimate it is $580 million (20% of 2019 subject premiums) for 2020.
Property catastrophe treaty - As a subsidiary of The Cincinnati Insurance Company, Cincinnati Specialty Underwriters is a named insured under our corporate property catastrophe treaty. All terms and conditions of this reinsurance coverage apply to policies underwritten by Cincinnati Specialty Underwriters.
Inadequate estimates, assumptions or reliance on third-party data used for critical accounting estimates
Inability of our subsidiaries to pay dividends consistent with current or past levels
Inability or unwillingness to nimbly develop and introduce coverage product updates and innovations that our competitors offer and consumers expect to find in the marketplace
We have prepared the consolidated financial statements of Cincinnati Financial Corporation and our subsidiaries for the year ended December 31, 2019, in accordance with accounting principles generally accepted in the United States of America (GAAP).
Deloitte & Touche LLP, our independent registered public accounting firm, audited the consolidated financial statements of Cincinnati Financial Corporation and subsidiaries for the year ended December 31, 2019. Deloitte & Touche LLP met with our audit committee to discuss the results of its examination. They have the opportunity to discuss the adequacy of internal controls and the quality of financial reporting without management present.
The company’s management assessed the effectiveness of the company’s internal control over financial reporting as of December 31, 2019, as required by Section 404 of the Sarbanes Oxley Act of 2002. Management’s assessment was based on the criteria established in the Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and was designed to provide reasonable assurance that the company maintained effective internal control over financial reporting as of December 31, 2019. The assessment led management to conclude that, as of December 31, 2019, the company’s internal control over financial reporting was effective based on those criteria.
In accordance with guidance issued by the Securities and Exchange Commission, the company may exclude acquisitions from management's assessment of the effectiveness of internal control over financial reporting for the first year in which the acquisition occurred. The company's management has excluded the assessment of internal controls of MSP Underwriting Limited, rebranded as Cincinnati Global Underwriting Ltd., which was acquired on February 28, 2019, and further discussed in Note 20, Acquisition in the Notes to the Consolidated Financial Statements. At December 31, 2019, Cincinnati Global Underwriting Ltd. accounted for approximately 2% of both consolidated assets and consolidated revenue.
We have audited the accompanying consolidated balance sheets of Cincinnati Financial Corporation and subsidiaries (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2019, and the related notes and the schedules listed in the Index at Item 15(c) (collectively referred to as the “financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
As discussed in Note 1 to the financial statements, effective January 1, 2018, the Company adopted Accounting Standards Update No. 2016-01, Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Liabilities, using the modified retrospective approach.
We tested the underlying data that served as the basis for the actuarial analysis, including historical claims data, to test the reasonableness of key inputs to the actuarial estimate.
Our portfolio investments are primarily in publicly traded fixed-maturity and equity security investments. Fixed-maturity investments (taxable bonds, tax-exempt bonds, redeemable preferred equities and commercial mortgage- backed securities) classified as available for sale and equity investments (common and nonredeemable preferred equities) are recorded at fair value in the consolidated financial statements. Beginning January 1, 2018, changes in fair value of equity securities are now reported in net income instead of other comprehensive income as stated below under ‘Adopted Accounting Updates’. The number of fixed-maturity securities with fair value below 100% of amortized cost can be expected to fluctuate as interest rates rise or fall. Because of our strong capital and long-term investment horizon, our general intent is to hold fixed-maturity investments until maturity, regardless of short-term fluctuations in fair values.
Impairment charges for fixed maturities are recorded for other-than-temporary declines in value if fair value is below amortized cost and, in the asset impairment committee’s judgment, the fair value is not expected to be recouped within a designated recovery period. Our invested asset impairment policy also states that fixed maturities with fair value below their amortized cost that the company (1) intends to sell or (2) more likely than not will be required to sell before recovery of their amortized cost basis are deemed to be other-than-temporarily impaired (OTTI). The amortized cost of any such securities is reduced to fair value as the new cost basis, and a realized loss is recorded in the period in which it is recognized. When these two criteria are not met, and the company believes that full collection of interest and/or principal is not likely, we determine the net present value of future cash flows by using the effective interest rate implicit in the security at the date of acquisition as the discount rate and compare that amount with the amortized cost and fair value of the security. The difference between the net present value of the expected future cash flows and amortized cost of the security is considered a credit loss and recognized as a
realized loss in the period in which it occurred. The difference between the fair value and the net present value of the cash flows of the security, the noncredit loss, is recognized in other comprehensive income as an unrealized loss. We had no fixed-maturity securities with a noncredit loss for the years ended 2019, 2018 and 2017.
Investment income, net of expenses, consists mainly of interest and dividends. We record interest on an accrual basis and record dividends at the ex-dividend date. We amortize premiums and discounts on fixed-maturity securities using the effective interest method over the expected life of the security.
Fair value is defined as the exit price or the amount that would be (1) received to sell an asset or (2) paid to transfer a liability in an orderly transaction between marketplace participants at the measurement date. When determining an exit price, we rely upon observable market data whenever possible. We primarily base fair value for investments in equity and fixed-maturity securities (including redeemable preferred stock and assets held in separate accounts) on quoted market prices or on prices from the company’s nationally recognized pricing vendor, an outside resource that supplies global securities pricing, dividend, corporate action and descriptive information to support fund pricing, securities operations, research and portfolio management. The company obtains and reviews the pricing service’s valuation methodologies and related inputs and validates these prices by replicating a sample across each asset class using a discounted cash flow model. When a price is not available from these sources, as in the case of securities that are not publicly traded, we determine the fair value using various inputs including quotes from independent brokers. The fair value of investments not priced by the company’s nationally recognized pricing vendor is immaterial.
Property casualty written premiums are deferred and recorded as earned premiums primarily on a pro rata basis over the terms of the policies. We record as unearned premiums the portion of written premiums that applies to unexpired policy terms. Expenses associated with successfully acquiring insurance policies - commissions, premium taxes and underwriting costs - are deferred and amortized over the terms of the policies. We assess recoverability of deferred acquisition costs at a level consistent with the way we acquire, service and manage insurance policies and measure profitability. We analyze our acquisition cost assumptions to reflect actual experience, and we evaluate potential premium deficiencies.
We establish a liability for traditional long-duration contracts as we receive premiums. The amount of this liability is the present value of future expenses and benefits less the present value of future net premiums. Net premium is the portion of gross premium required to provide for all expenses and benefits. We estimate future expenses and benefits and net premium using assumptions for expected expenses, mortality, morbidity, withdrawal rates and investment income. We include a provision for deviation, meaning we allow for some uncertainty in making our assumptions. We establish our assumptions when the contract is issued, and we generally maintain those assumptions for the life of the contract. We use both our own experience and industry experience, adjusted for historical trends, in arriving at our assumptions for expected mortality, morbidity and withdrawal rates. We use our own experience and historical trends for setting our assumption for expected expenses. We base our assumption for expected investment income on our own experience, adjusted for current and future economic conditions.
We carry the assets of separate account BOLIs at fair value. The liabilities on separate account BOLIs primarily are the contract holders’ claims to the related assets and are carried at an amount equal to the contract holders’ account value. At December 31, 2019, the current fair value of the BOLI invested assets and cash exceeded the current fair value of the contract holders’ account value by approximately $52 million. At December 31, 2018, the current fair value of the contract holders' account value exceeded the current fair value of the BOLI invested assets and cash by approximately $3 million. If the BOLI projected fair value were to fall below the value we guaranteed, a liability would be established with a corresponding charge to the company’s earnings.
Written premium is recorded, net of contract specific retrocessions, on an ultimate estimate basis and primarily earned on a pro rata basis over the coverage period of the treaty. Expenses are recorded as per contract terms and deferred over the earning period of the premium.
We recognize goodwill and intangible assets generated through acquisitions within other assets in the consolidated balance sheets. Goodwill arises when the fair value of consideration transferred exceeds the fair value of the net identifiable assets acquired at the acquisition date. Goodwill and intangible assets with an indefinite life are not amortized. Intangible assets with a definite life are amortized on a straight-line basis over the estimated useful lives as follows: broker relationships, 15 years; internally developed technology, five years; value of business acquired, over the remaining coverage period of the underlying insurance contracts. We test for impairments on an annual basis or more frequently if events or circumstances indicate that the asset might be impaired. The company performed its annual impairment test on goodwill and intangibles on September 30, which did not result in the recognition of an impairment loss.
In January 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-01, Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 revised the accounting related to the classification and measurement of investments in equity securities and the presentation of certain fair value changes for financial liabilities measured at fair value. The company adopted this ASU on January 1, 2018, and applied it on a modified retrospective basis without prior period amounts restated. As a result of the adoption, $2.503 billion of after-tax unrealized gains on equity securities was reclassified on January 1, 2018, from accumulated other comprehensive income to retained earnings. Results of operations were impacted as changes in fair value of equity securities are now reported in net income instead of reported in other comprehensive income. As a result of the adoption of this ASU, for the year ended December 31, 2018, the net investment loss of $402 million in the consolidated statements of income included a decrease of $404 million from the fair value change of equity securities.
In March 2017, the FASB issued ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. ASU 2017-08 amends guidance on the amortization period of premiums on certain purchased callable debt securities. The amendments shorten the amortization period of premiums on certain purchased callable debt securities to the earliest call date. The amendments should be applied on a modified retrospective basis through a cumulative-effect adjustment to beginning retained earnings. The company adopted this ASU effective January 1, 2019, and it did not have a material impact on our company's consolidated financial position, cash flows or results of operations.
At December 31, 2019 and 2018, the company had fixed-maturity investments with a fair value of $117 million and $112 million, respectively, on deposit with various states in compliance with regulatory requirements. In addition, cash and fixed-maturity investments deposited with third parties used as collateral to secure liabilities on behalf of insureds, cedants and other creditors had a fair value of $95 million and $75 million at December 31, 2019 and 2018, respectively.
At December 31, 2019, Apple, Inc. (Nasdaq:AAPL), an equity holding, was our largest single investment holding with a fair value of $414 million, which was 5.5% of our publicly traded common equities portfolio and 2.1% of the total investment portfolio.
The following table provides investment income and investment gains and losses:
For the years ended December 31, 2019, 2018 and 2017, there were no credit losses on fixed-maturity securities for which a portion of OTTI has been recognized in other comprehensive income.
During 2017, we other-than-temporarily impaired six securities. At December 31, 2017, 249 fixed-maturity investments with a total unrealized loss of $18 million had been in an unrealized loss position for 12 months or more. Of that total, no fixed-maturity investments had fair values below 70% of amortized cost. There were no equity security investments in an unrealized loss position for 12 months or more as of December 31, 2017.
The fair value hierarchy gives the highest priority to quoted prices with readily available independent data in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable market inputs (Level 3). When various inputs for measurement fall within different levels of the fair value hierarchy, the lowest observable input that has a significant impact on fair value measurement is used. Our valuation techniques have not changed from those used at December 31, 2018, and ultimately management determines fair value. Financial instruments reported at fair value in our consolidated financial statements are categorized based upon the following characteristics or inputs to the valuation techniques:
The technique used for the Level 2 fixed-maturity securities and taxable fixed maturities in separate accounts is the application of market based modeling. The inputs used for all classes of fixed-maturity securities listed in the table below include relevant market information by asset class, trade activity of like securities, marketplace quotes, benchmark yields, spreads off benchmark yields, interest rates, U.S. Treasury or swap curves, yield to maturity and economic events. Specific to commercial mortgage-backed securities, key inputs also include prepayment and default projections based on past performance of the underlying collateral and current market data. All of the Level 2 fixed-maturity securities are priced by a nationally recognized pricing vendor.
Outstanding principal and interest for these life policy loans totaled $32 million and $33 million at December 31, 2019 and 2018, respectively. To determine the fair value, we make the following significant assumptions: (1) the discount rates used to calculate the present value of expected payments are the risk-free spot rates, as nonperformance risk is minimal; and (2) the loan repayment rate by which policyholders pay off their loan balances is in line with past experience.
We use actuarial methods, models, assumptions and judgment to estimate, as of a financial statement date, the property casualty loss and loss expense reserves required to pay for and settle all outstanding insured claims, including incurred but not reported (IBNR) claims, as of that date. The actuarial estimate is subject to review and adjustment by an inter-departmental committee that includes actuarial, claims, underwriting, loss prevention and finance management. This committee is familiar with relevant company and industry business, claims and underwriting trends, as well as general economic and legal trends that could affect future loss and loss expense payments. The amount we will actually have to pay for claims can be highly uncertain. This uncertainty, together with the size of our reserves, makes the loss and loss expense reserves our most significant estimate.
The following table provides a reconciliation of the property casualty incurred losses and allocated loss adjustment expenses (ALAE) development and paid losses and ALAE development information at December 31, 2019.
The following table shows the average annual percentage payout of incurred losses for the commercial casualty line of business:
The following table shows the workers’ compensation incurred and paid losses and ALAE development by accident year. The table also shows the IBNR reserves plus expected development on reported losses and claim frequency:
The following table shows the average annual percentage payout of incurred losses for the workers’ compensation line of business:
The following table shows the average annual percentage payout of incurred losses for the commercial property line of business:
The following table shows the personal auto incurred and paid losses and ALAE development by accident year. The table also shows the IBNR reserves plus expected development on reported losses and claim frequency:
We have one line of credit through multiple commercial banks that was due to expire May 13, 2019. Effective February 4, 2019, we extended our unsecured revolving credit facility for five years, amending the expiration to February 4, 2024, with the option of two one-year extensions. The borrowing capacity was increased to $300 million from $225 million with an additional $300 million accordion feature. Terms and conditions are similar to the former agreement except the net worth covenant has been eliminated and the debt-to-total capital maximum shall not exceed 35%. On December 6, 2019, we exercised our option to extend the term of the line of credit one year to February 4, 2025. We had no compensating balance requirements on short-term debt for either 2019 or 2018. At December 31, 2019 and 2018, $39 million and $32 million was drawn on the line of credit, respectively. The interest rate charged on our borrowings on this credit agreement ranged from 2.59% to 3.41% during 2019 and ranged from 2.45% to 4.75% during 2018. In addition, we have letters of credit related to our Cincinnati Re and Cincinnati Global operations with no amounts drawn at December 31, 2019 and 2018.
The finance lease term for equipment and autos is 3 to 6 years while the operating lease term for real estate properties is typically 5 years. Lease obligations totaled $57 million and $46 million in 2019 and 2018, respectively. Included in the consolidated balance sheet lease obligations is a net $1 million for interest and remaining lease residual values for finance leases we expect to pay. Below are the expected lease obligations we expect to pay through years 2025 and thereafter:
The following table provides lease cost and other information for the year ended December 31, 2019:
As of December 31, 2019 and 2018, we had a gross unrecognized tax benefit of $34 million. We carried no amounts for unrecognized tax benefits for the year ended December 31, 2017. The following is a tabular reconciliation of the total amounts of unrecognized tax benefits.
The statute of limitations for federal tax purposes has closed for tax years ended December 31, 2015 and earlier. In 2019, the IRS began its examination of the tax year ended December 31, 2017. At this time, no adjustments have been proposed. In addition to our IRS filings, we file income tax returns with immaterial amounts in various state jurisdictions. The statute of limitations for state income tax purposes has closed for tax years ended December 31, 2015 and earlier.
Cincinnati Global operates in the United Kingdom and as such, is subject to tax in that jurisdiction. The statute of limitation for tax return review by Her Majesty’s Revenue and Customs (HMRC) has closed for tax years ended December 31, 2017 and earlier. There are currently no tax returns under review by HMRC.
As more fully discussed in Note 1, Accounting Policies and Note 20, Acquisition, we closed on the acquisition of Cincinnati Global during the first quarter of 2019. As a result of this acquisition, $59 million of net deferred tax assets were acquired or established at the acquisition date with an offsetting valuation allowance of $55 million.
The following is a tabular reconciliation of the total amounts of our Cincinnati Global valuation allowance.
As of December 31, 2019, Cincinnati Global had operating loss carryforwards of $147 million in the United Kingdom. These Cincinnati Global losses can only be utilized within the Cincinnati Global group in the United Kingdom and cannot offset the income of our CFC group domestic operations in the United States.
The sources of dilution of our common shares are certain equity-based awards as discussed in Note 17, Share-Based Associate Compensation Plans. The above table includes the number of anti-dilutive share-based awards at year-end 2019, 2018 and 2017. We did not include these share-based awards in the computation of net income per common share (diluted) because their exercise would have anti-dilutive effects.
We maintain a supplemental executive retirement plan (SERP) with a benefit obligation of $11 million at
The discount rate was increased by 0.61 percentage points for the qualified pension plan and 0.64 percentage points for the SERP due to market interest rate conditions at the beginning of 2019. The discount rate assumptions for our benefit obligation generally track with high-quality rated corporate bond yields chosen in our theoretical settlement portfolio, and yearly adjustments reflect any changes to those bond yields. We believe the expected return on plan assets is representative of the expected long-term rate of return on these assets, which is consistent with 2019 expectations of interest rates and based partially on the fact that the plan’s common stock holdings pay dividends. We review historical actual return on plan assets when determining our expected long-term rate of return. Total portfolio return for 2019 was 24.5% and for 2018 was negative 1.7%. Our compensation increase assumptions in 2019 reflect anticipated rates of inflation, real return on wage growth and merit and promotional increases.
Our funded status improved for 2019 primarily due to higher returns on plan assets partially offset by actuarial losses from decreases in discount rates and assumed lump sum rates.
The 2019 amount recognized in net periodic benefit cost and other comprehensive income improved from 2018 largely due to changes in the actuarial gain resulting from increases in discount and assumed lump sum rates. The estimated costs to be amortized from AOCI into net periodic benefit cost over the next year for our plans are $3 million in actuarial loss and less than $1 million in prior service cost.
Service costs and non-service costs (benefit) are allocated in the same proportion primarily to underwriting, acquisition and insurance expenses line item with the remainder allocated to the insurance losses and contract holders' benefits line item on the consolidated statements of income for 2019, 2018 and 2017.
The pension plan assets are managed to maximize total return over the long term while providing sufficient liquidity and current return to satisfy the cash flow requirements of the plan. The plan’s day-to-day investment decisions are managed by our internal investment department; however, overall investment strategies are discussed with our employee benefits committee. Our investment strategy is to weight our portfolio towards large-cap, high-quality, dividend-growing equities that we have historically favored. As our plan matures and interest rates normalize, we expect a greater allocation to fixed-income securities to better align asset and liability market risks. Our fixed-maturity bond portfolio is investment grade. The plan does not engage in derivative transactions.
Excluding cash, during 2019 we held approximately 77% of our pension portfolio in domestic common equity investments. The remainder of the portfolio consisted of 8% in states, municipalities and taxable political subdivisions fixed-maturity investments, 8% in domestic corporate fixed-maturity investments and 7% in United States government fixed maturity investments. Our common equity portfolio consisted of 23% in the financial sector, 21% in the information technology sector, 13% in the healthcare sector, 13% in the industrial sector, and 11% in the consumer discretionary industrial sector at year-end 2019. No additional sectors accounted for 10% or more of our common equity portfolio balance at year-end 2019.
We estimate $9 million of benefit payments from the SERP during 2020. We expect to make the following benefit payments for our qualified plan and SERP, reflecting expected future service:
$8 million in 2019, $7 million in 2018 and $7 million in 2017, on premium volume of $48 million, $45 million and $45 million for 2019, 2018 and 2017, respectively.
December 31, 2019, 2018 and 2017, respectively. The related income tax benefit recognized was $6 million,
$9 million, $5 million and $7 million, respectively, from associates in consideration for option exercises during 2019, 2018 and 2017. The weighted-average remaining contractual life for options expected to vest as of December 31, 2019, was 8.48 years.
Service-based restricted stock units granted to associates are valued at fair value of the shares on the date of grant less the present value of the dividends that holders of restricted stock units do not receive on the shares underlying the restricted stock units during the vesting period. Service-based restricted stock units generally cliff vest three years after the date of grant. We also grant restricted stock units which vest on a three year ratable vesting schedule. Service-based restricted stock units vested during the year had an intrinsic value of $25 million, $24 million and $23 million for the years ended December 31, 2019, 2018 and 2017, respectively.
For the three-year performance period ended December 31, 2019, our total shareholder return exceeded five of our nine peers. We expect payout of these shares at the target level to occur in March of 2020. During 2019, we issued 20,549 shares of performance-based restricted stock units at the threshold-level performance hurdle for the three-year performance period ended December 31, 2018, as our total shareholder return exceeded four of nine peers in our 2016 peer group. We issued 80,666 shares of performance-based restricted stock units during 2018 at the target-level performance hurdle for the three-year performance period ended December 31, 2017, as our total shareholder return exceeded five of nine peers in our 2015 peer group. Performance-based awards vested during the year had an intrinsic value of $2 million, $6 million and $7 million for the years ended December 31, 2019, 2018 and 2017, respectively.
The following assumptions were used in determining fair value for performance-based grants issued:
We report as Other the noninvestment operations of the parent company and its noninsurer subsidiary, CFC Investment Company. We also report as Other the underwriting results of Cincinnati Re, our reinsurance assumed operation, and Cincinnati Global, our London-based global specialty underwriter, which was acquired on February 28, 2019.
Our investments’ revenues consist of pretax net investment income and investment gains and losses.
Other revenues are primarily finance income and earned premiums of Cincinnati Re and Cincinnati Global.
Loss before income taxes for the Other category is primarily due to interest expense from debt of the parent company, operating expenses of our headquarters and premiums earned minus loss and loss expenses and underwriting expenses of Cincinnati Re and Cincinnati Global.
This table includes unaudited quarterly financial information for the years ended December 31, 2019 and 2018:
As aggregate consideration for the purchase of the share capital of Cincinnati Global and its subsidiaries, the company paid £48 million, or $64 million, in cash to Munich Re at the closing of the acquisition. The amount paid at closing was calculated as the difference between the target net asset value (NAV) set forth in the SPA and the estimated NAV of Cincinnati Global and its subsidiaries at the closing date. On August 1, 2019, the company and Munich Re agreed to an adjusted purchase price of £47 million, or $63 million, reflecting a £1 million decrease in the NAV of Cincinnati Global. This agreement represented the final purchase price with no further adjustments to the assets acquired and liabilities assumed.
The fair value of the assets acquired, liabilities assumed and the allocation of the final purchase price on the acquisition date have been summarized in the following table: