We evaluate the performance of our insurance segments using industry financial measurements determined under SAP and certain measures determined under GAAP. We evaluate our investment operations segment based on investment returns of assets managed. Financial information about our segments for 2014 is set forth in this Item 7 and in Note 15 to our consolidated financial statements included in Item 8 of this Form 10-K.
Our 2014 business insurance net written premiums increased 3.8% when compared to 2013 as a result of focusing our underwriting efforts on larger risks with higher average premiums. This segment’s 2014 net loss and ALAE and expense ratios remained the same when compared to 2013. Business insurance underwriting results for the first half of 2014 were impacted by a combination of harsh weather and an increased frequency in large fire losses, primarily related to our Business Owner’s Policy ("BOP") product. In response, we identified several classes of business and larger premium accounts that disproportionately impacted our underwriting performance, stopped writing certain classes of business, and reduced the marketing of our BOP product to accounts with premium greater than $25,000.
We have experienced steady premium growth and solid underwriting performance in our specialty insurance segment, excluding the impact of the terminated RED program business. Our E&S property and E&S casualty units have both produced strong and consistent underwriting performance. Our E&S property unit has benefited from disciplined underwriting and fewer than normal catastrophe events, particularly in Florida where the majority of this business is written. Our E&S casualty unit benefited from organic growth as a result of the additions of underwriters in more geographic locations and the 2014 acquisition of Partners General Insurance Agency, a managing general underwriter, by our parent State Auto Mutual. This acquisition should continue to provide growth opportunities in 2015.
Going forward, we believe that our Program business should generate improved underwriting results given our small-to-medium account and association business focus in select states, strong underwriting and claim controls, and rigorous pricing discipline.
At the end of 2014, we completed a new sourcing arrangement with a third party that assumed responsibility for maintaining all legacy system applications. This arrangement will allow our IT associates to focus on higher priority strategic initiatives to replace all of our legacy policy administration and billing systems with a new Guidewire platform. The initiatives will take several years to complete and will begin in 2015 with the development and installation of new agent portals designed to improve customer service, enhance productivity and should improve the efficiency with which we quote, bind, issue and service our policies.
The following table sets forth the participants and their participation percentages in the Pooling Arrangement. Except as otherwise noted, there were no changes to the participants or to their participation percentages during 2014.
The following table sets forth certain key performance indicators we use to monitor our operations for the years ended December 31, 2014, 2013 and 2012:
Earned premiums in 2014 were $1,074.1 million compared to $1,055.0 million and $1,042.1 million in 2013 and 2012, respectively. Earned premium growth in 2014 was driven by higher average new business premium, increased renewal pricing, and the addition of new distribution relationships.
One of the more significant differences between GAAP and SAP is that SAP requires all underwriting expenses to be expensed immediately and not deferred over the same period that the premium is earned. In converting SAP underwriting results to GAAP underwriting results, acquisition costs are deferred and amortized over the periods the related written premiums are earned. For a discussion of deferred acquisition costs, see “Critical Accounting Policies-Deferred Acquisition Costs” section included in this Item 7.
The accounting for pension benefits also contributes to the difference between our GAAP loss and expense ratios and our SAP loss and expense ratios. At January 1, 2013, we adopted new SAP pension guidance, which required the recognition of service costs for non-vested participants. In accordance with GAAP, service costs related to non-vested participants were recognized over a two year vesting period ending December 31, 2014. See “Critical Accounting Policies - Pension and Postretirement Benefit Obligations section included in this Item 7.
In the following discussion of the results of our insurance segments, we sometimes refer to GAAP financial measures in the context of “as reported” and to non-GAAP financial measures in the context of “pro forma.” These pro forma, or non-GAAP financial measures, may (i) exclude the impact of the HO QS Arrangement cession for the years ended December 31, 2014, 2013 and 2012, (ii) exclude the one-time impact of the unearned premium transfer associated with the termination of the HO QS Arrangement at December 31, 2014, (iii) exclude the impact of the unearned premium transfer associated with the termination of the umbrella quota share reinsurance agreement for the year ended December 31, 2012, and (iv) exclude the impact of the terminated RED program business, which is in run-off. We believe the use of these non-GAAP financial measures will enable investors to (a) better understand the impact of the reinsurance arrangement cession on our reported results for the years ended December 31, 2014, 2013 and 2012, and (b) perform a meaningful comparison of our results of operations for the years ended December 31, 2014, 2013 and 2012. We have also included Reconciliation Tables 1-9 and Tables 1-6 for readers to better understand the use and calculation of these non-GAAP financial measures.
To reduce risk and volatility, while at the same time providing us with additional catastrophe reinsurance protection, the State Auto Group entered into a quota share reinsurance agreement on December 31, 2011 with a syndicate of unaffiliated reinsurers covering its homeowners line of business (the “HO QS Arrangement”). Under the HO QS Arrangement, the State Auto Group ceded to the reinsurers 75% of its homeowners business under policies in force at December 31, 2011 and new and renewal policies thereafter issued during the term of the agreement. The HO QS Arrangement expired on December 31, 2014. Upon expiration, the Company recognized $89.5 million of unearned premium returned from the reinsurers. In accordance with the terms of the HO QS Arrangement, the participating reinsurers’ margin was capped at 9.0%, with any excess returned to the State Auto Group in the form of a profit commission. For the year ended December 31, 2014, the Company recognized $19.0 million of profit commission, which is reflected as a reduction in acquisition and operating expenses on our consolidated statements of income.
The following tables set forth, on a GAAP and pro forma basis, certain of our key performance indicators before and after the impact of the HO QS Arrangement cession for the years ended December 31, 2014, 2013 and 2012.
See additional pro forma reconciliation tables for the HO QS Arrangement cession on our homeowners line of business at Reconciliation Tables 7-9.
The following table sets forth the net written premiums by major product line of business for our personal insurance segment for the years ended December 31, 2014, 2013 and 2012.
The personal insurance segment's net written premiums increased 14.3% compared to the same 2013 period (Table 1). Net written premiums for the year ended December 31, 2014 reflect the expiration of the HO QS Arrangement, effective December 31, 2014, which resulted in a return of $89.5 million of unearned premium previously ceded under the agreement. Excluding the impact of the homeowners cession and the expiration of the HO QS Arrangement, pro forma net written premiums decreased 4.2%(1) , primarily due to a decline in the personal auto net written premiums of 6.0% compared to the same 2013 period (Table 1). The decline in personal auto net written premiums was primarily the result of continued efforts to improve personal auto profitability, as well as the continued remediation of our homeowners line of business that included, among other things, pricing and agency management actions.
For the years ended December 31, 2014 and 2013, respectively, the following table sets forth the reconciliation of as reported net written premiums to pro forma net written premiums that exclude the impact of the return of unearned premium associated with the termination of the HO QS Arrangement:
CustomFitSM homeowners: Since 2011, we have rolled out CustomFit, our by-peril rating approach, in all states except North Carolina (which has regulatory restrictions).
Wind and hail deductibles: We continue to analyze each state's wind and hail deductible, and all peril deductibles, at each annual rate review, making adjustments where necessary. We have implemented mandatory wind and hail deductibles in all targeted catastrophe prone states.
These actions have led to a reduction in companion automobile policies as a high percentage of our auto and homeowners policies are cross-sold. In an effort to attract new personal auto business, we introduced a new "Start-up Discount" in 2014 that recognizes longevity with the insured's previous carrier. The Start-up Discount was introduced in 18 states as of December 31, 2014, and we plan to introduce it in the remaining states by the end of 2015.
The personal insurance segment’s SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2014 was 57.8%, compared to 61.6% and 58.9% for the same 2013 and 2012 periods (Table 2). The 2014 improvement was primarily driven by the personal auto SAP non-catastrophe loss & ALAE ratio decline of 3.8 points compared to the same 2013 period (Table 2), as a result of improved personal injury protection and physical damage results, as well as the impact of prior year rate increases. In addition, our pricing and agency management actions in Arizona, Colorado, Georgia, Illinois and Michigan have reversed the unfavorable loss ratio trends in those states. Our remediation efforts in these five states will continue in 2015.
The following tables set forth, on a SAP and pro forma basis, certain of our key performance indicators for the homeowners line of business before and after the impact of the HO QS Arrangement cession for the year ended December 31, 2014 and 2013 and 2012:
The business insurance segment’s 2013 SAP non-catastrophe loss and ALAE ratio improved by 0.7 points when compared to the same 2012 period (Table 4). This improvement was primarily driven by prior period rate increases taken on all lines of business in this segment. The commercial auto and other & product liability SAP non-catastrophe loss and ALAE ratios improved 6.2 points and 4.5 points, respectively, when compared to the same 2012 period (Table 4), primarily as the result of an increase in earned premiums and greater favorable development of prior accident year losses. The improvement was partially offset by an increase in the fire & allied SAP non-catastrophe loss and ALAE ratio of 6.5 points, compared to the same 2012 period (Table 4) primarily driven by an increase in the severity of losses.
Effective January 1, 2013, the units within the specialty insurance segment changed from the three units of RED, Rockhill and Workers’ compensation to the four units of E&S property, E&S casualty, Programs (which includes the former RED unit) and Workers’ compensation. Previously reported financial information has been revised to reflect the effect of the change in units.
The following table sets forth the net written premiums by unit for our specialty insurance segment for the years ended December 31, 2014, 2013 and 2012.
The following table sets forth the SAP loss and LAE ratios for our specialty insurance segment with the catastrophe and non-catastrophe impact shown separately for the years ended December 31, 2014, 2013 and 2012:
The specialty insurance segment’s SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2014 was 86.9%, compared to 66.2% and 81.8%, respectively, for the same 2013 and 2012 periods (Table 6). The SAP non-catastrophe loss and ALAE ratio increase was primarily driven by reserve strengthening for terminated RED program business which is in run-off. Beginning in the third quarter 2013, we increased our involvement in managing litigated and higher severity RED program claim files. During the third quarter 2014, we assumed full file management of claim files for certain terminated RED programs from the third party administrators that had been managing the claims and performed a detailed, ground up analysis of those files, which we completed in the fourth quarter 2014. For the year ended December 31, 2014, RED reserves were strengthened by $96.7 million, which included the net cost of the ADC reinsurance agreement, compared to reserve strengthening in 2013 and 2012 of $21.3 million and $30.5 million, respectively.
In addition to the 2014 reserve strengthening, the State Auto Group entered into an ADC reinsurance agreement as of December 31, 2014, that provides $40.0 million of coverage for adverse development in excess of carried reserves for the terminated RED restaurant program, which represented approximately 59.0% of carried RED reserves at December 31, 2014. Partially offsetting the impact of the RED reserve strengthening were improvements in the SAP non-catastrophe loss and ALAE ratios for the E&S property and E&S casualty units for the year ended December 31, 2014.
Our GAAP expense ratio was 33.7% in 2014 compared to 33.6% and 33.2% in 2013 and 2012, respectively.
Losses and loss expenses for a calendar year represent the combined estimated ultimate liability for claims occurring in the current calendar year along with any change in estimated ultimate liability for claims occurring in prior years. The following table sets forth the provision for losses and loss expenses for those claims occurring in the current and prior years, along with the GAAP loss and LAE ratio for the years ended December 31, 2014, 2013 and 2012:
In the personal and business insurance segments, the non-catastrophe loss and ALAE reserves contributed $23.1 million of favorable development. The business insurance segment contributed $16.7 million of this favorable development, driven by other & product liability and commercial auto, which developed favorably by $11.9 million and $5.3 million, respectively. The favorable development in these lines was driven by lower than anticipated severity from accident years 2012 and prior. The personal insurance segment contributed $6.4 million of this favorable development, primarily from accident year 2013.
In the specialty insurance segment, the non-catastrophe loss and ALAE reserves accounted for $85.9 million of adverse development related primarily to accident years 2011 and 2012, which was driven by RED reserve strengthening. Adverse development of prior accident year RED reserves was $96.7 million. Somewhat offsetting the unfavorable development of RED reserves was favorable development of $5.7 million in the Workers' compensation unit, $3.9 million in the E&S property unit and $2.1 million in the E&S casualty unit. Favorable development in these lines was driven by better than anticipated severity emerging primarily from the 2012 and 2013 accident years.
We experienced favorable catastrophe loss development of $5.4 million in 2013 related to catastrophe losses primarily from accident year 2012.
The favorable development in 2012 resulted primarily from accident years 2011 and 2010. The more notable items contributing to the 2012 favorable development were:
In the personal and business insurance segments, the non-catastrophe loss and ALAE reserves contributed $28.0 million of favorable development related to the prior three accident years, primarily in the personal auto liability, other & product liability, and fire & allied lines with $10.5 million, $9.4 million and $5.1 million of the favorable development, respectively. The favorable development in these lines was driven by emergence of lower than anticipated claim severity.
The following table sets forth loss and loss expenses payable by major line of business at December 31, 2014 and 2013:
obligations of the U.S. government or government agencies, for which there is no limit. Our fixed maturity portfolio is composed of high quality, investment grade issues, comprised mostly of debt issues rated A or higher. We obtain investment ratings from Moody’s, Standard & Poor’s and Fitch. If there is a split rating, we assign the lowest rating obtained. At December 31, 2014, there were no fixed maturity investments rated below investment grade in our available-for-sale investment portfolio.
The following table sets forth the amortized cost and fair value of available-for-sale fixed maturities by contractual maturity at December 31, 2014:
At December 31, 2014, our equity portfolio consisted of approximately 32 different large-cap stocks and 72 small-cap stocks. The largest single fund holding was 16.3% of the equity portfolio based on fair value and the top ten positions accounted for 50.1% of the equity portfolio. At December 31, 2013, our equity portfolio consisted of approximately 40 different large-cap stocks and 76 small-cap stocks. The largest single fund holding was 9.2% of the equity portfolio based on fair value, and the top ten positions accounted for 33.7% of the equity portfolio. Since our equity portfolio consists primarily of large-cap value-oriented stocks, with a smaller allocation to small-cap equities, when large-cap stocks and/or value-oriented stocks perform well our equity portfolio typically performs well compared to benchmarks. Conversely, when growth stocks outperform value and/or small- to mid-cap stocks outperform large-cap stocks, our equity portfolio does not perform as well compared to benchmarks.
ensure adequate cash flow to meet claims as they are presented. We also manage liquidity risk by maintaining sufficient cash balances, owning some agency and U.S. Treasury securities at all times, purchasing bonds of major issuers, and purchasing bonds that are part of a medium or large issue. The fixed maturity portfolio does not have any direct exposure to either exchange rate risk or commodity risk. We do not rely on the use of derivative financial instruments. We categorize our fixed maturities as available-for-sale in order to provide us greater flexibility in managing our portfolio. We do not maintain a trading portfolio.
The following table sets forth the composition of the insurers providing Credit Enhancements, along with the corresponding underlying credit rating of the issuer of the security, at December 31, 2014:
Generally, we reinvest the proceeds from the call, maturity, or sale of securities within our Muni Portfolio, into both tax exempt and taxable fixed income securities with lower rates of return.
At December 31, 2014, we have two international funds, Fund 1 and Fund 2, which are included in other invested assets available-for-sale. Fund 1 and Fund 2 had betas of 0.69 and 0.84 respectively, using the MSCI EAFE Index as a benchmark. The following tables set forth what changes might occur in the values of Funds 1 and 2 given a change in the MSCI EAFE Index at December 31, 2014:
Our investment operations revenue for the year ended December 31, 2014 was primarily impacted by the following factors.
Interest earned on our fixed maturity securities in 2014 increased slightly compared to 2013, primarily due to an increase of $0.9 million in Treasury Inflation-Protected Securities ("TIPS") interest income. Because TIPS are dependent on changes in the Consumer Price Index, they are directly impacted by the change in the rate of inflation (as inflation declines TIPS income decreases and vice versa). Income earned on our TIPS securities in 2013 decreased by $2.7 million when compared to 2012.
When a fixed maturity security has been determined to have an other-than-temporary decline in fair value, the impairment charge is separated into an amount representing the credit loss, which is recognized in earnings, and the amount related to non-credit factors, which is recognized in accumulated other comprehensive income. See “Critical Accounting Policies - Investments” included in this Item 7 for OTTI impairment indicators. Future increases or decreases in fair value, if not other-than-temporary, are included in accumulated other comprehensive income (loss). We did not recognize any impairments on our fixed maturity portfolio during 2014 or 2013, but we recognized OTTI on our fixed maturity portfolio during 2012 of $0.2 million.
The following table sets forth our unrealized holding gains by investment type, net of deferred tax that was included as a component of accumulated comprehensive income at December 31, 2014 and 2013, and the change in unrealized holding gains, net of deferred tax, for the year ended December 31, 2014:
As of December 31, 2014, Level 3 assets as a percentage of total assets were 0.3%, which we have determined to be insignificant.
For the year ended December 31, 2014, the federal income tax benefit was $80.6 million compared to federal income tax expense of $0.5 million for 2013 and a federal income tax benefit of $0.1 million for 2012. The income tax benefit was primarily due to $82.6 million of deferred tax benefit resulting from the reversal of the valuation allowance against net deferred tax assets at December 31, 2014.
See “Critical Accounting Policies - Income Taxes” included in this Item 7. See Note 8, “Federal Income Taxes” to our consolidated financial statements included in Item 8 of this Form 10-K for a reconciliation between our actual federal income tax (benefit) expense and the amount computed at the indicated statutory rate for the years ended December 31, 2014, 2013 and 2012.
Liquidity refers to our ability to generate adequate amounts of cash to meet our short and long-term needs. Our primary sources of cash are premiums, investment income, investment sales and the maturity of fixed income security investments. The significant outflows of cash are payments of claims, commissions, premium taxes, operating expenses, income taxes, dividends, interest and principal payments on debt and investment purchases. The cash outflows may vary due to uncertainties regarding settlement of large losses or catastrophe events. As a result, we continually monitor our investment and reinsurance programs to ensure they are appropriately structured to enable the insurance subsidiaries to meet anticipated short and long-term cash requirements without the need to sell investments to meet fluctuations in claim payments.
We maintain a portion of our investment portfolio in relatively short-term and highly liquid investments to ensure the immediate availability of funds to pay claims and expenses. At December 31, 2014 and 2013, we had $86.3 million and $80.3 million, respectively, in cash and cash equivalents, and $2,282.6 million and $2,176.3 million, respectively, of total available-for-sale investments. Included in our fixed maturities available-for-sale were $8.8 million and $8.7 million of securities on deposit with insurance regulators, as required by law, at December 31, 2014 and 2013, respectively. In addition, substantially all of our
Net cash provided by operating activities was $75.6 million and $72.1 million in 2014 and 2013, respectively, compared to net cash used in operating activities of $285.6 million in 2012. Net cash from operations will vary from period to period if there are significant changes in underwriting results, primarily a combination of the level of premiums written and loss and loss expenses paid, changes in cash flows from investment income or federal income tax activity. The change from 2014 and 2013 compared to 2012 was primarily due to our settlement payment of $261.4 million related to the December 31, 2011 change to the Pooling Arrangement in which, among other things, the overall participation percentage of the STFC Pooled Companies was reduced from 80% to 65% (the "12.31.11 pool change") and our payment of $75.5 million related to our share of the State Auto Group’s initial net unearned premium transfer under the HO QS Arrangement, both of which occurred in 2012.
Net cash used in investing was $56.5 million and $23.0 million in 2014 and 2013, respectively, compared to net cash provided by investing activities of $9.3 million for 2012. The following factors significantly contributed to the fluctuations between those years:
The change in 2013 was primarily attributable to less sales proceeds of available for sale securities when compared to 2012, as well as, a lower level of call activity in 2013 compared to the same 2012 period.
In 2012, we continued to raise funds to complete the settlement of amounts owed in connection with the 12.31.11 pool change and the HO QS Arrangement.
On July 11, 2013, State Auto P&C obtained a loan (the “FHLB Loan”) from the Federal Home Loan Bank of Cincinnati (the “FHLB”). State Auto P&C became a member of the FHLB during the first quarter of 2013. The FHLB Loan is a 20-year term loan, callable after three years with no prepayment penalty thereafter, in the principal amount of $85.0 million. The FHLB Loan provides for interest-only payments during its term, with principal due in full at maturity. The interest rate is fixed over the term of the loan at 5.03%. The FHLB Loan is fully secured by a pledge of specific investment securities of State Auto P&C. Proceeds from the FHLB Loan, along with cash on hand, were used by State Auto Financial to redeem all of its outstanding Senior Notes.
State Auto Financial’s Delaware business trust subsidiary (the “Capital Trust”) has outstanding $15.0 million liquidation amount of capital securities, due 2033. In connection with the Capital Trust’s issuance of the capital securities and the related purchase by State Auto Financial of all of the Capital Trust’s common securities (liquidation amount of $0.5 million), State Auto Financial has issued to the Capital Trust $15.5 million aggregate principal amount of unsecured Floating Rate Junior Subordinated Debt Securities due 2033 (the “Subordinated Debentures”). The sole assets of the Capital Trust are the Subordinated Debentures and any interest accrued thereon. Interest on the Capital Trust’s capital and common securities is payable quarterly at a rate equal to the three-month LIBOR rate plus 4.20%, adjusted quarterly. The applicable interest rates for December 31, 2014 and 2013 were 4.44%, respectively.
Related to our notes payable, our primary market risk exposure is to the change in interest rates and our credit rating. For a discussion regarding our credit ratings see “Credit and Financial Strength Ratings” included in this Item 7. Based upon the notes payable carrying value at December 31, 2014, we had $15.5 million notes payable with variable interest and $85.3 million notes payable with interest fixed at 5.03%, which equated to approximately 15.2% variable interest debt and 84.8% fixed interest debt. Our decision to obtain fixed versus variable interest rate debt is influenced primarily by the following factors: (a) current market interest rates; (b) anticipated future market interest rates; (c) availability of fixed versus variable interest instruments; and (d) our currently existing notes payable fixed and variable interest rate position. See our contractual obligations table included in “Contractual Obligations” included in this Item 7.
Members of the State Auto Group follow the customary industry practice of reinsuring a portion of their exposures and paying to the reinsurers a portion of the premiums received. Insurance is ceded principally to reduce net liability on individual risks or for individual loss occurrences, including catastrophic losses. Although reinsurance does not legally discharge the individual members of the State Auto Group from primary liability for the full amount of limits applicable under their policies, it does make the assuming reinsurer liable to the extent of the reinsurance ceded.
On December 31, 2011, the State Auto Group entered into the HO QS Arrangement, which was a three-year quota share reinsurance agreement covering our homeowners line of business. Under the HO QS Arrangement, the State Auto Group ceded to reinsurers 75% of its homeowners business under policies in force at the effective date and new and renewal policies thereafter issued during the term of the agreement. The HO QS Arrangement expired December 31, 2014 and was replaced with a one-year property aggregate excess catastrophe reinsurance agreement, effective January 1, 2015. See the "Property Catastrophe" discussion below for further information.
Each member of the State Auto Group is party to working reinsurance treaties for casualty, workers’ compensation and property lines with several reinsurers arranged through reinsurance intermediaries. These agreements are described in more detail below. We have also secured other reinsurance to limit the net cost of large loss events for certain types of coverage. The State Auto Group also makes use of facultative reinsurance for unique risk situations. The State Auto Group also participates in state insurance pools and associations. In general, these pools and associations are state sponsored and/or operated, impose mandatory participation by insurers doing business in that state, and offer coverage for hard-to-place risks at premium rates established by the state sponsor or operator, thereby transferring risk of loss to the participating insurers in exchange for premiums which may not be commensurate with the risk assumed.
As of December 31, 2014, the State Auto Group entered into an ADC reinsurance agreement that provides $40.0 million of coverage for adverse development in excess of carried reserves for the terminated RED restaurant program.
Members of the State Auto Group maintain a property catastrophe excess of loss reinsurance agreement, covering property catastrophe related events affecting at least two risks. As of June 1, 2014, this property catastrophe reinsurance agreement was revised to increase the treaty limit. Under this agreement, the State Auto Group retains the first $55.0 million of catastrophe loss, each occurrence, with a 5.0% co-participation on the next $285.0 million (previously $265.0 million) of covered loss, each
As of January 1, 2015, the State Auto Group entered into a one-year property aggregate excess catastrophe reinsurance agreement with a syndicate of reinsurers covering property business underwritten by its personal insurance and business insurance segments, including automobile physical damage. This agreement provides reinsurance coverage of $75.0 million during 2015 for ISO PCS numbered catastrophes and certain other weather-related events after the retention of $165.0 million of losses by the State Auto Group. Individual occurrences are not subject to an occurrence deductible, but are subject to a maximum amount of $55.0 million consistent with the State Auto Group’s retention under its existing property catastrophe excess of loss reinsurance agreement. The agreement excludes property risks underwritten by the specialty insurance segment.
Also, certain unusual claim situations involving bodily injury liability, property damage, uninsured motorist and personal injury protection are covered by an arrangement that provides for $30.0 million of coverage in excess of $10.0 million retention for each loss occurrence. This reinsurance sits above the $8.0 million excess of $2.0 million arrangement. The rates for this reinsurance are negotiated annually. Policies underwritten by the E&S casualty and Programs units are not subject to this casualty excess of loss reinsurance agreement.
In addition to the workers’ compensation reinsurance described above, each company in the State Auto Group is party to a workers’ compensation catastrophe reinsurance agreement that provides additional reinsurance coverage for workers’ compensation losses involving multiple workers. Subject to $10.0 million of retention, reinsurers are responsible for 100.0% of the excess over $10.0 million up to $30.0 million of covered loss. For loss amounts over $30.0 million, the casualty excess of loss reinsurance agreement provides $20.0 million coverage in excess of $30.0 million. Workers’ compensation catastrophe coverage is subject to a “Maximum Any One Life” limitation of $10.0 million. This limitation means that losses associated with each worker may contribute no more than $10.0 million to covered loss under these agreements. The rates for the workers’ compensation catastrophe reinsurance agreement are negotiated annually.
For E&S casualty and Programs units risks, the State Auto Group has a combined casualty treaty whereby under Section A, we retain the first $1.0 million of covered loss and the reinsurers are responsible for 90.0% (previously 87.0%) of loss in excess of $1.0 million up to $10.0 million for all primary business and excess business written directly above a primary policy, at policy limits above $1.0 million. Under Section B, as respects excess policies over another carrier's primary policy, we have a $10.0 million proportional agreement where we retain $1.0 million of each risk and the reinsurers are responsible for 90.0% (previously 87.0%) of loss for each risk based on the percentage the $1.0 million we retain bears to the total policy limit. Under Section C, as respects policies at $1.0 million or less, we retain the first $1.25 million of Extra Contractual Obligations/Excess of Policy Limits ("ECO/XPL") and LAE coverage for policies with limits of $1.0 million or less, and the reinsurers are responsible for 100.0% of ECO/XPL and LAE coverage in excess of $1.3 million up to $4.0 million.
State Auto P&C, Milbank and SA Ohio are subject to regulations and restrictions under which payment of dividends from statutory surplus can be made to State Auto Financial during the year without prior approval of regulatory authorities. Under the insurance regulations of Iowa and Ohio (the states of domicile), the maximum amount of dividends that the Company may pay out of earned surplus to shareholders within a twelve month period without prior approval of the Department is limited to the greater of 10% of the most recent year-end policyholders' surplus or net income for the twelve month period ending the 31st day of December of the previous year-end. Pursuant to these rules, $77.8 million is available for payment to State Auto Financial from its insurance subsidiaries in 2015 without prior approval. State Auto Financial received dividends from its insurance subsidiaries in the amount of $20.0 million, $10.0 million and $20.0 million in 2014, 2013 and 2012, respectively.
The following table sets forth our credit and insurance company financial strength ratings as of February 27, 2015:
We regularly monitor our investment portfolio for declines in value that are other-than-temporarily impaired (“OTTI”), an assessment that requires significant management judgment regarding the evidence known. Such judgments could change in the future as more information becomes known which could negatively impact the amounts reported herein. We consider the following factors when assessing our equity securities and other invested assets for OTTI: (i) the length of time and/or the significance of decline below cost; (ii) our ability and intent to hold these securities through their recovery periods; (iii) the current financial condition of the issuer and its future business prospects; and (iv) the ability of the market value to recover to cost in the near term. We recognize OTTI charges on our externally managed small-cap equity portfolio and a segment of our large-cap portfolio, as we are unable to make the assertion regarding our intent to hold these securities that are currently valued below cost until recovery in the near term. When an equity security or other invested asset has been determined to have a decline in fair value that is other-than-temporary, we adjust the cost basis of the security to fair value. This results in a charge to earnings as a realized loss, which is not reversed for subsequent recoveries in fair value. Future increases or decreases in fair value, if not other-than-temporary, are included in other comprehensive income (loss).
Reserve ranges provide a quantification of the variability in the loss reserve projections. The primary determinant in estimating the loss reserve range boundaries are the variances measured within the historical reserving data for the various lines of business. MBE of loss reserves considers the expected variation to establish an appropriate position within a range. At December 31, 2014, MBE loss and ALAE reserves for the STFC Pooled Companies’ share of the Pooled Companies’ reserves were $950.5 million, within an estimated range of $817.0 million to $984.1 million (dollar amounts presented are on a direct basis, gross of salvage and subrogation recoverable, and before reinsurance, except for the STFC Pooled Companies’ participation in the inter-company Pooling Arrangement; therefore, these values cannot be compared to other loss and loss expenses payable tables included elsewhere within this Form 10-K).
An important assumption underlying the loss reserve estimation methods for casualty lines is that the loss cost trends implicitly built into the loss and ALAE patterns will continue into the future. To estimate the sensitivity of reserves to an unexpected change in inflation, projected calendar year payment patterns were applied to the December 31, 2014, other & product liability loss and ALAE reserve to generate estimated annual incremental loss and ALAE payments for each subsequent calendar year. Then, for purposes of sensitivity testing, an additional annual loss cost trend of 10% was added to the trend implicitly embedded in the estimated payment pattern, and revised incremental loss and ALAE payments were calculated. This type of inflationary increase could arise from a variety of sources including tort law changes, development of new medical procedures, social inflation, and other inflationary changes in costs beyond assumed levels.
The estimated cumulative impact that this additional, unexpected 10% increase in the loss cost trend would have on our results of operations over the lifetime of the underlying claims in other & product liability is an increase of $71.8 million on reserves, or a $46.7 million reduction to net income, assuming a tax rate of 35%. Inflation changes have much more impact on the longer tail commercial lines like other & product liability and workers’ compensation, and much less impact on the shorter tail personal lines’ reserves.
The following tables set forth the loss and loss expenses payable by major line of business at December 31, 2014 and 2013:
To calculate the State Auto Group’s December 31, 2014 benefit obligation for each of the benefit plans, we used a discount rate of 3.85% based on an evaluation of the expected future benefit cash flows of our benefit plans used in conjunction with the Citigroup Pension Discount Curve at the measurement date. A lower discount rate results in, all else being equal, a higher present value of the benefit obligation. To calculate our benefit obligation at December 31, 2014 and net periodic benefit cost for the year ended December 31, 2015, a discount rate of 3.85% and an expected long-term rate of return on plan assets of 7.00% were used. We selected an expected long-term rate of return on our plan assets by considering the mix of investments and stability of investment portfolio along with actual investment experience during the lifetime of the plans. Our assumptions regarding the discount rate and expected return on plan assets could have a significant effect on the amounts related to our benefit obligations and net periodic benefit cost depending on the degree of change between reporting periods.
As a result of adopting the revised mortality assumptions and the change in the discount rate, the benefit plan's liabilities increased by $52.6 million for the year ended December 31, 2014.
The following table sets forth an illustration of variability with respect to the discount rate on our share of the State Auto Group’s December 31, 2014 benefit obligation and expected net periodic benefit cost for the year ending December 31, 2015, along with the variability of the expected return on plan assets to our expected net periodic benefit cost for the year ending December 31, 2015. Holding all other assumptions constant, sensitivity to changes in any one of our key assumptions are as follows:
In accordance with the Financial Accounting Standards Board’s Accounting Standards Codification 740, Income Taxes (ASC 740), we periodically evaluate our deferred tax assets, which requires significant judgment, to determine if they are realizable based upon weighing all available evidence, both positive and negative, including our historical and anticipated future taxable income. In making such judgments, significant weight is given to evidence that can be objectively verified.
At December 31, 2014, consistent with the above process, we evaluated the need for a valuation allowance against our net deferred tax assets and determined that it was more likely than not that our deferred tax asset would be realized. As a result, in accordance with the guidance in ASC 740, we reversed our deferred tax asset valuation allowance and recognized an $82.6 million federal income tax benefit in the fourth quarter of 2014.
Management anticipates generating taxable income over the next three years that will allow for the realization of all of our net operating loss ("NOL") carryforwards prior to the end of 2017. The NOL carryforwards do not begin to expire until 2030 and will not fully expire until 2032.
Based on ASC 740 intraperiod tax allocation guidelines, the following sets forth the change in valuation allowance attributable to continuing operations and other comprehensive income for the years ended December 31, 2014 and 2013:
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of State Auto Financial Corporation and subsidiaries at December 31, 2014 and 2013, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), State Auto Financial Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework (2013 framework) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 3, 2015 expressed an unqualified opinion thereon.
We have audited State Auto Financial Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). State Auto Financial Corporation’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
The consolidated financial statements also include the operations and financial position of 518 Property Management and Leasing, LLC (“518 PML”), an Ohio limited liability company whose only members are State Auto P&C and Stateco. Farmers Casualty Insurance Company ("Farmers"), a former wholly owned subsidiary of State Auto Financial, was merged with State Auto P&C at the close of business on December 31, 2012.
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of losses and loss expenses payable and the realization of deferred tax assets. In connection with the determination of losses and loss expenses payable, management uses historical data, current business conditions and assumptions about future conditions to formulate estimates of the ultimate cost to settle claims. Deferred tax assets are evaluated periodically by management to determine if they are realizable, requiring management to make certain judgments and assumptions. In evaluating the ability to recover deferred tax assets, management considers all available evidence, including loss carryback potential, past operating results, existence of cumulative losses in the most recent years, projected performance of the business, future taxable income, including the ability to generate capital gains, and prudent and feasible tax planning strategies. If, based on available information, it is more likely than not that the deferred income tax assets will not be realized, then a valuation allowance must be established with a corresponding charge to net income and/or other comprehensive income (loss). These estimates by their nature are subject to uncertainties for various reasons.
The Company views gross unrealized losses on fixed maturities and equity securities as being temporary since it is its assessment that these securities will recover in the near term, allowing the Company to realize the anticipated long-term economic value. The Company regularly monitors its investments that have fair values less than cost or amortized cost for signs of other-than-temporary impairment, an assessment that requires significant management judgment regarding the evidence known. Such judgments could change in the future as more information becomes known, which could negatively impact the amounts reported. Among the factors that management considers for fixed maturity securities are the financial condition of the issuer, including receipt of scheduled principal and interest cash flows, and intent to sell, including if it is more likely than not that the Company will be required to sell the investments before recovery. When a fixed maturity security has been determined to have an other-than-temporary impairment, the impairment charge is separated into an amount representing the credit loss, which is recognized in earnings as a realized loss and the amount related to non-credit factors, which is recognized in other comprehensive income. Future increases or decreases in fair value, if not other-than-temporary, are included in other comprehensive income.
The Company recognizes deferred income tax assets and liabilities for the expected future tax effects attributable to temporary differences between the financial statement and tax return bases of assets and liabilities, based on enacted tax rates and other provisions of the tax law. The effect of a change in tax laws or rates on deferred tax assets and liabilities is recognized in income in the period in which such change is enacted. Deferred tax assets and liabilities include provisions for unrealized investment gains and losses as well as the net funded status of pension and other postretirement benefit obligations with the changes for each period included in the respective components of other comprehensive income. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that all or some portion of the deferred tax assets will not be realized.
Comprehensive income is defined as all changes in an enterprise’s equity during a period other than those resulting from investments by owners and distributions to owners. Comprehensive income includes net income and other comprehensive income. Other comprehensive income includes all other non-owner related changes to equity and includes net unrealized gains and losses on available-for-sale investments, derivative instruments and unrecognized benefit plan obligations, adjusted for deferred federal income taxes.
The following tables set forth the cost or amortized cost and fair value of available-for-sale securities by lot at December 31, 2014 and 2013:
The following table sets forth the realized and unrealized holding gains (losses) on the Company’s investment portfolio for the years ended December 31, 2014, 2013 and 2012:
There was a deferred federal income tax liability on the net unrealized holding gains at December 31, 2014 of $55.3 million and a deferred federal income tax liability, net of a valuation allowance, on the net unrealized holding gains at December 31, 2013 of $41.6 million.
The fair value estimate of the Company’s fixed maturity investments are determined by evaluations that are based on observable market information rather than market quotes. Inputs to the evaluations include, but are not limited to, market prices from recently completed transactions and transactions of comparable securities, interest rate yield curves, credit spreads, and other market-observable information. The fixed maturity portfolio pricing obtained from the pricing service is reviewed for reasonableness. Regularly, samples of security prices are referred back to the pricing service for more detailed explanation as to how the pricing service arrived at that particular price. The explanations are reviewed for reasonableness by the portfolio manager or investment officer. Additionally, the prices and assumptions are verified against an alternative pricing source for reasonableness and accuracy. Any discrepancies with the pricing are returned to the pricing service for further explanation and if necessary, adjustments are made. To date, the Company has not identified any significant discrepancies in the pricing provided by its third party pricing service. Investments valued using these inputs include U.S. treasury securities and obligations of U.S. government agencies, obligations of states and political subdivisions, corporate securities (except for two securities discussed below), and U.S. government agencies residential mortgage-backed securities. All unadjusted estimates of fair value for fixed maturities priced by the pricing service are included in the amounts disclosed in Level 2 of the hierarchy. If market inputs are unavailable, then no fair value is provided by the pricing service. For these securities, fair value is determined either by requesting brokers who are knowledgeable about these securities to provide a quote; or the Company internally determines the fair values by employing widely accepted pricing valuation models, and depending on the level of observable market inputs, renders the fair value estimate as Level 2 or Level 3. The Company holds two fixed maturity corporate securities included in Level 3. The Company estimates the fair value of one security using the present value of the future cash flows and the Company obtains a broker quote of the other security’s fair value. Due to the limited amount of observable market information for both of these securities, the Company includes the fair value estimates in Level 3.
Favorable development of unallocated loss adjustment expenses contributed approximately $8.0 million of the 2013 development, while $5.4 million was attributable to favorable development on catastrophe reserves, which is lower than 2012, but, in line with the Company's historical favorable development. The personal and business insurance segments non-catastrophe loss and ALAE reserves accounted for $18.3 million of favorable development driven by the other & product liability, commercial auto and homeowners lines with $8.3 million, $8.0 million and $2.9 million of favorable development, respectively. The favorable development in these lines was driven by the emergence of lower than anticipated claim severity. Somewhat offsetting the favorable development was adverse development in the personal auto line, specifically the no-fault coverage. The specialty insurance segment non-catastrophe loss and ALAE reserves accounted for $10.5 million of adverse development, driven by RED reserve strengthening of $21.3 million related to a large restaurant program and a commercial auto trucking program. Somewhat offsetting the unfavorable development was favorable development of workers' compensation reserves of $12.3 million driven by better than anticipated severity emerging across all accident years, with approximately one third coming from accident year 2012.
loss and ALAE reserves accounted for $27.8 million of adverse development related to the latest two accident years, which was driven by RED reserve strengthening.
The following table sets forth the effect of the Company’s external reinsurance on its income statements for the years ended December 31, 2014, 2013 and 2012, prior to the reinsurance transaction with State Auto Mutual under the Pooling Arrangement, as discussed in Note 6a:
The following table sets forth the reinsurance transactions on the Company’s balance sheets for the Pooling Arrangement between the STFC Pooled Companies and State Auto Mutual at December 31, 2014 and 2013:
The following table sets forth the reinsurance transactions on the Company’s income statements for the Pooling Arrangement between the STFC Pooled Companies and State Auto Mutual for the years ended December 31, 2014, 2013 and 2012:
Pursuant to the Pooling Arrangement, State Auto Mutual receives all premiums and pays all losses and expenses associated with the insurance business produced by the pool participants and then settles the intercompany balances generated by these transactions with the participating companies on a quarterly basis within 60 days following each quarter end. No interest is paid on this balance. When settling the intercompany balances, State Auto Mutual provides the pool participants with full credit for the premiums written and net losses paid during the quarter and retains all receivable amounts from insureds and agents and reinsurance recoverable on paid losses from unaffiliated reinsurers. Any receivable amounts that are ultimately deemed to be uncollectible are charged-off by State Auto Mutual and allocated to the pool members on the basis of pool participation. As a result, the Company has an off-balance sheet credit risk related to the balances due to State Auto Mutual from insurers, agents and reinsurers, which are offset by the unearned premium from the respective policies. The Company’s share of the premium balances due to State Auto Mutual from agents and insureds at December 31, 2014 and 2013 is approximately $297.0 million and $295.5 million, respectively.
In May 2003, State Auto Financial formed a Delaware business trust (the “Capital Trust”) to issue $15.0 million of mandatorily redeemable preferred capital securities to a third party and $0.5 million of common securities to State Auto Financial (the capital and common securities are collectively referred to as the “Trust Securities”). The Capital Trust loaned $15.5 million, the proceeds from the issuance of its Trust Securities, to State Auto Financial in the form of Floating Rate Junior Subordinated Debt Securities due in 2033 (the “Subordinated Debentures”). The Subordinated Debentures and interest accrued thereon are the Capital Trust’s only assets. Interest on the Trust Securities is payable quarterly at a rate equal to the three-month LIBOR rate plus 4.20% adjusted quarterly (total 4.44% at December 31, 2014). Because the interest rate and interest payment dates on the Subordinated Debentures are the same as the interest rate and interest payment dates on the Trust Securities, payments from the Subordinated Debentures finance the distributions paid on the Trust Securities. State Auto Financial has the right to redeem the Subordinated Debentures, in whole or in part, on or after May 2008. State Auto Financial has unconditionally and irrevocably guaranteed payment of any required distributions on the capital securities, the redemption price when the capital securities are to be redeemed, and any amounts due if the Capital Trust is liquidated or terminated. State Auto Financial’s equity interest in the Capital Trust is included in other invested assets. In accordance with the Consolidation Topic of the FASB ASC 810, State Auto Financial determined that the business trust is a variable interest entity for which it is not the primary beneficiary and therefore, does not consolidate the Capital Trust with the Company.
The following table sets forth the tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities at December 31, 2014 and 2013:
At December 31, 2014, the tax benefit of the net operating loss carryforward was $58.0 million; if not used, it will expire in 2032.
At December 31, 2014, the Company carried no balance for uncertain tax positions. The Company had no accrual for the payment of interest and penalties at December 31, 2014 or 2013.
The following table sets forth information regarding the Company’s share of pension and postretirement benefit plans’ components of net periodic cost for the years ended December 31, 2014, 2013 and 2012:
The following table sets forth the weighted average assumptions used to determine the benefit plans’ obligations at December 31, 2014 and 2013:
The benefit plans’ obligations are long-term in nature and consequently the investment strategies have a long-term time horizon. In establishing the long-term rate of return assumption on plan assets, management, along with its pension consulting actuary, reviews the historical performance of the plan assets and the stability in the mix of the investment portfolio. The expected inflation rate and expected real rates of return of applicable asset classes are then determined to assist in setting appropriate assumptions.
The following table sets forth the assumed health care cost trend rates used for the years ended December 31, 2014, 2013 and 2012:
The assumed health care cost trend rates have a significant effect on the amounts reported for the postretirement plan. The following table sets forth the effects of a one percentage point change in assumed health care cost trend rates for the year ended December 31, 2014:
The following table sets forth the asset allocation targets, as a percentage of total fair value, which are used as a guide by management when allocating funds as they become available.
Effective January 1, 2014, the Investment Committee approved a change to a liability driven investment (LDI) for the pension plan assets. The primary goal of the LDI strategy is to shift the asset allocation to more closely align with the plan liability, thereby reducing the volatility of the funded status. The implementation of the LDI strategy will occur over a period of time and the actual asset allocation at any point in time is dependent upon the funded status and the level of interest rates. This glide path helps to balance interest rate risk, curve steepness risk, and credit spread risk, as incremental changes are made to the allocation over time. The new allocation strategy reduces exposure to equity holdings and increases exposure to long duration fixed income. This change will result in lower volatility for the plan assets. By moving more of the plan's assets to long duration fixed income, the duration of the assets will increase to more closely match the duration of the plan's liabilities. While the LDI approach is new for the pension plan, the investment policy objective is unchanged.
The following tables set forth the Company’s share of pension plan’s available-for-sale securities within the fair value hierarchy at December 31, 2014 and 2013:
The following tables set forth the Company’s share of the postretirement plan’s available-for-sale securities within the fair value hierarchy at December 31, 2014 and 2013:
The Company maintains a defined contribution plan that covers substantially all employees of the Company. The Company matches the first 1% of contributions of participants’ salary at the rate of one dollar for each dollar contributed. Participant
contributions of 2% to 6% are matched at a rate of 50 cents for each dollar contributed. In addition, the Company contributes a percentage of the employee’s annual income for those employees hired on or after January 1, 2010, and for those employees hired prior to January 1, 2010 who chose to freeze their existing accrued pension benefit effective June 30, 2010. The Company’s share of the expense under the plan totaled $5.1 million, $4.6 million and $4.5 million for 2014, 2013 and 2012, respectively.
The following tables set forth the changes in the Company’s accumulated other comprehensive income component (AOCI), net of tax, for the years ended December 31, 2014, 2013 and 2012:
The Company maintains share-based compensation plans for key employees and outside, or non-employee, directors. The share-based compensation plan for key employees is the State Auto Financial Corporation 2009 Equity Compensation Plan (the “Equity Plan”). The stock-based compensation plan for outside directors is the Outside Directors Restricted Share Unit Plan (the “RSU Plan”).
The Equity Plan provides for the award of qualified and nonqualified stock options, restricted shares, performance shares, performance units and other stock-based awards. The Company has reserved 3.0 million common shares under the Equity Plan. As of December 31, 2014, a total of 0.8 million common shares are available for issuance under the Equity Plan. The Equity Plan provides that (i) no more than 33% of the common shares authorized for issuance under the Equity Plan may be granted in the form of awards other than stock options, (ii) the maximum number of common shares subject to awards of stock options, restricted shares and performance shares that may be granted in any calendar year is equal to 1.5% of the total number of common shares of the Company outstanding as of December 31 of the prior year, and (iii) the maximum number of common shares subject to awards of stock options, restricted shares and performance shares that may be granted in any calendar year to any one individual is 250,000 shares. The Equity Plan automatically terminates on May 8, 2019.
As of December 31, 2014, there was $0.8 million of total unrecognized compensation cost related to non-vested restricted share compensation arrangements. The remaining cost is expected to be recognized over a period of 2.25 years.
The RSU Plan is an unfunded deferred compensation plan which currently provides each outside director with an award of 1,400 restricted share units (the “RSU award”) following each annual meeting of shareholders. The amount of the award may change from year to year, based on the provision described below. The RSU awards are fully vested six months after the date of grant. RSU awards are not common shares of the Company and, as such, no participant has any rights as a holder of common shares under the RSU Plan. RSU awards represent the right to receive an amount, payable in cash or common shares of the Company, as previously elected by the outside director, equal to the value of a specified number of common shares of the Company at the end of the restricted period. Such election may be changed within the constraints set forth in the RSU Plan. The restricted period
During 2014 and 2013, common shares valued at approximately $51,000 and $51,000, respectively, were distributed by the Company under the RSU Plan.
The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes closed-form pricing model. The following tables present the weighted-average assumptions used in the option pricing model for options granted to employees during 2014, 2013 and 2012. The expected life of the options for employees represents the period of time the options are expected to be outstanding and is based on historical trends. For non-employees the expected life of the option approximates the remaining contractual term of the option. The expected stock price volatility is based on the historical volatility of the Company’s stock for a period approximating the expected life and the expected dividend yield is based on the Company’s most recent period’s dividend payout. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant and has a term approximating the expected life of the option.
The fair value of share-based awards granted to employees was estimated at the date of grant using the Black-Scholes option-pricing model. The following table sets forth the weighted average fair values and related assumptions for options granted for the years ended December 31, 2014, 2013 and 2012:
The following table sets forth information pertaining to the total options outstanding and exercisable at December 31, 2014:
The following table sets forth the options to purchase shares of common stock and the restricted share units ("RSU award") provided to each outside director of the Company, that were not included in the computation of diluted earnings per common share because the exercise price of the options, or awards, was greater than the average market price or their inclusion would have been antidilutive for the years ended December 31, 2014, 2013 and 2012:
The following table sets forth financial information regarding the Company’s reportable segments for the years ended December 31, 2014, 2013 and 2012:
In accordance with the Contingencies Topic of the Financial Accounting Standards Board's Accounting Standards Codification, the Company accrues for a litigation-related liability when it is probable that such a liability has been incurred and the amount can be reasonably estimated. The Company reviews all litigation on an ongoing basis when making accrual and disclosure decisions. For certain legal proceedings, the Company cannot reasonably estimate losses or a range of loss, if any, particularly for proceedings that are in their early stages of development or where the plaintiffs seek indeterminate damages. Various factors, including, but not limited to, the outcome of potentially lengthy discovery and the resolution of important factual questions, may need to be determined before probability can be established or before a loss or range of loss can be reasonably estimated. If the loss contingency in question is not both probable and reasonably estimable, the Company does not establish an accrual and the matter will continue to be monitored for any developments that would make the loss contingency both probable and reasonably estimable. Based on currently available information known to the Company, it believes that its reserves for litigation-related liabilities are reasonable. However, in the event that a legal proceeding results in a substantial judgment against, or settlement by, the Company, there can be no assurance that any resulting liability or financial commitment would not have a material adverse effect on the financial condition, results of operations or cash flows of the consolidated financial statements of the Company.