The Company leases its principal executive offices in New York, New York, as well as approximately 171 field and claim offices throughout the United States under leases or subleases with third parties. The Company also leases offices outside the United States, including in Canada, the United Kingdom and the Republic of Ireland. The Company owns six buildings in Hartford, Connecticut. The Company also owns buildings located in other areas of Connecticut; Norcross, Georgia; St. Paul, Minnesota; and Omaha, Nebraska. The Company owns a building in London, England, which houses a portion of Business Insurance’s operations in the United Kingdom.
The following is a discussion and analysis of the Company’s financial condition and results of operations for the years ended December 31, 2019 and 2018, including year-to-year comparisons between 2019 and 2018. Year-to-year comparisons between 2018 and 2017 have been omitted from this Form 10-K, but may be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the year ended December 31, 2018.
Net unfavorable prior year reserve development of $60 million ($47 million after-tax)
Total investments of $77.88 billion; fixed maturities and short-term securities comprise 94% of total investments
Total debt of $6.56 billion, resulting in a debt-to-total capital ratio of 20.2% (21.7% excluding net unrealized investment gains, net of tax, included in shareholders' equity)
On December 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act of 2017 (TCJA) which, among other changes, reduced the U.S. Federal tax rate from 35% to 21% beginning on January 1, 2018 and imposed a tax on undistributed and previously untaxed post-1986 foreign earnings and profits (accumulated foreign earnings). Total income tax expense for 2017 included a net charge of $129 million to reflect the estimated impact of the changes in tax law and tax rates included in TCJA at the date of enactment, primarily reflecting the revaluation of the Company’s deferred tax assets and liabilities at the new statutory federal tax rate of 21%, and the recognition of tax imposed on the accumulated foreign earnings.
reflecting the impacts of (i) the increase in income before income taxes and (ii) the reduction in income tax expense in 2018 resulting from the Company's $200 million voluntary contribution to its qualified domestic pension plan, which provided a 35% tax benefit rather than a 21% tax benefit.
Earned premiums in 2019 were $28.27 billion, $1.21 billion or 4% higher than in 2018. In Business Insurance, earned premiums in 2019 increased by 4% over 2018. In Bond & Specialty Insurance, earned premiums in 2019 increased by 6% over 2018. In Personal Insurance, earned premiums in 2019 increased by 5% over 2018. Factors contributing to the increases in earned premiums in each segment in 2019 as compared with 2018 are discussed in more detail in the segment discussions that follow.
Net investment income in 2019 was $2.47 billion, comparable with 2018. Net investment income from fixed maturity investments in 2019 was $2.07 billion, $90 million higher than in 2018, primarily resulting from a higher average level of fixed maturity investments and higher long-term interest rates. Net investment income from short-term securities in 2019 was $105 million, $13 million higher than in 2018, primarily resulting from higher short-term interest rates. Net investment income generated by the Company's remaining investment portfolios in 2019 was $333 million, $108 million lower than in 2018, primarily reflecting lower returns from private equity limited partnerships and real estate partnerships.
Other net realized investment gains in 2019 included $59 million of net realized investment gains related to fixed maturity investments, $12 million of net realized investment gains related to equity securities sold and $15 million of net realized investment losses related to foreign currency translation and other investments.
Other revenues in all years presented included installment premium charges. Other revenues in all years also included revenues from Simply Business, which was acquired in August 2017. Other revenues in 2017 also included a gain related to the settlement of a reinsurance dispute.
Claims and claim adjustment expenses in 2019 were $19.13 billion, $842 million or 5% higher than in 2018, primarily reflecting the impacts of (i) net unfavorable prior year reserve development compared to net favorable prior year reserve development in 2018, (ii) loss cost trends, (iii) higher loss estimates in the general liability line for primary and excess coverages and in the commercial automobile product line, (iv) higher business volumes and (v) higher non-catastrophe weather-related losses, partially offset by (vi) significantly lower catastrophe losses and (vii) lower loss estimates in the workers' compensation product line. Catastrophes in 2019 primarily resulted from Hurricane Dorian and several winter, wind and hail storms throughout the United States. Catastrophes in 2018 primarily resulted from wildfires in California, Hurricanes Florence and Michael, wind and hail storms in several regions of the United States and winter storms in the eastern United States.
Factors contributing to net prior year reserve development during the years ended December 31, 2019, 2018 and 2017 are discussed in more detail in note 7 of notes to the consolidated financial statements.
that is designated a catastrophe by internationally recognized organizations that track and report on insured losses resulting from catastrophic events, such as Property Claim Services (PCS) for events in the United States and Canada; and
aggregate threshold is applied for International business across all reportable segments. The threshold for 2019 ranged from approximately $19 million to $30 million of losses before reinsurance and taxes.
Amortization of deferred acquisition costs in 2019 was $4.60 billion, $220 million or 5% higher than in 2018. Amortization of deferred acquisition costs is discussed in more detail in the segment discussions that follow.
Income tax expense in 2019 was $516 million, $78 million or 18% higher than in 2018, primarily reflecting the impacts of (i) the $177 million increase in income before income taxes in 2019 and (ii) the reduction in income tax in 2018 resulting from the Company's $200 million voluntary contribution to its qualified domestic pension plan, which provided a 35% tax benefit rather than a 21% tax benefit.
The Company’s effective tax rate was 16%, 15% and 25% in 2019, 2018 and 2017, respectively. The effective tax rates in all years were lower than the respective statutory rate of 21% in both 2019 and 2018 and 35% in 2017, primarily due to the impact of tax-exempt investment income on the calculation of the Company’s income tax provision. The effective tax rate in 2018 also included the impact of the reduction in income tax expense resulting from the Company's $200 million voluntary contribution to its qualified domestic pension plan in 2018, which provided a 35% tax benefit rather than a 21% tax benefit. The effective tax rate in 2017 reflected the net charge related to TCJA and the impact of the resolution of prior year tax matters.
The combined ratio of 96.5% in 2019 was 0.4 points lower than the combined ratio of 96.9% in 2018. The loss and loss adjustment expense ratio of 66.9% in 2019 was 0.1 points higher than the loss and loss adjustment expense ratio of 66.8% in 2018. The underwriting expense ratio of 29.6% in 2019 was 0.5 points lower than the underwriting expense ratio of 30.1% in 2018.
Gross and net written premiums in 2019 increased by 6% and 5%, respectively, over 2018. Net written premium growth in 2019 was impacted by ceded written premiums related to the new catastrophe reinsurance treaty entered into in the first quarter of 2019.
Factors contributing to the changes in gross and net written premiums in each segment in 2019 as compared with 2018 are discussed in more detail in the segment discussions that follow.
Other revenues in all years presented included installment premium charges and other policyholder service charges, as well as revenues from Simply Business, which was acquired in August 2017.
General and administrative expenses in 2019 were $2.63 billion, comparable with 2018.
Select Accounts. Net written premiums of $2.91 billion in 2019 increased by 3% over 2018. Net written premiums in 2019 were reduced by the new catastrophe reinsurance treaty. Business retention rates remained strong in 2019. Renewal premium changes in 2019 remained positive and were higher than in 2018. New business premiums in 2019 increased over 2018.
National Accounts. Net written premiums of $1.05 billion in 2019 increased by 3% over 2018. Net written premiums in 2019 included a benefit related to a transaction to close out prior year liabilities with a former customer. Business retention rates remained strong in 2019. Renewal premium changes in 2019 were slightly positive but lower than in 2018. New business premiums in 2019 increased over 2018.
International. Net written premiums of $1.07 billion in 2019 decreased by 1% from 2018, primarily driven by the impact of changes in foreign currency exchange rates, as well as decreases in the Company's operations at Lloyd's.
Net investment income in 2019 was $233 million, level with 2018. Included in Bond & Specialty Insurance are certain legal entities whose invested assets and related net investment income are reported exclusively in this segment and not allocated among all business segments. As a result, reported net investment income in Bond & Specialty Insurance reflects a significantly smaller proportion of allocated net investment income, including net investment income from the Company’s non-fixed maturity investments that experienced a decrease in investment income in 2019. Refer to the “Net Investment Income” section of the “Consolidated Results of Operations” discussion for a description of the factors contributing to the Company’s consolidated net investment income in 2019 as compared with the 2018. In addition, refer to note 2 of notes to the consolidated financial statements for a discussion of the Company’s net investment income allocation methodology.
Factors contributing to net favorable prior year reserve development during the years ended December 31, 2019, 2018 and 2017 are discussed in more detail in note 7 of notes to the consolidated financial statements.
Amortization of deferred acquisition costs in 2019 was $478 million, $24 million or 5% higher than in 2018, generally consistent with the increase in earned premiums.
Income tax expense in 2019 was $151 million, $47 million or 24% lower than in 2018, primarily reflecting the impact of the $222 million decrease in income before income taxes in 2019.
The combined ratio of 79.5% in 2019 was 10.5 points higher than the combined ratio of 69.0% in 2018. The loss and loss adjustment expense ratio of 42.2% in 2019 was 10.7 points higher than the loss and loss adjustment expense ratio of 31.5% in 2018. The underwriting expense ratio of 37.3% in 2019 was 0.2 points lower than the underwriting expense ratio of 37.5% in 2018.
Gross written premiums in 2019 increased by 10% over 2018. Net written premiums in 2019 increased by 8% over 2018. Net written premium growth in 2019 was impacted by higher ceded written premiums for several reinsurance treaties, including those related to the new catastrophe reinsurance treaty entered into in the first quarter of 2019.
Domestic. Net written premiums in 2019 were $2.47 billion, $181 million or 8% higher than in 2018. Excluding the surety line of business, for which the following are not relevant measures, business retention rates remained strong in 2019. Renewal premium changes in 2019 remained positive and were higher than in 2018. New business premiums in 2019 increased over 2018.
International. Net written premiums in 2019 were $268 million, $30 million or 13% higher than in 2018, primarily driven by increases in the United Kingdom and Canada, partially offset by the impact of changes in foreign currency exchange rates.
On December 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act of 2017 (TCJA) which, among other changes, reduced the U.S. Federal tax rate from 35% to 21% beginning on January 1, 2018 and imposed a tax on undistributed and previously untaxed post-1986 foreign earnings and profits (accumulated foreign earnings).
Segment income in 2019 was $824 million, $527 million or 177% higher than segment income of $297 million in 2018. The increase in segment income before income taxes primarily reflected the pre-tax impacts of (i) significantly lower catastrophe losses and (ii) higher net favorable prior year reserve development, partially offset by (iii) lower underlying underwriting margins. Catastrophe losses in 2019 and 2018 were $411 million and $1.06 billion, respectively. Net favorable prior year reserve development in 2019 and 2018 was $133 million and $109 million, respectively. The lower underlying underwriting margins primarily reflected
(i) higher non-catastrophe weather-related losses in Agency Homeowners and Other and (ii) the impact on earned premiums related to the Company's new catastrophe reinsurance treaty, mostly impacting Agency Homeowners and Other, partially offset by (iii) earned pricing that exceeded loss cost trends in Agency Automobile and (iv) higher business volumes. Income tax expense in 2019 was higher than in 2018, primarily reflecting the impacts of (i) the increase in segment income before income taxes and (ii) the reduction in income tax expense in 2018 resulting from the Company's voluntary contribution to its qualified domestic pension plan.
Net investment income in 2019 was $419 million, $11 million or 3% higher than in 2018. Refer to the “Net Investment Income” section of the “Consolidated Results of Operations” discussion for a description of the factors contributing to the Company’s consolidated net investment income in 2019 as compared with the 2018. In addition, refer to note 2 of notes to the consolidated financial statements for a discussion of the Company’s net investment income allocation methodology.
Factors contributing to net favorable prior year reserve development during the years ended December 31, 2019 and 2018 are discussed in more detail in note 7 of notes to the consolidated financial statements. Net prior year reserve development in 2017 was not significant.
Amortization of deferred acquisition costs in 2019 was $1.62 billion, $81 million or 5% higher than in 2018, generally consistent with the increase in earned premiums.
The combined ratio of 94.2% in 2019 was 6.4 points lower than the combined ratio of 100.6% in 2018. The loss and loss adjustment expense ratio of 68.0% in 2019 was 6.1 points lower than the loss and loss adjustment expense ratio of 74.1% in 2018. The underwriting expense ratio of 26.2% in 2019 was 0.3 points lower than the underwriting expense ratio of 26.5% in 2018.
Domestic Agency Automobile net written premiums of $5.12 billion in 2019 were 3% higher than in 2018. Net written premiums in 2019 were reduced by the new catastrophe reinsurance treaty. Business retention rates remained strong in 2019. Renewal premium changes in 2019 remained positive but were lower than in 2018. New business premiums in 2019 increased over 2018.
Domestic Agency Homeowners and Other net written premiums of $4.54 billion in 2019 were 9% higher than in 2018. Net written premiums in 2019 were reduced by the new catastrophe reinsurance treaty. Business retention rates remained strong in 2019. Renewal premium changes in 2019 remained positive and were higher than in 2018. New business premiums in 2019 increased over 2018.
In the home office and field office category, which accounts for the vast majority of policyholders with active asbestos-related claims, the number of policyholders with open asbestos claims and net asbestos-related payments were comparable with 2018. Payments on behalf of policyholders in this category continue to be influenced by a high level of litigation activity in a limited number of jurisdictions where individuals alleging serious asbestos-related injury, primarily mesothelioma, continue to target defendants who were not traditionally primary targets of asbestos litigation.
The Company’s quarterly asbestos reserve reviews include an analysis of exposure and claim payment patterns by policyholder category, as well as recent settlements, policyholder bankruptcies, judicial rulings and legislative actions. The Company also analyzes developing payment patterns among policyholders in the home office and field office category and the assumed reinsurance and other category as well as projected reinsurance billings and recoveries. In addition, the Company reviews its historical gross and net loss and expense paid experience, year-by-year, to assess any emerging trends, fluctuations or characteristics suggested by the aggregate paid activity. Conventional actuarial methods are not utilized to establish asbestos reserves, and the Company’s evaluations have not resulted in a reliable method to determine a meaningful average asbestos defense or indemnity payment.
The following table displays activity for asbestos losses and loss expenses and reserves:
In establishing environmental reserves, the Company evaluates the exposure presented by each policyholder and the anticipated cost of resolution, if any. In the course of this analysis, the Company generally considers the probable liability, available coverage and relevant judicial interpretations. In addition, the Company considers the many variables presented, such as: the nature of the alleged activities of the policyholder at each site; the number of sites; the total number of potentially responsible parties at each site; the nature of the alleged environmental harm and the corresponding remedy at each site; the nature of government enforcement activities at each site; the ownership and general use of each site; the overall nature of the insurance relationship between the Company and the policyholder, including the role of any umbrella or excess insurance the Company has issued to the policyholder; the involvement of other insurers; the potential for other available coverage, including the number of years of coverage; the role, if any, of non-environmental claims or potential non-environmental claims in any resolution process; and the applicable law in each jurisdiction. Conventional actuarial methods are not used to estimate these reserves.
The Company continues to receive notices from policyholders tendering claims for the first time, frequently under policies issued prior to the mid-1980s. These policyholders continue to present smaller exposures, have fewer sites and are lower-tier defendants. Further, in many instances, clean-up costs have been reduced because regulatory agencies are willing to accept risk-based site analyses and more efficient clean-up technologies. Over the past several years, the Company has experienced generally favorable trends in the number of new policyholders tendering environmental claims for the first time and in the number of pending declaratory judgment actions relating to environmental matters. However, the degree to which those favorable trends have continued has been less than anticipated. In addition, reserve development on existing environmental claims as well as the costs associated with coverage litigation on environmental matters have been greater than anticipated, driven by claims and legal developments in a limited number of jurisdictions. As a result of these factors, in 2019, 2018 and 2017, the Company increased its net environmental reserves by $76 million, $55 million and $65 million, respectively.
The carrying value of the Company’s fixed maturity portfolio at December 31, 2019 was $68.13 billion. The Company closely monitors the duration of its fixed maturity investments, and investment purchases and sales are executed with the objective of having adequate funds available to satisfy the Company’s insurance and debt obligations. The weighted average credit quality of the Company’s fixed maturity portfolio, both including and excluding U.S. Treasury securities, was “Aa2” at both December 31, 2019 and 2018. Below investment grade securities represented 2.1% and 2.3% of the total fixed maturity investment portfolio at December 31, 2019 and 2018, respectively. The weighted average effective duration of fixed maturities and short-term securities was 4.0 (4.3 excluding short-term securities) at December 31, 2019 and 4.5 (4.7 excluding short-term securities) at December 31, 2018. The decrease in duration compared with December 31, 2018 primarily reflected the decrease in market interest rates during 2019.
The carrying values of investments in fixed maturities classified as available for sale at December 31, 2019 and 2018 were as follows:
Rated using external rating agencies or by the Company when a public rating does not exist.
Included in commercial mortgage-backed securities and project loans at December 31, 2019 and 2018 were $557 million and $456 million of securities guaranteed by the U.S. government, respectively, and $2 million of securities guaranteed by government-sponsored enterprises at both December 31, 2019 and 2018.
The following table sets forth the Company’s fixed maturity investment portfolio rated using external ratings agencies or by the Company when a public rating does not exist:
The following table displays the funding sources for the $10.32 billion of municipal bonds identified as revenue bonds in the foregoing table at December 31, 2019:
Rated using external rating agencies or by the Company when a public rating does not exist. Ratings shown are the higher of the rating of the underlying issuer or the insurer in the case of securities enhanced by third-party insurance for the payment of principal and interest in the event of issuer default.
The Company bases its investment decision on the underlying credit characteristics of the municipal security. The weighted average credit rating of the municipal bond portfolio was “Aaa/Aa1” at December 31, 2019.
The following table shows the geographic distribution of the Company’s long-term fixed maturity investments in debt securities issued by foreign governments at December 31, 2019:
The following table shows the Company’s Eurozone exposure at December 31, 2019 to all debt securities issued by foreign governments, financial companies, sovereign corporations (including sovereign banks) whose securities are backed by the respective country’s government and all other corporate securities (comprised of industrial corporations and utility companies) which could be affected if economic conditions deteriorated due to a prolonged recession:
Rated using external rating agencies or by the Company when a public rating does not exist. The table includes $619 million of short-term securities which have high ratings issued by external rating agencies for short-term issuances. For purposes of this table, the short-term securities, which are rated “A-1+” and/or “P-1,” are included as “Aaa” rated securities.
The Company’s fixed maturity investment portfolio at December 31, 2019 and 2018 included $3.28 billion and $2.57 billion, respectively, of residential mortgage-backed securities, including pass-through-securities and collateralized mortgage obligations (CMOs), all of which are subject to prepayment risk (either shortening or lengthening of duration). While prepayment risk for securities and its effect on income cannot be fully controlled, particularly when interest rates move dramatically, the Company’s investment strategy generally favors securities that reduce this risk within expected interest rate ranges. The Company makes investments in residential CMOs that are either guaranteed by GNMA, FNMA or FHLMC, or if not guaranteed, are senior or super-senior positions within their respective securitizations. Both guaranteed and non-guaranteed residential CMOs allocate the distribution of payments from the underlying mortgages among different classes of bondholders. In addition, non-guaranteed residential CMOs provide structures that allocate the impact of credit losses to different classes of bondholders. Senior and super-senior CMOs are protected, to varying degrees, from credit losses as those losses are initially allocated to subordinated bondholders. The Company’s investment strategy is to purchase CMO tranches that are expected to offer the most favorable return given the Company’s assessment of associated risks. The Company does not purchase residual interests in CMOs. For more information regarding the Company’s investments in residential mortgage-backed securities, see note 3 of notes to the consolidated financial statements.
The Company has, from time to time, engaged in securities lending activities from which it generates net investment income by lending certain of its investments to other institutions for short periods of time. At December 31, 2019 and 2018, the Company had $404 million and $367 million of securities on loan, respectively, as part of a tri-party lending agreement. The average monthly balance of securities on loan during 2019 and 2018 was $368 million and $319 million, respectively. Borrowers of these securities provide collateral equal to at least 102% of the market value of the loaned securities plus accrued interest. The Company did not incur any investment losses in its securities lending program for the years ended December 31, 2019 and 2018.
The Company meets its capital requirements to support its underwriting at Lloyd’s using a combination of the share capital and retained earnings of the Company's subsidiaries participating in Lloyd's, trust deposits and uncollateralized letters of credit. Securities with a fair value of approximately $173 million and $115 million held by a wholly-owned subsidiary at December 31, 2019 and 2018, respectively, and $34 million and $33 million held by TRV at December 31, 2019 and 2018, respectively, were pledged into Lloyd’s trust accounts to provide a portion of the Lloyd’s capital requirements. For more information regarding the Company’s utilization of uncollateralized letters of credit, see “Liquidity and Capital Resources” herein.
At December 31, 2019 and 2018, below investment grade securities comprised 2.1% and 2.3%, respectively, of the fair value of the Company’s fixed maturity investment portfolio. Included in below investment grade securities at December 31, 2019 were securities in an unrealized loss position that, in the aggregate, had an amortized cost of $152 million and a fair value of $146 million, resulting in a net pre-tax unrealized investment loss of $6 million. These securities in an unrealized loss position represented less than 1% of both the amortized cost and fair value of the fixed maturity portfolio at December 31, 2019 and accounted for approximately 21% of the total gross pre-tax unrealized investment loss in the fixed maturity portfolio at December 31, 2019.
Impairment charges included in net realized investment gains in the consolidated statement of income were $4 million and $1 million for the years ended December 31, 2019 and 2018, respectively. See note 3 of notes to the consolidated financial statements for further information.
During the year ended December 31, 2019, the Company incurred pre-tax realized losses of $8 million on the sale of fixed maturity investments having a fair value of $317 million.
The tables below set forth the probabilities that estimated losses, comprising claims and allocated claim adjustment expenses (but excluding unallocated claim adjustment expenses), from a single event occurring in a one-year timeframe will equal or exceed the indicated loss amounts (expressed in dollars, net of tax, and as a percentage of the Company’s common equity), based on the proprietary and third-party computer models utilized by the Company at December 31, 2019. For example, on the basis described below the tables, the Company estimates that there is a one percent chance that the Company’s loss from a single U.S. and Canadian hurricane in a one-year timeframe would equal or exceed $1.6 billion, or 7% of the Company’s common equity at December 31, 2019.
An event that has, for example, a 2% likelihood of exceedance is sometimes described as a “1-in-50 year event.” As noted above, however, the probabilities in the table represent the likelihood of losses from a single event equaling or exceeding the indicated threshold loss amount in a one-year timeframe, not over a multi-year timeframe. Also, because the probabilities relate to a single event, the probabilities do not address the likelihood of more than one event occurring in a particular period, and, therefore, the amounts do not address potential aggregate catastrophe losses occurring in a one-year timeframe.
The threshold loss amounts in the tables above, which are based on the Company’s in-force portfolio at December 31, 2019 and catastrophe reinsurance program at January 1, 2020, are net of reinsurance, after-tax and exclude unallocated claim adjustment expenses, which historically have been less than 10% of loss estimates. For further information regarding the Company’s reinsurance, see “Item 1 - Business-Reinsurance.” The amounts for hurricanes reflect U.S. and Canadian exposures and include property exposures, property residual market exposures and an adjustment for certain non-property exposures. The hurricane loss amounts are based on the Company’s catastrophe risk model estimates and include losses from the hurricane hazards of wind and storm surge. The amounts for earthquakes reflect U.S. and Canadian property and workers’ compensation exposures. The Company does not believe that the inclusion of hurricane or earthquake losses arising from other geographical areas or other exposures would materially change the estimated threshold loss amounts.
Severe weather events over the last two decades have underscored the unpredictability of future climate trends and created uncertainty regarding insurers’ exposures to financial loss as a result of catastrophes and other weather-related events. The insurance industry experienced increased catastrophe losses due to a number of potential causal factors, including, in addition to weather/climate variability, more people living in high-risk areas, population growth in areas with weaker enforcement of building codes, urban expansion and an increase in the average size of a house. For example, hurricane and storm surge activity have impacted areas further inland than previously experienced, and demographic changes have resulted in larger populations in coastal areas which historically have been subject to severe storms, thus expanding the Company’s potential for losses from hurricanes. Additionally, both the frequency and severity of tornado and hail storms in the United States have been more volatile during the last decade. The frequency and severity of wildfire losses have been elevated in more recent years, due in part to record droughts in California that some climate studies suggest are likely to increase over time. Demographic changes in areas prone to wildfires have expanded the Company’s potential for losses from wildfires. Moreover, the Company’s catastrophe models may be less reliable due to the increased unpredictability in frequency and severity of severe weather events, emerging trends in climate conditions, inadequate reflection of regulatory changes and the other factors mentioned above. Accordingly, the Company may be subject to increased losses from catastrophes and other weather-related events.
Changing climate conditions could also impact the creditworthiness of issuers of securities in which the Company invests. For example, water supply adequacy could impact the creditworthiness of bond issuers with significant assets or business activities in the Southwestern United States, and more frequent and/or severe hurricanes could impact the creditworthiness of issuers with significant assets or business activities in the Southeastern United States, among other areas. See “Item 1A - Risk Factors-Our investment portfolio is subject to credit and interest rate risk, and may suffer reduced or low returns or material realized or unrealized losses.”
emerging issues, including changing climate conditions, to consider potential changes to its modeling and the use of such modeling, as well as to help determine the need for new underwriting strategies, coverage modifications or new products. See “Item 1A - Risk Factors-The effects of emerging claim and coverage issues on our business are uncertain, and court decisions or legislative changes that take place after we issue our policies can result in an unexpected increase in the number of claims and have a material adverse impact on our results of operations.”
Net reinsurance recoverables at December 31, 2019 were comparable to recoverables at December 31, 2018.
At December 31, 2019, the Company held $823 million of collateral in the form of letters of credit, funds and trust agreements held to fully or partially collateralize certain reinsurance recoverables.
Premiums. The Company’s earned premiums are a function of net written premium volume. Net written premiums comprise both renewal business and new business and are recognized as earned premium over the life of the underlying policies. When business renews, the amount of net written premiums associated with that business may increase or decrease (renewal premium change) as a result of increases or decreases in rate and/or insured exposures, which the Company considers as a measure of units of exposure (such as the number and value of vehicles or properties insured). Net written premiums from both renewal and new business, and therefore earned premiums, are impacted by competitive market conditions as well as general economic conditions, which, particularly in the case of Business Insurance, affect audit premium adjustments, policy endorsements and mid-term cancellations. Property and casualty insurance market conditions are expected to remain competitive. Net written premiums may also be impacted by the structure of reinsurance programs and related costs, as well as changes in foreign currency exchange rates.
Overall, the Company expects retention levels (the amount of expiring premium that renews, before the impact of renewal premium changes) will remain strong by historical standards during 2020. In Business Insurance, the Company expects that domestic renewal premium changes for 2020 will remain positive and will be higher than the level attained in 2019. In Bond & Specialty Insurance, the Company expects that renewal premium changes with respect to domestic management liability business for 2020 will remain positive and will be higher than the level attained in 2019. In Personal Insurance, the Company expects that domestic Agency Automobile renewal premium changes for 2020 will remain positive but will be lower than the level attained in 2019. The Company expects that domestic Agency Homeowners and Other renewal premium changes for 2020 will remain positive and will be higher than the level attained in 2019. The need for state regulatory approval for changes to personal and many commercial property and casualty insurance prices, as well as competitive market conditions, may impact the timing and extent of renewal premium changes. Given the relatively smaller amount of premium that the Company generates from outside the United States and the transactional nature of some of those markets, particularly Lloyd’s, international renewal premium changes during 2020 could be somewhat higher, broadly consistent with or somewhat lower than the levels attained in 2019; however, the Company expects that international renewal premium changes for the first half of 2020 will remain positive and will be higher than the level attained in the same period of 2019.
Property and casualty insurance market conditions are expected to remain competitive during 2020 for new business. In each of the Company’s business segments, new business generally has less of an impact on underwriting profitability than renewal business, given the volume of new business relative to renewal business. However, in periods of meaningful increases in new business, despite its positive impact on underwriting gains over time, the impact of higher new business levels may negatively impact the combined ratio for a period of time.
Economic conditions in the United States and elsewhere could change due to a variety of factors, including the political and regulatory environment, changes to monetary policy, inflation or deflation (including the impact of rapid changes in wages and/or commodity prices), changes in tariffs or other international trade regulations, fluctuations in interest rates and foreign currency exchange rates, high levels of global debt after an extended period of low interest rates, the United Kingdom’s withdrawal from the European Union, a shutdown of the U.S. government, the failure by the U.S. government to raise the debt ceiling, changes to the U.S. Federal budget and further potential changes in tax laws or health care legislation in the United States. The resulting changes in levels of economic activity could positively or negatively impact exposure changes at renewal and the Company’s ability to write business at acceptable rates. Additionally, changes in levels of economic activity could positively or negatively impact audit premium adjustments, policy endorsements and mid-term cancellations after policies are written. All of the foregoing, in turn, could positively or negatively impact net written premiums during 2020, and because earned premiums are a function of net written premiums, earned premiums could be impacted on a lagging basis.
Catastrophe losses and non-catastrophe weather-related losses are inherently unpredictable from period to period. The Company’s results of operations could be adversely impacted if significant catastrophe and/or non-catastrophe weather-related losses were to occur.
In Bond & Specialty Insurance, the Company expects that for 2020 in the aggregate, the underlying underwriting margin will be broadly consistent with 2019 and the underlying combined ratio will be slightly higher than in 2019.
The Company also invests much smaller amounts in equity securities, real estate, private equity limited partnerships, hedge funds, and real estate partnerships and joint ventures. These investment classes have the potential for higher returns but also the potential for higher degrees of risk, including less stable rates of return and less liquidity.
Statement of Income for the years ended December 31, 2019, 2018 and 2017
Statement of Changes in Shareholders’ Equity for the years ended December 31, 2019, 2018 and 2017
Statement of Cash Flows for the years ended December 31, 2019, 2018 and 2017
Schedule II - Condensed Financial Information of Registrant (Parent Company Only)
Evaluation of the estimate of claims and claim adjustment expense reserves
Assessing the assumptions and methodologies underlying the Company’s reserve estimate by participating in quarterly discussions with the Company’s actuaries;
Evaluating the Company’s estimates by performing independent analyses of net and gross claims and claim adjustment expense reserves for certain lines of business;
Assessing the Company's internally prepared actuarial analyses in comparison to the Company's internal experience and related industry trends for selected other lines of business; and
(1) Total other-than-temporary impairment (OTTI) losses were $(3) million, $(1) million and $(13) million for the years ended December 31, 2019, 2018 and 2017, respectively. Of total OTTI, credit losses of $(4) million, $(1) million and $(14) million for the years ended December 31, 2019, 2018 and 2017, respectively, were recognized in net realized investment gains. In addition, unrealized gains (losses) from other changes in total OTTI of $1 million, $0 million and $1 million for the years ended December 31, 2019, 2018 and 2017, respectively, were recognized in other comprehensive income (loss) as part of changes in net unrealized gains (losses) on investment securities having credit losses recognized in the consolidated statement of income.
Financial Instruments: Recognition and Measurement of Financial Assets and Financial Liabilities
The Company adopted the updated guidance for leases for the quarter ended March 31, 2019 and elected to utilize a cumulative-effect adjustment to the opening balance of retained earnings for the year of adoption. Accordingly, the Company’s reporting for the comparative periods prior to adoption continue to be presented in the financial statements in accordance with previous lease accounting guidance. The Company also elected to apply all practical expedients applicable to the Company in the updated
guidance for transition for leases in effect at adoption, including using hindsight to determine the lease term of existing leases, the option to not reassess whether an existing contract is a lease or contains a lease and whether the lease is an operating or finance lease. The adoption of the updated guidance resulted in the Company recognizing a right-of-use asset of $320 million as part of other assets and a lease liability of $384 million as part of other liabilities in the consolidated balance sheet, as well as de-recognizing the liability for deferred rent that was required under the previous guidance, for its corporate real estate agreements at March 31, 2019. The cumulative effect adjustment to the opening balance of retained earnings at January 1, 2019 was zero. The adoption of the updated guidance did not have a material effect on the Company’s results of operations or liquidity.
Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract
While insurance contracts are not within the scope of this updated guidance, the Company’s revenue related to certain services with no underlying insurance risk is subject to the updated guidance. These services include the following: (i) insurance-related services, such as risk management services, claims administration, loss control and risk management information services on behalf of non-insureds; (ii) servicing carrier fees for various residual market pools and associations; and (iii) administrative fees related to servicing third-party insurers’ obligations to participate in the Workers' Compensation Residual Market Plans in certain states. The adoption of the updated guidance did not have a material impact on the Company's revenues. These revenues are earned as the Company completes its performance obligations, which primarily occurs on a pro rata basis over the contract service period and reported in fee income in the Company’s consolidated statement of income.
Commissions earned from on-line insurance brokerage services are also subject to this updated guidance and there was not a material impact on these commissions from the adoption of the updated guidance. Commissions are generally earned upon collection of the gross premium in accordance with the contracts and an accrual is made to recognize policy cancellations, either at the policyholder’s direction or for non-payment. Commissions are reported in other revenues in the Company's consolidated statement of income.
instruments measured at amortized cost (including reinsurance recoverables and structured settlements that are recorded as part of reinsurance recoverables) and requires an entity to estimate the credit losses expected over the life of an exposure or pool of exposures. The estimate of expected credit losses should consider historical information, current information, as well as reasonable and supportable forecasts, including estimates of prepayments. The expected credit losses, and subsequent adjustments to such losses, are recorded through an allowance account that is deducted from the amortized cost basis of the financial asset, with the net carrying value of the financial asset presented on the consolidated balance sheet at the amount expected to be collected.
The Company uses the equity method of accounting for investments in private equity limited partnerships, hedge funds and real estate partnerships. The partnerships and the hedge funds generally report investments on their balance sheet at fair value. The financial statements prepared by the investee are received by the Company on a lag basis, with the lag period generally dependent upon the type of underlying investments. The private equity and real estate partnerships provide financial information quarterly which is generally available to investors, including the Company, within three months following the date of the reporting period. The hedge funds provide financial information monthly, which is generally available to investors within one month following the date of the reporting period. The Company regularly requests financial information from the partnerships prior to the receipt of the partnerships’ financial statements and records any material information obtained from these requests in its consolidated financial statements.
Also included in other investments are non-public common equities, preferred equities and derivatives. Non-public common equities and preferred equities are reported at fair value with changes in fair value recognized in net income. Prior to January 1, 2018, non-public common equities and preferred equities were reported at fair value with changes in fair value, net of taxes, charged or credited directly to other comprehensive income. The Company’s derivative financial instruments are carried at fair value, with the changes in fair value reflected in the consolidated statement of income in net realized investment gains (losses). For a further discussion of the derivatives used by the Company, see note 3.
the equity method of accounting, whereby the Company’s share of the investee’s earnings or losses in the fund is reported in net investment income.
Some of the factors considered in identifying other-than-temporary impairments of fixed maturities include: (1) the extent to which the fair value has been less than amortized cost; (2) the financial condition, near-term and long-term prospects for the issuer, including the relevant industry conditions and trends, and implications of rating agency actions and offering prices; (3) the likelihood of the recoverability of principal and interest; (4) whether it is more likely than not that the Company will be required to sell the investment prior to an anticipated recovery in value; and (5) the length of time and extent to which the fair value has been less than amortized cost.
The Company may, from time to time, sell invested assets subsequent to the balance sheet date that it did not intend to sell at the balance sheet date. Conversely, the Company may not sell invested assets that it asserted that it intended to sell at the balance sheet date. Such changes in intent are due to events occurring subsequent to the balance sheet date. The types of events that may result in a change in intent include, but are not limited to, significant changes in the economic facts and circumstances related to
As a result of the reviews performed for the years ended December 31, 2019, 2018 and 2017, the Company determined that the estimated fair value substantially exceeded the respective carrying value of its reporting units for those years and that goodwill was not impaired. The Company also determined during its reviews for each year that its other indefinite-lived intangible assets and finite-lived intangible assets were not impaired.
The Company does not apply any statutory accounting practices that would be considered a prescribed or permitted statutory accounting practice that differs from NAIC statutory accounting practices.
The Company assigns functional currencies to its foreign operations, which are generally the currencies of the local operating environment. Foreign currency amounts are remeasured to the functional currency, and the resulting foreign exchange gains or losses are reflected in earnings. Functional currency amounts are then translated into U.S. dollars. The foreign currency remeasurement and translation are calculated using current exchange rates for items reported in the balance sheets and average
International, through its operations in Canada, the United Kingdom and the Republic of Ireland, provides property and casualty insurance and risk management services to several customer groups, including, among others, those in the technology, manufacturing and public services industry sectors. International also provides insurance for both the foreign exposures of United States organizations and the United States exposures of foreign organizations through Global Services. At its Lloyd’s syndicate (Syndicate 5000), for which the Company provides 100% of the capital, International underwrites six principal businesses - international marine, retail marine, global property, construction & special risks, energy and aviation.
Bond & Specialty Insurance surety business in Brazil and Colombia is conducted through Junto Holding Brasil S.A. (Junto) and Junto Holding Latam S.A. in Brazil. The Company owns 49.5% of both Junto, a market leader in surety coverages in Brazil, and Junto Holding Latam S.A., which owns a majority interest in JMalucelli Travelers Seguros S.A., a Colombian surety provider. These joint venture investments are accounted for using the equity method and are included in “other investments” on the consolidated balance sheet.
Automobile policies provide coverage for liability to others for both bodily injury and property damage, uninsured motorist protection, and for physical damage to an insured’s own vehicle from collision, fire, flood, hail and theft. In addition, many states require policies to provide first-party personal injury protection, frequently referred to as no-fault coverage.
Except as described below for certain legal entities, the Company allocates its invested assets and the related net investment income to its reportable business segments. Pre-tax net investment income is allocated based upon an investable funds concept, which takes into account liabilities (net of non-invested assets) and appropriate capital considerations for each segment. For investable
Pre-refunded bonds of $2.06 billion and $2.85 billion at December 31, 2019 and 2018, respectively, were bonds for which states or municipalities have established irrevocable trusts, almost exclusively comprised of U.S. Treasury securities and obligations of U.S. government and government agencies and authorities. These trusts were created to fund the payment of principal and interest due under the bonds.
The Company’s fixed maturity investment portfolio at December 31, 2019 and 2018 included $3.28 billion and $2.57 billion, respectively, of residential mortgage-backed securities, which include pass-through securities and collateralized mortgage obligations (CMOs). Included in the totals at December 31, 2019 and 2018 were $1.52 billion and $859 million, respectively, of GNMA, FNMA, FHLMC (excluding FHA project loans) and Canadian government guaranteed residential mortgage-backed pass-through securities classified as available for sale. Also included in those totals were residential CMOs classified as available for sale with a fair value of $1.76 billion and $1.71 billion at December 31, 2019 and 2018, respectively. Approximately 54% and 52% of the Company’s CMO holdings at December 31, 2019 and 2018, respectively, were guaranteed by or fully collateralized by securities issued by GNMA, FNMA or FHLMC. The weighted average credit rating of the $816 million and $828 million of non-guaranteed CMO holdings at December 31, 2019 and 2018, respectively, was “Aaa/Aa1” and “Aa1,” respectively. The weighted average credit rating of all of the above securities was Aaa/Aa1” at both December 31, 2019 and 2018.
At December 31, 2019 and 2018, the Company had $404 million and $367 million, respectively, of securities on loan as part of a tri-party lending agreement.
The Company recognized $61 million and ($29) million of net gains (losses) on equity securities still held as of December 31, 2019 and 2018, respectively.
Entities which do not have sufficient equity at risk to allow the entity to finance its activities without additional financial support or in which the equity investors, as a group, do not have the characteristic of a controlling financial interest are referred to as variable interest entities (VIE). A VIE is consolidated by the variable interest holder that is determined to have the controlling financial interest (primary beneficiary) as a result of having both the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and the obligation to absorb losses or right to receive benefits from the VIE that could potentially be significant to the VIE. The Company determines whether it is the primary beneficiary of an entity subject to consolidation based on a qualitative assessment of the VIE’s capital structure, contractual terms, nature of the VIE’s operations
The following tables summarize, for all investments in an unrealized loss position at December 31, 2019 and 2018, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position. The fair value amounts reported in the tables are estimates that are prepared using the process described in note 4. The Company also relies upon estimates of several factors in its review and evaluation of individual investments, using the process described in note 1, in determining whether such investments are other-than-temporarily impaired.
At December 31, 2019, the Company had no fixed maturity investments reported at fair value for which fair value was less than 80% of amortized cost.
The following tables present the cumulative amount of, and the changes during the year in, credit losses on fixed maturities held at December 31, 2019 and 2018, that were recognized in the consolidated statement of income from other-than-temporary impairments (OTTI) and for which a portion of the OTTI was recognized in other comprehensive income (loss) in the consolidated balance sheet.
The fair value of a financial instrument is the estimated amount at which the instrument could be exchanged in an orderly transaction between knowledgeable, unrelated, willing parties, i.e., not in a forced transaction. The estimated fair value of a financial instrument may differ from the amount that could be realized if the security was sold in an immediate sale, e.g., a forced transaction. Additionally, the valuation of investments is more subjective when markets are less liquid due to the lack of market based inputs, which may increase the potential that the estimated fair value of an investment is not reflective of the price at which an actual transaction would occur.
The pricing service evaluates each asset class based on relevant market information, relevant credit information, perceived market movements and sector news. The market inputs utilized in the pricing evaluation, listed in the approximate order of priority,
The pricing service utilized by the Company has indicated that it will only produce an estimate of fair value if there is objectively verifiable information to produce a valuation. If the pricing service discontinues pricing an investment, the Company would be required to produce an estimate of fair value using some of the same methodologies as the pricing service but would have to make assumptions for any market-based inputs that were unavailable due to market conditions. The Company reviews the estimates of fair value provided by the pricing service and compares the estimates to the Company’s knowledge of the market to determine if the estimates obtained are representative of the prices in the market. In addition, the Company has periodic discussions with the pricing service to discuss and understand any changes in process and their responsiveness to changes occurring in the markets. The Company also monitors all monthly price changes and further evaluates any securities whose value changed more than 10% from the prior month. The Company has implemented various other processes including randomly selecting purchased or sold securities and comparing execution prices to the estimates from the pricing service as well as reviewing securities whose valuation did not change from their previous valuation (stale price review). The Company also uses a second independent pricing service to further test the primary pricing service’s valuation of the Company’s fixed maturity portfolio. These processes have not highlighted any significant issues with the fair value estimates received from the primary pricing service.
The Company holds investments in various publicly-traded securities which are reported in other investments. These investments include mutual funds and other small holdings. The $16 million fair value of these investments at both December 31, 2019 and 2018 was disclosed in Level 1. At December 31, 2019 and 2018, the Company held investments in non-public common and preferred equity securities, with fair value estimates of $20 million and $36 million, respectively, reported in other investments, where the fair value estimate is determined either internally or by an external fund manager based on recent filings, operating results, balance sheet stability, growth and other business and market sector fundamentals. Due to the significant unobservable inputs in these valuations, the Company includes the total fair value estimate for all of these investments at December 31, 2019 and 2018 in the amount disclosed in Level 3.
The following tables present the changes in the Level 3 fair value category for the years ended December 31, 2019 and 2018.
The following tables present the carrying value and fair value of the Company’s financial assets and financial liabilities disclosed, but not carried, at fair value, and the level within the fair value hierarchy at which such assets and liabilities are categorized.
The Company utilizes a corporate catastrophe excess-of-loss reinsurance treaty with unaffiliated reinsurers to manage its exposure to losses resulting from catastrophes and to protect its capital. In addition to the coverage provided under this treaty, the Company also utilizes a reinsurance agreement entered into in connection with catastrophe bonds issued by Long Point Re III to protect against certain weather-related and earthquake losses in the Northeastern United States, a Northeast property catastrophe excess-of-loss reinsurance treaty to protect against losses resulting from weather-related and earthquake catastrophes in the Northeastern United States and an underlying property aggregate catastrophe excess-of-loss reinsurance treaty to protect against the accumulation of certain property losses in North America. The Company also utilizes excess-of-loss treaties to protect against earthquake losses up to a certain threshold in Business Insurance (for certain markets) and for Personal Insurance, and several reinsurance treaties specific to its international operations.
Also included in reinsurance recoverables are amounts related to certain structured settlements. Structured settlements are annuities purchased from various life insurance companies to settle certain personal physical injury claims, of which workers’ compensation claims comprise a significant portion. In cases where the Company did not receive a release from the claimant, the structured settlement is included in reinsurance recoverables and the related claim cost is included in the liability for claims and claim adjustment expense reserves, as the Company retains the contingent liability to the claimant. If it is expected that the life insurance company is not able to pay, the Company would recognize an impairment of the related reinsurance recoverable if, and to the extent, the purchased annuities are not covered by state guaranty associations. In the event that the life insurance company fails to make the required annuity payments, the Company would be required to make such payments.
Reinsurance recoverables include amounts recoverable on both paid and unpaid claims and claim adjustment expenses and were as follows:
The deductible for any calendar year is equal to 20% of the insurer’s direct earned premiums for covered lines for the preceding calendar year. The Company’s estimated deductible under the program is $2.61 billion for 2020. The annual cap limits the amount
Amortization expense of intangible assets was $15 million, $17 million and $13 million for the years ended December 31, 2019, 2018 and 2017, respectively. Amortization expense for all intangible assets subject to amortization is estimated to be $15 million in 2020, $14 million in 2021, $13 million in 2022, $12 million in 2023 and $12 million in 2024. Amortization expense for intangible assets arising from insurance contracts acquired in a business combination is estimated to be $5 million in 2020, $4 million in 2021, $3 million in 2022, $3 million in 2023 and $2 million in 2024.
Reinsurance recoverables on unpaid losses at December 31, 2019 decreased by $147 million from December 31, 2018, primarily reflecting a decrease in recoverables related to mandatory pools and associations. Reinsurance recoverables on unpaid losses at December 31, 2018 increased by $59 million over December 31, 2017, primarily reflecting the 2018 impacts of catastrophe losses and the asbestos reserve increase, partially offset by cash collections.
of reorganization is not confirmed by June 30, 2020. Due to the risks and uncertainties associated with the PG&E bankruptcy and other factors, the Company has not yet recognized a subrogation benefit related to these claims.
Included in the claims and claim adjustment expense reserves are reserves for long-term disability and annuity claim payments, primarily arising from workers’ compensation insurance and workers’ compensation excess insurance policies, that are discounted to the present value of the estimated future payments. The discount rates used were a range of 3.5% to 5.0% at December 31, 2019 and 5.0% at December 31, 2018. Total reserves net of the discount were $2.48 billion and $2.45 billion, and the related amount of discount was $1.16 billion and $1.16 billion, at December 31, 2019 and 2018, respectively. Accretion of the discount is reported as part of “claims and claim adjustment expenses” in the consolidated statement of income and was $49 million, $49 million and $50 million in 2019, 2018 and 2017, respectively.
In 2019, estimated claims and claim adjustment expenses incurred included $164 million of net unfavorable development for claims arising in prior years, including $60 million of net unfavorable prior year reserve development and $49 million of accretion of discount that impacted the Company's results of operations.
Commercial automobile - higher than expected loss experience in the segment's domestic operations for recent accident years;
Environmental reserves - an increase of $76 million, primarily in the segment's domestic general liability product line,
Commercial property - better than expected loss experience in the segment's domestic operations for recent accident years.
Bond & Specialty Insurance. Net favorable prior year reserve development in 2019 totaled $65 million, primarily driven by better than expected loss experience in the segment's domestic operations in the general liability product line for management liability coverages and in the fidelity and surety product line for multiple accident years.
Workers' compensation - better than expected loss experience in the segment’s domestic operations for multiple accident years; and
General liability (excluding asbestos and environmental) - higher than expected loss experience in the segment's domestic operations for both primary and excess coverages for multiple accident years; and
Workers' compensation - better than expected loss experience in the segment's domestic operations for multiple accident years;
Commercial multi-peril - better than expected loss experience for liability coverages for multiple accident years,
Asbestos reserves - an increase of $225 million, primarily in the segment's domestic general liability product line;
Environmental reserves - an increase of $65 million, primarily in the segment's domestic general liability product line; and
The following is a summary of claims and claim adjustment expense reserves, including certain components, for the Company’s major product lines by reporting segment at December 31, 2019.
Net discount amount includes discount of $67 million on reinsurance recoverables for long-term disability and annuity claim payments.
Includes structured settlements in cases where the Company did not receive a release from the claimant.
The incurred and paid amounts have been translated from the local currency to U.S. dollars using the December 31, 2019 spot rate for all years presented in the table above in order to isolate changes in foreign exchange rates from loss development.
Asbestos Reserves. Because each policyholder presents different liability and coverage issues, the Company generally reviews the exposure presented by each policyholder at least annually. Among the factors which the Company may consider in the course of this review are: available insurance coverage, including the role of any umbrella or excess insurance the Company has issued to the policyholder; limits and deductibles; an analysis of the policyholder’s potential liability; the jurisdictions involved; past and anticipated future claim activity and loss development on pending claims; past settlement values of similar claims; allocated claim adjustment expense; the potential role of other insurance; the role, if any, of non-asbestos claims or potential non-asbestos claims in any resolution process; and applicable coverage defenses or determinations, if any, including the determination as to whether or not an asbestos claim is a products/completed operation claim subject to an aggregate limit and the available coverage, if any, for that claim.
2018 Debt Issuance. On March 7, 2018, the Company issued $500 million aggregate principal amount of 4.05% senior notes that will mature on March 7, 2048. The net proceeds of the issuance, after the deduction of the underwriting discount and expenses payable by the Company, totaled approximately $491 million. Interest on the senior notes is payable semi-annually in arrears on March 7 and September 7. Prior to September 7, 2047, the senior notes may be redeemed, in whole or in part, at the Company’s option, at any time or from time to time, at a redemption price equal to the greater of (a) 100% of the principal amount of any senior notes to be redeemed or (b) the sum of the present values of the remaining scheduled payments of principal and interest to but excluding September 7, 2047 on any senior notes to be redeemed (exclusive of interest accrued to the date of redemption) discounted to the date of redemption on a semi-annual basis (assuming a 360-day year consisting of twelve 30-day months) at the then current Treasury rate (as defined in the senior notes), plus 15 basis points. On or after September 7, 2047, the senior notes may be redeemed, in whole or in part, at the Company’s option, at any time or from time to time, at a redemption price equal to 100% of the principal amount of any senior notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date.
Senior Notes-The Company’s various senior debt issues are unsecured obligations that rank equally with one another. Interest payments are made semi-annually. The Company generally may redeem some or all of the notes prior to maturity in accordance with terms unique to each debt instrument.
The Company’s consolidated balance sheet includes the debt instruments acquired in a business acquisition, which were recorded at fair value as of the acquisition date. The resulting fair value adjustment is being amortized over the remaining life of the respective debt instruments using the effective-interest method. The amortization of the fair value adjustment reduced interest expense by $1 million and $2 million for the years ended December 31, 2019 and 2018, respectively.
The Travelers Companies, Inc. fully and unconditionally guarantees the payment of all principal, premiums, if any, and interest on certain debt obligations of its subsidiaries Travelers Property Casualty Corp. and Travelers Insurance Group Holdings, Inc. The guarantees pertain to the $200 million 7.75% notes due 2026 and the $500 million 6.375% notes due 2033.
The Company is party to a five-year, $1.0 billion revolving credit agreement with a syndicate of financial institutions that expires on June 4, 2023. Pursuant to the credit agreement covenants, the Company must maintain a minimum consolidated net worth, defined as shareholders’ equity determined in accordance with GAAP (excluding accumulated other comprehensive income (loss)) plus (a) trust preferred securities (not to exceed 15% of total capital) and (b) mandatorily convertible securities (combined with trust preferred securities, not to exceed 25% of total capital) less goodwill and other intangible assets. The threshold is adjusted downward by an amount equal to 70% of the aggregate amount of common stock repurchased by the Company after March 31, 2018, up to a maximum deduction of $1.75 billion. The threshold was $12.55 billion at December 31, 2019 and could decline to a minimum of $12.494 billion during the term of the credit agreement, subject to the Company repurchasing an additional $80 million of its common stock. In addition, the credit agreement contains other customary restrictive covenants as well as certain customary events of default, including with respect to a change in control, which is defined to include the acquisition of 35% or more of the Company’s voting stock and certain changes in the composition of the Company’s Board of Directors. At December 31, 2019, the Company was in compliance with these covenants. Generally, the cost of borrowing under this agreement will range from LIBOR plus 75 basis points to LIBOR plus 137.5 basis points, depending on the Company’s credit ratings. At December 31, 2019, that cost would have been LIBOR plus 100 basis points, had there been any amounts outstanding under the credit agreement. In the event that LIBOR is no longer available, the credit agreement provides that the Company and the syndicate of financial institutions use commercially reasonable efforts to jointly agree upon an alternate rate of interest.
The Company has a shelf registration statement filed with the Securities and Exchange Commission that expires on June 10, 2022 which permits it to issue securities from time to time at prices and on other terms to be determined at the time of offering.
Common shares acquired are reported as treasury stock in the consolidated balance sheet.
TRV is not dependent on dividends or other forms of repatriation from its foreign operations to support its liquidity needs. The undistributed earnings of the Company’s foreign operations are intended to be permanently reinvested in those operations, and such earnings were not material to the Company's financial position or liquidity at December 31, 2019.
For the years ended December 31, 2019, 2018 and 2017, TRV declared cash dividends per common share of $3.23, $3.03 and $2.83, respectively, and paid cash dividends of $844 million, $814 million and $785 million, respectively.
Statutory net income of the Company’s domestic and international insurance subsidiaries was $2.74 billion, $2.61 billion and $2.30 billion for the years ended December 31, 2019, 2018 and 2017, respectively. Statutory capital and surplus of the Company’s domestic and international insurance subsidiaries was $21.33 billion and $20.77 billion at December 31, 2019 and 2018, respectively.
The following table presents the changes in the Company’s accumulated other comprehensive income (AOCI) for the years ended December 31, 2019, 2018 and 2017.
(Increases) decreases income tax expense on the consolidated statement of income.
The U.S. Treasury issued final regulations for the tax discounting of loss reserves that became effective in June 2019. The final regulations did not materially impact the Company’s amounts payable related to the transition rules for discounting loss reserves.
During the fourth quarter of 2017, the Company recorded provisional amounts for the tax imposed on accumulated foreign earnings and partnership investments, as well as the amount due under the transition rule relating to the change in discounting of claims incurred, based on information available at December 31, 2017. In 2018, the Company made minor adjustments to the provisional amounts for taxes related to accumulated foreign earnings based upon final earnings from its foreign operations and the proposed
regulations issued by the U.S. Treasury. These minor adjustments were consistent with final regulations issued by the U.S. Treasury in January 2019. The Company also made minor adjustments to the provisional amount for taxes related to partnership investments based upon the latest available information associated with those investments (Form K-1s) that were received in 2018 and 2019.
If the Company determines that any of its deferred tax assets will not result in future tax benefits, a valuation allowance must be established for the portion of these assets that are not expected to be realized. The net change in the valuation allowance for deferred tax assets was an increase of $19 million in 2019, $16 million relating to the Company's Republic of Ireland subsidiary, $2 million relating to the Company's consolidated Brazilian subsidiary and $1 million relating to the Company's Canadian subsidiary. Based upon a review of the Company’s anticipated future taxable income, and also including all other available evidence, both positive and negative, the Company’s management concluded that it is more likely than not that the net deferred tax assets will be realized.
The IRS is conducting an examination of the Company’s U.S. income tax returns for 2017 and 2018. The Company does not expect any significant changes to its liability for unrecognized tax benefits during the next twelve months.
The number of shares of the Company’s common stock initially authorized for grant under the 2014 Incentive Plan was 10 million shares. In May 2019, 2017 and 2016, the Company’s shareholders authorized an additional 3.1 million, 2.5 million and 4.4 million shares of the Company’s common stock, respectively, for grant under the 2014 Incentive Plan. The following are not counted towards the combined 20.0 million shares available and will be available for future grants under the 2014 Incentive Plan: (i) shares of common stock subject to awards that expire unexercised, that are forfeited, terminated or canceled, that are settled in cash or other forms of property, or otherwise do not result in the issuance of shares of common stock, in whole or in part; (ii) shares that are used to pay the exercise price of stock options and shares used to pay withholding taxes on awards generally; and (iii) shares purchased by the Company on the open market using cash option exercise proceeds; provided, however, that the increase in the number of shares of common stock available for grant pursuant to such market purchases shall not be greater than the number that could be repurchased at fair market value on the date of exercise of the stock option giving rise to such option proceeds. In addition, the 20.0 million shares authorized by shareholders for issuance under the 2014 Incentive Plan will be increased by any shares subject to awards under the 2004 Incentive Plan that were outstanding as of May 27, 2014 and subsequently expire, are forfeited, canceled, settled in cash or otherwise terminate without the issuance of shares.
A summary of stock option activity under the 2014 Incentive Plan and the legacy plans as of and for the year ended December 31, 2019 is as follows:
Represents awards for which the requisite service has been rendered, including those that are retirement eligible.
On February 4, 2020, the Company, under the 2014 Incentive Plan, granted 2,474,036 stock option awards with an exercise price of $132.58 per share. The fair value attributable to the stock option awards on the date of grant was $14.41 per share.
upon the Company attaining the relevant performance period minimum threshold return on equity and the recipient meeting certain years of service criteria, generally three years for full vesting, subject to proration for certain termination conditions. If the performance period return on equity is below the minimum threshold, none of the performance shares will vest. If performance meets or exceeds the minimum performance threshold, a range of performance shares will vest (50% to 150% for awards granted in 2018, 2019 and 2020), depending on the actual return on equity attained.
The total fair value of shares that vested during the years ended December 31, 2019, 2018 and 2017 was $130 million, $135 million and $166 million, respectively.
A summary of restricted stock units, deferred stock units and performance share activity under the 2014 Incentive Plan and the legacy plans as of and for the year ended December 31, 2019 is as follows:
Reflects the number of performance shares attributable to the performance goals attained over the completed performance period (three years) and for which service conditions have been met.
Represents the current year change in estimated performance shares to reflect the attainment of performance goals for the awards that were granted in each of the years 2017 through 2019.
95,953 shares of restricted common stock were also issued outside of the 2014 Incentive Plan in 2017 in connection with the acquisition of Simply Business, of which 41,997 shares remain unvested and are not included in this table. See note 9.
The Company sponsors a qualified non-contributory defined benefit pension plan (the qualified domestic pension plan), which covers substantially all U.S. domestic employees and provides benefits under a cash balance formula, except that certain limited groups of legacy participants are covered by a prior traditional final average pay formula. In addition, the Company sponsors a nonqualified defined benefit pension plan which covers certain highly-compensated employees, pension plans for employees of its foreign subsidiaries, and a postretirement health and life insurance benefit plan for employees satisfying certain age and service requirements and for certain retirees.
The $451 million actuarial loss experienced in 2019 for the qualified domestic pension plan was largely driven by the decrease in the assumed discount rate from the prior year that was used to determine the projected benefit obligation at December 31, 2019. The $273 million actuarial gain experienced in 2018 for the qualified domestic pension plan was largely driven by the increase in the assumed discount rate from the prior year that was used to determine the projected benefit obligation at December 31, 2018.
The following table indicates the line items in which the respective service costs and non-service cost (benefit) are presented in the consolidated statement of income for the years ended December 31, 2019, 2018 and 2017.
The Company’s overall investment strategy is to achieve a mix of approximately 35% to 65% of investments for long-term growth and 35% to 65% for near-term insurance payments with a wide diversification of asset types, fund strategies and fund managers. The current target allocations for plan assets are 25% to 75% fixed income securities, with the remainder allocated to short-term securities. Fixed income securities include corporate bonds of companies from diversified industries, mortgage-backed securities and U.S. Treasuries.
The Company’s other postretirement benefit plans had financial assets of $12 million at both December 31, 2019 and 2018, which are measured at fair value on a recurring basis. The assets are primarily corporate bonds, which are categorized as level 2 in the fair value hierarchy.
The Company enters into lease agreements for real estate that is primarily used for office space in the ordinary course of business. These leases are accounted for as operating leases, whereby lease expense is recognized on a straight-line basis over the term of the lease. See note 1-Adoption of Accounting Standards-Leases for additional information regarding the accounting for leases.
Lease expense is included in general and administrative expenses in the consolidated statement of income. Additional information regarding the Company’s real estate operating leases is as follows:
Lease expense was $185 million and $188 million, respectively, for the years ended December 31, 2018 and 2017 for real estate and other operating leases.
In the ordinary course of its insurance business, the Company has received and continues to receive claims for insurance arising under policies issued by the Company asserting alleged injuries and damages from asbestos- and environmental-related exposures
that are the subject of related coverage litigation. The Company is defending asbestos- and environmental-related litigation vigorously and believes that it has meritorious defenses; however, the outcomes of these disputes are uncertain. In this regard, the Company employs dedicated specialists and comprehensive resolution strategies to manage asbestos and environmental loss exposure, including settling litigation under appropriate circumstances. Currently, it is not possible to predict legal outcomes and their impact on future loss development for claims and litigation relating to asbestos and environmental claims. Any such development could be affected by future court decisions and interpretations, as well as future changes, if any, in applicable legislation. Because of these uncertainties, additional liabilities may arise for amounts in excess of the Company’s current insurance reserves. In addition, the Company’s estimate of ultimate claims and claim adjustment expenses may change. These additional liabilities or changes in estimates, or a range of either, cannot now be reasonably estimated and could result in income statement charges that could be material to the Company’s results of operations in future periods.
Investment Commitments - The Company has unfunded commitments to private equity limited partnerships and real estate partnerships in which it invests. These commitments totaled $1.66 billion and $1.60 billion at December 31, 2019 and 2018, respectively.
Total other-than-temporary impairments (OTTI) for the year ended December 31, 2017, and the amounts comprising total OTTI that were recognized in net realized investment gains and in other comprehensive income (OCI), were as follows: