We own six buildings and related parking facilities in Cedar Rapids, Iowa. Three buildings are used as our corporate headquarters, and three buildings are available to commercial tenants as leased office space. Our corporate headquarters includes: a five-story office building, a two-story office building and an eight-story office building in which a portion of the first floor (approximately 6.0 percent of the building's square footage) is leased to tenants. In December 2013, we acquired a three-building commercial real estate complex immediately adjacent to our corporate headquarters. This complex includes a three-story office building, a ten-story office building and a one-story office building which are available for lease to commercial tenants (approximately 39.0 percent of the complex's square footage is leased). In December 2014, we entered into a two-year lease for approximately 24,664 square feet of office space in a building across the street from our corporate headquarters. This space will be used by certain of our administrative and property and casualty operations personnel while portions of our corporate headquarters buildings are undergoing renovation. All seven buildings are connected by a skywalk system. We also own a 250-space parking ramp for use by our employees which is located adjacent to our corporate headquarters.
Our other three regional office locations in Los Angeles, California, Westminster, Colorado, and Webster, Texas, and our claims office in Metairie, Louisiana, conduct operations in leased office space.
The following table shows a brief description of our owned and leased office space as of December 31, 2014. We believe our current facilities are adequate to meet our needs with additional space available for future expansion, if necessary, at each of our owned and leased facilities:
In 2012, we adopted new deferred policy acquisition cost accounting guidance on a prospective basis. As a result of the adoption, the amount of underwriting expenses eligible for deferral has decreased.
It is important to note that our actual results could differ materially from those projected in forward-looking statements. Information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in "Forward-Looking Information" and Part I, Item 1A, "Risk Factors" of this report.
For 2014, approximately 49.5 percent of our property and casualty direct written premiums were written in Texas, Iowa, California, New Jersey, and Missouri; approximately 77.9 percent of our life insurance premiums were written in Iowa, Wisconsin, Minnesota, Illinois and Nebraska.
Catastrophe losses is a commonly used non-GAAP financial measure, which utilizes the designations of the Insurance Services Office (ISO) and are reported with losses and loss settlement expense amounts net of reinsurance recoverables, unless specified otherwise. According to the ISO, a catastrophe loss is defined as a single unpredictable incident or series of closely related incidents that result in $25.0 million or more in U.S. industry-wide direct insured losses to property and that affect a significant number of insureds and insurers ("ISO catastrophe"). In addition to ISO catastrophes, we also include as catastrophes those events ("non-ISO catastrophes"), which may include U.S. or international losses, that we believe are, or will be, material to our operations, either in amount or in number of claims made. Management, at times, may determine for comparison purposes that it is more meaningful to exclude extraordinary catastrophe losses and resulting litigation. The frequency and severity of catastrophic losses we experience in any year affect our results of operations and financial position. In analyzing the underwriting performance of our property and casualty insurance segment, we evaluate performance both including and excluding catastrophe losses. Portions of our catastrophe losses may be recoverable under our catastrophe reinsurance agreements. We include a discussion of the impact of catastrophes because we believe it is meaningful for investors to understand the variability in our periodic earnings.
In 2014, the decrease in net income was driven by an increase in losses and loss settlement expenses offset by an increase in property and casualty premium revenue. The increase in losses and loss settlement expenses is primarily attributable to an increase in catastrophe losses from spring and summer convective storms in regions of the U.S. where we conduct much of our business and an increase in frequency and severity in fire-related losses in our commercial property line of business. The increase in property and casualty premium revenue represents organic growth and is the result of a combination of rate increases across most commercial and personal lines and, to a lesser extent, new business writings.
During 2013, the increase in net income was driven by growth in property and casualty premium revenue and a reduction in the combined ratio. Net premiums earned increased to $754.8 million compared to $695.0 million in 2012. This increase represents organic growth and is the result of a combination of rate increases across most commercial and personal lines and new business writings. The reduction in the combined ratio resulted from lower catastrophe losses.
In 2013, we continued to expand the geographical footprint of our life insurance subsidiary by receiving approval to operate in Nevada, after receiving approval in 2012 to operate in California, Maryland and Delaware, further leveraging the Mercer Insurance Group acquisition. Our life management team continues to improve service to our agents by increasing marketing support and automating life product processes.
At a special meeting held on January 24, 2012, our shareholders approved our reorganization into a new holding company structure. United Fire Group, Inc. has replaced United Fire & Casualty Company as the publicly held
(2) The GAAP expense ratio is calculated by dividing nondeferred underwriting expenses and amortization of deferred policy acquisition costs by net premiums earned. The expense ratio measures a company's operational efficiency in producing, underwriting and administering its insurance business. The statutory expense ratio is calculated in a similar fashion as GAAP but uses net premiums written instead of net premiums earned.
Direct premiums written increased $84.0 million in 2014 as compared to 2013 due to organic growth and is the result of a combination of rate increases across most commercial and personal lines and, to a lesser extent, new business writings.
Direct premiums written increased $72.2 million in 2013 as compared to 2012 due to organic growth and is the result of a combination of rate increases across most commercial and personal lines and new business writings.
Our 2012 losses included Super Storm Sandy, which occurred in October 2012 and represented $25.0 million ($20.0 million direct and $5.0 million assumed) of incurred losses, and 26 other catastrophes, where our largest single pre-tax catastrophe loss totaled $12.3 million.
The following table represents the primary reinsurers we utilize and their financial strength ratings as of December 31, 2014:
In 2012 we experienced favorable reserve development of $73.4 million for reserves established for claims that occurred in prior years. The majority of this favorable development is related to our long-tail lines of commercial business including other liability, workers' compensation and auto liability.
The following table depicts our net loss ratios for 2014, 2013 and 2012:
The net loss ratio in our commercial lines of business, excluding assumed reinsurance, was 64.7 percent in 2014 compared to 62.7 percent in 2013 and 66.5 percent in 2012. The deterioration in 2014 as compared to 2013 was primarily the result of an increase in catastrophe losses from spring and summer storms in regions of the U.S where we conduct much of our business and an increase in frequency and severity in fire-related losses in our commercial property line of business partially offset by an improvement in the loss ratio for workers' compensation and commercial automobile.
The improvement in 2013 as compared to 2012 was primarily the result of an increase in net premiums earned and a reduction in catastrophe losses.
Construction defect claims generally relate to allegedly defective work performed in the construction of structures such as apartments, condominiums, single family dwellings or other housing, as well as the sale of defective building materials. Such claims seek recovery due to damage caused by alleged deficient construction techniques or workmanship. The reporting of such claims can be quite delayed due to an extended statute of limitations, sometimes up to ten years. Court decisions have expanded insurers' exposure to construction defect claims as well. Defense costs are also a part of the insured expenses covered by liability policies and can be significant, sometimes greater than the cost of the actual paid claims.
Our commercial automobile insurance covers physical damage to an insured's vehicle, as well as liabilities to third parties. Automobile physical damage insurance covers loss or damage to vehicles from collision, vandalism, fire, theft, flood or other causes. Automobile liability insurance covers bodily injury, damage to property resulting from automobile accidents caused by the insured, uninsured or underinsured motorists and the legal costs of defending the insured against lawsuits. The improvement in our commercial automobile insurance line in 2014 as compared to 2013 was primarily due to favorable results from loss control and re-underwriting initiatives which focused on under-performing accounts and agents. The deterioration in our commercial automobile insurance line in 2013 as compared to 2012 was the result of an increase in claim frequency.
During 2014 and 2013, there were no claims that exceeded our $1.5 million reinsurance retention level. During 2012, there was one claim that exceeded our $1.5 million reinsurance retention level.
Our personal lines consist primarily of fire and allied lines (including homeowners) and automobile lines. In 2014, the net loss ratio increased 16.7 percentage points compared to 2013. The change was primarily due to catastrophe loss experience from spring and summer storms in the U.S. in 2014. In 2013, catastrophe activity decreased resulting in a decrease in the net loss ratio as compared to 2012. Rate increases in the fire and allied lines are the primary driver of the increased premiums while retention remained relatively unchanged.
We will continue pursuing opportunities to grow our personal lines business in the future. We have added within our CATography™ Underwriter tool the ability to determine whether the premium we charge for an exposure is adequate in areas where hurricanes and earthquakes occur. We have also implemented predicative analytics and data prefill for our personal automobile line. Data prefill is a data accessing methodology that allows for a more complete profile of our customers at the agent's point of sale during the quotation process. We also plan to implement predictive analytics and data prefill for our homeowners line.
Our assumed reinsurance is the business we choose to write by participating in programs insuring insurance companies. The net loss ratio deterioration in 2014 was due to a combination of an increase in catastrophe losses and from an increase in frequency and severity in fire-related losses. The net loss ratio improvement in 2013 was driven by a decrease in catastrophe losses. The net loss ratio in 2012 was impacted by catastrophe losses associated with Super Storm Sandy as well as the adverse reserve development from Thailand floods.
In 2013, we renewed our participation in all but one of our assumed programs and added two new programs to our portfolio. Losses and loss settlement expenses assumed decreased in 2013 as compared to 2012 primarily due to a decrease in catastrophe losses. We added two new programs to replace the lost premium from the program not renewed and to take advantage of areas where we had exposure capacity. One of the new programs has worldwide exposure and the other has exposure in the United Kingdom and Japan.
Our underwriting expense ratio, which is a percentage of other underwriting expenses over net premiums earned, was 31.3 percent, 31.8 percent and 31.4 percent for 2014, 2013, and 2012, respectively. The decrease in the underwriting expense ratio in 2014 was primarily due to a decrease in employee compensation and employee benefit costs offset slightly by a decrease in underwriting expenses eligible for deferral due to a deterioration in the profitability of certain lines of business caused by an increase in claims severity. The increase in the underwriting expense ratio in 2013 was primarily driven by an increase in employee benefit costs and an increase in contingent commission expenses.
United Life Insurance Company underwrites all of our life insurance business. Our principal life insurance products are deferred and immediate annuities, universal life products and traditional life (primarily single premium whole life insurance) products. We also underwrite and market other traditional products, including term life insurance and whole life insurance. Deferred and immediate annuities (72.8 percent), traditional life products (19.4 percent), universal life products (6.8 percent), and other life products (1.0 percent) comprised our 2014 life insurance premium revenues, as determined on the basis of statutory accounting principles. We do not write variable annuities or variable insurance products.
Amortization of deferred policy acquisition costs decreased 5.6 percent in 2014 as compared to 2013 primarily as a result of lower sales and fewer costs being deferred.
Deferred annuity deposits increased 34.0 percent in 2014, as compared to 2013, due to crediting rate increases which occurred in the latter half of 2013. Deferred annuity deposits decreased 24.8 percent in 2013 as compared to 2012 as we lowered the credited rate offered during the low interest rate environment.
Net cash outflow related to the Company's annuity business was $77.7 million in 2014 and 2013, respectively, compared to a net cash outflow of $42.3 million in 2012. This result is attributed to the activity described previously.
As of December 31, 2014, we had a net operating loss ("NOL") carryforward of $6.3 million, which is due to our purchase of American Indemnity Financial Corporation in 1999. No NOLs will expire in 2015.
Due to our determination that we may not be able to fully realize the benefits of the NOLs acquired in the purchase of American Indemnity Financial Corporation, which are only available to offset the future taxable income of our property and casualty insurance operations and are further limited as to the amount that can be utilized in any given year, we have recorded a valuation allowance against these NOLs that totaled $1.8 million at December 31, 2014. Based on a yearly review, we determine whether the benefit of the NOLs can be realized, and, if so, the decrease in the valuation allowance is recorded as a reduction to current federal income tax expense. If NOLs expire during the year, the decrease in the valuation allowance is offset with a corresponding decrease to the deferred income tax asset. The valuation allowance was reduced by $0.5 million in 2014 due to the realization of $1.6 million in NOLs.
As of December 31, 2014, we had no alternative minimum tax ("AMT") credit carryforwards.
Interest rate volatility increased, the U.S. yield curve flattened, and longer maturity treasury rates fell consistently throughout 2014. The U.S. 30-year bond returned over 29 percentage points and, with the yield declining from 3.97 percent to 2.96 percent, helped most fixed income sectors produce solid returns for the year. That said, U.S. economic performance was positive overall, particularly in the areas of job creation with an overall decrease in the unemployment rate and an increase in output. U.S. energy production grew significantly for most of 2014, which helped boost consumer sentiment and domestic production of goods and services year-over-year. Annualized U.S. Gross Domestic Product ("GDP") increased to 2.6 percent in 2014. The Federal Reserve (the "FED") ended its latest bond buying program in October 2014 as planned, and began the process of policy normalization. All-in-all however, weaker foreign economies, lower inflation and global easing were too much to overcome and government yields fell during the year. Corporate default rates hovered near cyclical lows, although there has been an uptick in downgrades and defaults in the leveraged energy space due to the collapse in oil prices that occurred during the second half of 2014. Aside from the oil and gas industry, risk premiums fell across most fixed income asset classes with spreads declining due to a very strong demand for yield. Finally, equity investors remained bullish enough on U.S. stocks to produce annual double-digit returns once again. Market consensus now is that rates will stay low, and the investment environment remains dominated by central banks aggressively fighting disinflation and sluggish real growth.
The Company's assets are invested to meet liquidity needs and maximize after-tax returns while maintaining an appropriate balance of risk. The return on our portfolio is an important component of overall financial results, but quality and safety of principal is the highest priority of our investment program. Our general investment philosophy is to purchase financial instruments with the expectation that we will hold them to their maturity. However, active management of our available-for-sale portfolio is considered necessary to achieve portfolio objectives and maximize risk-adjusted returns as market conditions change.
At December 31, 2014, we classified $2.8 billion, or 99.4 percent, of our fixed maturities portfolio as available-for-sale, compared to $2.8 billion, or 99.6 percent, at December 31, 2013. Available-for-sale securities are carried at fair value, with changes in fair value recognized as a component of accumulated other comprehensive income in stockholders' equity. We classify our remaining fixed maturities as held-to-maturity or trading. We record held-to-maturity securities at amortized cost. We record trading securities, primarily convertible redeemable preferred debt securities, at fair value, with any changes in fair value recognized in earnings.
The following table shows the composition of fixed maturity securities held in our available-for-sale, held-to-maturity and trading security portfolios, by credit rating at December 31, 2014 and 2013. Information contained in the table is generally based upon the issue credit ratings provided by Moody's, unless the rating is unavailable, in which case we obtain it from Standard & Poor's.
The weighted average effective duration of our portfolio of fixed maturity securities, at December 31, 2014 and 2013 was 5.0 years.
The weighted average effective duration of our portfolio of fixed maturity securities was 4.8 years at December 31, 2014 compared to 4.9 years at December 31, 2013.
In 2013, our investment income, net of investment expenses, increased $0.9 million to $112.8 million as compared to 2012, primarily due to an increase in value of investments that are accounted for under the equity method of accounting partially offset by the impact of low investment yields.
In 2014, 2013 and 2012, we reported net realized investment gains of $7.3 million, $8.7 million and $5.5 million, respectively. The following table summarizes the components of our net realized investment gains or losses:
In addition to investment income, possible sales of investments and proceeds from calls or maturities of fixed maturity securities also can provide liquidity. During the next five years, $1.1 billion, or 37.1 percent of our fixed maturity portfolio will mature.
During 2014, 2013 and 2012, pursuant to authorization by our Board of Directors, we repurchased 461,835; 59,603; and 340,159 shares of our common stock respectively, which used cash totaling $12.9 million in 2014, $1.6 million in 2013 and $7.3 million in 2012. At December 31, 2014, we were authorized to purchase an additional 1,608,282 shares of our common stock under our share repurchase program, which expires in August 2016.
The NAIC adopted risk-based capital requirements, which requires us to calculate a minimum capital requirement for each of our insurance companies based on individual company insurance risk factors. These "risk-based capital" results are used by state insurance regulators to identify companies that require regulatory attention or the initiation of regulatory action. At December 31, 2014, all of our insurance companies had capital well in excess of required levels.
This projection of our obligation for future policy benefits considers only actual future cash outflows. The future policy benefit reserves presented on the Consolidated Balance Sheets is the net present value of the benefits to be paid, less the net present value of future net premiums.
beneficiary to receive the benefit under the policy. Depending on the terms of a particular policy, future premiums from the policyholder may be required for the policy to remain in force. In contrast, the future policy benefit reserves for our life insurance segment presented on the Consolidated Balance Sheets are generally based on historical assumptions for mortality and policy lapse rates and are on a discounted basis. Accordingly, the amounts presented above for future policy benefit reserves significantly exceeds the amount of future policy benefit reserves reported on our Consolidated Balance Sheets at December 31, 2014.
We estimated the pension contribution for 2015 in accordance with the Pension Protection Act of 2006 (the "Act"). Contributions for future years are dependent on a number of factors, including actual performance versus assumptions made at the time of the actuarial valuations and maintaining certain funding levels relative to regulatory requirements. Contributions in 2015, and in future years, are expected to be at least equal to the IRS minimum required contribution in accordance with the Act.
Critical accounting policies are defined as those that are representative of significant judgments and uncertainties and that may potentially result in materially different results under different assumptions and conditions. We base our discussion and analysis of our results of operations and financial condition on the amounts reported in our Consolidated Financial Statements, which we have prepared in accordance with GAAP. As we prepare these Consolidated Financial Statements, we must make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses for the reporting period. We evaluate our estimates on an ongoing basis. We base our estimates on historical experience and on other assumptions we believe to be reasonable under the circumstances. Actual results could differ from those estimates. We believe our most critical accounting policies are as follows.
We value our available-for-sale fixed maturity, trading securities, equity securities, short-term investments and money market accounts at fair value in accordance with the current accounting guidance on fair value measurements. We exclude unrealized appreciation or depreciation on investments carried at fair value, with the exception of trading securities, from net income, and report it, net of applicable deferred income taxes, as a component of accumulated other comprehensive income in stockholders' equity.
Level 2: Valuations are based on quoted prices for similar financial instruments, other than quoted prices included in Level 1, in markets that are not active or on inputs that are observable either directly or indirectly for the full term of the financial instrument.
The fair value of securities that are categorized as Level 2 is determined by management after reviewing fair values obtained from independent pricing services and brokers. These fair values are corroborated by other market observable data. Such estimated fair values do not necessarily represent the values for which these securities could have been sold at the reporting date.
We record an asset for certain costs of underwriting new business, primarily commissions, premium taxes and variable underwriting and policy issue expenses that have been deferred. The amount of underwriting compensation expense eligible for deferral is based on time studies and a ratio of success in policy placement. At December 31, 2014 and 2013, our DAC asset was $72.9 million and $67.7 million, respectively.
To calculate the premium deficiency charge by line of business, we estimate an expected loss and loss settlement expense ratio which is based on our best estimate of future losses for each line of business. Shock losses and large catastrophe losses not expected to continue in the future are excluded from this analysis. This calculation is performed on a quarterly basis. The expected loss and loss settlement expense ratios are the only assumptions we utilize in our premium deficiency calculation. Changes in these assumptions can have a significant impact on the amount of premium deficiency charge recognized for a line of business.
We defer and amortize policy acquisition costs on traditional life insurance policies over the premium-paying period in proportion to the ratio of the expected annual premium revenue to the expected total premium revenue. Expected annual premium revenue and gross profits are based on the same mortality and withdrawal assumptions used in determining future policy benefits. These assumptions are not revised after policy issuance unless the recorded DAC asset is deemed to be unrecoverable from future expected profits.
We defer policy acquisition costs related to non-traditional business and amortize these costs in proportion to the ratio of the expected annual gross profits to the expected total gross profits. The assumptions used to determine expected gross profits include interest rate spread, mortality experience, and expense margins and policy lapse experience. Of these factors, we anticipate that assumptions for investment returns, expenses and persistency are
earnings and financial position would be improved. We believe our reserving philosophy, coupled with what we believe to be aggressive and successful claims management and loss settlement practices, has resulted in year-to-year redundancies in reserves. We believe our approach produces recorded reserves that are reasonable as to their relative position within a range of reasonable reserves from year-to-year.
Due to the formula-based nature of our IBNR and loss settlement expense reserve calculations, changes in the key assumptions utilized to generate these reserves can result in a quantifiable impact on our reported results. It is not possible to isolate and measure the potential impact of just one of these factors, and future loss trends could be partially impacted by all factors concurrently. Nevertheless, it is meaningful to view the sensitivity of the reserves to potential changes in these variables. To demonstrate the sensitivity of reserves to changes in significant assumptions, the following example is presented. The amounts reflect the pre-tax impact on earnings from a hypothetical percentage change in the calculation of IBNR and loss settlement expense reserves at December 31, 2014. The impact to pre-tax earnings would be a decrease if the reserves were to be adjusted upwards and an increase if the reserves were to be adjusted downwards. We believe that the changes presented are reasonably likely based upon an analysis of our historical IBNR and loss settlement expense reserve experience.
Our reserve for other liability claims at December 31, 2014, is $474.4 million and consists of 5,610 claims, compared with $487.6 million, consisting of 5,592 claims at December 31, 2013. Of the $474.4 million total reserve for other liability claims, $158.3 million is identified as defense costs and $30.6 million is identified as general overhead required in the settlement of claims.
Included in the other liability and assumed reinsurance lines of business are reserves for asbestos and other environmental losses and loss settlement expenses. At December 31, 2014 and 2013, we had $5.0 million and $4.6 million, respectively, in direct and assumed asbestos and environmental loss reserves. The estimation of loss reserves for environmental claims and claims related to long-term exposure to asbestos and other substances is one of the most difficult aspects of establishing reserves, especially given the inherent uncertainties surrounding such claims. Although we record our best estimate of loss and loss settlement expense reserves, the ultimate amounts paid upon settlement of such claims may be more or less than the amount of the reserves, because of the significant uncertainties involved and the likelihood that these uncertainties will not be resolved for many years.
Like the other liability line of business, workers' compensation losses and loss settlement expense reserves are based upon variables that create imprecision in estimating the ultimate reserve. Estimates for workers' compensation are
We engage an independent actuarial firm to render an opinion as to the reasonableness of the statutory reserves internal management establishes. During 2014 and 2013, we engaged the services of Regnier Consulting Group, Inc.
It is management's policy to utilize staff adjusters to develop our estimate of case-basis loss reserves. IBNR and loss settlement expense reserves are established through various formulae that utilize pertinent, recent Company historical data. The calculations are supplemented with knowledge of current trends and events that could result in adjustments to the level of IBNR and loss settlement expense reserves. On a quarterly basis, we compare our estimate of total reserves to the estimates prepared by Regnier by line of business to ensure that our estimates are within the actuary's acceptable range. Regnier performs a review of loss and loss settlement expense reserves at each year end using generally accepted actuarial guidelines to ensure that the recorded reserves appear reasonable. Our net reserves for losses and loss settlement expenses as of December 31, 2014 and 2013 were $905.7 million and $885.5 million, respectively. In 2014 and 2013, after considering the independent actuary's range of reasonable estimates, management believes that carried reserves were reasonable and therefore did not adjust the recorded amount.
Future Policy Benefits and Losses, Claims and Loss Settlement Expenses - Life Insurance Segment
The following table reflects the estimated pre-tax impact to DAC, net of unearned revenue liabilities to our universal life and fixed annuity products that could occur in a twelve-month period because of an unlocking adjustment due to reasonably likely changes in significant assumptions. Changes in assumptions of the same magnitude in the opposite direction would have an impact of a similar magnitude but opposite direction of the examples provided.
We engage an independent actuarial firm to assist us in establishing our future policy benefit reserves for statutory and GAAP reporting and to render an opinion as to the reasonableness of the statutory reserves we establish. Statutory reserves are established using prescribed assumptions which are considerably more conservative assumptions regarding future investment earnings and contractual benefit payments than are used for GAAP reserves. During 2014 and 2013, we engaged the services of Griffith, Ballard and Company as our independent actuarial firm for the life insurance segment. We anticipate that this engagement will continue in 2015.
In addition, for the postretirement benefit plan, a 100 basis point decrease in the medical trend rate would decrease the postretirement benefit obligation at December 31, 2014, by $11.7 million, while a 100 basis point increase in the medical trend rate would increase the benefit obligation at December 31, 2014, by $14.7 million.
Departure of Chief Financial Officer; Appointment of Interim Principal Financial Officer
As previously disclosed, effective November 14, 2014, Dianne M. Lyons, our Senior Vice President and Chief Financial Officer, resigned and Kevin W. Helbing, our Assistant Vice President and Controller, assumed the position of Interim Principal Financial Officer. A search for Ms. Lyons' replacement is ongoing.
On February 1, 2012, United Fire & Casualty Company completed a corporate reorganization (the "Reorganization") that resulted in the creation of United Fire Group, Inc., an Iowa corporation, as the holding company and sole owner of United Fire & Casualty Company. In connection with the Reorganization, each share of United Fire & Casualty Company common stock (par value $3.33 1/3 per share) that was issued and outstanding immediately prior to the effective date was automatically converted into a share of United Fire Group, Inc. common stock (par value $0.001 per share). In addition, each outstanding option to purchase or other right to acquire shares of United Fire & Casualty Company common stock was automatically converted into an option to purchase or right to acquire, upon the same terms and conditions, an identical number of shares of United Fire Group, Inc. common stock. United Fire Group, Inc. became the publicly held corporation upon completion of the Reorganization.
We have accounted for the Reorganization as a merger of entities under common control, which is similar to the former "pooling of interests method" to account for business combinations. Accordingly, the accompanying Consolidated Financial Statements include the consolidated financial position and results of operations of United Fire & Casualty Company on the same basis as was historically presented, except that the amount reported for common stock at par value has been retrospectively restated to report the par value of United Fire Group, Inc. common stock. The resulting difference has been recorded in additional paid-in capital for all periods presented.
attorney-in-fact. The trust agreements also require the trustees to pay to United Fire & Indemnity Company all of the profits and benefits received by the trustees as underwriters of the Lloyds plan, which means that United Fire & Indemnity Company has the right to receive 100 percent of the gains and profits from the Lloyds plan. The trustees serve at the pleasure of United Fire & Indemnity Company, which may remove a trustee and replace that trustee at any time. Termination of a trustee must be accompanied by the resignation of the trustee as an underwriter, so that the trustee can obtain the capital contribution from the Lloyds plan to reimburse United Fire & Indemnity Company. By retaining the ability to terminate trustees, United Fire & Indemnity Company possesses the ability to name and remove the underwriters.
The accompanying Consolidated Financial Statements have been prepared on the basis of U.S. generally accepted accounting principles ("GAAP"), which differ in some respects from those followed in preparing our statutory reports to insurance regulatory authorities. Our stand-alone financial statements submitted to insurance regulatory authorities are presented on the basis of accounting practices prescribed or permitted by the insurance departments of the states in which we are domiciled ("statutory accounting principles").
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The financial statement categories that are most dependent on management estimates and assumptions include: investments; deferred policy acquisition costs; reinsurance receivables and recoverables (for net realizable value); future policy benefits and losses, claims and loss settlement expenses; and pension and postretirement benefit obligations.
universal life and deferred annuity policies (i.e., non-traditional business), income and expenses are reported when charged and credited to policyholder account balances in order to result in recognition of profits over the lives of the related contracts. We accomplish this by means of a provision for future policy benefits and the deferral and subsequent amortization of policy acquisition costs.
Liabilities for future policy benefits for traditional products are computed by the net level premium method, using interest assumptions ranging from 4.5 percent to 6.0 percent and withdrawal, mortality and morbidity assumptions appropriate at the time the policies were issued. Liabilities for non-traditional business are stated at policyholder account values before surrender charges. Liabilities for traditional immediate annuities are based primarily upon future anticipated cash flows using assumptions for mortality and interest rates. Liabilities for deferred annuities are carried at the account value.
Other long-term investments consist primarily of our interests in limited liability partnerships that are recorded on the equity method of accounting. Mortgage loans are recorded at their unpaid principal balance. Policy loans are recorded at the outstanding loan amount due from policyholders. Included in investments at December 31, 2014 and 2013, are securities on deposit with, or available to, various regulatory authorities as required by law, with fair values of $1,643,369 and $1,620,505, respectively.
In 2014, 2013, and 2012, we made payments for income taxes of $9,626, $13,628 and $11,920, respectively. In addition, we received federal tax refunds of $615, $8,744 and $15,798 in 2014, 2013 and 2012, respectively, that resulted from the utilization of our 2009 net operating losses and net capital losses in the carryback period. We made no interest payments in 2014 and 2013. In 2012, we made interest payments of $961. These payments exclude interest credited to policyholders' accounts.
We defer policy acquisition costs related to non-traditional business and amortize these costs in proportion to the ratio of the expected annual gross profits to the expected total gross profits. The assumptions used to determine expected gross profits include interest rate spread, mortality experience, expense margins and policy lapse experience. Of these factors, we anticipate that assumptions for investment returns, expenses and persistency are reasonably likely to have a significant impact on the rate of DAC amortization each year. Changes in the amount or timing of expected gross profits result in adjustments to the cumulative amortization of these costs. The effect on amortization of DAC for revisions to estimated gross profits is reported in earnings in the period the estimated gross profits are revised.
The effect on DAC that results from the assumed realization of unrealized gains (losses) on investments allocated to non-traditional life insurance business is recognized with an offset, or "shadow" DAC, to net unrealized investment appreciation as of the balance sheet date. The “shadow" DAC adjustment decreased the DAC asset by $13,383 and increased the DAC asset by $3,407 at December 31, 2014 and 2013, respectively.
Depreciation expense totaled $6,122, $4,391 and $5,440 for 2014, 2013 and 2012, respectively.
Goodwill and other intangible assets arise as a result of business combinations and consist of the excess of the fair value of consideration paid over the tangible assets acquired and liabilities assumed. We evaluate goodwill and other intangible assets for impairment at least on an annual basis or whenever events or changes in circumstances indicate that it is more likely than not that the carrying amount of goodwill and other intangible assets may exceed its implied fair value. Goodwill is evaluated at the reporting unit level. Any impairment is charged to operations in the period that the impairment is identified. In 2014, 2013 and 2012, we performed a qualitative assessment of our goodwill. As a result of this assessment, we did not recognize an impairment charge on our goodwill in 2014, 2013 or 2012.
We file a consolidated federal income tax return. We also file income tax returns in various state jurisdictions. We are no longer subject to federal or state income tax examination for years before 2009. The Internal Revenue Service is conducting a routine examination of our income tax return for the 2011 tax year.
We utilize the Black-Scholes option pricing method to establish the fair value of non-qualified stock options granted under our equity compensation plans. Our determination of the fair value of stock options on the date of grant using this option-pricing model is affected by our stock price, as well as assumptions regarding a number of complex and subjective variables, which include the expected volatility in our stock price, the expected term of the award, the expected dividends to be paid over the term of the award and the expected risk-free interest rate. Any changes in these assumptions may materially affect the estimated fair value of the award. For our restricted and unrestricted stock awards, we utilize the fair value of our common stock on the date of grant to establish the fair value of the award. Refer to Note 9 "Stock-Based Compensation" for further discussion.
In April 2014, the FASB issued new guidance on reporting discontinued operations and disclosures of disposals of components of an entity. The new guidance raises the threshold for a disposal to qualify as a discontinued operation and requires new disclosures of both discontinued operations and certain other disposals that do not meet the definition of a discontinued operation. It is effective for annual periods beginning after December 15, 2014. Early adoption is permitted but only for disposals that have not been reported in financial statements previously issued. The Company will adopt the guidance on January 1, 2015. Management currently does not expect the adoption of the new guidance to have an impact on the Company's financial position or results of operations.
The proceeds and gross realized gains (losses) on the sale of available-for-sale securities for 2014, 2013 and 2012, were as follows:
Net investment income for the years ended December 31, 2014, 2013 and 2012, is comprised of the following:
A summary of changes in net unrealized investment appreciation for 2014, 2013 and 2012, is as follows:
We continually monitor the difference between our cost basis and the estimated fair value of our investments. Our accounting policy for impairment recognition requires OTTI charges to be recorded when we determine that it is more likely than not that we will be unable to collect all amounts due according to the contractual terms of the fixed maturity security or that the anticipated recovery in fair value of the equity security will not occur in a reasonable amount of time. Any shortfalls in these expected future cash flows are considered a credit loss impairment and are charged to earnings as a component of realized losses, while non-cash flow related factors are considered a non-credit loss impairment and are recorded to accumulated other comprehensive income as a component of unrealized losses.
Impairment charges on investments are recorded based on the fair value of the investments at the measurement date. Factors considered in evaluating whether a decline in value is other-than-temporary include: the length of time and the extent to which fair value has been less than cost; the financial condition and near-term prospects of the issuer; our intention to hold the investment; and the likelihood that we will be required to sell the investment.
The tables on the following pages summarize our fixed maturity and equity securities that were in an unrealized loss position at December 31, 2014 and 2013. The securities are presented by the length of time they have been continuously in an unrealized loss position. It is possible that we could recognize OTTI charges in future periods on securities held at December 31, 2014 if future events or information cause us to determine that a decline in fair value is other-than-temporary.
We have evaluated the near-term prospects of the issuers of our fixed maturity securities in relation to the severity and duration of the unrealized loss which resulted in the recognition of a $139 credit loss OTTI in our Consolidated Statements of Income and Comprehensive Income for the year ended December 31, 2013. There were no OTTI losses on fixed maturity securities recognized in 2014 or 2012. We believe the unrealized depreciation in value of other securities in our fixed maturity portfolio is primarily attributable to changes in market interest rates and not the credit quality of the issuer. We have no intention to sell and it is more likely than not that we will not be required to sell these securities until the fair value recovers to at least equal our cost basis or the securities mature.
A summary of the carrying value and estimated fair value of our financial instruments at December 31, 2014 and 2013 is as follows:
The following table provides a summary of the changes in fair value of our Level 3 securities for 2014:
In 2014, we renewed our participation in all but one of our assumed programs and added one new program to our portfolio. Loss and loss settlement expenses ceded increased in 2014 as compared to 2013 primarily due to an increase in catastrophe losses. We increased participation in one program in our assumed portfolio to replace lost premium from the program not renewed.
In 2012, we renewed our participation in all of our assumed programs. We reduced our participation in programs with heavier Northeast U.S. exposure in response to the exposure added in this region from the Mercer Insurance Group acquisition. Losses and loss settlement expenses assumed were higher than historic levels due to several natural disasters, primarily the Thailand floods and Super Storm Sandy.
We have several programs that provide reinsurance coverage. This reinsurance coverage limits the risk of loss that we retain by reinsuring direct risks in excess of our retention limits. The following table provides a summary of our primary reinsurance programs. Retention amounts reflect the accumulated retentions and co-participation of all layers within a program. In 2013, we added a $3,000 aggregate annual deductible to our core program multi-line (casualty excess and property excess) which was increased to $4,000 in 2014.
The ceding of insurance does not legally discharge United Life from primary liability under its policies. United Life must pay the loss if the reinsurer fails to meet its obligations. We periodically monitor the financial condition of our reinsurers to confirm that they are financially stable. We believe that all of our reinsurers are in an acceptable financial condition. Approximately 99.0 percent of ceded life insurance in force as of December 31, 2014 has been ceded to five reinsurers.
Because property and casualty insurance reserves are estimates of the unpaid portions of incurred losses that have been reported to us, as well as losses that have been incurred but not reported ("IBNR"), the establishment of appropriate reserves, including reserves for catastrophes, is an inherently uncertain and complex process. The ultimate cost of losses and related loss settlement expenses may vary materially from recorded amounts, which are based on management's best estimates. We regularly update our reserve estimates as new information becomes available and as events unfold that may affect the resolution of unsettled claims. Changes in prior year reserve estimates, which may be material, are reported as a component of losses and loss settlement expenses incurred in the period such changes are determined.
Reserves for all other lines of business, with the exception of assumed reinsurance, experienced favorable reserve development in 2012, only to a lesser extent than the other liability line. We attribute this remaining reserve development to the factors noted above. Our assumed reinsurance line was impacted by adverse reserve development on prior year catastrophes from accident year 2011 (Japan earthquake and tsunami, Thailand flood, and Christchurch, New Zealand earthquake) and from accident year 2010 (Canterbury, New Zealand earthquake).
pay dividends if declared by our Board of Directors, out of funds legally available, and subject to any other restrictions that may be applicable to us.
In 2014, 2013 and 2012 ,United Fire & Casualty Company received dividends from its wholly-owned subsidiaries of $13,500, $26,335 and $19,750, respectively. In 2014, 2013 and 2012, United Fire & Casualty Company paid dividends to United Fire Group, Inc. totaling $29,000, $13,175 and $26,950, respectively. These intercompany dividend payments are eliminated for reporting in our Consolidated Financial Statements.
A majority of our custodial assets are subject to a tri-party agreement between one of our subsidiary companies, United Life Insurance Company ("United Life"), the custodian, and the Iowa Insurance Commissioner. Under this agreement, as long as United Life maintains the minimum aggregate value of securities in the account (based on its legal reserve requirements), it is free to invest, withdraw or loan these funds or pay dividends using these funds without approval from the Commissioner. Investment of these funds is subject to the same limitations on asset class and credit quality imposed by the Commissioner on all insurance company invested assets. Investment income derived from these custodied funds is available for general corporate purposes and to satisfy corporate obligations without approval from the Commissioner.
We also offer a health and dental benefit plan to all of our eligible employees and retirees that consists of two programs: (1) the self-funded employee health and dental benefit plan and (2) the self-funded (pre-65) and fully-funded (post-65) retiree health and dental benefit plan (the "postretirement benefit plan"). The postretirement benefit plan provides health and dental benefits to our retirees (and covered dependents) who have met the service and participation requirements stipulated by the postretirement benefit plan. The third party administrators for the postretirement benefit plan are responsible for making medical and dental care benefit payments. Participants are required to submit claims for reimbursement or payment to the claims administrator within twelve months after the end of the calendar year in which the charges were incurred. An unfunded benefit obligation is reported for the postretirement benefit plan in the accompanying Consolidated Balance Sheets.
Pooled separate accounts includes two separate funds, a bond and mortgage separate account and a real estate separate account;
We have an internal investment/retirement committee, which includes our Chief Executive Officer, Chief Investment Officer, and Chief Operating Officer, all of whom receive monthly information on the value of the pension plan
assets and their performance. Quarterly, the committee meets to review and discuss the performance of the pension plan assets as well as the allocation of investments within the pension plan.
As of December 31, 2014, we had six external investment managers that are allowed to exercise investment discretion, subject to limitations, if any, established by the investment/retirement committee. We utilize multiple investment managers in order to maximize the pension plan's investment return while mitigating risk. None of our investment managers uses leverage in managing the pension plan. Annually, the investment/retirement committee meets with each investment manager to review the investment manager's goals, objectives and the performance of the assets they manage. The decision to establish or terminate a relationship with an investment manager is at the discretion of our investment/retirement committee.
The following tables present the categorization of the pension plan's assets measured at fair value on a recurring basis at December 31, 2014 and 2013:
For the pension plan, the benefit obligation is the projected benefit obligation. For the postretirement benefit plan, the benefit obligation is the accumulated postretirement benefit obligation.
Effective July 1, 2012, the former employees of Mercer Insurance Group, Inc. became eligible to participate in our pension plan. The inclusion of these employees resulted in an additional $854 of net periodic benefit cost recognized for 2012.
We have a profit-sharing plan in which employees who meet service requirements are eligible to participate. The amount of our contribution is discretionary and is determined annually, but cannot exceed the amount deductible for federal income tax purposes. Our contribution to the profit-sharing plan for 2014, 2013 and 2012, was $3,847, $6,029 and $1,812, respectively.
amended, the "Stock Plan"). At December 31, 2014, there are 1,646,947 authorized shares remaining available for future issuance. The Stock Plan is administered by the Board of Directors, which determines those employees who will receive awards, when awards will be granted, and the terms and conditions of the awards. The Board of Directors may also take any action it deems necessary and appropriate for the administration of the Stock Plan. Pursuant to the Stock Plan, the Board of Directors may, at its sole discretion, grant awards to our employees who are in positions of substantial responsibility with United Fire.
The activity in the Director Plan is displayed in the following table:
In 2014, 2013, and 2012, we recognized stock-based compensation expense of $1,944, $1,777 and $1,764, respectively. Stock-based compensation expense is recognized over the vesting period of the stock options.
The analysis below details the award activity for 2014 and the awards outstanding at December 31, 2014, for both of our plans and ad hoc options, which were granted prior to the adoption of the other plans:
In 2014, 2013 and 2012 we recognized $588, $407 and $329, respectively, in compensation expense related to the restricted stock awards. At December 31, 2014, we had $1,861 in compensation expense that has yet to be recognized through our results of operations related to the restricted stock awards. The intrinsic value of the non-vested restricted stock awards outstanding totaled $459, $358 and $1,187 at December 31, 2014, 2013 and 2012, respectively.
The following table summarizes information regarding the stock options outstanding and exercisable at December 31, 2014:
We write both commercial and personal lines of property and casualty insurance. We focus on our commercial lines, which represented 91.0 percent of our property and casualty insurance premiums earned for 2014. Our personal lines represented 9.0 percent of our property and casualty insurance premiums earned for 2014.
Our property and casualty insurance segment experiences some seasonality with regard to premiums written, which are generally highest in January and July and lowest during the fourth quarter. Although we experience some seasonality in our premiums written, premiums are earned ratably over the period of coverage. Losses and loss settlement expenses incurred tend to remain consistent throughout the year, with the exception of catastrophe losses. Catastrophes inherently are unpredictable and can occur at any time during the year from man-made or natural disaster events that include, but are not limited to, hail, tornadoes, hurricanes and windstorms.
Life insurance in force, before ceded reinsurance, totaled $5,366,061 and $5,300,209 as of December 31, 2014 and 2013, respectively. Traditional life insurance products represented 67.7 percent and 66.7 percent of our insurance in-force at December 31, 2014 and 2013, respectively. Universal life insurance represented 27.3 percent and 28.4 percent of insurance in force at December 31, 2014 and 2013, respectively.
At December 31, 2014, our future minimum rental payments are as follows:
During the term of this credit agreement, we have the right to increase the total credit facility from $100,000 up to $125,000 if no event of default has occurred and is continuing and certain other conditions are satisfied. The credit facility is available for general corporate purposes, including working capital, acquisitions and liquidity purposes. Any principal outstanding under the credit facility is due in full at maturity, on December 22, 2015. The interest rate is based on our monthly choice of either a base rate or the London Interbank Offered Rate ("LIBOR") plus, in each case, a calculated margin amount. A commitment fee on each lender's unused commitment under the credit facility is also payable quarterly.
There was no outstanding balance on the credit facility at December 31, 2014 or 2013. We did not incur any interest expense related to this credit facility in 2014 or 2013. We incurred $780 in interest expense related to this credit facility in 2012. We were in compliance with all covenants of the credit agreement at December 31, 2014.
In connection with our acquisition of Mercer Insurance Group on March 28, 2011, we acquired three statutory trusts with outstanding issuances of trust preferred securities balances as of the acquisition date of $15,614. We redeemed each of the trusts and related issuances in full in 2012. We incurred $509 of interest expense related to these trust preferred securities for 2012.
The carrying value of our goodwill was $15,091 at both December 31, 2014 and 2013, respectively. The goodwill is fully allocated to our property and casualty insurance segment.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), United Fire Group, Inc.'s 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) and our report, dated March 2, 2015, expressed an unqualified opinion thereon.