The Company does not have any lease agreements, but Employers Mutual has entered into leases for 16 branch and service office facilities. The Company’s home office, which also serves as the home office of Employers Mutual, is located in four office buildings in Des Moines, Iowa, all of which are owned by Employers Mutual. Employers Mutual also owns office buildings in which the Milwaukee and Lansing branch offices operate.
An inter-company reinsurance program is in place between the Company's insurance subsidiaries in the property and casualty insurance segment and Employers Mutual. This reinsurance program is intended to reduce the volatility of the Company's quarterly results caused by excessive catastrophe and storm losses, and provide protection from both the frequency and severity of such losses. The reinsurance program consists of two semi-annual aggregate catastrophe excess of loss treaties. The first treaty is effective each year from January 1 through June 30, and has a retention of $22.0 million and a limit of $24.0 million. The total cost of this treaty was approximately $6.0 million in 2018. The second treaty is effective each year from July 1 through December 31, and has a retention of $15.0 million and a limit of $12.0 million. The total cost of this treaty was approximately $1.4 million in 2018. The terms of these treaties were the same in 2017 and 2016, with the exceptions of the retention amount contained in the treaty covering the first half of the year, which was $20.0 million in each of those years, and the costs, which totaled approximately $6.3 million during the first half of 2016 and $1.5 million during the second half of 2016. Losses and settlement expenses ceded to Employers Mutual under the inter-company reinsurance program totaled $5.2 million, $19.2 million and $7.5 million in 2018, 2017 and 2016, respectively. All catastrophe and storm losses assumed by the property and casualty insurance subsidiaries (net of applicable reinsurance recoveries from external reinsurance protections purchased by the pool participants) are subject to the terms of these treaties, and there is no co-participation provision.
Insurance pricing has historically been cyclical in nature. Periods of excess capital and increased competition encourage price reductions and liberal underwriting practices (referred to as a soft market) as insurance companies compete for market share, while attempting to cover the inevitable underwriting losses from these actions with investment income. A prolonged soft market generally leads to a reduction in the adequacy of capital in the insurance industry. To cure this condition, underwriting practices are tightened, premium rate levels increase and competition subsides as companies strive to strengthen their balance sheets (referred to as a hard market). At the end of 2013, premium rate level increases were beginning to decline, after increasing consistently during the three previous years. This trend of declining premium rate increases continued through 2017, with 2017 premium rates overall being essentially flat. Rates increased modestly during 2018, and the outlook for 2019 is that the Company's overall premium rate level will continue to increase slightly.
On November 20, 2018, the Company announced receipt of a non-binding indicative proposal dated November 15, 2018 from Employers Mutual to purchase all the outstanding common stock of the Company not already owned by Employers Mutual, and the formation of a special committee of the Company's board of directors to consider the proposal. The proposal, which is subject to certain conditions, provides that the shares will be purchased at a price of $30 per share in cash. The special committee, which consists of the Company's four independent directors, has retained its own independent financial and legal advisors to assist it in considering the proposal. Management has worked diligently to provide the financial advisors of both Employers Mutual and the Company with the information requested to perform their duties. There can be no assurance that any definitive agreement will be finalized and executed or that the proposal transaction or any other transaction will be approved or consummated.
During the fourth quarter of 2018, management elected to recognize $11.9 million of losses on the Company's fixed maturity portfolio to take advantage of a 14 percent tax differential that could be realized by carrying these losses back to a previous tax year subject to the prior 35 percent tax rate. This resulted in a $1.7 million tax benefit for the Company. In addition, management was able to reinvest the proceeds from the sales into fixed maturity securities with similar characteristics at a higher book yield.
Innovation continues to be an important part of the Company's overall strategy and has become entrenched in its operations. The Company simply cannot maintain the status quo and expect to be successful as the pace of change in the insurance industry continues to accelerate. To remain competitive in this quickly changing market and achieve our goal of being a leader in innovation, systems are being upgraded and additional team members with the skills necessary to meet these objectives are being hired. This will result in an increase in the Company's acquisition expense ratio. While a higher acquisition expense ratio is not desirable, management views these expenses as an investment in the Company's future, and expects future results to benefit from these expenditures.
The Company’s consolidated financial statements are prepared on the basis of GAAP. The Company also prepares financial statements for each of its insurance subsidiaries based on statutory accounting principles that are filed with insurance regulatory authorities in the states where they do business. Statutory accounting principles are designed to address the concerns of state regulators and stress the measurement of the insurer’s ability to satisfy its obligations to its policyholders and creditors.
Underlying Loss and Settlement Expense Ratio. Management uses certain non-GAAP financial measures for evaluating the Company’s performance. These measures are considered non-GAAP financial measures under applicable Securities and Exchange Commission (SEC) rules because they are not displayed as separate line items in the consolidated financial statements or are not required to be disclosed in the notes to financial statements or, in some cases, include or exclude certain items not ordinarily included or excluded in the most comparable GAAP financial measure. The Company’s calculation of non-GAAP financial measures may differ from similar measures used by other companies, so investors should exercise caution when comparing the Company’s non-GAAP financial measures to the measures used by other companies. In this report, a non-GAAP financial measure known as the "underlying loss and settlement expense ratio" is utilized in describing the Company's results of operations with respect to the property and casualty insurance segment. The most directly comparable GAAP financial measure is reconciled to this non-GAAP financial measure under "Results of Operations" section later in this discussion.
The underlying loss and settlement expense ratio represents the loss and settlement expense ratio, excluding the impact of catastrophe and storm losses and development on prior years’ reserves. Management uses this ratio as an indicator of the property and casualty insurance segment’s underwriting discipline and performance for the current accident year. Management believes this ratio is useful for investors to understand the property and casualty insurance segment’s periodic earnings and variability of earnings caused by the unpredictable nature (i.e., the timing and amount) of catastrophe and storm losses and development on prior years’ reserves. While this measure is consistent with measures utilized by investors and analysts to evaluate performance, it is not intended as a substitute for the GAAP financial measure of loss and settlement expense ratio.
GAAP Combined Ratio. The combined ratio (expressed as a percentage) is the sum of the loss and settlement expense ratio and the acquisition expense ratio, and measures a company’s overall underwriting profit/loss. If the combined ratio is at or above 100, an insurance company cannot be profitable without investment income (and may not be profitable if investment income is insufficient). Management uses the GAAP combined ratio in evaluating the Company’s overall underwriting profitability and as a measure for comparison of the Company’s profitability relative to the profitability of its competitors who prepare GAAP-basis financial statements.
In the reinsurance segment, Employers Mutual records the case and IBNR loss reserves reported by the ceding companies for the Home Office Reinsurance Assumed Department ("HORAD") book of business. Since many ceding companies in the HORAD book of business do not report IBNR loss reserves, Employers Mutual establishes a bulk IBNR loss reserve, which is based on an actuarial reserve analysis, to cover a lag in reporting. For Mutual Re, Employers Mutual records the case and IBNR loss reserves reported to it by the management of the association, along with a relatively small IBNR loss reserve to cover a one-month reporting lag. The booking of the lag IBNR loss reserve may be suspended, and negative bulk IBNR loss reserves may be established, during periods when the actuarial reviews indicate Mutual Re's carried reserves are more than adequate to cover its liabilities. To verify the adequacy of the reported reserves, an actuarial evaluation of Mutual Re’s reserves is performed at each year-end.
Following is a summary of the carried loss and settlement expense reserves for the property and casualty insurance segment at December 31, 2018 and 2017.
As previously noted, ultimate loss and allocated settlement expense amounts expected to be incurred are established by accident year and line of business. The amount of IBNR loss and allocated settlement expense reserves carried at each reporting date is determined by subtracting the amounts incurred to date from the ultimate estimated incurred amounts.
As previously noted, one assumption underlying the reserve estimation process is that the inflation trends implicitly built into the historical loss and allocated settlement expense development patterns will continue into the future. To estimate the sensitivity of the estimated ultimate loss and allocated settlement expense payments to an unexpected change in inflationary trends, the actuarial department derived expected payment patterns separately for each major line of business. These patterns were applied to the December 31, 2018 loss and allocated settlement expense reserves to generate estimated annual incremental loss and allocated settlement expense payments for each subsequent calendar year. Then, for the purpose of sensitivity testing, an explicit annual inflationary variance of one percent was added to the inflationary trend that is implicitly embedded in the estimated payment patterns, and revised incremental loss and settlement expense payments were calculated. This unexpected inflation trend could arise from a variety of sources including a change in economic inflation, social inflation and, especially for the workers’ compensation line of business, the introduction of new medical technologies and procedures, changes in the utilization of procedures and changes in life expectancy. The estimated cumulative impact that this unexpected one percent variance in the inflationary trend would have on the Company’s results of operations over the lifetime of the underlying claims is shown below. A variance in the inflationary trend would also affect the Company’s financial position in that the Company’s equity would be impacted by an amount equivalent to the change in net income. A variance of this type would typically be recognized in loss and settlement expense reserves and, accordingly, would not have a material effect on liquidity because the claims have not been paid. A one percent variance in the projected inflationary trend is considered reasonably likely based on the range of actuarial indications developed during the analysis of the property and casualty insurance segment’s carried reserves. The after-tax impact on earnings is calculated using the federal corporate tax rate of 21 percent.
The Company uses standard actuarial methods to produce estimates of ultimate loss ratios by accident year and line of business. Underlying each selection are explicit assumptions regarding the ultimate claim frequency and severity associated with the selected ultimate ratio. As the assumptions are based on estimates made at a specific point in time, it is likely that the ultimate claim frequency and severity experience, and, therefore, the ultimate loss ratio, will vary upwards or downwards from prior estimates. The expected variation will be greater for less mature accident years, and decreases as each accident year ages. This uncertainty is reflected in the unpaid loss estimates underlying the selected estimated ultimate loss ratios, which produce the carried loss reserves. Assuming the unpaid loss estimates are unbiased, the cumulative impact on the Company's results of operations of a one percent variance in the associated carried loss reserves over the lifetime of the underlying claims is shown below. A variance in carried loss reserves would also affect the Company’s financial position in that the Company’s equity would be impacted by an amount equivalent to the change in net income. A one percent variance in the unpaid loss estimates underlying the selected ultimate loss ratio estimates is considered reasonably likely based on the range of actuarial indications developed during the analysis of the property and casualty insurance segment’s carried loss reserves. The after-tax impact on earnings is calculated using the federal corporate tax rate of 21 percent.
Similar to the loss reserving process, the Company uses standard actuarial methods to produce estimates of ultimate ratios by accident year and line of business for allocated settlement expenses. Underlying each selection are explicit assumptions regarding the ultimate claim frequency and settlement expense severity associated with the selected estimated ultimate ratio. As the assumptions are based on estimates made at a specific point in time, it is likely that the ultimate allocated settlement expense ratios will vary upwards or downwards from prior estimates. The expected variation will be greater for less mature accident years, and decreases as each accident year ages. This uncertainty is reflected in the unpaid allocated settlement expense estimates underlying the selected estimated ultimate ratios, which produce the carried allocated settlement expense reserves. Assuming the unpaid allocated settlement expense estimates are unbiased, the cumulative impact on the Company's results of operations of a one percent variance in the associated allocated settlement expense reserves over the lifetime of the underlying claims is shown below. A variance in carried allocated settlement expense reserves would also affect the Company’s financial position in that the Company’s equity would be impacted by an amount equivalent to the change in net income. A one percent variance in the unpaid allocated settlement expense estimates underlying the selected estimated ultimate allocated settlement expense ratios is considered reasonably likely based on the range of actuarial indications developed during the analysis of the property and casualty insurance segment’s carried allocated settlement expense reserves. The after-tax impact on earnings is calculated using the federal corporate tax rate of 21 percent.
The property and casualty insurance subsidiaries have exposure to asbestos and environmental claims arising primarily from the other liability line of business. These exposures are closely monitored by management, and IBNR loss reserves have been established to cover estimated ultimate losses. The loss and settlement expense reserves associated with asbestos claims have increased each year for the last several years due to continued reporting of new claims at a rate not previously anticipated, as well as updated internal ultimate loss and settlement expense evaluations. In 2018, the settlement expense reserves for asbestos claims were strengthened by $1.5 million. During 2017, a settlement was reached with a former insured, resulting in the Company recognizing $4.5 million (its share) of losses and settlement expenses to remove all past and future asbestos liability exposure related to that policyholder.
At December 31, 2018, there was no backlog in the processing of assumed reinsurance information. Approximately $150.6 million, or 61 percent, of the reinsurance segment’s carried reserves were reported by the ceding companies. Employers Mutual receives loss reserve and paid loss data from its ceding companies on individual excess of loss contracts. If a claim involves a single or small group of claimants, a summary of the loss and claim outlook is normally provided. Summarized data is provided for catastrophe claims and pro rata business, which is subject to closer review if inconsistencies are suspected.
Assumed reinsurance losses tend to be reported later than direct losses. This lag is reflected in loss projection factors for assumed reinsurance that tend to be higher than for direct business. The result is that assumed reinsurance IBNR loss reserves as a percentage of total reserves tend to be higher than for direct loss reserves. IBNR loss reserves totaled $108.9 million and $103.1 million at December 31, 2018 and 2017, respectively, and accounted for approximately 44 percent and 45 percent, respectively, of the reinsurance segment’s total loss and settlement expense reserves. IBNR loss reserves are, by nature, less precise than case loss reserves. A five percent change in IBNR loss reserves at December 31, 2018 would equate to $4.3 million, net of tax, which represents 56.9 percent of the net loss reported for 2018 and 0.8 percent of stockholders’ equity.
The after-tax impact on the Company’s earnings, calculated using the federal corporate tax rate of 21 percent, under each scenario is as follows:
The Company has exposure to construction defect claims arising from general liability policies issued by the pool participants to contractors. Most of the pool participants’ construction defect claims are concentrated in a limited number of states, and the pool participants have taken steps to mitigate this exposure. Construction defect is a highly uncertain exposure due to such issues as whether coverage exists, definition of an occurrence, determination of ultimate damages, and allocation of such damages to financially responsible parties. Newly reported construction defect claims numbered 392, 463 and 374 in 2018, 2017 and 2016, respectively, and produced incurred losses and paid settlement expenses of approximately $4.1 million, $4.8 million and $3.6 million in each respective period. Incurred losses and paid settlement expenses on all construction defect claims totaled approximately $6.4 million in 2018. At December 31, 2018, the Company carried case loss reserves of approximately $8.0 million on 398 open construction defect claims.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The following fair value hierarchy prioritizes inputs to valuation techniques used to measure fair value.
The Company regularly monitors its investment portfolio for investments whose fair value is less than the carrying value for indications of “other-than-temporary” impairment (except for, beginning in 2018, equity securities carried at fair value, with changes in fair value recognized in net income). Several factors are used to determine whether the carrying value of an individual investment has been “other-than-temporarily” impaired. Such factors include, but are not limited to (1) the investment’s value and performance in the context of the overall markets, (2) length of time and extent the investment’s fair value has been below carrying value, (3) key corporate events, and (4) the amount of collateral available. For fixed maturity securities, if the present value of cash flows expected to be collected is less than the amortized cost of the security, a credit loss is deemed to exist and the security is considered “other-than-temporarily” impaired. The portion of the impairment related to a credit loss is recognized through earnings, and the portion of the impairment related to other factors, if any, is recognized through “other comprehensive income”. Alternatively, if the Company has the intent to sell a fixed maturity security that is in an unrealized loss position, or determines that it will "more likely than not" be required to sell a fixed maturity security that is in an unrealized loss position before recovery of its amortized cost basis, then the carrying value is reduced to fair value and the entire amount of the impairment is recognized through earnings.
Employers Mutual sponsors two defined benefit pension plans (a qualified plan and a non-qualified supplemental plan) and two postretirement benefit plans that provide certain health reimbursement arrangement (HRA) and life insurance benefits for eligible retired employees. Although the Company has no employees of its own, it is responsible for its share of the expenses and related prepaid assets and liabilities of these plans, as determined under the terms of the pooling agreement and the cost allocation methodologies applicable to its subsidiaries that do not participate in the pooling agreement.
The net periodic pension and postretirement benefit costs, as well as the prepaid assets and liabilities of these plans, are determined by actuarial valuations. Inherent in these valuations are key assumptions regarding the discount rate and the expected long-term rate of return on plan assets. The assumptions used in the actuarial valuations are updated annually. Material changes in the net periodic pension and postretirement benefit costs may occur in the future due to changes in these assumptions or changes in other factors, such as the number of plan participants, the level of benefits provided, asset values and applicable legislation or regulations.
In accordance with GAAP, the funded status of defined benefit pension and other postretirement plans is recognized as an asset or liability on the balance sheet.
Results of operations by segment and on a consolidated basis for the three years ended December 31, 2018 are as follows:
1 Underlying loss and settlement expense ratio: The loss and settlement expense ratio is the ratio (expressed as a percentage) of losses and settlement expenses incurred to premiums earned, which management uses as a measure of underwriting profitability of the Company’s property and casualty insurance business. The underlying loss and settlement expense ratio is a non-GAAP financial measure which represents the loss and settlement expense ratio, excluding the impact of catastrophe and storm losses and development on prior years’ reserves. Management uses this ratio as an indicator of the property and casualty insurance segment’s underwriting discipline and performance for the current accident year. Management believes this ratio is useful for investors to understand the property and casualty insurance segment’s periodic earnings and variability of earnings caused by the unpredictable nature (i.e., the timing and amount) of catastrophe and storm losses and development on prior years’ reserves. While this measure is consistent with measures utilized by investors and analysts to evaluate performance, it is not intended as a substitute for the GAAP financial measure of loss and settlement expense ratio.
On November 20, 2018, the Company announced receipt of a non-binding indicative proposal dated November 15, 2018 from Employers Mutual to purchase all the outstanding common stock of the Company not already owned by Employers Mutual, and the formation of a special committee of the Company's board of directors to consider the proposal. The proposal, which is subject to certain conditions, provides that the shares will be purchased at a price of $30 per share in cash. The special committee, which consists of the Company's four independent directors, has retained its own independent financial and legal advisors to assist it in considering the proposal. There can be no assurance that any definitive agreement will be finalized and executed or that the proposal transaction or any other transaction will be approved or consummated.
The Company reported a net loss of $7.5 million ($(0.35) per share) in 2018 compared to net income of $39.2 million ($1.84 per share) in 2017. Included in the net loss reported for 2018 is a pre-tax decrease of $28.8 million in unrealized gains on the Company's equity investments stemming from the decline in equity markets that occurred in the fourth quarter. Updated accounting guidance adopted by the Company on January 1, 2018 requires that changes in unrealized gains and losses on equity investments be recognized in net income, whereas in 2017 and prior years these amounts were recognized through other comprehensive income. Also included in the net loss reported for 2018 is a $12.4 million pre-tax realized investment loss, primarily resulting from $11.9 million of losses recorded in the fixed maturity portfolio during the fourth quarter, that was recognized to capture a $1.7 million tax benefit stemming from a 14 percent tax differential that could be achieved by carrying these losses back to a prior tax year subject to the previous 35 percent federal corporate tax rate. Net income in 2017 included a one-time $9.1 million deferred income tax benefit resulting from the enactment of the Tax Cuts and Jobs Act of 2017 (TCJA). The enactment of the TCJA lowered the federal corporate tax rate from 35 percent to 21 percent beginning in 2018. From an underwriting perspective, the reinsurance segment's GAAP combined ratio decreased to 106.2 percent in 2018 from 111.9 percent in 2017, while the property and casualty insurance segment's GAAP combined ratio increased to 103.3 percent in 2018 from 99.4 percent in 2017.
Premiums earned, losses and settlement expenses incurred, and the corresponding loss and settlement expense ratios, by line of business for each segment and on a consolidated basis, for the two years ended December 31, 2018 are as follows:
Premiums earned for the property and casualty insurance segment increased 4.9 percent to $495.4 million in 2018 from $472.4 million in 2017. The majority of this increase is attributed to small rate level increases on renewal business, an increase in retained commercial lines policies and new commercial lines business. Commercial lines new business premium (representing 14 percent of the pool participants’ direct premiums written) was approximately 8 percent higher than in 2017. Management continues to seek growth in most territories for its commercial lines of business, particularly outside of the core Midwest market, which will help diversify the pool participants' book of business geographically while staying consistent with the industry and the commercial lines mix of business. Renewal business premium increased approximately 5 percent during 2018. After factoring in the continued implementation of some mandatory rate reductions on workers' compensation business, the overall rate change on renewal business was approximately 1.7 percent. Rate levels are expected to be mixed during 2019, with the largest rate increases expected in the commercial auto line of business. Rate decreases are expected to slow or stop in the workers' compensation and general liability lines of business, and rates on most other lines of business are expected to increase slightly. Policy retention remained strong during 2018 at 87 percent.
Favorable development on the property and casualty insurance segment's prior years' reserves totaled $15.3 million and $15.7 million in 2018 and 2017, respectively. Included in the development amount reported for 2018 is $1.5 million of adverse development due to strengthening of asbestos settlement expense reserves. Included in the development amount reported for 2017 is $4.5 million of adverse development experienced in the other liability line of business stemming from the settlement of claims for past and future legal fees and losses on a multi-year asbestos exposure associated with a former insured. Management's experience with selecting ultimate loss and settlement expense ratios under the accident year ultimate methodology implemented in 2016 has led to more refined ultimate selections closer to the actuarial central estimate. As a result, the magnitude of favorable development reported in future periods is expected to be somewhat less than what has been observed in recent periods. For a detailed discussion of the development experienced on prior accident years’ reserves during 2018 and 2017, see the discussion entitled “Loss and Settlement Expense Reserves” under the “Narrative Description of Business” heading in the Business Section under Part I, Item 1 of this Form 10-K.
Catastrophe and storm losses totaled $37.0 million in 2018, compared to $29.6 million in 2017. The 2018 amount was capped at $37.0 million because the retention amounts under both of the semi-annual aggregate excess of loss treaties with Employers Mutual were filled ($22.0 million in the first half of the year and $15.0 million in the second half of the year). There were seven events in 2018 that generated losses of $2.0 million or more. Six of those events stemmed from Midwest convective storms that produced wind, hail and/or tornado damage. The seventh event involved losses associated with Hurricane Florence. Current accident year catastrophe and storm losses, net of the amounts ceded to Employers Mutual, accounted for 7.5 percentage points of the loss and settlement expense ratio in 2018, compared to 6.3 percentage points in 2017. Catastrophe and storm losses ceded to Employers Mutual totaled $5.2 million in 2018, compared to $19.2 million in 2017. The inter-company reinsurance program had no impact on the loss and settlement expense ratio reported for 2018, but reduced the ratio by 3.1 percentage points in 2017. The inter-company reinsurance program has been renewed for 2019, with no change in terms.
The acquisition expense ratio for the reinsurance segment decreased to 23.2 percent in 2018 from 23.6 percent in 2017. The decline is primarily due to a decrease in contingent commissions.
Net investment income increased 4.7 percent to $47.6 million in 2018 from $45.5 million in 2017. This increase is primarily due to an increase in the fixed maturity portfolio book yield, and to a lesser extent, growth in the fixed maturity portfolio. The pre-tax yield on the fixed maturity portfolio increased to approximately 3.68 percent at December 31, 2018, from 3.45 percent at December 31, 2017 and 3.50 percent at December 31, 2016. The effective duration of the fixed maturity portfolio, excluding interest-only securities, declined slightly to 4.9 at December 31, 2018 from 5.0 at December 31, 2017. The Company’s equity portfolio produced dividend income of $6.1 million in 2018, compared to $6.0 million in 2017.
Net realized investment gains (losses) and, beginning in 2018, the change in unrealized gains on equity investments, declined to a loss of $41.3 million in 2018, from a gain of $6.6 million in 2017. Included in the net loss reported for 2018 is a decrease of $28.8 million in unrealized gains on the Company's equity investments stemming from the decline in equity markets that occurred in the fourth quarter. Net realized investment gains on equity investments totaled $8.0 million in 2018, compared to $18.2 million in 2017. Management elected to re-balance a portion of the common stock portfolios in 2017, which generated the larger amount of gains. Due to the recent increase in interest rates, management chose to recognize $11.9 million of losses on the fixed maturity portfolio during the fourth quarter of 2018 in order to increase book yield without sacrificing quality or duration, while also taking advantage of a 14 percent tax differential that could be achieved by carrying these losses back to a previous tax year subject to the prior 35 percent federal corporate tax rate. Total realized losses recognized on the fixed maturity portfolio during 2018 amounted to $18.5 million, compared to $4.3 million in 2017. The amounts reported include losses of $2.7 million and $6.3 million in 2018 and 2017, respectively, from declines in the carrying value of a limited partnership that the Company invests in to help protect the equity portfolio from a sudden and significant decline in value (an equity tail-risk hedging strategy).
Other income totaled $9.2 million in 2018, compared to $4.8 million in 2017. The 2018 amount includes $7.5 million of net periodic pension and postretirement benefit income and $637,000 of foreign currency exchange gains recognized on the reinsurance segment’s foreign currency denominated reinsurance business. The 2017 amount includes $5.1 million of net periodic pension and postretirement benefit income and $1.6 million of foreign currency exchange losses.
The Company reported an income tax benefit of $7.2 million in 2018 compared to income tax expense of $578,000 in 2017. The effective tax rate for 2018 was 49.1 percent, compared to 1.5 percent in 2017. The 2018 effective tax rate is calculated using an income tax benefit relative to a pretax loss, thus the larger number is actually indicative of a low effective tax rate. The 2017 effective tax rate is impacted by a $9.1 million reduction in the deferred tax liability related to the enactment of the TCJA. Excluding this deferred income tax benefit, the effective tax rate for 2017 was 24.2 percent. The primary contributors to the differences between the effective tax rates and the United States federal corporate tax rate of 21 percent for 2018 and 35 percent for 2017 are tax-exempt interest income earned and the dividends received deduction and, for 2018, a $1.7 million tax benefit stemming from the 14 percent tax differential realized from the carry-back of realized investment losses to a tax year subject to the 35 percent tax rate.
Because the change in the deferred tax liability was recognized in net income, the amounts contained in the accumulated other comprehensive income line in stockholders' equity continued to reflect deferred income taxes at the previous 35 percent tax rate (commonly referred to as "stranded tax effects"). In February 2018, the Financial Accounting Standards Board issued updated guidance to allow a reclassification to be made from accumulated other comprehensive income to retained earnings for the stranded tax effects resulting from the enactment of the TCJA. The Company adopted this guidance in 2017, and transferred the stranded tax effects in accumulated other comprehensive income to retained earnings.
Premiums earned increased 2.5 percent to $607.2 million in 2017 from $592.4 million in 2016. Rate levels for both segments continued to be constrained by a high level of competition, especially for quality accounts with good loss experience; however, there were some indications of moderate rate level improvement during the fourth quarter. Average rate level increases were slightly positive for the year in the property and casualty insurance segment, with variances by line of business. In the reinsurance segment, rate levels stabilized somewhat during the January 1, 2017 renewal season, when approximately 70 percent of the business renewed, after several years of continuous declines. The lines of business experiencing the greatest profitability challenges in the property and casualty insurance segment, namely commercial auto and personal lines, received larger (mid-single digit) rate increases. During the January 1, 2018 renewal season, moderate price increases were achieved on most of the reinsurance segment's property per risk and catastrophe programs.
Premiums earned for the reinsurance segment decreased 0.8 percent to $134.8 million in 2017 from $135.9 million in 2016. This decrease was primarily attributed to Mutual Re's withdrawal from non-standard automobile business, but also reflected a decline in some casualty business that converted from a pro rata structure in 2016 to an excess of loss structure in 2017. However, the addition of some new business and growth on some existing accounts largely offset those declines. Underwriting capacity remained strong during the January 1, 2018 renewal season, despite the unusually large amount of catastrophe and storm losses incurred by the reinsurance industry in 2017. As a result, reinsurance rate levels only increased moderately for those lines and territories most affected by the 2017 events (property per risk and catastrophe programs), and remained stable in most segments of the market not affected by the 2017 events. Rate levels for international business were also stable, with renewal rates largely flat or up slightly.
The loss and settlement expense ratio for the property and casualty insurance segment decreased to 64.1 percent in 2017 from 64.5 percent in 2016. Lower catastrophe and storm losses and an improvement in the underlying loss and settlement expense ratio were the primary drivers of the decline in the loss and settlement expense ratio. Catastrophe and storm losses, net of the amounts ceded to Employers Mutual under the inter-company reinsurance program, accounted for 6.3 percentage points of the loss and settlement expense ratio in 2017, compared to 7.7 percentage points in 2016. The property and casualty insurance subsidiaries ceded $19.2 million of catastrophe and storm losses to Employers Mutual under the inter-company reinsurance program in 2017, compared to $7.5 million in 2016. Taking the loss recoveries and the premiums paid to Employers Mutual into consideration, the inter-company reinsurance program reduced the property and casualty insurance segment's loss and settlement expense ratios by 3.1 and 0.5 percentage points for the years ended December 31, 2017 and 2016, respectively. The inter-company reinsurance program was renewed for 2018. The only change was a $2 million increase in the retention amount under the treaty covering the first half of the year (from $20.0 million to $22.0 million). The cost of the program remained at $7.4 million. The underlying loss and settlement expense ratio improved during the second half of 2017, primarily reflecting reductions in the current accident year ultimate loss and settlement expense ratio projections in the commercial property and other liability lines of business. The commercial auto and personal lines of business, which posted loss and settlement expense ratios of 85.4 percent and 72.1 percent, respectively, in 2017, continued to underperform. Management continued to devote a significant amount of time and effort to the initiatives that had been undertaken to improve the performance of these lines of business, including rate increases and more selective risk selection.
Favorable development on the property and casualty insurance segment's prior years' reserves totaled $15.7 million and $24.4 million in 2017 and 2016, respectively. Included in the development amount reported for 2017 was $4.5 million of adverse development experienced in the other liability line of business stemming from the settlement of claims for past and future legal fees and losses on a multi-year asbestos exposure associated with a former insured. Under the new reserving methodology implemented in the third quarter of 2016, development on prior accident years' reserves was determined primarily by changes in the prior accident years' ultimate loss and settlement expense ratio projections established by management. As a result, the explicit drivers of development on prior years' reserves were identifiable beginning in 2017. Due to additional insights gained and the adjustments made under the new reserving methodology during 2017, the magnitude of favorable development reported in future periods was expected to be somewhat less than what had been observed in recent periods. For a detailed discussion of the development experienced on prior accident years’ reserves during 2017 and 2016, see the discussion entitled “Loss and Settlement Expense Reserves” under the “Narrative Description of Business” heading in the Business Section under Part I, Item 1 of this Form 10-K.
Aside from catastrophe and storm losses, the remaining increase in the reinsurance segment's loss and settlement expense ratio was due to a decline in favorable development on prior years' reserves. It was expected that future development would still be favorable, but less so than what had been observed in the recent past, and closer to neutral. For a detailed discussion of the development experienced on prior accident years’ reserves during 2017 and 2016, see the discussion entitled “Loss and Settlement Expense Reserves” under the “Narrative Description of Business” heading in the Business Section under Part I, Item 1 of this Form 10-K.
Acquisition and other expenses increased 0.9 percent to $198.4 million in 2017 from $196.6 million in 2016. The acquisition expense ratio decreased to 32.7 percent in 2017 from 33.2 percent in 2016. Both segments contributed to the decrease in this ratio. To remain competitive in the quickly changing insurance market and achieve management's goal of being a leader in innovation, upgrades were being made to the Company's systems and additional team members with the skills necessary to meet these objectives were being hired. As a result, the Company's acquisition expense ratio was projected to increase in 2018.
The acquisition expense ratio for the property and casualty insurance segment decreased to 35.3 percent in 2017 from 35.8 percent in 2016. This decrease was primarily attributed to a decline in policyholder dividend expense, largely from a couple of the pool participants' safety dividend groups. Partially offsetting the decrease were higher expenses for agents' contingent commissions, data analytics initiatives, and salaries.
Other income totaled $4.8 million in 2017 compared to $5.8 million in 2016. Other income reported for both years included net periodic postretirement benefit income resulting from the amortization of a large prior service credit that resulted from an amendment of Employers Mutual's postretirement medical plan in the fourth quarter of 2013. This prior service credit was recognized in accumulated other comprehensive income in the fourth quarter of 2013, and was being amortized out of accumulated other comprehensive income and into net income over a period of 10 years. The 2017 amount included $5.1 million of net periodic pension and postretirement benefit income and $1.6 million of foreign currency exchange losses recognized on the reinsurance segment’s foreign currency denominated reinsurance business. The 2016 amount included $4.8 million of net periodic pension and postretirement benefit income and $356,000 of foreign currency exchange gains, respectively.
Income tax expense decreased 96.6 percent to $578,000 in 2017 from $17.0 million in 2016. As noted above, the TCJA was signed into law on December 22, 2017, lowering the federal corporate tax rate from 35 percent to 21 percent effective January 1, 2018. Companies were required to calculate deferred taxes using tax rates expected to be in effect when tax timing differences reversed, which, as of December 22, 2017, was now 21 percent rather than the previous 35 percent. The Company was in a net deferred tax liability position on the date of enactment, which meant that the reduction in the tax rate resulted in a lower deferred tax liability. This reduction in the deferred tax liability ($9.1 million) was reflected as a deferred income tax benefit in the fourth quarter. Including this deferred income tax benefit, the effective tax rate for 2017 was 1.5 percent, and was expected to be in the mid-teens in future years compared to the upper twenties historically. Excluding this deferred income tax benefit, the effective tax rate for 2017 was 24.2 percent, compared to 26.9 percent in 2016. The primary contributors to the differences between these effective tax rates and the United States federal corporate tax rate of 35 percent were tax-exempt interest income earned, the dividends received deduction, and, especially in 2016, investment tax credits recognized from renewable energy tax credit investments ($672,000 in 2017 and $1.4 million in 2016).
The Company is a holding company whose principal asset is its investment in its property and casualty insurance subsidiaries and its reinsurance subsidiary (“insurance subsidiaries”). As a holding company, the Company is dependent upon cash dividends from its insurance subsidiaries to meet all its obligations, including cash dividends to stockholders, the funding of the Company’s stock repurchase program and, in 2019, expenses associated with evaluating and responding to Employers Mutual's non-binding indicative proposal to purchase all of the common stock of the Company not already owned by Employers Mutual. State insurance regulations restrict the maximum amount of dividends insurance companies can pay without prior regulatory approval. The maximum amount of dividends that the insurance subsidiaries can pay to the Company in 2019 without prior regulatory approval is approximately $48.0 million. The Company received $21.1 million, $5.7 million and $9.7 million of dividends from its insurance subsidiaries and paid cash dividends to its stockholders totaling $19.1 million, $18.0 million and $16.2 million in 2018, 2017 and 2016, respectively.
The Company participates in reverse repurchase arrangements, involving the purchase of investment securities from third-party sellers with the agreement that the purchased securities be sold back to the third-party sellers for agreed-upon prices at specified future dates. The third-party sellers are required to pledge collateral with a value greater than the amount of cash received in the transactions. In accordance with GAAP, the investment securities purchased under the reverse repurchase agreements are not reflected in the Company's consolidated balance sheets, but instead a receivable is recorded for the principal amount lent. The Company's receivable under reverse repurchase agreements was $0 and $16.5 million at December 31, 2018 and 2017, respectively.
The Company’s cash balance was $337,000 and $347,000 at December 31, 2018 and 2017, respectively.
Employers Mutual contributed $8.0 million, $7.0 million and $9.0 million to its qualified pension plan in 2018, 2017 and 2016, respectively, and plans to contribute approximately $7.0 million to the qualified pension plan in 2019. The Company reimbursed Employers Mutual $2.4 million, $2.1 million and $2.7 million for its share of the pension contributions in 2018, 2017 and 2016, respectively. Employers Mutual did not make any contributions to its postretirement benefit plans during 2018, 2017, or 2016, and does not expect to make any contributions in 2019 due to the plan amendment that was announced during 2013.
The Company’s total cash and invested assets at December 31, 2018 and 2017 are summarized as follows:
At December 31, 2018, the Company had unrealized losses on fixed maturity securities available-for-sale as presented in the following table. The estimated fair value is based on quoted market prices, where available. In cases where quoted market prices are not available, fair values are based on a variety of valuation techniques depending on the type of security. None of these securities are considered to be in concentrations by either security type or industry. The Company uses several factors to determine whether the carrying value of an individual security has been “other-than-temporarily” impaired. Such factors include, but are not limited to, the security’s value and performance in the context of the overall markets, length of time and extent the security’s fair value has been below carrying value, key corporate events and the amount of collateral available. Based on these factors, the absence of management’s intent to sell these securities prior to recovery or maturity, and the fact that management does not anticipate that it will be forced to sell these securities prior to recovery or maturity, it was determined that the carrying value of these securities were not “other-than-temporarily” impaired at December 31, 2018. Risks and uncertainties inherent in the methodology utilized in this evaluation process include interest rate risk and the overall performance of the economy, all of which have the potential to adversely affect the value of the Company’s investments. Should a determination be made at some point in the future that these unrealized losses are “other-than-temporary”, the Company’s earnings would be reduced by approximately $8.6 million, net of tax; however, the Company’s financial position would not be affected because unrealized losses on fixed maturity securities available-for-sale are reflected in the Company’s financial statements as a component of stockholders’ equity, net of deferred taxes.
The Company does not purchase non-investment grade fixed maturity securities. Any non-investment grade fixed maturity securities held are the result of rating downgrades that occurred subsequent to their purchase. At December 31, 2018, the Company held $4.2 million of non-investment grade fixed maturity securities in a net unrealized loss position of $421,000.
The following table reflects the Company's contractual obligations as of December 31, 2018. Included in the table are the estimated payments that the Company expects to make in the settlement of its 30.0 percent aggregate participation percentage of the pool participants' loss and settlement expense reserves, and with respect to its long-term debt. The Company does not have any lease agreements, but Employers Mutual has entered into leases for 16 branch and service office facilities, the costs of which are charged to the pool and allocated among the pool participants based on their respective participation interests.
2 Long-term debt reflects the surplus notes issued by the Company’s property and casualty insurance subsidiaries to Employers Mutual, which have no maturity date. Excluded from long-term debt are pension and other postretirement benefit obligations.
Municipal fixed maturity securities, including taxable, tax-exempt and pre-refunded securities, totaled $283.7 million as of December 31, 2018. Municipal securities are well diversified between general obligation and revenue bonds, as well as geographically. The Company’s credit analysis of municipal securities is predominantly based on the underlying credit quality of the obligor. Therefore, although a portion of the Company’s municipal securities are guaranteed by financial guaranty insurers, reliance is placed on the underlying obligor to pay all contractual cash flows. The ratings of insured municipal securities generally reflect the rating of the underlying primary obligor. The average quality of the municipal fixed maturity securities portfolio is Aa1/AA+ with over 98 percent of securities rated A3/A- or higher. Approximately $25.0 million of the Company’s municipal securities have been pre-refunded, which means that funds have been set aside in escrow to satisfy the future interest and principal obligations of the securities.
Prepayment risk refers to changes in prepayment patterns that can shorten or lengthen the expected timing of principal repayments and thus the average life and the effective yield of a security. Such risk exists within the portfolio of mortgage-backed securities. Prepayment risk is monitored regularly through the analysis of interest rate simulations. At December 31, 2018, the effective duration of the mortgage-backed securities, excluding interest-only securities, is 7.7 with an average life of 10.0 years and a yield to worst of 3.5 percent. At December 31, 2017, the effective duration of the mortgage-backed securities, excluding interest-only securities, was 6.9, with an average life of 8.6 years and a yield to worst of 3.1 percent.
Management assessed the effectiveness of the Company’s internal control over financial reporting based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) (the COSO criteria). Based on this assessment, management believes that, as of December 31, 2018, the Company maintained effective internal control over financial reporting.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the 2018 consolidated financial statements of the Company and our report dated March 6, 2019 expressed an unqualified opinion thereon.
As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for the recognition and measurement of certain financial instruments in 2018 due to the adoption of ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities.
In March 2017, the FASB issued updated guidance in Compensation-Retirement Benefits Topic 715 of the ASC. The objective of this update is to improve the presentation of net periodic pension and postretirement benefit costs by disaggregating the components of these expenses (disclosing the service cost component separately from the other components) for income statement reporting, if a subtotal of income from operations is presented. The Company does not report a subtotal of income from operations in its financial statements. Also included in this update is a prohibition against including components of the net periodic pension and postretirement benefit costs, other than the service cost component, in any capitalized assets. In conjunction with the adoption of this updated guidance, management elected to begin reporting all components of net periodic pension and postretirement benefit income, other than the service cost component, as other income in the consolidated statements of income. The service cost component continues to be reported in other underwriting expenses. This change in reporting was applied retrospectively for comparison purposes and did not impact the net income (loss) amounts reported, as other income and other underwriting expenses increased by the same amount ($7.5 million, $5.1 million and $4.8 million for the years ended December 31, 2018, 2017 and 2016, respectively). The prohibition against including net periodic pension and postretirement benefit costs, other than the service cost component, in capitalized assets was adopted prospectively on January 1, 2018. The impact of the exclusion of these costs from capitalized assets resulted in a negligible impact on the deferred policy acquisition cost asset calculation at December 31, 2018 compared to that which would have been calculated previously.
In August 2018, the FASB issued updated guidance related to Fair Value Measurement Topic 820 of the ASC. The objective of this update is to improve the effectiveness of disclosures in the notes to financial statements as part of the FASB's disclosure framework project. As it relates to the Company's footnote disclosures, this update removes disclosure of the amount of, and reasons for, transfers between Level 1 and Level 2 of the fair value hierarchy, as well as the policy for timing of transfers between levels, but adds disclosure of the amount of unrealized gains and losses included in other comprehensive income for recurring Level 3 fair value measurements still held at the end of the reporting period. The Company adopted these disclosure modifications in 2018.
Costs related to the acquisition of insurance contracts are deferred and amortized to expense as the associated premium revenue is recognized. Only incremental costs and costs directly related to the successful acquisition of new or renewal insurance contracts are capitalized. Accordingly, acquisition costs consist of commissions, premium taxes, and salary and benefit expenses (beginning in 2018, only the service cost component is included from the pension and postretirement benefit plans) of employees directly involved in the underwriting of insurance policies that are successfully issued.
The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to the estimated realizable value. In determining estimated realizable value, the computation gives effect to the premium to be earned, related investment income, anticipated losses and settlement expenses, anticipated policyholder dividends, and certain other costs expected to be incurred to administer the insurance policies as the premium is earned. The anticipated losses and settlement expenses are not discounted and are based on the Company’s projected loss and settlement expense ratios for the next twelve months, which include catastrophe loads based on historical results adjusted for recent trends. The occurrence of a significant catastrophic event, and/or the accumulation of catastrophe losses would not have a direct impact on the determination of premium deficiencies; however, such occurrences would be included in the historical results that are used to establish the catastrophe loads. A premium deficiency is first recognized by expensing the amount of unamortized deferred policy acquisition costs necessary to eliminate the deficiency. If the premium deficiency is greater than the unamortized deferred policy acquisition costs, a liability is accrued for the excess deficiency. The Company did not record a premium deficiency for the years ended December 31, 2018, 2017 or 2016.
Liabilities for losses reflect losses incurred through the balance sheet date and are based upon the estimated ultimate loss ratios established by line of business and accident year, and estimates of losses expected under assumed reinsurance contracts. Liabilities for settlement expenses are provided by estimating expenses expected to be incurred in settling the claims provided for in the loss reserves. Changes in reserve estimates are reflected in net income in the year such changes are recorded (see note 4).
The Company participates in a reverse repurchase arrangement involving the purchase of investment securities from third-party sellers, with the agreement that the purchased securities be sold back to the third-party sellers for agreed-upon prices at specified future dates. The third-party sellers are required to pledge collateral with a value greater than the amount of cash received in the transactions. In accordance with GAAP, the investment securities purchased under the reverse repurchase agreements are not reflected in the Company's consolidated balance sheets, but instead a receivable is recorded for the principal amount lent. Net proceeds/disbursements related to the reverse repurchase transactions are reported as a component of investing activities in the consolidated statements of cash flows, and the income as a component of operating activities.
Premiums and discounts on fixed maturity securities are amortized over the expected life of the security as an adjustment to yield using the effective interest method. Amortization of premiums and discounts on mortgage-backed securities incorporate prepayment assumptions to estimate expected lives. Prepayment assumptions are reviewed quarterly and adjusted as necessary. Gains and losses realized on the disposition of investments are included in net income. The cost of investments sold is determined on the specific identification method using the highest cost basis first. Included in investments at December 31, 2018 and 2017 are securities on deposit with various regulatory authorities as required by law amounting to $11.6 million and $11.3 million, respectively.
The Company has a stock-based compensation plan for non-employee directors. Compensation expense under this plan is based upon the grant date fair value, and is recognized as the requisite service period is rendered. The Company has no other stock-based compensation plans of its own; however, Employers Mutual has several stock plans which utilize the common stock of the Company. The Company receives the current fair value for all shares issued under Employers Mutual's plans, and a portion of the compensation expense recognized by Employers Mutual is allocated to the Company’s property and casualty insurance subsidiaries though their participation in the pooling agreement (see note 2). For granted options and restricted stock awards, compensation expense is based upon the grant date fair value, and is recognized as the requisite service period is rendered. For granted restricted stock units, the expense is determined in accordance with the liability-based model, whereby Employers Mutual records a liability representing the current value of the Company's stock granted for the portion of the service period that has been rendered (both the liability and the resulting expense are allocated to the Company's property and casualty insurance subsidiaries through the pooling agreement). Excess tax benefits (deficiencies) related to non-qualified stock option activities allocated to the Company's property and casualty insurance subsidiaries through the pooling agreement are recognized through the consolidated statements of income as components of current and deferred income taxes, with the associated cash flows reflected as cash flows from operating activities. Because a portion of Employers Mutual’s stock compensation expense is reflected in the Company’s financial statements and issuances of the Company’s stock under Employers Mutual’s stock plans have an impact on the Company’s capital accounts, the disclosures required by the Compensation - Stock Compensation Topic 718 of the FASB ASC are included in the Company’s consolidated financial statements (see note 13).
Employers Mutual has various employee benefit plans, including two defined benefit pension plans, and two postretirement benefit plans that provide retiree healthcare and life insurance benefits. Although the Company has no employees of its own, it is responsible for its share of the plans' expenses and related prepaid assets and liabilities (the "funded status") as determined under the terms of the pooling agreement. Accordingly, the Company recognizes its share of the funded status of Employers Mutual’s pension and postretirement benefit plans on its balance sheet. In addition, the Company is responsible for its share of costs of these plans allocated by Employers Mutual to subsidiaries that do not participate in the pooling agreement (see note 2).
Employers Mutual collects from agents, policyholders and ceding companies all premiums written associated with the insurance business produced by the pool participants and the assumed reinsurance business ceded to the reinsurance subsidiary. Employers Mutual also collects from its reinsurers all losses and settlement expenses recoverable under the reinsurance contracts protecting the pool participants and the reinsurance subsidiary (see note 2), as well as the fronting business ceded to the reinsurance subsidiary. Employers Mutual settles with the pool participants (monthly) and the reinsurance subsidiary (quarterly) the premiums written from these insurance policies and the paid losses and settlement expenses recoverable under the external reinsurance contracts, providing full credit for the premiums written and the paid losses and settlement expenses recoverable under the external reinsurance contracts generated during the period (not just the collected portion). Due to this arrangement, and since a significant portion of the premium balances are collected over the course of the underlying coverage periods, Employers Mutual carries a substantial receivable balance for insurance and reinsurance premiums in process of collection and, to a lesser extent, paid losses and settlement expenses recoverable from the external reinsurance companies. Any of these receivable amounts that are ultimately deemed to be uncollectible are charged-off by Employers Mutual and the expense is charged to the reinsurance subsidiary or allocated to the pool members on the basis of pool participation. As a result, the Company has off-balance sheet arrangements with an unconsolidated entity that results in credit-risk exposures (Employers Mutual’s insurance and reinsurance premium receivable balances, and paid loss and settlement expense recoverable amounts) that are not reflected in the Company’s financial statements. The average annual expense for such charge-offs allocated to the Company over the past ten years is $414,000. Based on this historical data, this credit-risk exposure is not considered to be material to the Company’s results of operations or financial position and, accordingly, no loss contingency liability has been recorded.
Included in the underlying reinsurance business assumed by the reinsurance subsidiary are reinsurance transactions conducted with foreign cedants denominated in their local functional currencies. In accordance with the terms of the quota share agreement (see note 2), the reinsurance subsidiary assumes all foreign currency exchange gains/losses associated with contracts that are subject to the quota share agreement. The reinsurance subsidiary also has foreign currency exchange gains/losses associated with the business assumed outside the quota share agreement. The assets and liabilities resulting from these foreign reinsurance transactions are reported in U.S. dollars based on the foreign currency exchange rates that existed at the balance sheet dates. The foreign currency exchange rate gains/losses reported in the consolidated statements of income that resulted from these foreign reinsurance transactions are reported in U.S. dollars re-measured from the foreign currency exchange rates that existed at the inception of each reinsurance contract. The foreign currency exchange rate gains/losses resulting from these re-measurements to U.S. dollars are reported as a component of other income in the consolidated statements of income.
In June 2016, the FASB issued updated guidance in Financial Instruments-Credit Losses Topic 326 of the ASC. The objective of this update is to provide information about expected credit losses on financial instruments and other commitments to extend credit. Specifically, this updated guidance replaces the current incurred loss impairment methodology, which delays recognition of a loss until it is probable a loss has been incurred, with a methodology that reflects expected credit losses considering a broader range of reasonable and supportable information. This guidance covers financial assets that are not accounted for at fair value through net income, thus is not applicable to the Company's equity investments. This guidance is effective for interim and annual periods beginning after December 15, 2019, and is to be applied with a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (modified-retrospective approach). Early adoption is permitted, but only to fiscal years beginning after December 15, 2018. The Company will adopt this guidance during the first quarter of 2020. The Company is currently evaluating the impact this guidance will have on the Company's consolidated financial condition and net income.
The operations of the Company are highly integrated with those of Employers Mutual through participation in a property and casualty reinsurance pooling agreement (the "pooling agreement"), a quota share retrocessional reinsurance agreement (the "quota share agreement") and inter-company reinsurance programs. All transactions occurring under the pooling agreement, quota share agreement and the inter-company reinsurance programs are based on statutory accounting principles. Certain adjustments are made to the statutory-basis amounts assumed by the property and casualty insurance subsidiaries and the reinsurance subsidiary to bring the amounts into compliance with GAAP.
The Company’s three property and casualty insurance subsidiaries and two subsidiaries of Employers Mutual (Union Insurance Company of Providence and EMC Property & Casualty Company) are parties to a pooling agreement with Employers Mutual. Under the terms of the pooling agreement, each company cedes to Employers Mutual all of its insurance business, and assumes from Employers Mutual an amount equal to its participation in the pool. All premiums, losses, settlement expenses, and other underwriting and administrative expenses, excluding the voluntary reinsurance business assumed by Employers Mutual from nonaffiliated insurance companies, are prorated among the parties on the basis of participation in the pool. Employers Mutual negotiates reinsurance agreements that provide protection to the pool and each of its participants, including protection against losses arising from catastrophic events. The aggregate participation of the Company’s property and casualty insurance subsidiaries in the pool is 30 percent.
The reinsurance subsidiary purchases additional reinsurance protection in peak exposure territories from external parties in which coverage is triggered when losses experienced by the insurance industry from a catastrophic event exceed a specified threshold. Any reinsurance recoveries received from external parties reduces the amount of losses ceded to Employers Mutual under the inter-company reinsurance program. During 2018, the reinsurance subsidiary recovered $5.2 million under these treaties. No recoveries were made from external parties in 2017 or 2016.
The reinsurance subsidiary does not directly reinsure any of the insurance business written by Employers Mutual or the other pool participants; however, Employers Mutual assumes reinsurance business from Mutual Re, which provides a small amount of reinsurance protection to the members of the EMC Insurance Companies pooling agreement. As a result, the reinsurance subsidiary’s assumed exposures include a small portion of the EMC Insurance Companies’ direct business, after ceded reinsurance protections purchased by Mutual Re are applied. In addition, the reinsurance subsidiary does not reinsure any “involuntary” facility or pool business that Employers Mutual assumes pursuant to state law. The reinsurance subsidiary assumes all foreign currency exchange gain/loss associated with contracts incepting on January 1, 2006 and thereafter that are subject to the quota share agreement. Operations of the quota share agreement and the inter-company reinsurance program, as well as the purchase of the reinsurance protection from external parties, give rise to inter-company balances with Employers Mutual, which are generally settled during the month following the end of each quarter. The investment and income tax activities of the reinsurance subsidiary are not subject to the quota share agreement.
The net foreign currency exchange gains (losses) assumed by the reinsurance subsidiary from Employers Mutual were $266,000 in 2018, $(978,000) in 2017 and $367,000 in 2016. The total amount of net foreign currency exchange gains (losses) assumed by the reinsurance subsidiary, including the business written on a direct basis outside the quota share agreement, were $637,000 in 2018, $(1.6) million in 2017 and $356,000 in 2016.
Changes in reserve estimates are reflected in net income in the year such changes are recorded. Following is an analysis of the reserve development the Company experienced during the past three years. Care should be exercised when attempting to analyze the financial impact of the reported development amounts because, as noted above, the overall expectation is that, more often than not, favorable development will occur as the prior accident years’ reserves run off.
For the property and casualty insurance segment, the December 31, 2018 estimate of loss and settlement expense reserves for accident years 2017 and prior decreased $15.3 million from the estimate at December 31, 2017. This decrease represents 3.0 percent of the December 31, 2017 gross carried reserves and is primarily attributed to reductions in prior year ultimate loss and settlement ratios for every line of business except workers' compensation and auto physical damage. Other liability experienced favorable development, driven by a reduction in the expected ultimate loss and settlement ratios for accident years 2013, 2015 and 2017, although the ultimate settlement expense ratios for several prior years were reduced slightly as well. Favorable development in the commercial property line was produced by reductions in the ultimate loss and settlement ratios for accident years 2013-2017, as both reported and expected ultimate claim severity decreased. Commercial auto liability had favorable development from decreases in the ultimate loss and settlement ratios for accident years 2011, 2014 and 2017, since ultimate claim severities are now projected to be better than initially expected. Ultimate loss and settlement ratios for surety bonds have been lowered for accident years 2016 and 2017 due to lower than expected reported losses to date, and homeowners ultimate loss and settlement ratios were reduced for accident years 2014 and 2017. Workers' compensation and auto physical damage experienced adverse development on direct loss and settlement expenses. Adverse development in workers' compensation is the result of an increase in the 2017 accident year ultimate loss and settlement ratio due to an initial underestimate of both the ultimate frequency and severity, especially winter related slip and fall claims. The 2017 accident year ultimate loss and settlement ratio for auto physical damage was increased due to an increase in frequency associated with fourth quarter 2017 claims. Prior year development was flat in the personal auto liability line of business.
For the property and casualty insurance segment, the December 31, 2017 estimate of loss and settlement expense reserves for accident years 2016 and prior decreased $15.7 million from the estimate at December 31, 2016. This decrease represented 3.2 percent of the December 31, 2016 gross carried reserves and was primarily attributed to reductions in prior year ultimate loss ratios for every line of business except commercial auto liability and surety bonds (included in "other" lines of business). Commercial auto liability experienced adverse development as ultimate loss and settlement expense ratios were increased for accident years 2013-2016 due to increases in projected severity and/or frequency. The adverse development from surety bonds was due to two large accident year 2015 losses. The two lines of business contributing the majority of favorable development were other liability and workers' compensation. Other liability’s ultimate loss ratios were decreased for most accident years from 2001 through 2016 mainly in response to decreases in expected ultimate severity. Workers' compensation’s favorable development reflected a reduction in the accident year 2016 ultimate ratio as reported losses to date were materially more favorable than anticipated in frequency and severity assumptions underlying the December 31, 2016 selection. Included in the development amount was adverse development experienced in the other liability line of business stemming from the settlement of claims for past and future legal fees and losses on a multi-year asbestos exposure associated with a former insured, and a slight strengthening of remaining reserves.
For the reinsurance segment, the December 31, 2017 estimate of loss and settlement expense reserves for accident years 2016 and prior decreased $3.9 million from the estimate at December 31, 2016. This decrease represented 1.9 percent of the December 31, 2016 gross carried reserves and primarily reflected favorable development in the property/casualty global pro rata and excess contracts, and the per risk excess contracts. For the property/casualty global pro rata contracts, the favorable development was related to a change in ultimate loss assumptions for several prior years due to the use of company experience in place of Reinsurance Association of America data for calculating development factors to ultimate.
For the reinsurance segment, the December 31, 2016 estimate of loss and settlement expense reserves for accident years 2015 and prior decreased $10.9 million from the estimate at December 31, 2015. This decrease represented 5.5 percent of the December 31, 2015 gross carried reserves and was attributed to favorable development in the 2015 accident year in the HORAD pro rata line of business, and an increase in the amount of negative bulk IBNR loss reserve carried on prior years' reserves in the Mutual Re book of business.
Following is information about reported incurred and paid claims development as of December 31, 2018, net of reinsurance, as well as cumulative claim frequency and the amount of IBNR loss reserves carried (representing both IBNR liabilities and expected loss reserve development on reported claims). The information displayed for assumed reinsurance is restated to reflect all foreign currency denominated transactions on the basis of current (December 31, 2018) exchange rates. The number of reported claims (cumulative claim frequency) for the Company’s direct insurance business represents the total number of claims reported by the participants in the pooling agreement, and is determined on the basis of each unique combination of claimant, specific policy coverage, and type of loss. This is in contrast to all other reported amounts that are stated at the aggregate 30 percent pool participation percentage of the Company's property and casualty insurance subsidiaries. The cumulative claim frequency for the Company’s assumed reinsurance business is not readily available. Consistent with industry practices, bordereauxs on pro rata accounts often exclude claim frequency information, and if it is included, the level of detail provided by the ceding companies can vary significantly. Excess of loss contracts customarily report total losses subject to the treaty without detailed loss listings.
The Company has exposure to asbestos and environmental related claims associated with the insurance business written by the parties to the pooling agreement and the reinsurance business assumed from Employers Mutual by the reinsurance subsidiary. Asbestos and environmental losses paid by the Company have averaged $2.8 million per year over the past five years. Reserves for asbestos and environmental related claims for direct insurance and assumed reinsurance business totaled $11.6 million and $11.7 million ($11.1 million and $11.4 million net of reinsurance) at December 31, 2018 and 2017, respectively.
At present, the pool participants are defending approximately 1,737 asbestos bodily injury lawsuits, some of which involve multiple plaintiffs. Most of the lawsuits are subject to express reservation of rights based upon the lack of an injury within the applicable policy periods, because many asbestos lawsuits do not specifically allege dates of asbestos exposure or dates of injury. The pool participants’ policyholders named as defendants in these asbestos lawsuits are typically peripheral defendants who have little or no exposure and are often dismissed from asbestos litigation with nominal or no payment (i.e., small contractors, supply companies, and a furnace manufacturer).
Prior to 2008, actual losses paid for asbestos-related claims had been minimal due to the plaintiffs’ failure to identify an exposure to any asbestos-containing products associated with the pool participants’ current and former policyholders. However, paid losses and settlement expenses have increased significantly since 2008 as a result of claims attributed to one former policyholder. During the period 2009 through 2018, the Company's share of paid losses and settlement expenses attributed to this former policyholder, a furnace manufacturer, was $14.2 million (mostly settlement expenses). A coverage-in-place agreement was executed with this former policyholder in 2009 and a national coordinating counsel was retained to address the multi-state litigation issues. The national coordinating counsel has provided, and continues to provide, significant services in the areas of document review, discovery, deposition and trial preparation. The asbestos exposure associated with this former policyholder has increased in recent years, and this trend may possibly continue into the future with increased per plaintiff settlements. Approximately 702 asbestos exposure claims associated with this former policyholder remain open. During 2017, a settlement was reached with another former insured, resulting in the Company recognizing $4.5 million (its share) of losses and settlement expenses to remove all past and future asbestos liability exposure related to that policyholder.
While the Company does not have a significant amount of exposure to asbestos claims, management has been strengthening the reserves carried for these exposures when deemed appropriate. In 2018, the settlement expense reserves for asbestos claims were strengthened by $1.5 million.
The NAIC utilizes a risk-based capital model to help state regulators assess the capital adequacy of insurance companies and identify insurers that are in, or are perceived as approaching, financial difficulty. This model establishes minimum capital needs based on the risks applicable to the operations of the individual insurer. The risk-based capital requirements for property and casualty insurance companies measure three major areas of risk: asset risk, credit risk and underwriting risk. Companies having less statutory surplus than required by the risk-based capital requirements are subject to varying degrees of regulatory scrutiny and intervention, depending on the severity of the inadequacy. At December 31, 2018, the Company’s insurance subsidiaries had total adjusted statutory capital of $527.1 million, which exceeds the minimum risk-based capital requirement of $101.9 million.
The amount of dividends available for distribution to the Company by its insurance subsidiaries is limited by law to a percentage of the statutory unassigned surplus of each of the subsidiaries as of the previous December 31, as determined in accordance with accounting practices prescribed by insurance regulatory authorities of the state of domicile of each subsidiary. Under Iowa law, the maximum dividend that may be paid within a 12 month period without prior regulatory approval is restricted to the greater of 10 percent of statutory surplus as regards policyholders as of the preceding December 31, or net income of the preceding calendar year on a statutory basis, not greater than earned statutory surplus. North Dakota, the state of domicile of Dakota Fire Insurance Company, imposes similar restrictions, except that the maximum dividend is limited to the lesser of 10 percent of statutory surplus as regards policyholders as of the preceding December 31, or net income excluding capital gains of the preceding calendar year on a statutory basis, not greater than earned statutory surplus. At December 31, 2018, $48.0 million was available for distribution to the Company in 2019 without prior approval.
The carrying amounts and the estimated fair values of the Company’s financial instruments as of December 31, 2018 and 2017 are summarized in the tables below.
Short-term investments generally include money market funds, U.S. Treasury bills and commercial paper. Short-term investments are carried at fair value, which approximates cost, due to the highly liquid nature of the securities. Short-term securities are classified as Level 1 fair value measurements when the fair values can be validated by recent trades. When recent trades are not available, fair value is deemed to be the cost basis and the securities are classified as Level 2 fair value measurements.
The estimated fair value of the surplus notes is derived by discounting future expected cash flows at a rate deemed appropriate over a 25-year term (the surplus notes have no stated maturity date, and the interest to be paid is assumed to continue at the current interest rate in place of 2.73 percent).
U.S. Treasury securities (including bonds, notes, and bills) are priced according to a number of live data sources, including active market makers and inter-dealer brokers. Prices from these sources are reviewed based on the sources’ historical accuracy for individual issues and maturity ranges.
A small number of the Company’s securities are not priced by the independent pricing service. One of these was an equity security that was reported as a Level 3 fair value measurement since no observable inputs were used in its valuation. This security was sold in 2018 and in prior periods was reported at the fair value obtained from the Securities Valuation Office (SVO) of the National Association of Insurance Commissioners (NAIC). The SVO established a per share price for this security based on an annual review of that company's financial statements, typically performed during second quarter. The other securities not priced by the Company's independent pricing service consist of six fixed maturity securities (eight at December 31, 2017). Two of these fixed maturity securities, classified as Level 3 fair value measurements, are corporate securities that convey premium tax benefits and are not publicly traded. The fair values for these securities are based on discounted cash flow analyses. The other fixed maturity securities are classified as Level 2 fair value measurements. The fair values for these fixed maturity securities were obtained from either the SVO, the Company’s investment custodian, or the Company's investment department using similar pricing techniques as the Company's independent pricing service.
Presented in the table below is a reconciliation of the assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2018 and 2017. Any unrealized gains or losses on fixed maturiy securities are recognized in other comprehensive income (loss). Any gains or losses from settlements, disposals impairments and, starting in 2018, unrealized gains or losses on equity securities, are reported as realized investment gains or losses in net income.
Investments of the Company’s insurance subsidiaries are subject to the insurance laws of the state of their incorporation. These laws prescribe the kind, quality and concentration of investments that may be made by insurance companies. In general, these laws permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common stocks and real estate mortgages. The Company believes that it is in compliance with these laws.
The amortized cost and estimated fair value of securities available-for-sale as of December 31, 2018 and 2017 are as follows. All fixed maturity securities are classified as available-for-sale and are carried at fair value.
Nearly all of the fixed maturity securities that are in an unrealized loss position are considered investment grade by credit rating agencies. Because management does not intend to sell these securities, does not believe it will be required to sell these securities before recovery, and believes it will collect the amounts due on these securities, it was determined that these securities were not “other-than-temporarily” impaired at December 31, 2018.
A summary of realized investment gains and (losses) and the change in unrealized investment gains on equity investments is as follows:
Temporary differences between the consolidated financial statement carrying amount and tax basis of assets and liabilities that give rise to significant portions of the deferred income tax asset (liability) at December 31, 2018 and 2017 are as follows:
The actual income tax expense benefit for the years ended December 31, 2018, 2017 and 2016 differed from the “expected” income tax expense (benefit) for those years (computed by applying the United States federal corporate tax rate of 21 percent during 2018 and 35 percent during 2017 and 2016 to income (loss) before income tax) as follows:
The Company had no provision for uncertain income tax positions at December 31, 2018 or 2017. The Company recognized no interest expense or other penalties related to U.S. federal or state income taxes during 2018, 2017 or 2016. It is the Company’s accounting policy to reflect income tax penalties as other expense, and interest as interest expense.
The Company’s property and casualty insurance subsidiaries have $25.0 million of surplus notes issued to Employers Mutual. The interest rate on the surplus notes was increased to 2.73 percent from 1.35 percent effective February 1, 2018. Reviews of the interest rate are conducted by the Inter-Company Committees of the boards of directors of the Company and Employers Mutual every five years, with the next review due in 2023. Payments of interest and repayments of principal can only be made out of the applicable subsidiary’s statutory surplus and are subject to prior approval by the insurance commissioner of the respective states of domicile. The surplus notes are subordinate and junior in right of payment to all obligations or liabilities of the applicable insurance subsidiaries. Total interest expense incurred on these surplus notes was $654,000 in 2018 and $337,000 in both 2017 and 2016. At December 31, 2018, the Company’s property and casualty insurance subsidiaries had received approval and paid the 2018 interest expense on the surplus notes.
Employers Mutual also offers postretirement benefit plans which provide an HRA and life insurance benefits for eligible retired employees. Substantially all of its employees may become eligible for those benefits if they reach age 55 and have attained the required length of service while working for Employers Mutual. Under the HRA, Employers Mutual reimburses eligible participants, up to a pre-determined maximum, for amounts expended to enroll in publicly available individual health care plans and/or pay for qualifying out-of-pocket health care costs. The obligations of the HRA are based on the total amount of reimbursements expected to be made by Employers Mutual over the lives of the participants, rather than the total amount of medical benefits expected to be paid over the participants’ lives. Therefore, the obligations of the HRA are not directly impacted by changes in the cost of health care. However, the maximum amount Employers Mutual will reimburse eligible participants may be adjusted periodically based on an analysis of the change in health care costs. Such adjustments are reflected as plan amendments and increased the postretirement benefit plans' benefit obligation $2.7 million in 2017. During December 2017, Employers Mutual notified its employees that the life insurance benefit will be eliminated for employees retiring after 2018. As a result, the postretirement benefit plans' benefit obligation as of December 31, 2017 decreased $3.8 million. This change is also reflected as a plan amendment. The life insurance plan is noncontributory. The benefits provided under both plans are subject to change.
The following table sets forth the funded status of Employers Mutual’s pension and postretirement benefit plans as of December 31, 2018 and 2017, based upon measurement dates of December 31, 2018 and 2017, respectively.
The actuarial gains in the projected benefit obligations of the pension and postretirement benefit plans during 2018 are largely due to the increases in the discount rate assumptions, partially offset by losses from an extension in the retirement rate assumption. For the pension plans, a decline in the interest credit rate assumption also contributed to the actuarial gain.
Net periodic pension benefit cost allocated to the Company amounted to $1.2 million, $2.8 million and $2.9 million for the years ended December 31, 2018, 2017 and 2016, respectively. Net periodic postretirement benefit income allocated to the Company for the years ended December 31, 2018, 2017 and 2016 amounted to $3.2 million, $2.9 million, and $3.0 million, respectively.
Employers Mutual manages its VEBA trust assets internally. The VEBA trust assets are reviewed relative to liabilities to determine the optimum allocation focusing on both asset accumulation and income generation. Assets contained in the VEBA trust are invested in fixed income, international equity and domestic equity mutual funds, an emerging markets exchange traded fund (ETF) and universal life insurance policies issued by EMC National Life Company, an affiliate of Employers Mutual, that carry a guaranteed interest rate of 4.5 percent.
Presented below is a reconciliation of the assets measured at fair value using significant unobservable inputs (Level 3) for the years ended December 31, 2018 and 2017.
Pooled Separate Accounts: Each of the funds held by the Plan is in a pooled or commingled investment vehicle that is maintained by the fund sponsor, each with many investors. The Plan asset is represented by a “unit of account” and a per unit value, whose value is the accumulated value of the underlying investments less liabilities. The net asset value is determined by the issuer of the fund by taking the fair value of the underlying investments less any liabilities divided by the number of units outstanding. Sponsors of the funds specify the source(s) used for the underlying investment asset prices and the protocol used to value each fund.
The Company participates in other benefit plans sponsored by Employers Mutual, including its 401(k) Plan, Board and Executive Non-Qualified Excess Plans and Defined Contribution Supplemental Executive Retirement Plan. The Company’s share of expenses for these plans amounted to $3.3 million, $2.9 million and $2.7 million in 2018, 2017 and 2016, respectively.
The Company has a stock-based compensation plan for non-employee directors. Employers Mutual also has several stock plans which utilize the common stock of the Company. Employers Mutual can provide the common stock required under its plans by: 1) using shares of common stock that it currently owns; 2) purchasing common stock in the open market; or 3) directly purchasing common stock from the Company at the current fair value. Employers Mutual's current practice is to purchase common stock from the Company for use in all of its stock plans (including its non-employee director stock purchase plan and its employee stock purchase plan). A portion of the compensation expense recognized by Employers Mutual (as the requisite service period for restricted stock awards/units is rendered) is allocated to the Company’s property and casualty insurance subsidiaries though their participation in the pooling agreement.
During 2017, Employers Mutual began issuing restricted stock unit awards rather than restricted stock awards. In connection with this change, Employers Mutual now acquires stock to fulfill its obligations to the recipients of the restricted stock unit awards on the date they vest, rather than on the grant date of the awards. Because of this change, an account Employers Mutual established to hold previously granted restricted stock awards until they vest will periodically contain excess shares of the Company's stock stemming from forfeitures and surrenders. During 2018, the Company repurchased 30,523 shares of stock from this unvested restricted stock account at an average cost of $26.30. These repurchased shares are not deemed to be shares repurchased under the Company's stock repurchase program. Like restricted stock awards, restricted stock unit awards generally have a vesting period of four years, with shares vesting in equal annual cumulative increments commencing on the first anniversary of the grant. Upon death, disability or change in control, any granted but unvested restricted stock units become fully vested and settled. Upon qualifying for "Approved Retirement" [attaining 70 points (combined age plus whole years of continuous service) with a minimum age of 55 years, or reaching age 65], restricted stock units will generally become non-forfeitable on a pro-rated basis over the 12 months following the grant date. Settlement of non-forfeitable restricted stock units is deferred until the date on which the restricted stock units would otherwise vest and settle pursuant to the normal four-year vesting schedule. Holders of unvested restricted stock units do not receive compensation income equal to the amount of dividends declared on the common stock.
The Company recognized compensation expense from these plans totaling $1.2 million ($949,000 net of tax), $801,000 ($521,000 net of tax) and $788,000 ($512,000 net of tax) in 2018, 2017 and 2016, respectively. Due to the historically small number of forfeitures, the Company has elected to recognize the reduction to compensation expense from forfeitures as they occur.
For restricted stock awards, the average of the high and low trading prices of the Company's common stock on the dates of grant were used to determine their fair values. In 2016, the Company received the full fair value, as of the grant date, for all shares issued in connection with Employers Mutual's grant of restricted stock awards. At December 31, 2018, the Company’s portion of the unrecognized compensation cost associated with restricted stock awards that are not currently vested was $314,000 with a 0.84 year weighted-average period over which the compensation expense is expected to be recognized. The Company's portion of the total fair value of restricted stock awards that vested was $429,000, $545,000 and $414,000 in 2018, 2017 and 2016, respectively. A summary of restricted stock awards activity for 2018, 2017 and 2016 is as follows:
On May 30, 2008, the Company registered 750,000 shares of its common stock for use in the Employers Mutual Casualty Company 2008 Employee Stock Purchase Plan. All employees are eligible to participate in the plan, though this plan is currently suspended pending the outcome of Employers Mutual's non-binding indicative proposal to purchase all outstanding shares of the Company. An employee may participate in the plan, when not suspended, by delivering, during the first twenty days of the calendar month preceding the first day of an election period, a payroll deduction authorization to the plan administrator; or making a cash contribution (employees designated as “Insiders” are required to give six months advance notice prior to participating in the plan). Participants pay 85 percent of the fair market value of the stock on the date of purchase. The plan is administered by the Board of Directors of Employers Mutual, which has the right to amend or terminate the plan at any time; however, no such amendment or termination shall adversely affect the rights and privileges of participants. Expenses allocated to the Company in connection with this plan totaled $116,000, $100,000 and $78,000 in 2018, 2017 and 2016, respectively.
The Company does not have any lease agreements, but Employers Mutual has entered into leases for 16 branch and service office facilities, the costs of which are charged to the pool and allocated among the pool participants based on their respective participation interests.
The Company and Employers Mutual and its other subsidiaries are parties to numerous lawsuits arising in the normal course of the insurance business. The Company believes that the resolution of these lawsuits will not have a material adverse effect on its financial condition or its results of operations. The companies involved have established reserves which are believed adequate to cover any potential liabilities arising out of all such pending or threatened proceedings.
1 Since the weighted-average number of shares outstanding for the quarters are calculated independently of the weighted-average number of shares outstanding for the year, quarterly net income per share may not total to annual net income per share.