dependence upon our relationship with the Exchange and the management fee under the agreement with the subscribers at the Exchange;
The Exchange is a reciprocal insurance exchange organized under Article X of Pennsylvania's Insurance Company Law of 1921 under which individuals, partnerships, and corporations are authorized to exchange reciprocal or inter-insurance contracts with each other, or with individuals, partnerships, and corporations of other states and countries, providing indemnity among themselves from any loss which may be insured against under any provision of the insurance laws except life insurance. Each applicant for insurance to the Exchange signs a subscriber's agreement, which contains an appointment of Indemnity as their attorney-in-fact to transact the business of the Exchange on their behalf.
Pursuant to the subscriber's agreement and for its services as attorney-in-fact, we earn a management fee calculated as a percentage of the direct and assumed premiums written by the Exchange.
Our earnings are primarily driven by the management fee revenue generated for the policy issuance and renewal services we provide for the Exchange. Management fee revenue is based upon all direct and assumed premiums written by the Exchange and the management fee rate, which is not to exceed 25%. Our Board of Directors establishes the management fee rate at least annually, generally in December for the following year. The process of setting the management fee rate includes the evaluation of current year operating results compared to both prior year and industry estimated results for both Indemnity and the Exchange, and consideration of several factors for both entities including: their relative financial strength and capital position; projected revenue, expense and earnings for the subsequent year; future capital needs; as well as competitive position.
The policy issuance and renewal services we provide to the Exchange include sales, underwriting and policy issuance services. The sales related services we provide include agent compensation and certain sales and advertising support services. Agent compensation includes scheduled commissions to agents based upon premiums written as well as additional commissions and bonuses to agents, which are earned by achieving targeted measures. Agent compensation comprised approximately 68% of our 2017 expenses. The underwriting services we provide include underwriting and policy processing and comprised approximately 10% of our 2017 expenses. The remaining services we provide include customer service and administrative support. We also provide information technology services that support all the functions listed above that comprised approximately 10% of our 2017 expenses.
management services for EFL, in accordance with the service agreements between each of the subsidiaries and Indemnity. Claims handling services include costs incurred in the claims process, including the adjustment, investigation, defense, recording and payment functions, as well as an allocation of costs for departments that support these claims functions. Life management services include costs incurred in the management and processing of life insurance business. Investment management services are related to investment trading activity, accounting and all other functions attributable to the investment of funds, including an allocation of costs for departments that support the investment function. The amounts incurred for these services are the responsibility of the Exchange and its insurance subsidiaries as outlined in the subscriber's agreement and the services agreements, and are reimbursed to Indemnity as cost. State insurance regulations require that intercompany service agreements and any material amendments be approved in advance by the state insurance department. See Part II, Item 8. "Financial Statements and Supplementary Data - Note 13, Related Party, of Notes to Financial Statements" contained within this report.
Our results of operations are tied to the growth and financial condition of the Exchange as the Exchange is our sole customer and our earnings are largely generated from management fees based on the direct and assumed premiums written by the Exchange. The Exchange generates revenue by insuring preferred and standard risks, with personal lines comprising 71% of the 2017 direct and assumed written premiums and commercial lines comprising the remaining 29%. The principal personal lines products are private passenger automobile and homeowners. The principal commercial lines products are commercial multi-peril, commercial automobile and workers compensation.
Total operating expenses increased 7.6% and 2.5% in 2017 and 2016, respectively. The increase in operating expenses for 2017 was driven by increases in commissions, personnel costs and information technology-related professional fees. The increase in operating expenses for 2016 was driven by an increase in commissions, partially offset by lower non-commission expenses primarily from lower personnel costs across all expense categories.
Total investment income increased in 2017 driven by higher net investment income and realized investment gains, offset by lower earnings from limited partnership investments. Total investment income decreased in 2016 primarily due to lower earnings generated from limited partnership investments.
For purposes of determining whether the market is active or inactive, the classification of a financial instrument is based upon the following definitions:
Level 3 securities are valued based upon unobservable inputs, reflecting our estimates of value based upon assumptions used by market participants. Securities are assigned to Level 3 in cases where non-binding broker quotes are significant to the valuation and there is a lack of transparency as to whether these quotes are based upon information that is observable in the marketplace. Fair value estimates for securities valued using unobservable inputs require significant judgment due to the illiquid nature of the market for these securities and represent the best estimate of the fair value that would occur in an orderly transaction between willing market participants at the measurement date under current market conditions. Fair value for these securities are generally determined using non-binding broker quotes received from outside broker dealers based upon security type and market conditions. Remaining securities, where a price is not available, are valued using an estimate of fair value based upon indicative market prices that include significant unobservable inputs not based upon, nor corroborated by, market information, including the utilization of discounted cash flow analyses which have been risk-adjusted to take into account illiquidity and other market factors. This category primarily consists of corporate and other debt securities priced using non-binding broker quotes.
The primary basis for the valuation of limited partnership interests is financial statements prepared by the general partner. Because of the timing of the preparation and delivery of these financial statements, the use of the most recently available financial statements provided by the general partners generally result in a quarter delay in the inclusion of the limited partnership results in our Statements of Operations. Due to this delay, these financial statements do not reflect the market conditions experienced in the fourth quarter of 2017.
valuations prior to the release of the fund's quarterly and annual financial statements. Based upon that information from the general partner, we consider whether additional disclosure is warranted. We analyze limited partnerships measured at fair value based upon NAV to determine if the most recently available NAV reflects fair value at the balance sheet date, with an adjustment being made where appropriate (change of plus or minus 5% compared to most recent NAV).
Accumulated and projected benefit obligations are expressed as the present value of future cash payments. We discount those cash payments based upon a yield curve developed from corporate bond yield information with maturities that correspond to the payment of benefits. Lower discount rates increase present values and subsequent year pension expense, while higher discount rates decrease present values and subsequent year pension expense. The construction of the yield curve is based upon yields of corporate bonds rated AA or equivalent quality. Target yields are developed from bonds at various maturity points and a curve is fitted to those targets. Spot rates (zero coupon bond yields) are developed from the yield curve and used to discount benefit payment amounts associated with each future year. The present value of plan benefits is calculated by applying the spot/discount rates to projected benefit cash flows. A single discount rate is then developed to produce the same present value. The cash flows from the yield curve were matched against our projected benefit payments in the pension plan, which have a duration of about 19 years. This yield curve supported the selection of a 3.73% discount rate for the projected benefit obligation at December 31, 2017 and for the 2018 pension expense. The same methodology was used to develop the 4.24% and 4.57% discount rates used to determine the projected benefit obligation for 2016 and 2015, respectively, and the pension expense for 2017 and 2016, respectively. A 25 basis point decrease in the discount rate assumption, with other assumptions held constant, would increase pension cost in the following year by $4.8 million, of which our share would be approximately $2.0 million, and would increase the pension benefit obligation by $46.0 million.
Unrecognized actuarial gains and losses arise from several factors, including experience and assumption changes in the obligations and from the difference between expected returns and actual returns on plan assets. These unrecognized gains and losses are recorded in the pension plan obligation and accumulated other comprehensive income (loss) on the Statements of Financial Position. These amounts are systematically recognized to net periodic pension expense in future periods, with gains decreasing and losses increasing future pension expense. If actuarial net gains or losses exceed 5% of the greater of the projected benefit obligation and the market-related value of plan assets, the excess is recognized through the net periodic pension expense equally over the estimated service period of the employee group, which is currently 14 years.
We use a four year averaging method to determine the market-related value of plan assets, which is used to determine the expected return component of pension expense. Under this methodology, asset gains or losses that result from returns that differ from our long-term rate of return assumption are recognized in the market-related value of assets on a level basis over a four year period. The market-related asset experience during 2017 that related to the actual investment return being different from that assumed during the prior year was a gain of $67.4 million. Recognition of this gain will be deferred and recognized over a four year period, consistent with the market-related asset value methodology. Once factored into the market-related asset value, these experience gains and losses will be amortized over a period of 14 years, which is the remaining service period of the employee group.
Estimates of fair values of the pension plan assets are obtained primarily from the trustee and custodian of our pension plan. Our Level 1 category includes a money market fund that is a mutual fund for which the fair value is determined using an exchange traded price provided by the trustee and custodian. Our Level 2 category includes commingled pools. Estimates of fair values for securities held by our commingled pools are obtained primarily from the trustee and custodian. The methodologies used by the trustee and custodian that support a financial instrument Level 2 classification include multiple verifiable, observable inputs including benchmark yields, reported trades, broker/dealer quotes, issuers spreads, two-sided markets, benchmark securities, bids, offers, and reference data. There were no Level 3 investments in 2017 or 2016. We expect our net pension benefit costs to increase slightly from $34.6 million in 2017 to $35.5 million in 2018. The lower discount rate of 3.73% will increase our 2018 net pension benefit costs by approximately $10.0 million. We are making accelerated pension contributions of $80 million, of which $40 million was made in January 2018, and an additional $40 million will be made in April 2018. These additional contributions along with normal plan progression will reduce the 2018 net pension benefit costs by approximately $9.1 million, which mostly offsets the increase due to the change in discount rate. Our share of the net pension benefit costs after reimbursements was $14.3 million in 2017. We expect our share of the net pension benefit costs to be approximately $14.7 million in 2018.
The Exchange implemented rate increases in 2017, 2016, and 2015 in order to meet loss cost expectations. As the Exchange writes policies with annual terms only, rate actions take 12 months to be fully recognized in written premium and 24 months to be fully recognized in earned premiums. Since rate changes are realized at renewal, it takes 12 months to implement a rate
change to all policyholders and another 12 months to earn the increased or decreased premiums in full. As a result, certain rate actions approved in 2016 were reflected in 2017, and recent rate actions in 2017 will be reflected in 2018. The Exchange continuously evaluates pricing and product offerings to meet consumer demands.
Changes in premium levels attributable to the growth in policies in force directly affects the profitability of the Exchange and has a direct bearing on our management fee. The Exchange's continued focus on underwriting discipline and the maturing of its pricing sophistication models has contributed to its growth in new policies in force, steady policy retention ratios, and increased average premium per policy. The continued growth of its policy base is dependent upon the Exchange's ability to retain existing, and attract new, subscribers/policyholders. A lack of new policy growth or the inability to retain existing customers could have an adverse effect on the Exchange's premium level growth, and consequently our management fee.
Management fees are returned to the Exchange when subscribers/policyholders cancel their insurance coverage mid-term and unearned premiums are refunded to them. We maintain an allowance for management fees returned on mid-year policy cancellations that recognizes the management fee anticipated to be returned to the Exchange based on historical mid-term cancellation experience. Our cash flows are unaffected by the recording of this allowance.
Service agreement revenue includes service charges we collect from subscribers/policyholders for providing extended payment terms on policies written and assumed by the Exchange, and late payment and policy reinstatement fees. The service charges are fixed dollar amounts per billed installment. Service agreement revenue totaled $29.1 million, $29.2 million and $30.0 million in 2017, 2016 and 2015, respectively. The decrease in service agreement revenue compared to the growth in policies in force reflects the continued shift to payment plans that do not incur service charges or offer a premium discount for certain payment methods. The shift to these plans is driven by the consumers' desire to avoid paying service charges and to take advantage of the discount.
Commissions - Commissions increased $53.7 million in 2017 compared to 2016, and $45.9 million in 2016 compared to 2015, primarily as a result of the increased direct and assumed premiums written by the Exchange of 6.0% and 6.2%, respectively.
In 2016, compared to 2015, non-commission expense decreased $14.6 million. Information technology costs decreased $2.1 million primarily due to decreased personnel costs somewhat offset by an increase in professional fees. Customer service costs decreased $4.7 million primarily due to decreased credit card processing fees and personnel costs. Administrative and other costs decreased $7.8 million due to decreased personnel costs, including incentive compensation forfeited by senior executives who separated from service during 2016, somewhat offset by an increase in professional fees. Personnel costs in all expense categories were impacted by decreased pension costs primarily due to an increase in the pension discount rate as well as decreased medical costs.
Net realized gains were $1.3 million in 2017, compared to gains of $0.7 million in 2016 and $0.5 million in 2015. Net realized gains in 2017 were primarily due to gains from the sales of fixed maturity securities, partially offset by losses from sales of equity securities, while gains in 2016 were primarily attributable to gains from sales of common stock trading securities. Net realized gains in 2015 were due to gains from sales on nonredeemable preferred stock, which were partially offset by losses from sales of fixed maturity securities.
The components of equity in earnings (losses) of limited partnerships are as follows for the years ended December 31:
$10.0 million in 2016, compared to 2015. The decrease in earnings in 2017 was primarily the result of lower earnings in real estate investments that were partially offset by higher earnings from private equity investments. The decrease in earnings in 2016 was primarily the result of lower earnings from private equity investments that were partially offset by higher earnings from real estate investments.
The financial statements of the Exchange are prepared in accordance with statutory accounting principles prescribed by the Commonwealth of Pennsylvania. Financial statements prepared under statutory accounting principles focus on the solvency of the insurer and generally provide a more conservative approach than under GAAP. Statutory direct written premiums of the Exchange and its wholly owned property and casualty subsidiaries grew 6.0% to $6.7 billion in 2017 from $6.3 billion in 2016. These premiums, along with investment income, are the major sources of cash that support the operations of the Exchange. Policyholders' surplus, determined under statutory accounting principles, was $8.8 billion and $7.7 billion at December 31, 2017 and 2016, respectively. The Exchange and its wholly owned property and casualty subsidiaries' year-over-year policy retention ratio continues to be high at 89.6% at December 31, 2017 and 89.8% at December 31, 2016.
We individually analyze all positions with emphasis on those that have, in our opinion, declined significantly below cost. In compliance with impairment guidance for debt securities, we perform further analysis to determine if a credit-related impairment has occurred. Some of the factors considered in determining whether a debt security is credit impaired include potential for the default of interest and/or principal, level of subordination, collateral of the issue, compliance with financial covenants, credit ratings and industry conditions. We have the intent to sell all credit-impaired debt securities; therefore, the entire amount of the impairment charges are included in earnings and no impairments are recorded in other comprehensive income. For available-for-sale equity securities, a charge is recorded in the Statements of Operations for positions that have experienced other-than-temporary impairments. (See the "Results of Operations" section herein for further information.) We believe our investment valuation philosophy and accounting practices result in appropriate and timely measurement of value and recognition of impairment.
Fixed maturities classified as available-for-sale are carried at fair value with unrealized gains and losses, net of deferred taxes, included in shareholders' equity. Net unrealized gains on fixed maturities, net of deferred taxes, amounted to $3.3 million at December 31, 2017, compared to $3.2 million at December 31, 2016.
The following table presents a breakdown of the fair value of our fixed maturity portfolio by sector and rating: (1)
(1) Ratings are supplied by S&P, Moody's, and Fitch. The table is based upon the lowest rating for each security.
The funded status of our postretirement benefit plans is recognized in the Statements of Financial Position, with a corresponding adjustment to accumulated other comprehensive income, net of tax. At December 31, 2017, shareholders' equity amounts related to these postretirement plans decreased by $8.1 million, net of tax at the newly enacted tax rate of 21%, of which $7.7 million represents amortization of the prior service cost and net actuarial loss and $15.8 million represents the current period actuarial loss. The 2017 actuarial loss was primarily due to the change in the discount rate assumption used to measure the future benefit obligations to 3.73% in 2017, from 4.24% in 2016, somewhat offset by the actual investment returns outperforming the assumed rate of return. At December 31, 2016, shareholders' equity amounts related to these postretirement plans decreased by $24.6 million, net of tax, of which $5.5 million represents amortization of the prior service cost and net actuarial loss and $30.1 million represents the current period actuarial loss. The 2016 actuarial loss was primarily due to the change in the discount rate assumption used to measure the future benefit obligations to 4.24% in 2016, from 4.57% in 2015. Although we are the sponsor of these postretirement plans and record the funded status of these plans, the Exchange and its subsidiaries reimburse us for approximately 59% of the annual benefit expense of these plans, which represents pension benefits for our employees performing claims and life insurance functions and their share of service department costs.
On November 7, 2016, we entered into a credit agreement for a $100 million senior secured draw term loan credit facility ("Credit Facility") for the acquisition of real property and construction of an office building that will serve as part of our principal headquarters. As of December 31, 2017, we have drawn $75 million against the facility. Under the agreement, an additional $25 million will be drawn on June 1, 2018 ("Draw Period"). During the Draw Period, we will make monthly interest only payments under the Credit Facility and thereafter the Credit Facility converts to a fully-amortized term loan with monthly payments of principal and interest over a period of 28 years. Borrowings under the Credit Facility will bear interest at a fixed rate of 4.35%. In addition, we are required to pay a quarterly commitment fee of 0.08% on the unused portion of the Credit Facility during the Draw Period. We capitalize applicable interest charges incurred during the construction period of long-term building projects as part of the historical cost of the asset.
Net cash provided by operating activities was $197.1 million in 2017, compared to $254.3 million in 2016 and $217.4 million in 2015. Decreased cash provided by operating activities in 2017 was primarily due to higher commissions and bonuses paid to agents, pension contributions, and general operating expenses paid, compared to 2016. Cash paid for agent commissions and bonuses increased to $923.4 million in 2017, compared to $870.6 million in 2016, due to higher scheduled commissions driven by premium growth and higher bonus award payments resulting from profitable underwriting results. We contributed $58.9 million to our pension plan in 2017, compared to $17.4 million in 2016. Additionally, our Board approved an $80 million accelerated pension contribution. We contributed $40 million in January 2018 and plan to make an additional $40 million contribution in April 2018. We are reimbursed approximately 59% of the net periodic benefit cost of the pension plans from the Exchange and its subsidiaries, which represents pension benefits for our employees performing claims and life insurance functions and their share of service department costs. Cash paid for general operating expenses increased $23.1 million to $199.1 million in 2017 driven by higher information technology-related professional fees and hardware and software costs. Somewhat offsetting the decrease in cash provided in 2017 was an increase in management fee revenue received, reflecting the increase in direct and assumed premiums written by the Exchange. In 2016, increased cash from operating activities, compared to 2015, was primarily due to an increase in management fee revenue received, reflecting the increase in direct and assumed premiums written by the Exchange, combined with lower general operating expenses paid. Somewhat offsetting this increase in cash provided was an increase in commissions and bonuses paid to agents combined with a decrease in reimbursements collected from affiliates, compared to 2015.
No shares of our Class A nonvoting common stock were repurchased in 2017, 2016 and 2015 in conjunction with our stock repurchase program. In October 2011, our Board of Directors approved a continuation of the current stock repurchase program for a total of $150 million with no time limitation. This repurchase authority includes, and is not in addition to, any unspent amounts remaining under the prior authorization. We had approximately $17.8 million of repurchase authority remaining under this program at December 31, 2017, based upon trade date.
1) cash and cash equivalents, which total approximately $215.7 million at December 31, 2017, 2) a $100 million bank revolving line of credit, and 3) liquidation of assets held in our investment portfolio, including preferred stock and investment grade bonds which totaled approximately $371.0 million at December 31, 2017. Volatility in the financial markets could impair our ability to sell certain of our fixed income securities or cause such securities to sell at deep discounts. Additionally, we have the ability to curtail or modify discretionary cash outlays such as those related to shareholder dividends and share repurchase activities.
We have certain obligations and commitments to make future payments under various contracts. As of December 31, 2017, the aggregate obligations were as follows:
Long-term debt amount differs from the balance presented on the Statements of Financial Position as the long-term debt amount in the table above includes interest and principal payments based upon total expected draw commitments and excludes commitment fees.
Limited partnership commitments will be funded as required for capital contributions at any time prior to the agreement expiration date. The commitment amounts are presented using the expiration date as the factor by which to age when the amounts are due. At December 31, 2017, our total commitment to fund limited partnerships that invest in private equity securities was $6.6 million, mezzanine debt was $8.2 million, and real estate activities was $1.5 million.
Contributions anticipated in future years depend upon certain factors that cannot be reasonably predicted. Additional contributions may be made due to future plan changes, our business or investment strategy, or pending law changes. The obligations for our unfunded benefit plans, including the Supplemental Employee Retirement Plan (SERP) for our executive and senior management, are not included in gross contractual obligations. The recorded accumulated benefit obligation for this plan at December 31, 2017 is $17.1 million. We expect to have sufficient cash flows from operations to meet the future benefit payments as these become due.
We are reimbursed from the Exchange and its subsidiaries for a portion of the costs related to the pension, other commitments and operating leases.
Our ERM process is founded on a governance framework that includes oversight at multiple levels of our organization, including our Board of Directors and executive management. Accountability to identify, manage, and mitigate risk is
By virtue of its legal structure as a reciprocal insurer, the Exchange does not have the ability to enter into contractual relationships and therefore, Indemnity serves as the attorney-in-fact on behalf of the Exchange for all claims handling and investment management services, which include certain common overhead and service department functions in accordance with the subscriber's agreement. The Exchange's insurance subsidiaries also utilize Indemnity for these services, including life management services for EFL, in accordance with the services agreements between each of the subsidiaries and Indemnity. The amounts incurred for these services are the responsibility of the Exchange and its insurance subsidiaries as outlined in the subscriber's agreement and the services agreements. These amounts are reimbursed to us based upon appropriate utilization statistics (employee count, square footage, vehicle count, project hours, etc.) in accordance with the subscriber's agreement and the service agreements between us and the Exchange's wholly owned subsidiaries. All reimbursements are made on an actual cost basis and do not include a profit component. These reimbursements are settled on a monthly basis. State insurance regulations require that intercompany service agreements and any material amendments be approved in advance by the state insurance department.
We hold a surplus note for $25 million from EFL that is payable on demand on or after December 31, 2018; however, no principal or interest payments may be made without prior approval by the Pennsylvania Insurance Commissioner. Interest payments are scheduled to be paid semi-annually. We recognized interest income on the note of $1.7 million in 2017, 2016 and 2015.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 22, 2018 expressed an unqualified opinion thereon.
(3) A one-time adjustment was made in the fourth quarter of 2017 to reclassify stranded tax effects of the components of accumulated other comprehensive income ("AOCI") resulting from enactment of TCJA from AOCI to retained earnings. See Note 2, "Significant Accounting Policies".
Erie Indemnity Company ("Indemnity", "we", "us", "our") is a publicly held Pennsylvania business corporation that has since its incorporation in 1925 served as the attorney-in-fact for the subscribers (policyholders) at the Erie Insurance Exchange ("Exchange"). The Exchange, which also commenced business in 1925, is a Pennsylvania-domiciled reciprocal insurer that writes property and casualty insurance. We function solely as the management company and all insurance operations are the responsibility of the Exchange.
Our primary function, as attorney-in-fact, is to perform certain services on behalf of the subscribers at the Exchange relating to policy issuance and renewals including the sales, underwriting, and issuance of policies. This is done in accordance with a subscriber's agreement (a limited power of attorney) executed individually by each subscriber (policyholder), which appoints us as their common attorney-in-fact to transact certain business on their behalf and to manage the affairs of the Exchange. Pursuant to the subscriber's agreement and for its services as attorney-in-fact, we earn a management fee calculated as a percentage of the direct and assumed premiums written by the Exchange.
The services we provide to the subscribers at the Exchange are related to the sales, underwriting and issuance of policies. The sales related services we provide include agent compensation and certain sales and advertising support services. Agent compensation includes scheduled commissions to agents based upon premiums written as well as additional commissions and bonuses to agents, which are earned by achieving targeted measures. Agent compensation comprised approximately 68% of our 2017 expenses. The underwriting services we provide include underwriting and policy processing and comprised approximately 10% of our 2017 expenses. The remaining services we provide include customer service and administrative support. We also provide information technology services that support all the functions listed above that comprised approximately 10% of our 2017 expenses.
Our results of operations are tied to the growth and financial condition of the Exchange. If any events occurred that impaired the Exchange's ability to grow or sustain its financial condition, including but not limited to reduced financial strength ratings, disruption in the independent agency relationships, significant catastrophe losses, or products not meeting customer demands, the Exchange could find it more difficult to retain its existing business and attract new business. A decline in the business of the Exchange almost certainly would have as a consequence a decline in the total premiums paid and a correspondingly adverse effect on the amount of the management fees we receive. We also have an exposure to a concentration of credit risk related to the unsecured receivables due from the Exchange and its subsidiaries. See Note 14, "Concentrations of Credit Risk" contained within this report.
In March 2017, the FASB issued ASU 2017-08, "Receivables-Nonrefundable Fees and Other Costs", which shortens the amortization period for certain purchased callable debt securities held at a premium from maturity date to the earliest call date. ASU 2017-08 is effective for interim and annual reporting periods beginning after December 31, 2018. The guidance should be applied using a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Early adoption is permitted, including adoption in an interim period. We have evaluated this guidance and are already in compliance, therefore there is no impact on our financial statements.
We performed an analysis in accordance with the steps identified in the new guidance around the recognition, measurement, and presentation of management fee revenue. Our service fee revenue was determined to be outside of the scope of this new guidance.
The second performance obligation is acting as the attorney-in-fact on behalf of the Exchange for all claims handling and investment management services, which include certain common overhead and service department functions. The amounts incurred for these services are the responsibility of the Exchange and are reimbursed to Indemnity at cost in accordance with the subscriber's agreement. Beginning January 1, 2018, a small portion of our management fee will be allocated to this performance obligation. The majority of the revenue allocated to this performance obligation will be recognized over several years because the economic benefit of the service provided (i.e. the claims handling services) and the control of the promised asset (i.e. the claims handling services) transfers to the customer over several years. We have also determined that we are functioning in a principal capacity for this performance obligation and the expenses and related reimbursements will be presented gross on our Statements of Operations effective January 1, 2018.
The adoption will not have a material impact on our financial condition, earnings, or earnings per share, and will have no impact on our cash flows.
income (loss). Realized gains and losses on sales of available-for-sale securities are recognized in income based upon the specific identification method. Interest and dividend income are recognized as earned and recorded to net investment income.
short and long-term prospects of the issuer and its industry based upon analysts' recommendations;
identical or comparable assets or liabilities. Such valuation techniques often use market multiples derived from a set of comparables. The income approach uses valuation techniques to convert future cash flows or earnings to a single discounted present value amount. The measurement is based upon the value indicated by current market expectations on those future amounts. The cost approach is derived from the amount that is currently required to replace the service capacity of an asset. If information becomes available that would impair the cost of investments owned by the partnerships, then the general partner would adjust to the net realizable value. For real estate limited partnerships, the general partners record these at fair value based upon an independent appraisal or internal estimates of fair value.
Unrealized gains and losses for these investments are reflected in equity in earnings (losses) of limited partnerships in our Statements of Operations in accordance with the equity method of accounting or the fair value option, as applicable. Cash contributions made to and distributions received from the partnerships are recorded in the period in which the transaction occurs.
On December 22, 2017, the Tax Cuts and Jobs Act ("TCJA") was enacted which reduced the corporate tax rate from 35% to 21% effective January 1, 2018. This resulted in a re-measurement of our net deferred taxes to reflect the new rate at which the deferred items will be realized. The re-measurement of the net deferred tax asset as an other income tax expense resulted in tax effects of items within AOCI, which did not reflect the current enacted tax rate. As a result, we elected to make a one-time adjustment to reclassify the stranded tax effects from AOCI to retained earnings in accordance with ASU 2018-02. Income tax amounts are estimates based on our initial analysis and current interpretation of this legislation. Given the complexity of the legislation, anticipated guidance from the U.S. Treasury, and the potential for additional guidance from the Securities and Exchange Commission ("SEC") or the FASB, these estimates may be adjusted during 2018.
We earn management fees from the Exchange for providing policy issuance and renewal services including certain sales, underwriting, and policy issuance services. Pursuant to the subscriber's agreements with the subscribers (policyholders) at the Exchange, we may retain up to 25% of all direct and assumed premiums written by the Exchange. Management fee revenue is calculated by multiplying the management fee rate by the direct and assumed premiums written by the Exchange. The
Exchange issues policies with annual terms only. Management fees are recorded as revenue upon policy issuance or renewal, as substantially all of the services required to be performed by us have been satisfied at that time. Certain activities are performed and related costs are incurred by us subsequent to policy issuance in connection with the services provided to the Exchange; however, these activities are inconsequential and perfunctory.
We recorded a one-time net non-cash tax expense of $10.1 million at December 31, 2017 as a result of the enactment of the TCJA on December 22, 2017. See Note 10, "Income Taxes". This resulted in a reduction in Class A basic earnings per share of $0.22 and diluted earnings per share of $0.19, and a reduction in Class B basic earnings per share of $33 and diluted earnings per share of $32.
Other investments measured at fair value represent real estate funds included on the balance sheet as limited partnership investments that are reported under the fair value option using the net asset value practical expedient. These amounts are not required to be categorized in the fair value hierarchy. The investments can never be redeemed with the funds. Instead, distributions are received when liquidation of the underlying assets of the funds occur. It is estimated that the underlying assets will generally be liquidated between 5 and 10 years from the inception of the funds. The fair value of these investments is based on the net asset value (NAV) information provided by the general partner. Fair value is based on our proportionate share of the NAV based on the most recent partners' capital statements received from the general partners, which is generally one quarter prior to our balance sheet date. These values are then analyzed to determine if the NAV represents fair value at our balance sheet date, with adjustment being made where appropriate. We consider observable market data and perform a review validating the appropriateness of the NAV at each balance sheet date. It is likely that all of the investments will be redeemed at a future date for an amount different than the NAV of our ownership interest in partners' capital as of December 31, 2017 and December 31, 2016. During the years ended December 31, 2017 and 2016, no contributions were made and distributions totaling $0.5 million and $0.9 million, respectively, were received from these investments. There were no unfunded commitments related to the investments as of December 31, 2017 and $0.3 million as of December 31, 2016.
Transfers into and/or (out) of Level 3 are primarily attributable to the availability of market observable information and the re-evaluation of the observability of pricing inputs.
When a non-binding broker quote was the only input available, the security was classified within Level 3. Use of non-binding brokers quotes totaled $10.1 million at December 31, 2017. The unobservable inputs are not reasonably available to us.
The amortized cost and estimated fair value of fixed maturities at December 31, 2017, are shown below by remaining contractual term to maturity. Mortgage-backed securities are allocated based upon stated maturity dates. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Realized gains (losses) on investments were as follows for the years ended December 31:
Other-than-temporary impairments on fixed maturity investments recognized in earnings were $0.2 million, $0.4 million and $1.6 million for the years ended December 31, 2017, 2016 and 2015, respectively. We have the intent to sell all credit-impaired fixed maturity securities; therefore, the entire amount of the impairment charges were included in earnings and no non-credit impairments were recognized in other comprehensive income. See also Note 2, "Significant Accounting Policies".
In 2016, we announced the construction of a new office building that will serve as part of our principal headquarters. The costs associated with this project are included in construction in progress. Capitalized interest included in construction in progress was $0.6 million for 2017. There was no capitalized interest in 2016. The project is expected to span approximately three years and is financed using a senior secured draw term loan credit facility. See Note 7, "Borrowing Arrangements".
In 2016, we entered into a credit agreement for a $100 million senior secured draw term loan credit facility ("Credit Facility") for the acquisition of real property and construction of an office building that will serve as part of our principal headquarters. Under the agreement, $25 million will be drawn on December 1, 2016, June 1, 2017, December 1, 2017, and June 1, 2018 ("Draw Period"). During the Draw Period, we will make monthly interest only payments under the Credit Facility and thereafter the Credit Facility converts to a fully-amortized term loan with monthly payments of principal and interest over a period of 28 years. Borrowings under the Credit Facility will bear interest at a fixed rate of 4.35%. In addition, we are required to pay a quarterly commitment fee of 0.08% on the unused portion of the Credit Facility during the Draw Period. Total draws against the facility are $75 million as of December 31, 2017. Bonds with a fair value of $108.3 million were pledged as collateral for the facility and are reported as available-for-sale securities in the Statements of Financial Position as of December 31, 2017. The bank requires compliance with certain covenants, which include leverage ratios, debt restrictions and minimum net worth, for our Credit Facility. We are in compliance with all covenants at December 31, 2017.
The scheduled maturity of the $100 million Credit Facility begins on January 1, 2019 with annual principal payments of $1.9 million in 2019, $2.0 million in 2020, $2.0 million in 2021, $2.1 million in 2022 and $92.0 million thereafter.
Prior to 2003, the employee pension plan purchased annuities from Erie Family Life Insurance Company ("EFL"), a wholly owned subsidiary of the Exchange, for certain plan participants that were receiving benefit payments under the pension plan. These are nonparticipating annuity contracts under which EFL has unconditionally contracted to provide specified benefits to beneficiaries; however, the pension plan remains the primary obligor to the beneficiaries. A contingent liability of $19.5 million at December 31, 2017, exists in the event EFL does not honor the annuity contracts.
Pension plan costs represent the total cost before reimbursements to Indemnity from the Exchange and its subsidiaries.
The rate of compensation increase for the employee plan is age-graded. An equivalent single compensation increase rate of 3.32% in 2017, 2016 and 2015 would produce similar results.
Projected benefit obligations increased $135.0 million at December 31, 2017 compared to December 31, 2016. The increase was driven by normal increases in benefit accruals, the lower discount rate and the improvement to the death benefit payable to active employees, partially offset by updated mortality tables.
The following table describes plans with assets less than accumulated benefit obligation at December 31:
Both the defined benefit pension plan and the SERP had accumulated benefit obligations in excess of plan assets at December 31, 2017 and 2016.
The estimated net actuarial loss and prior service cost for the pension plans that will be amortized from accumulated other comprehensive income into pension cost during 2018 is $12.8 million and $1.1 million, respectively.
Effective December 31, 2016, a plan amendment was adopted to enhance the surviving spouse's death benefits, which increased the pension plan obligation by $3.6 million and the SERP obligation by $0.3 million in 2017. In 2016, a plan amendment was adopted to allow part time employees to participant in the pension plan, which added prior service cost of $1.7 million in 2016. Additionally, there were two new SERP participants in 2017 and one new participant in 2016, which contributed $1.2 million and $0.4 million, respectively.
The employee pension plan utilizes a return seeking and a liability asset matching allocation strategy. It is based upon the understanding that 1) equity investments are expected to outperform debt investments over the long-term, 2) the potential volatility of short-term returns from equities is acceptable in exchange for the larger expected long-term returns, and 3) a portfolio structured across investment styles and markets (both domestic and foreign) reduces volatility. As a result, the employee pension plan's investment portfolio utilizes a broadly diversified asset allocation across domestic and foreign equity and debt markets. The investment portfolio is composed of commingled pools that are dedicated exclusively to the management of employee benefit plan assets.
All full-time and regular part-time employees are eligible to participate in a traditional qualified 401(k) or a Roth 401(k) savings plan. We match 100% of the participant contributions up to 3% of compensation and 50% of participant contributions over 3% and up to 5% of compensation. Matching contributions paid to the plan were $12.8 million in 2017, $12.1 million in 2016, and $11.6 million in 2015. The Exchange and its subsidiaries reimburse us for approximately 60% of the matching contributions. Employees are permitted to invest the employer-matching contributions in our Class A common stock. Employees, other than executive and senior officers, may sell the shares at any time without restriction, provided they are in compliance with applicable insider trading laws; sales by executive and senior officers are subject to additional pre-clearance restrictions imposed by our insider trading policies. The plan acquires shares in the open market necessary to meet the obligations of the plan. Plan participants held 0.2 million shares of our Class A common stock at December 31, 2017 and 2016.
The fair value of LTIP awards is measured at each reporting date at the current share price of our Class A common stock. A liability is recorded and compensation expense is recognized ratably over the performance period.
Our deferred compensation plan allows executives, senior vice presidents and other selected officers to elect to defer receipt of a portion of their compensation and AIP cash awards until a later date. Employer 401(k) matching contributions that are in excess of the annual contribution or compensation limits are also credited to the participant accounts for those who elected to defer receipt of some portion of their base salary. Participants select hypothetical investment funds for their deferrals which are credited with the hypothetical returns generated.
Effective January 1, 2017, our Board of Directors approved an unfunded, non-qualified incentive compensation deferral plan for participants of the AIP and LTIP. Participants can elect to defer up to 100% of their annual AIP award and/or up to 100% of their LTIP award for each performance period. Deferred awards will be credited to a deferred stock account as credits denominated in Class A shares of the Company stock until retirement or other separation from service from the Company. Participants are 100% vested at date of deferral. Vested share credits will be paid to participants upon separation from service in approximate equal annual installments of Class A shares for a period of three years.
We also have a deferred stock compensation plan for our outside directors to further align the interests of directors with those of our shareholders that provides for a portion of the directors' annual compensation in shares of our Class A common stock. Each director vests in the grant 25% every three months over the course of a year. Dividends paid by us are credited to each director's account which vest immediately. We do not issue new shares of common stock to directors. Our practice is to repurchase shares of our Class A common stock in the open market to satisfy these awards.
Prior to October 2015, these shares were accounted for as a liability which was equal to the total number of share credits earned at the current fair market value. Directors were paid shares of our Class A common stock equal to the number of share credits in their deferred stock account upon ending board service.
In October 2015 we established a rabbi trust to hold the shares earned by outside directors. The rabbi trust purchased 9,663 shares of our common stock on the open market at an average price of $121.85 for $1.2 million in 2017, 7,432 shares at an average price of $99.23 for $0.7 million in 2016, and 94,938 shares at an average price of $94.99 for $9.0 million in 2015 to satisfy the liability of the stock compensation plan for outside directors. The rabbi trust is classified and accounted for as equity in a manner consistent with the accounting for treasury stock. Dividends received on the shares in the rabbi trust are used to purchase additional shares. The shares are distributed to the outside director from the rabbi trust upon ending board service. The annual charge related to these awards totaled $0.9 million, $0.5 million and $1.9 million in 2017, 2016 and 2015, respectively.
On January 22, 2018, we amended the rabbi trust to permit the trust to also hold the shares earned by executives, senior vice presidents, and other selected officers who receive share awards as participants in the incentive compensation deferral plan.
The change in tax rate represents the tax effect of the re-measurement of deferred tax assets and liabilities due to the enactment of the TCJA. Income tax expense increased by $10.1 million related to the TCJA, which included an increase of $19.9 million related to the re-measurement of our net deferred tax asset partially offset by a deferred tax benefit of $9.8 million primarily related to the acceleration of pension contributions.
Deferred tax balances were tax effected at 21% in 2017, the corporate tax rate effective January 1, 2018, as a result of the enactment of the TCJA on December 22, 2017. For 2016, balances were tax effected at the then effective tax rate of 35%.
We had no valuation allowance recorded at December 31, 2017 or December 31, 2016. At December 31, 2017, we had an uncertain tax position of $2.3 million, for which a current liability was recorded. As a related temporary tax difference was also recognized, there was no impact to our results of operations or financial position. We recognized interest of $0.1 million related to this uncertain tax position in income tax expense. The IRS has examined our tax filings through tax year ended 2012. We are currently not under IRS audit, nor have we been notified of an upcoming IRS audit.
We are the attorney-in-fact for the subscribers (policyholders) at the Exchange, a reciprocal insurance exchange. In that capacity, we provide all services and facilities necessary to conduct the Exchange's insurance business. Indemnity and the Exchange together constitute a single insurance business. Consequently, we are not subject to state corporate income or franchise taxes in states where the Exchange conducts its business and the states collect premium tax in lieu of corporate income or franchise tax, as a result of the Exchange's remittance of premium taxes in those states.
A management fee is charged to the Exchange for services we provide under subscriber's agreements with subscribers at the Exchange. The fee is a percentage of direct and assumed premiums written by the Exchange. This percentage rate is adjusted at least annually by our Board of Directors but cannot exceed 25%. The effective management fee rate charged the Exchange was 25% in 2017, 2016 and 2015. The Board of Directors elected to maintain the fee at 25% beginning January 1, 2018.
There is no provision in the subscriber's agreement for termination of our appointment as attorney-in-fact by the subscribers at the Exchange and the appointment is not affected by a policyholder's disability or incapacity.
All reimbursements are made on an actual cost basis and do not include a profit component. We record these reimbursements as receivables from the Exchange and its subsidiaries with a corresponding reduction to our expenses. Reimbursements are settled on a monthly basis. The amounts incurred on behalf of the Exchange and its subsidiaries were as follows for the years ended December 31:
We are involved in litigation arising in the ordinary course of conducting business. In accordance with current accounting standards for loss contingencies and based upon information currently known to us, we establish reserves for litigation when it is probable that a loss associated with a claim or proceeding has been incurred and the amount of the loss or range of loss can be reasonably estimated. When no amount within the range of loss is a better estimate than any other amount, we accrue the minimum amount of the estimable loss. To the extent that such litigation against us may have an exposure to a loss in excess of the amount we have accrued, we believe that such excess would not be material to our financial condition, results of operations, or cash flows. Legal fees are expensed as incurred. We believe that our accruals for legal proceedings are appropriate and, individually and in the aggregate, are not expected to be material to our financial condition, operations, or cash flows.
The cumulative sum of quarterly basic and diluted net income per share amounts may not equal total basic and diluted net income per share for the year due to differences in weighted average shares and equivalent shares outstanding for each of the periods presented.
No items were identified in this period subsequent to the financial statement date that required adjustment or disclosure, other than the disclosure made in Note 9, "Incentive and Deferred Compensation Plans" regarding the amendment to the rabbi trust agreement.