Results of operations include the accounts of The Hanover Insurance Company (“Hanover Insurance”) and Citizens Insurance Company of America (“Citizens”), our principal U.S. domiciled property and casualty companies; Chaucer Holdings Limited (“Chaucer”), our United Kingdom (U.K.) domiciled specialist insurance underwriting group which operates through the Society and Corporation of Lloyd’s (“Lloyd’s”); and certain other insurance and non-insurance subsidiaries. Results of operations include our discontinued operations, consisting primarily of our former life insurance businesses, and our accident and health business.
Operating income before interest expense and income taxes was $406.2 million in 2014 compared to $393.4 million in 2013, an increase of $12.8 million. This increase is due to improved current accident year results, primarily in Commercial Lines, and from higher favorable development on prior years’ loss and loss adjustment expense (“LAE”) reserves (“prior years’ loss reserves”), in both our Personal Lines and Chaucer segments. These increases in operating income were partially offset by higher catastrophe losses in our domestic operations. Pre-tax catastrophe losses were $223.0 million, compared to $140.0 million during 2013. Favorable development on prior years’ loss reserves was $99.1 million in 2014, compared to $76.3 million in 2013.
Pricing in our Commercial and Personal Lines remains strong as we continue to respond to increased weather-related losses over recent years, as well as to the earnings impact of reduced investment income as a result of low interest rates, and other factors. We are continuing efforts to improve our underwriting results in both our Commercial and Personal Lines, through rate increases and improvements to our mix of business.
Underwriting results improved slightly in 2014, as compared to 2013, primarily due to improved current accident year results excluding catastrophe losses, substantially offset by higher catastrophe losses. The competitive nature of the Commercial Lines market requires us to be highly disciplined in our underwriting process to ensure that we write business at acceptable margins and we continue to seek rate increases across our lines of business.
Underwriting results declined in 2014, as compared to 2013. Higher catastrophe losses and lower earned premiums were partially offset by favorable development on prior years’ loss reserves and improved current accident year results, excluding catastrophes. We continue to seek rate increases in excess of underlying loss cost trends, subject to regulatory and competitive considerations.
In addition to consolidated net income, we assess our financial performance based upon pre-tax “operating income,” and we assess the operating performance of each of our four operating segments based upon the pre-tax operating income (loss) generated by each segment. Operating income before taxes excludes interest expense on debt and certain other items which we believe are not indicative of our core operations, such as net realized investment gains and losses (including net gains and losses on certain derivative instruments). Such gains and losses are excluded since they are determined by interest rates, financial markets and the timing of sales. Also, operating income before taxes excludes net gains and losses on disposals of businesses and real estate assets, gains and losses related to the repayment of debt, discontinued operations, costs to acquire businesses, restructuring costs, the cumulative effect of accounting changes and certain other items. Although the items excluded from operating income before taxes may be important components in understanding and assessing our overall financial performance, we believe a discussion of operating income before taxes enhances an investor’s understanding of our results of operations by highlighting net income attributable to the core operations of the business. However, operating income before taxes should not be construed as a substitute for income before income taxes and operating income should not be construed as a substitute for net income.
Net premiums written grew by $257.4 million for the year ended December 31, 2014, compared to the year ended December 31, 2013, and net premiums earned grew by $259.8 million. Chaucer accounted for $113.9 million of the net premiums written increase and $183.9 million of the net premiums earned increase, primarily due to growth in the casualty and marine lines, the increase in Chaucer’s economic interests in Syndicate 1084 to 100% in 2014, from 98% in 2013, and the favorable impact of foreign exchange movements. Additionally, growth in our Commercial Lines resulting from rate increases, increased retention and targeted new business expansion, was partially offset by a decrease in our Personal Lines net premiums written.
Operating income before interest expense and income taxes was $393.4 million for the year ended December 31, 2013, compared to $75.1 million for the year ended December 31, 2012, an increase of $318.3 million reflecting improvements in each of our insurance segments. This increase in operating income was primarily due to lower catastrophe and non-catastrophe related losses and higher favorable development.
Net premiums written grew by $184.3 million for the year ended December 31, 2013, compared to the year ended December 31, 2012, and net premiums earned grew by $211.4 million. Chaucer accounted for $127.0 million of the net premiums written increase and $71.1 million of the net premiums earned increase, primarily due to the increase in Chaucer’s economic interests in Syndicate 1084 to 98% in 2013, from 84% in 2012. Additionally, growth in our core commercial businesses, resulting from rate increases, strong retention and targeted new business expansion, was partially offset by a decrease in our Personal Lines net premiums written.
Commercial Lines underwriting loss for the year ended December 31, 2014 was $8.3 million, compared to an underwriting loss of $11.0 million for the year ended December 31, 2013, a change of $2.7 million. Catastrophe related losses for the year ended December 31, 2014 were $87.8 million, compared to $38.7 million for the year ended December 31, 2013, an increase of $49.1 million. Unfavorable development on prior years’ loss reserves for the year ended December 31, 2014 was $9.2 million compared to $3.3 million for the year ended December 31, 2013, an increase of $5.9 million.
Pricing in Commercial Lines continued to be favorable in 2014 as we and the industry reacted to reduced investment income as a result of low interest rates, elevated loss trends in commercial automobile liability lines, recent weather-related losses, and other factors. We are continuing efforts to improve our underwriting results, including through increased rates; however, our ability to increase Commercial Lines net premiums written while maintaining or improving underwriting results may be affected by price competition and the challenging economic environment. Also, in the past several years, weather-related catastrophe and non-catastrophe losses have been in excess of longer term averages. We continue to monitor these trends and consider them in our rate actions.
Chaucer’s underwriting profit for the year ended December 31, 2014 was $122.5 million, compared to $107.7 million for the year ended December 31, 2013, an improvement of $14.8 million. These improved results were primarily due to higher earned premiums, favorable development on prior years’ loss reserves, and lower catastrophe losses, partially offset by lower current accident year underwriting results. Favorable development on prior years’ loss reserves for the year ended December 31, 2014 was $104.6 million, compared to $94.6 million for the year ended December 31, 2013, a change of $10.0 million. Catastrophe losses for the year ended December 31, 2014 were $28.8 million, compared to $34.4 million for the year ended December 31, 2013, a decrease of $5.6 million. Higher current year non-catastrophe losses in our U.K. motor, and marine and aviation lines were partially offset by lower losses in our property line.
We continue to experience significant competition across the international insurance industry. Current pricing conditions in marine, energy and property continue to be affected by a continued absence of major industry losses, by new capital from a variety of sources and high levels of competition. Within casualty markets, after several years of rate decreases as a result of low loss activity and excess capacity, we expect modest rate increases for certain classes of business. U.K. motor rates were flat after three years of decline following significant increases in 2010 and 2011. We will seek rate increases for this business in 2015. There can be no assurance that we will be able to maintain adequate rates in light of economic and regulatory conditions in our markets.
Commercial Lines net premiums written were $2,007.2 million for the year ended December 31, 2013, compared to $1,902.0 million for the year ended December 31, 2012. This $105.2 million increase was primarily driven by rate increases, strong retention, and targeted new business expansion in our core commercial businesses, partially offset by exposure management actions that focus on reducing volatility from weather-related events and driving profit improvement.
Commercial Lines underwriting loss for the year ended December 31, 2013 was $11.0 million, compared to $224.2 million for the year ended December 31, 2012, a decrease of $213.2 million. This improvement reflected decreased catastrophe losses and lower unfavorable development on prior years’ loss reserves. Catastrophe related losses for the year ended December 31, 2013 were $38.7 million, compared to $193.4 million for the year ended December 31, 2012, a decrease of $154.7 million. Catastrophe losses in 2012 included $124.8 million of pre-tax losses related to Superstorm Sandy. Unfavorable development on prior years’ loss reserves for the year ended December 31, 2013 was $3.3 million, compared to unfavorable development of $29.0 million for the year ended December 31, 2012, a decrease of $25.7 million.
Commercial Lines current accident year underwriting profit, excluding catastrophes, was $31.0 million for the year ended December 31, 2013, compared to a loss of $1.8 million for the year ended December 31, 2012. This $32.8 million improvement in current accident year results was primarily due to lower losses in our commercial multiple peril, surety and workers’ compensation lines, partially offset by higher losses in our commercial automobile line. The improvement in current accident year losses in our commercial multiple peril and surety lines was primarily due to fewer large losses and underwriting actions, while commercial multiple peril also benefited from price increases. The improvement in current accident year losses in our workers’ compensation line primarily resulted from price increases. In our commercial automobile line, current accident year losses increased in our liability coverages.
Personal Lines current accident year underwriting profit, excluding catastrophes, was $118.2 million in the year ended December 31, 2013, compared to $94.0 million for the year ended December 31, 2012. This $24.2 million improvement in non-catastrophe current accident year results was primarily due to lower losses in our homeowners line.
Our loss reserves include case estimates for claims that have been reported and estimates for claims that have been incurred but not reported (“IBNR”) at the balance sheet date. They also include estimates of the expenses associated with processing and settling all
reported and unreported claims, less estimates of anticipated salvage and subrogation recoveries. Our property and casualty loss reserves are not discounted to present value.
There is greater inherent uncertainty in estimating insurance reserves for certain types of property and casualty insurance lines, particularly liability lines, where a longer period of time may elapse before a definitive determination of ultimate liability and losses may be made. In addition, the technological, judicial, regulatory and political climates involving these types of claims are continuously evolving. There is also greater uncertainty in establishing reserves with respect to business that is new to us, particularly new business which is generated with respect to newly introduced product lines, by newly appointed agents or in geographies in which we have less experience in conducting business, such as the program business written by AIX Holdings, Inc. (“AIX”), Chaucer’s U.S. casualty treaty and international liability lines, our professional liability specialty lines, and business written in the western part of the United States. In some of these cases, there is less historical experience or knowledge and less data upon which we can rely. A combination of business that is both new to us and has longer development periods, provides even greater uncertainty in estimating insurance reserves. In our management and professional liability, we are modestly increasing, and expect to continue to increase, our exposure to longer-tailed liability lines, including directors and officers liability, errors and omissions liability and product liability coverages. The Chaucer business acquired in 2011 contains several international and U.S. liability lines, of which financial institution and professional liability, U.S. casualty treaty liability, international liability and energy liability, contribute the most uncertainty. A significant portion of Chaucer’s growth in 2014 was due to our expanded underwriting capabilities in our U.S. casualty treaty lines.
We regularly review our reserving techniques, our overall reserving position and our reinsurance. Based on (i) our review of historical data, legislative enactments, judicial decisions, legal developments in impositions of damages and policy coverage, political attitudes and trends in general economic conditions, (ii) our review of per claim information, (iii) our historical loss experience and that of the industry, (iv) the nature of policies written by us, and (v) our internal estimates of required reserves, we believe that adequate provision has been made for loss reserves. However, establishment of appropriate reserves is an inherently uncertain process and there can be no certainty that current established reserves will prove adequate in light of subsequent actual experience. A significant change to the estimated reserves could have a material impact on our results of operations and financial position. An increase or decrease in reserve estimates would result in a corresponding decrease or increase in financial results. For example, each one percentage point change in the aggregate loss and LAE ratio resulting from a change in reserve estimation is currently projected to have an approximate $47 million impact on operating income, based on 2014 full year premiums.
While we estimate that a majority of our written premium is in what we would characterize as shorter-tailed classes of business, most of our loss reserves relate to longer-tail liability classes of business. Long-tailed classes include commercial liability, automobile liability, workers’ compensation and other types of third party coverage. Chaucer’s longer-tailed lines include aviation liability, marine liability, energy liability, nuclear liability, U.K. motor medical and liability, U.S. casualty treaty liability, international liability, specialist liability, and financial institutions and professional liability. For many liability claims, significant periods of time, ranging up to several years or more, may elapse between the occurrence of the loss, the discovery and reporting of the loss to us and the settlement of the claim. As a result, loss experience in the more recent accident years for long-tailed liability coverage has limited statistical credibility because a relatively small proportion of losses in these accident years (the calendar years in which losses are incurred) are reported claims and an even smaller proportion are paid losses. Liability claims are also more susceptible to litigation and can be significantly affected by changing contract interpretations, the legal environment and the risk and expense of protracted litigation. Consequently, the estimation of loss reserves for these coverages is more complex and typically subject to a higher degree of variability and uncertainty compared to short-tailed coverages.
Most of our indirect business from voluntary and involuntary pools is long-tailed casualty reinsurance. Reserve estimates for this business are therefore subject to the variability caused by extended loss emergence periods. The estimation of loss reserves for this business is further complicated by delays between the time the claim is reported to the ceding insurer and when it is reported by the ceding insurer to the pool manager and then to us, and by our dependence on the quality and consistency of the loss reporting by the ceding company and actuarial estimates by the pool manager.
The Chaucer segment contains run-off business comprised of liability lines, notably financial institutions and professional liability business written by Lloyd’s Syndicate 4000. There is particular uncertainty around the reserve estimates in respect of business written in 2007 and 2008 which have been subject to claims arising out of the financial turmoil in that time period, particularly in the financial institutions book. These claims are unlikely to be settled for some time since they contain numerous coverage issues and in many cases involve class action lawsuits that are likely to take several years to resolve. We have utilized substantially all of our available reinsurance with respect to losses and LAE related to Syndicate 4000 business written in 2008. Effective January 1, 2014, Syndicate 1084 accepted the reinsurance to close of the unpaid liabilities of Syndicate 4000 for the 2008 year of account and prior. This transaction resulted in the closure of the Syndicate 4000 and has no impact on a consolidated basis.
Monoline and Multi-Peril General Liability - reserves recorded for general liability on U.S. voluntary business were $469.0 million as of December 31, 2014. A key assumption for general liability is the implied adequacy of the underlying case reserves. A ten point change in case adequacy (e.g. 10% deficiency changed to 0% or 20% deficiency) would have changed estimated IBNR by approximately $36 million, either positive or negative, at December 31, 2014.
Specialty Programs - reserves recorded (including allocated LAE) for the AIX Companies were $255.7 million as of December 31, 2014. Two key assumptions underlying the actuarial reserve analysis for specialty programs are the expected loss and allocated LAE ratio (“ELR”) and the tail factor selection. A ten point change to the ELR and a five point change in the tail factor on AIX would have changed estimated IBNR by approximately $25 million at December 31, 2014.
New classes of business - reserves recorded for new classes of Chaucer business (primarily within international liability, U.S. casualty treaty and engineering lines) were $245 million as of December 31, 2014. An increase in the ultimate loss ratio by 5%, 10% and 15% in the 2012 and prior, 2013, and 2014 years of account, respectively, on these classes would have increased estimated IBNR by approximately $50 million at December 31, 2014.
Other lines are primarily comprised of our general liability, umbrella, professional and management liability, marine, voluntary pools, surety, and healthcare lines. Included in the above table, primarily in other lines, are $60.6 million, $61.9 million and $60.5 million of asbestos and environmental reserves as of December 31, 2014, 2013 and 2012, respectively. Included in the Chaucer segment in the above table are $203.3 million, $230.6 million and $272.4 million of reserves as of December 31, 2014, 2013 and 2012, respectively, related to Chaucer’s financial and professional liability lines written in 2008 and prior period.
Loss and LAE reserves for claims occurring in prior years developed favorably by $99.1 million, $76.3 million and $15.8 million during the years ended December 31, 2014, 2013 and 2012, respectively. The 2014 activity by segment includes favorable development of $104.6 million for Chaucer, and $5.1 million in Personal Lines, partially offset by unfavorable development of $10.6 for Commercial Lines and Other. The 2013 activity by segment includes favorable development of $94.6 million for Chaucer, partially offset by unfavorable development of $18.3 million in our domestic operations, consisting of $3.3 million, $13.7 million and $1.3 million for Commercial Lines, Personal Lines and Other, respectively.
marine and aviation lines, primarily in the 2011 through 2013 accident years,
favorable impact of foreign exchange rate movements on prior years’ loss reserves.
Lower than expected losses within our commercial multiple peril line, primarily related to accident years 2012 and 2013.
within casualty and other lines, specialist liability lines, primarily in the 2008 accident year,
marine and aviation line, primarily in the 2010 through 2012 accident years, and
The primary drivers of reserve development for the year ended December 31, 2012 were as follows:
Favorable development of previously established reserves in Chaucer’s lines of business as follows:
marine and aviation lines, primarily in the 2007 through 2011 accident years,
Higher than expected large losses within our commercial automobile line, primarily related to liability coverage in the 2011 accident year.
Total cash and investments increased $544.1 million, or 6.7%, for the year ended December 31, 2014, of which fixed maturities increased $407.5 million, equity securities increased $150.6 million, other investments increased $98.9 million and cash and cash equivalents decreased $112.9 million. Fixed maturities increased primarily due to the investment of positive operational cash flows and market value appreciation, partially offset by the impact of lower foreign currency exchange rates on non-U.S. dollar denominated bonds. The increase in equity securities is primarily due to the purchase of equity index exchange traded funds and dividend yielding common stocks, and the increase in other invested assets includes our participations in commercial mortgage loan originations. Cash and cash equivalents decreased due to funding net investments and financing activities, primarily the payment of external dividends and interest on our debt.
Our fixed maturity portfolio is comprised of corporate securities, taxable and tax-exempt municipal securities, residential mortgage-backed securities, commercial mortgage-backed securities, U.S. governmental securities, foreign government securities and asset-backed securities. Equity securities primarily consist of equity index exchange traded funds focused on developed and emerging markets and income-oriented large capitalization common stocks.
Net unrealized gains on fixed maturities increased $77.0 million, or 49.5%, to a net unrealized gain of $232.4 million at December 31, 2014, compared to $155.4 million at December 31, 2013, primarily due to lower prevailing interest rates and tightening of credit spreads.
Our fixed maturity and equity securities are classified as available-for-sale and are carried at fair value. Financial instruments whose value was determined using significant management judgment or estimation constituted less than 1% of the total assets we measured at fair value. (See also Note 5 - “Fair Value” in the Notes to Consolidated Financial Statements included in Financial Statements and Supplementary Data of this Form 10-K).
For the years ended December 31, 2014, 2013 and 2012 we recognized in earnings $5.5 million, $6.0 million, and $7.8 million, of other-than-temporary impairments (“OTTI”) on debt and equity securities, respectively. In 2014, OTTI on debt securities consisted of $3.8 million of municipal securities and $1.7 million on corporate securities in the industrial sector, all of which we intended to sell.
The following table provides information about our fixed maturities and equity securities that were in an unrealized loss position including the length of time the securities have been in an unrealized loss position. (See also Note 3 - “Investments” in the Notes to Consolidated Financial Statements included in Financial Statements and Supplementary Data of this Form 10-K).
The carrying values of fixed maturity securities on non-accrual status at December 31, 2014 and 2013 were not material. The effects of non-accruals compared with amounts that would have been recognized in accordance with the original terms of the fixed maturities, were reductions in net investment income of $2.1 million, $2.3 million and $2.5 million for the years ended December 31, 2014, 2013 and 2012, respectively. Any defaults in the fixed maturities portfolio in future periods may negatively affect investment income.
While the United States is beginning to reduce its extraordinary measures, other major central banks, such as the Bank of England, the European Central Bank and the Bank of Japan, continue with their stimulus policies as they seek higher growth, and in the case of the latter two, prevent deflation. The removal, modification or suggestion of changes in these policies could have an adverse effect on prevailing market interest rates and on issuers’ level of business activity or liquidity, increasing the probability of future defaults. While we may experience defaults on fixed income securities, particularly with respect to non-investment grade securities, it is difficult to foresee which issuers, industries or markets will be affected. As a result, the value of our fixed maturity portfolio could change rapidly in ways we cannot currently anticipate and we could incur additional realized and unrealized losses in future periods.
During 2014, we provided eligible former employees with a one-time choice of electing to receive a lump-sum settlement of their remaining qualified defined pension benefit. Including this voluntary lump-sum program, we settled $55.1 million of our pension obligations with an equal amount paid from plan assets. As a result, we recorded settlement losses of $10.8 million, reflecting the accelerated recognition of unamortized losses in the plan proportionate to the obligation that was settled. Additionally, we terminated a small qualified plan resulting in accelerating recognition of unamortized losses of $1.3 million.
The following table illustrates the estimated impact on the fair value of our fixed maturity portfolio at December 31, 2014 of hypothetical changes in prevailing interest rates, defined as changes in interest rates on U.S. Treasury debt. It does not reflect changes in credit spreads, liquidity spreads and other factors that affect the value of securities. Since changes in prevailing interest rates are often accompanied by changes in these other factors, the reader should not assume that an actual change in interest rates would result in the values illustrated.
Our equity securities portfolio is exposed to equity price risk arising from potential volatility in equity market prices. Portfolio characteristics are analyzed regularly and price risk is actively managed through a variety of techniques. A hypothetical increase or decrease of 10% in the market price of our equity securities would have resulted in an increase or decrease in the fair value of the equity securities portfolio of approximately $58 million at December 31, 2014 and approximately $43 million at December 31, 2013.
In addition, discontinued operations for the year ended December 31, 2012 included a net gain from the sale of our third party administration subsidiary, Citizens Management, Inc. (“CMI”), which was completed on April 30, 2012. CMI provided third party workers’ compensation and disability program administration services (such as claims administration, loss prevention and medical cost containment and in-house excess workers’ compensation coverage) to public entities, self-insured employers and group programs. This sale resulted in a net gain of $10.8 million after taxes.
We are subject to the tax laws and regulations of the U.S. and foreign countries in which we operate. We file a consolidated U.S. federal income tax return that includes the holding company and its U.S. subsidiaries. Generally, taxes are accrued at the U.S. statutory tax rate of 35% for income from the U.S. operations. Our primary non-U.S. jurisdiction is the U.K. In July 2012, the U.K. statutory rate decreased from 26% to 24% effective April 1, 2012 and from 24% to 23% effective April 1, 2013. Further decreases were enacted in July 2013 to reduce the statutory rate from 23% to 21% effective April 1, 2014 and from 21% to 20% effective April 1, 2015. We accrue taxes on certain non-U.S. income that is subject to U.S. tax at the U.S. tax rate. Foreign tax credits, where available, are utilized to offset U.S. tax as permitted. Certain of our non-U.S. income is not subject to U.S. tax until repatriated. Foreign taxes on this non-U.S. income are accrued at the local foreign rate and do not have an accrual for U.S. deferred taxes since these earnings are intended to be indefinitely reinvested overseas.
During 2014, we released the valuation allowance related to our deferred tax assets of $2.9 million recorded in 2013. The write off of this valuation allowance resulted from appreciation in our investment portfolio. We recorded the decrease in our valuation allowance of $2.9 million as an adjustment to income tax expense.
The IRS audits of the years 2007 through 2010 were settled in 2014 with no material impact to our financial position or results of operations.
We share insurance risk of the primary underlying contracts with various insurance entities through the use of reinsurance contracts. As a result, when we experience loss events that are subject to a reinsurance contract, reinsurance recoveries are recorded. The amount of the reinsurance recoverable can vary based on the size of the individual loss or the aggregate amount of all losses in a particular line, book of business or an aggregate amount associated with a particular accident year. The valuation of losses recoverable depends on whether the underlying loss is a reported loss, or an incurred but not reported loss. For reported losses, we value reinsurance recoverables at the time the underlying loss is recognized, in accordance with contract terms. For incurred but not reported losses, we estimate the amount of reinsurance recoverable based on the terms of the reinsurance contracts and historical reinsurance recovery information and apply that information to the gross loss reserve estimates. The most significant assumption we use is the average size of the individual losses for those claims that have occurred but have not yet been recorded by us. The reinsurance recoverable is based on what we believe are reasonable estimates and is disclosed separately on the financial statements. However, the ultimate amount of the reinsurance recoverable is not known until all losses are settled.
We currently have a U.S. qualified defined benefit plan, a defined benefit pension plan for our international subsidiary, Chaucer, and several smaller non-qualified benefit plans. In order to measure the liabilities and expense associated with these plans, we must make various estimates and key assumptions, including discount rates used to value liabilities, assumed rates of return on plan assets, employee turnover rates and anticipated mortality rates. Additionally, our Chaucer pension plan also must take into consideration inflation rates, specifically related to participant salary increases. These estimates and assumptions are reviewed at least annually and are based on our historical experience, as well as current facts and circumstances. In addition, we use outside actuaries to assist in measuring the expenses and liabilities associated with our defined benefit pension plans.
Two significant assumptions used in the determination of benefit plan obligations and expenses that are dependent on market factors, which have been subject to a greater level of volatility over the past few years, are the discount rate and the return on plan asset assumptions. The discount rate enables us to state expected future cash flows as a present value on the measurement date. We also use this discount rate in the determination of our pre-tax pension expense or benefit. A lower discount rate increases the present value of benefit obligations and increases pension expense. To determine the expected long-term return on plan assets, we generally consider historical mean returns by asset class for passive indexed strategies, as well as current and expected asset allocations, and adjust for certain factors that we believe will have an impact on future returns. Actual returns on plan assets in any given year seldom result in the achievement of the expected rate of return on assets. Actual returns on plan assets in excess of these expected returns will generally reduce our net actuarial losses (or increase actuarial gains) that are reflected in our accumulated other comprehensive income balance in shareholders’ equity, whereas actual returns on plan assets which are less than expected returns will generally increase our net actuarial losses (or decrease actuarial gains) that are reflected in accumulated other comprehensive income. These gains or losses are amortized into expense in future years.
As of December 31, 2014 and 2013, we determined our discount rate utilizing an independent yield curve which provides for a portfolio of high quality bonds that are expected to match the cash flows of our pension plan. Bond information used in the yield curve included only those rated Aa or better as of December 31, 2014 and 2013, respectively, and had been rated by at least two well-known rating agencies. At December 31, 2014, based upon our qualified plan liabilities and cash flows in relation to this discount curve, we decreased our discount rate to 4.375%, from 5.00% at December 31, 2013.
For the years ended December 31, 2014 and 2013, the expected rate of return on our qualified plan assets was 5.50% and 5.25%, respectively. The increase reflects improvements in the fixed maturities markets in general. Actual returns of the plan investments generated approximately $59 million of gains and $3 million of losses during 2014 and 2013, respectively, as compared to expected returns of approximately $28 million and $30 million, respectively. The plan assets consisted of 85% fixed maturities and 15% equities at December 31, 2014.
In 2014, actuarial losses of approximately $53 million primarily resulting from the decrease in the discount rate from the prior year and the aforementioned change in mortality assumptions, were partially offset by investment gains of approximately $31 million. Actuarial gains of approximately $37 million experienced in 2013 primarily resulted from the increase in the discount rate from 2012, and were partially offset by investment losses of approximately $33 million. The net loss in 2014 of $21.8 million and the net gain in 2013 of $4.2 million are reflected as decreases and increases, respectively, to accumulated other comprehensive income. The change in these actuarial gains and losses is amortized into earnings in future years. In 2014 and 2013, amortization of actuarial losses from prior years was $10.6 million and $12.9 million, respectively. In 2014, we also accelerated recognition of actuarial losses of $10.8 million resulting from the settlement of pension obligations related to a voluntary settlement program.
Discount Rate - A 25 basis point increase in the discount rate would decrease our pension expense in 2015 by $1.5 million and decrease our projected benefit obligation by $12.1 million. A 25 basis point reduction in the discount rate would increase our pension expense by $1.5 million and increase our projected benefit obligation by $12.6 million.
For the years ended December 31, 2014 and 2013, the expected rate of return on plan assets was 6.55% and 6.70%, respectively. The composition of Chaucer’s plan assets are 57% equities, 32% fixed maturities, and 11% real estate funds at December 31, 2014. Actual returns of the plan investments generated approximately $15 million and $17 million of gains during the years ended December 31, 2014 and 2013, respectively, as compared to expected returns of approximately $8 million and $6 million, respectively.
Expected Return on Plan Assets - A 25 basis point increase or decrease in the expected return on plan assets would decrease or increase our pension expense in 2015 by $ 0.3 million.
For equity method investments, we recognize an impairment when evidence demonstrates that a loss in value that is other-than-temporary has occurred. Evidence of a loss in value that is other-than-temporary may include the absence of an ability to recover the carrying amount of the investment or the inability of the investee to sustain a level of earnings that would justify the carrying amount of the investment. During each period, we evaluate whether an impairment indicator has occurred that may have a significant adverse effect on the carrying value of the investment. Impairment indicators may include: lower expectations of residual value from a limited partnership, reduced valuations of the investments held by limited partnerships, actual recent cash flows that are significantly less than expected cash flows or any other adverse events since the last financial statements received that might affect the value of the investee’s capital. OTTIs of equity method investments are recorded as realized losses, which reduce net income and earnings per share.
The statutory capital and surplus for our U.S. insurance subsidiaries increased $222.8 million during 2014, primarily due to operating results and increases from unrealized and realized gains on investments.
The NAIC prescribes an annual calculation regarding risk based capital (“RBC”). RBC ratios for regulatory purposes, as described in the glossary, are expressed as a percentage of the capital required to be above the Authorized Control Level (the “Regulatory Scale”); however, in the insurance industry, RBC ratios are widely expressed as a percentage of the Company Action Level. The following table reflects the Company Action Level, the Authorized Control Level and RBC ratios for Hanover Insurance (which includes Citizens and other U.S. insurance subsidiaries), as of December 31, 2014 and 2013, expressed both on the Industry Scale (Total Adjusted Capital divided by the Company Action Level) and Regulatory Scale (Total Adjusted Capital divided by Authorized Control Level):
Chaucer corporate members operate in the Lloyd’s market, which requires that these members deposit funds, referred to as “Funds at Lloyd’s”, to support their underwriting interests. Lloyd’s sets required capital annually for all participating syndicates based on each syndicate’s business plans, the rating and reserving environment, and discussions with regulatory and rating agencies. Although the minimum capital levels are set by Lloyd’s, it is the responsibility of Chaucer to continually monitor the risk profiles of its managed syndicates to ensure that the level of funding remains appropriate. Such capital is comprised of cash and cash equivalents, investments, undrawn letters of credit provided by various banks and other assets.
We have the following securities, assets and letters of credit pledged to Lloyd’s to satisfy these capital requirements at December 31, 2014. At December 31, 2014, we are in compliance with the capital requirements. We expect to be able to meet these capital requirements in the future.
At December 31, 2014, THG, as a holding company, held approximately $119.7 million of fixed maturities and cash. We believe our holding company assets will be sufficient to meet our 2015 obligations, which consist primarily of dividends to our shareholders (as and to the extent declared), the interest on our senior and subordinated debentures, certain costs associated with benefits due to our former life employees and agents, and, to the extent required, payments related to indemnification of liabilities associated with the sale of various subsidiaries. We do not expect that it will be necessary to dividend additional funds from our insurance subsidiaries in order to fund 2015 holding company obligations; however, we may decide to do so.
Sources of cash for our insurance subsidiaries primarily consist of premiums collected, investment income and maturing investments. Primary cash outflows are paid claims, losses and loss adjustment expenses, policy and contract acquisition expenses, other underwriting expenses and investment purchases. Cash outflows related to losses and loss adjustment expenses can be variable because of uncertainties surrounding settlement dates for liabilities for unpaid losses and because of the potential for large losses either individually or in the aggregate. We periodically adjust our investment policy to respond to changes in short-term and long-term cash requirements.
Net cash provided by operating activities was $564.7 million during 2014, as compared to $383.9 million in 2013 and $408.2 million in 2012. The $180.8 million change in 2014 compared to 2013 primarily resulted from increased premium collections during 2014, partially offset by a slight increase in claims payments. Additionally, in 2013 we made a payment related to the settlement of our life insurance postretirement benefit obligation which did not recur in 2014. The $24.3 million decrease in 2013 compared to 2012 is primarily due to the timing of reimbursements made to Lloyd’s related to claim payments made on our behalf, partially offset by lower claims payments in 2013.
Net cash used in investing activities was $600.7 million during 2014, as compared to $358.7 million during 2013 and $562.8 million in 2012. During 2014 and 2013, cash used in investing activities primarily related to net purchases of fixed maturities, equity securities, and other investments. During 2012, cash used was primarily related to net purchases of fixed maturities as we invested cash from Chaucer and net investments in equity securities. Cash used to purchase investments was partially offset by cash received from the sale of a building. See Note 3 - “Investments” in the Notes to Consolidated Financial Statements included in Financial Statements and Supplementary Data of this Form 10-K.
Net cash used in financing activities was $71.7 million during 2014, as compared to, $105.5 million during 2013 and $133.4 million in 2012. During 2014, cash used in financing activities primarily resulted from the payment of dividends to shareholders and the repurchase of common stock, partially offset by cash inflows related to the exercise of employee stock options. During 2013, cash used in financing activities primarily resulted from the repayment of approximately $121 million of debt, repurchases of common stock and the payment of dividends to shareholders, partially offset by the proceeds from the issuance, on March 20, 2013, of $175.0 million of unsecured subordinated debentures. During 2012, cash used in financing activities primarily resulted from the repayment of $72.4 million of debt, the payment of dividends to shareholders, and repurchases of our common stock, partially offset by the proceeds from FHLBB debt borrowings.
current estimate of liabilities and certain assumptions regarding investment returns and other factors, our qualified defined benefit pension plans and Chaucer pension plan collectively have plan liabilities in excess of plan assets by approximately $31 million. The ultimate payment amounts for our benefit plans are based on several assumptions, including but not limited to, the rate of return on plan assets, the discount rate for benefit obligations, mortality experience, interest crediting rates, inflation and the ultimate valuation and determination of benefit obligations. Since differences between actual plan experience and our assumptions are almost certain, changes both positive and negative to our current funding status and ultimately our obligations in future periods are likely.
Since October 2007 and through December 2014, our Board of Directors has authorized aggregate repurchases of our common stock of up to $600 million. Repurchases may be executed using open market purchases, privately negotiated transactions, accelerated repurchase programs or other transactions. We are not required to purchase any specific number of shares or to make purchases by any certain date under this program. During 2014, we repurchased approximately 0.3 million shares of our common stock at a cost of $20.4 million.
We also have a Standby Letter of Credit Facility (the “Amended Facility Agreement”) not to exceed £130.0 million (or $202.5 million) outstanding at any one time, with the option to increase the amount available for issuances of letters of credit to £195.0 million (or $303.8 million) in the aggregate on one occasion only during the term of the Amended Facility Agreement (subject to the consent of all lenders and assuming no default and satisfaction of other specified conditions). Amounts in U.S. dollars were converted based on the foreign currency exchange rate of 1.56 at December 31, 2014. Prior to the amendment, we had a Standby Letter of Credit Facility Agreement in place not to exceed $180.0 million outstanding at any one time, with a similar option to increase the amount available for issuances of letters of credit to $270.0 million. The amended agreement provides certain covenants including, but not limited to, the syndicates’ financial condition which were also in place prior to the amendment of the agreement. The Amended Facility Agreement provides regulatory capital supporting Chaucer’s underwriting activities for the 2014 and 2015 years of account and each prior open year of account and is generally renewed biennially to support new underwriting years. We may, from time to time, collateralize a portion of the outstanding letter of credit. A letter of credit commission fee on outstanding letters of credit and a commitment fee in respect of the utilized commitments under the Amended Facility Agreement are both payable quarterly. Chaucer is also required to pay customary agency fees. We paid $4.1 million and $2.7 million related to such fees in 2014 and 2013, respectively.
At December 31, 2014, we were in compliance with the covenants of the aforementioned debt agreements.
Our U.S. and international subsidiaries are lessees with a number of operating leases.
Reflects funding associated with the Chaucer plan based upon its current funded status and estimated additional funding required to support future salary increases through 2024. We do not expect to make any significant contributions to our U.S. qualified plan in order to meet our minimum funding requirements. However, additional contributions may be required in the future to both plans based on the level of pension assets and liabilities in future periods.
Earned premium - The portion of a premium that is recognized as income, or earned, based on the expired portion of the policy period, that is, the period for which loss coverage has actually been provided. For example, after six months, $50 of a $100 annual premium is generally considered earned premium. The remaining $50 of annual premium is unearned premium. Net earned premium is earned premium net of reinsurance.
Economic interest- The share of syndicate underwriting capacity supported by capital from Chaucer Holdings Limited.
Loss adjustment expenses (“LAE”) - Expenses incurred in the adjusting, recording, and settlement of claims. These expenses include both internal company expenses and outside services. Examples of LAE include claims adjustment services, adjuster salaries and fringe benefits, legal fees and court costs, investigation fees and claims processing fees.
Managing agent - An agent that runs the affairs of a syndicate.
In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of The Hanover Insurance Group, Inc. and its subsidiaries at December 31, 2014 and December 31, 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15(a)(2) present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Participations in commercial mortgage loan originations (“mortgage participations”) and other mortgage loans, included in other investments in the Consolidated Balance Sheets, are stated at unpaid principal balances, net of reserves. Interest income is accrued on the unpaid principal balances at the loans’ contractual interest rates. Reserves on mortgage participations and other mortgage loans are established and are collectively evaluated based on losses expected by the Company for loans that may not be collectible in full. In establishing reserves, the Company considers, among other things, the estimated fair value of the underlying collateral.
Other investments consist primarily of overseas deposits, mortgage participations and limited partnerships. Overseas deposits are investments maintained in overseas funds and managed exclusively by Lloyd’s. These funds are required in order to protect policyholders in overseas markets and enable the Company to operate in those markets. Overseas deposits are carried at fair value. Realized and unrealized gains and losses on overseas deposits, including the impact of foreign currency movements, are reflected in the income statement in the period the gain or loss was generated.
lived assets exceed the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the assets. When an impairment loss occurs, the Company reduces the carrying value of the asset to fair value and no longer depreciates the asset. Fair values are estimated using discounted cash flow analysis.
In accordance with the provisions of ASC 350, Intangibles- Goodwill and Other, the Company carries its goodwill at cost, net of amortization prior to January 1, 2002 and net of impairments. Increases to goodwill are generated through acquisition and represent the excess of the cost of an acquisition over the fair value of net assets acquired, including any intangibles acquired. Since January 1, 2002, goodwill is no longer amortized but rather, is reviewed for impairment. Additionally, acquisitions can also produce intangible assets, which have either a definite or indefinite life. Intangible assets with definite lives are amortized over that life, whereas those intangible assets determined to have an indefinite life are reviewed at least annually for impairment.
Insurance premiums written are generally recorded at the policy inception and are primarily earned on a pro rata basis over the terms of the policies for all products. Premiums written include estimates, primarily in the Chaucer segment, that are derived from multiple sources, which include the historical experience of the underlying business, similar businesses and available industry information. These estimates are regularly reviewed and updated, and any resulting adjustments are included in the current year’s results. Unearned premium reserves represent the portion of premiums written that relates to the unexpired terms of the underlying in-force insurance policies and reinsurance contracts. Premium receivables reflect the unpaid balance of premium written as of the balance sheet date. Premium receivables are generally short-term in nature and are reported net of an allowance for estimated uncollectible premium accounts. The Company reviews its receivables for collectability at the balance sheet date. The allowance for uncollectible accounts was not material as of December 31, 2014 and 2013. Ceded premiums are charged to income over the applicable term of the various reinsurance contracts with third party reinsurers. Reinsurance reinstatement premiums, when required, are recognized in the same period as the loss event that gave rise to the reinstatement premiums. Losses and related expenses are matched with premiums, resulting in their recognition over the lives of the contracts. This matching is accomplished through estimated and unpaid losses and amortization of deferred acquisition costs.
Deferred income taxes are generally recognized when assets and liabilities have different values for financial statement and tax reporting purposes, and for other temporary taxable and deductible differences as defined by ASC 740, Income Taxes (“ASC 740”). These temporary differences are measured at the balance sheet date using enacted tax rates expected to apply to taxable income in the years the temporary differences are expected to reverse. These differences result primarily from insurance reserves, deferred acquisition costs, tax credit carryforwards and deferred Lloyd’s underwriting income.
Earnings per share (“EPS”) for the years ended December 31, 2014, 2013 and 2012 is based on a weighted average of the number of shares outstanding during each year. Basic and diluted EPS is computed by dividing income available to common stockholders by the weighted average number of shares outstanding for the period. The weighted average shares outstanding used to calculate basic EPS differ from the weighted average shares outstanding used in the calculation of diluted EPS due to the effect of dilutive employee stock options, nonvested stock grants and other contingently issuable shares. If the effect of such items is antidilutive, the weighted average shares outstanding used to calculate diluted EPS are equal to those used to calculate basic EPS.
The Company’s reporting currency is the U.S. dollar. The functional currencies of the Company’s foreign operations are the U.K. pound sterling (“GBP”), U.S. dollar, and Canadian dollar. Assets and liabilities of foreign operations are translated into the U.S. dollar using the exchange rates in effect at the balance sheet date. Revenues and expenses of foreign operations are translated using the average exchange rate for the period. Gains or losses from translating the financial statements of foreign operations are recorded in the cumulative translation adjustment, as a separate component of accumulated other comprehensive income. Gains and losses arising from transactions denominated in a foreign currency, other than the Company’s functional currencies, are included in net income (loss), except for the Company’s foreign currency denominated available-for-sale investments. The Company’s foreign currency denominated available-for-sale investments’ change in exchange rates between the local currency and the functional currency at each balance sheet date represents an unrealized appreciation or depreciation in value of these securities, and is included as a component of accumulated other comprehensive income.
The Company manages its exposure to foreign currency risk primarily by matching assets and liabilities denominated in the same currency. To the extent that assets and liabilities in foreign currencies are not matched, the Company is exposed to foreign currency risk. For functional currencies, the related exchange rate fluctuations are reflected in other comprehensive income (loss). The Company translated Chaucer’s balance sheet at December 31, 2014 and 2013 from GBP to U.S. dollars using a conversion rate of 1.56 and 1.66, respectively. The Company recognized $4.2 million, $4.2 million and $6.3 million in foreign currency transaction gains in the Consolidated Statements of Income during the years ended December 31, 2014, 2013 and 2012, respectively.
In July 2013, the Financial Accounting Standards Board (“FASB”) issued ASC Update No. 2013-11 (Topic 740) Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force). This ASC update clarifies the applicable guidance for the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward as long as it is available, at the reporting date under the tax law of the applicable jurisdiction, to settle any additional income taxes that would result from the disallowance of a tax position (with certain exceptions). The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. This guidance was applicable for reporting periods beginning after December 15, 2013, with early adoption permitted, and was to be applied prospectively to all unrecognized tax benefits that existed at the effective date. Retrospective application to all prior periods upon the date of adoption was permitted. The Company implemented this guidance effective January 1, 2014. The effect of implementing this guidance was not material to the Company’s financial position or results of operations.
In March 2013, the FASB issued ASC Update No. 2013-05 (Topic 830) Foreign Currency Matters-Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity (a consensus of the FASB Emerging Issues Task Force). This ASC update clarifies the applicable guidance for the release of the cumulative translation adjustment into net income when a parent either sells all or a portion of its investment in a foreign entity. This guidance is also required to be applied when an entity no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity (with certain exceptions). Additionally, this update clarifies that the sale of an investment in a foreign entity includes events that result in an acquirer obtaining control of an acquiree in which it held an equity interest immediately before the acquisition date in a business combination achieved in stages. This guidance was applicable for reporting periods beginning after December 15, 2013, with early adoption permitted, and was to be applied prospectively to derecognition events occurring after the effective date. The Company implemented this guidance effective January 1, 2014. The effect of implementing this guidance was not material to the Company’s financial position or results of operations.
In May 2014, the FASB issued ASC Update No. 2014-09 (Topic 606) Revenue from Contracts with Customers. This ASC was issued to clarify the principles for recognizing revenue. Insurance Contracts and financial instrument transactions are not within the scope of this updated guidance, and; therefore, only an insignificant amount of the Company’s revenue is subject to this updated guidance. The updated guidance is effective for periods beginning after December 15, 2016 and is not expected to have a material effect on the Company’s financial position or results of operations.
In August 2014, the FASB issued ASC update No. 2014-15 (Subtopic 205-40) Presentation of Financial Statements - Going Concern. This ASC update provides guidance on determining when and how to disclose going concern uncertainties in the financial statements, and requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. The updated guidance is effective for annual periods ending after December 15, 2016 and interim periods thereafter. Early adoption is permitted. The Company does not expect the adoption of ASC update 2014-15 to have a material impact on its financial position or results of operations.
On April 30, 2012, the Company completed the sale of its third party administration subsidiary, Citizens Management, Inc. (“CMI”). The Company recognized net gains of $10.8 million after taxes related to this transaction during the year ended December 31, 2012. Included in this amount was a contingent gain with a fair value of $1.7 million that was entirely contributed to the Company’s charitable foundation.
The Company participates in a security lending program for the purpose of enhancing income. Securities on loan to various counterparties had a fair value of $20.9 million and $13.6 million at December 31, 2014 and 2013, respectively, and were fully collateralized by cash. The fair value of the loaned securities is monitored on a daily basis, and the collateral is maintained at a level of at least 102% of the fair value of the loaned securities. Securities lending collateral is recorded by the Company in cash and cash equivalents, with an offsetting liability included in expenses and taxes payable.
In accordance with Lloyd’s operating guidelines, the Company deposits funds at Lloyd’s to support underwriting operations. These funds are available only to fund claim obligations. At December 31, 2014 and 2013, fixed maturities with a fair value of approximately $450 million and $334 million, respectively, and cash of $2 million and $1 million, respectively, were on deposit with Lloyd’s.
The Company enters into various agreements that may require its fixed maturities to be held as collateral by others. At December 31, 2014 and 2013, fixed maturities with a fair value of $208.2 million and $160.9 million, respectively, were held as collateral for collateralized borrowings and other arrangements. Of these amounts, $195.7 million and $148.1 million related to the FHLBB collateralized borrowing program at December 31, 2014 and 2013, respectively. See Note 6-“Debt and Credit Arrangements” for additional information related to the Company’s FHLBB program.
The Company’s mortgage participations and other mortgage loans were $94.9 million and $2.5 million at December 31, 2014 and 2013, respectively.
In 2014, the Company purchased $93.4 million of participating interests in investment grade commercial mortgage loans originated and serviced by a third party. The Company shares, on a pro-rata basis, in all related cash flows of the underlying mortgages. Due to certain reacquisition rights retained by the third party in the loan participation arrangement, the Company accounts for its participating interests in mortgage loans as secured borrowings under ASC 860.
At December 31, 2014, scheduled maturities of mortgage participations and other mortgage loans were as follows: due in one year - $0.3 million; two years - $1.4 million; five to ten years - $73.4 million; and thereafter - $19.8 million. Actual maturities could differ from contractual maturities because borrowers may have the right to prepay obligations with or without the prepayment penalties and loans may be refinanced.
The Company held overseas deposits of $132.6 million and $149.6 million at December 31, 2014 and 2013, respectively, which are investments held in overseas funds and managed exclusively by Lloyd’s. These investments are also reflected in other investments in the Consolidated Balance Sheets.
The Company had no concentration of investments in a single investee that exceeded 10% of shareholders’ equity except for fixed maturities invested in Federal Home Loan Mortgage Corp. (“FHLMC”) and Federal National Mortgage Association (“FNMA”). At December 31, 2014, the Company held FHLMC and FNMA with fair values of $394.4 million and $315.8 million, respectively. At December 31, 2013, the Company held FHLMC and FNMA with fair values of $341.8 million and $253.2 million, respectively.
At December 31, 2014, there were contractual investment commitments of up to $83.5 million.
The carrying values of fixed maturity securities on non-accrual status at December 31, 2014 and 2013 were not material. The effects of non-accruals for the years ended December 31, 2014, 2013 and 2012, compared with amounts of net investment income that would have been recognized in accordance with the original terms of the fixed maturities, were reductions of $2.1 million, $2.3 million and $2.5 million, respectively.
For 2014, total OTTI was $5.4 million. Of this amount, $5.5 million was recognized in earnings including $0.1 million which was transferred from unrealized losses in accumulated other comprehensive income. The $5.5 million of OTTI recognized in earnings was related to fixed maturity securities that the Company intended to sell.
For 2013, total OTTI was $7.0 million. Of this amount, $6.0 million was recognized in earnings and $1.0 million was recorded as unrealized losses in accumulated other comprehensive income.
There were no credit impairments in 2014. The methodology and significant inputs used to measure the amount of credit losses on fixed maturities in 2013 and 2012 were as follows:
Asset-backed securities, including commercial and residential mortgage-backed securities - the Company utilized cash flow estimates based on bond specific facts and circumstances that include collateral characteristics, expectations of delinquency and default rates, loss severity, prepayment speeds and structural support, including subordination and guarantees.
Municipals - the Company utilized cash flow estimates based on bond specific facts and circumstances that may include the political subdivision’s taxing authority, the issuer’s ability to adjust user fees or other sources of revenue to satisfy its debt obligations and the ability to access insurance or guarantees.
The Company utilizes a third party pricing service for the valuation of the majority of its fixed maturity securities and receives one quote per security. When quoted market prices in an active market are available, they are provided by the pricing service as the fair value and such values are classified as Level 1. Since fixed maturities other than U.S. Treasury securities generally do not trade on a daily basis, the pricing service prepares estimates of fair value for those securities using pricing applications based on a market approach. Inputs into the fair value pricing common to all asset classes include: benchmark U.S. Treasury security yield curves; reported trades of identical or similar fixed maturity securities; broker/dealer quotes of identical or similar fixed maturity securities and structural characteristics such as maturity date, coupon, mandatory principal payment dates, frequency of interest and principal payments, and optional redemption features. Inputs into the fair value applications that are unique by asset class include, but are not limited to:
The Company utilizes a third party pricing service for the valuation of the majority of its equity securities and receives one quote for each equity security. When quoted market prices in an active market are available, they are provided by the pricing service as the fair value and such values are classified as Level 1. The Company holds certain equity securities that have been issued by privately-held entities that do not have an active market and for which the pricing service cannot provide fair values. Generally, the Company estimates fair value for these securities based on the issuer’s book value and market multiples. These securities are reported as Level 2 or Level 3 depending on the significance of the impact of unobservable judgment on the security’s value.
Other investments consist primarily of overseas trust funds, for which fair values are provided by the investment manager based on quoted prices for similar instruments in active markets and are reported as Level 2. Also included in other investments are mortgage participations and other mortgage loans as well as cost basis limited partnerships. Fair values of mortgage participations and other mortgage loans are estimated by discounting the future contractual cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and are reported as Level 3. The fair values of cost basis limited partnerships are based on the net asset value provided by the general partner and recent financial information and are reported as Level 3.
The Company has processes designed to ensure that the values received from its third party pricing service are accurately recorded, that the data inputs and valuation techniques utilized are appropriate and consistently applied and that the assumptions are reasonable and consistent with the objective of determining fair value. The Company performs a review of the fair value hierarchy classifications and of prices received from its pricing service on a quarterly basis. The Company reviews the pricing services’ policies describing its methodology, processes, practices and inputs, including various financial models used to value securities. Also, the Company reviews the portfolio pricing, including securities with changes in prices that exceed a defined threshold are verified to independent sources, if available. If upon review, the Company is not satisfied with the validity of a given price, a pricing challenge would be submitted to the pricing service along with supporting documentation for its review. The Company does not adjust quotes or prices obtained from the pricing service unless the pricing service agrees with the Company’s challenge. During 2014 and 2013, the Company did not adjust any prices received from brokers or its pricing service.
On June 17, 2011, the Company issued $300.0 million aggregate principal amount of 6.375% senior unsecured debentures due June 15, 2021. Additionally, on February 23, 2010, the Company issued $200.0 million aggregate principal amount of 7.50% senior unsecured debentures. At December 31, 2014 and 2013, the remaining 7.50% senior debentures have a par value of $164.6 million and $165.1 million, respectively, and mature on March 1, 2020. The Company also issued 7.625% senior unsecured debentures with a par value of $200.0 million on October 16, 1995. As of December 31, 2014 and 2013, the remaining 7.625% senior debentures have a par value of $81.1 million and $81.2 million, respectively, and mature on October 15, 2025. All of the Company’s senior debentures are subject to certain restrictive covenants, including limitations on the issuance or disposition of stock of restricted subsidiaries and limitations on liens. These debentures pay interest semi-annually. In addition, the Company’s subordinated debentures maturing February 3, 2027 have a par value of $59.7 million as of December 31, 2014 and 2013 and pay cumulative dividends semi-annually at 8.207%.
At December 31, 2014, the Company had a $200.0 million credit agreement which expires in November 2018. The Company had no borrowings under this agreement. Additionally, the Company had a Standby Letter of Credit Facility not to exceed £130.0 million (or $202.8 million based on the foreign currency exchange rate of 1.56 at December 31, 2014). This Letter of Credit Facility provides regulatory capital supporting Chaucer’s underwriting activities for the 2014 and 2015 years of account and each prior open year of account. Simultaneous with this agreement, THG entered into a Guaranty Agreement with Lloyds Bank plc, as Facility Agent and Security Agent, pursuant to which, THG unconditionally guarantees the obligations of Chaucer under the Letter of Credit Facility.
Interest expense was $65.2 million, $65.3 million, and $61.9 million in 2014, 2013 and 2012, respectively. At December 31, 2014, the Company was in compliance with the covenants associated with all of its debt indentures and credit arrangements.
Provisions for income taxes have been calculated in accordance with the provisions of ASC 740. A summary of the components of income before income taxes and income tax expense (benefit) in the Consolidated Statements of Income are shown below:
The income tax expense attributable to the consolidated results of continuing operations is different from the amount determined by multiplying income from continuing operations before income taxes by the U.S. statutory federal income tax rate of 35%. The sources of the difference and the tax effects of each were as follows:
The following are the components of the Company’s deferred tax assets and liabilities (excluding those associated with its discontinued operations).
The Company’s deferred tax asset as of December 31, 2014 also included assets of $110.0 million related to alternative minimum tax credit carryforwards and $15.8 million related to foreign tax credit carryforwards. The alternative minimum tax credit carryforwards have no expiration date and the foreign tax credit carryforwards will expire beginning in 2022. The Company may utilize the credits to offset regular federal income taxes due from future income, and although the Company believes that these assets are fully recoverable, there can be no certainty that future events will not affect their recoverability. The Company believes, based on objective evidence, it is more likely than not that the remaining deferred tax assets will be realized.
In prior years, the Company completed several transactions which resulted in the realization, for tax purposes only, of unrealized gains in its investment portfolio. The Company realized $69.6 million in 2012 as a result of such transactions. These transactions enabled the Company to realize capital loss carryforwards to offset these gains, and resulted in the release of the valuation allowance the Company held against the deferred tax asset related to these capital loss carryforwards. In 2012, the Company released $24.4 million of its valuation allowance which was recorded as a benefit in accumulated other comprehensive income. During 2014, 2013 and 2012, the Company recognized in income from continuing operations, related to non-operating income, $16.2 million, $17.5 million and $14.3 million, respectively. The remaining amount of $91.5 million in accumulated other comprehensive income will be released into income from continuing operations in future years, as the investment securities subject to these transactions are sold or mature. During 2012, the Company released $35.9 million of its valuation allowance related to its deferred tax asset held at the beginning of the year. The release of this valuation allowance resulted from the aforementioned transaction which utilized capital loss carryforwards, unrealized appreciation in its investment portfolio, and net realized capital gains in its Consolidated Statements of Income. Accordingly, the Company recorded decreases in its valuation allowance of $25.3 million as an adjustment to accumulated other comprehensive income, $7.7 million as an adjustment to income tax expense from continuing operations, and $2.9 million in discontinued operations.
There are no tax positions at December 31, 2014 and 2012 for which the ultimate deductibility is highly certain, but for which there is uncertainty about the timing of such deductibility. At December 31, 2013, the ultimate deductibility of a $4.8 million liability was highly certain, but there was uncertainty about the timing of such deductibility. Because of the impact of deferred tax accounting, other than interest and penalties, a change in the timing of deductions would not impact the annual effective tax rate.
Prior to 2002, the Chaucer segment provided defined benefit pension retirement benefits to certain of its employees. As of December 31, 2001, the defined benefit pension plan was closed to new members. The defined benefit obligation for this plan is based on the employees’ years of service and final pensionable salary. Contributions are made at least annually to this plan by both the Company and by employees. As of December 31, 2014, based on current estimates of plan liabilities and other assumptions, the projected benefit obligation of the qualified defined benefit pension plan exceeds plan assets by approximately $6 million.
The Company measures the funded status of its plans as of the date of its year-end statement of financial position. The Company utilizes a measurement date of December 31st to determine its benefit obligations, consistent with the date of its Consolidated Balance Sheets.
The following tables present for each hierarchy level the U.S. qualified defined benefit plan’s investment assets that are measured at fair value at December 31, 2014 and 2013. (Refer to Note 5 - “Fair Value” for a description of the different levels in the Fair Value Hierarchy).
The investment strategy of the Chaucer defined benefit pension plan is to invest primarily in growth assets in the form of equity funds which are expected to provide a positive return that exceeds inflation over the longer term in order to protect the existing and future liabilities of the pension plan. In order to reduce volatility and diversify the portfolio, the target allocation includes an exposure to corporate bond and commercial property funds. In 2013, the Company modified its investment allocation strategy and began shifting assets from equity securities into fixed maturities. The Company shifted assets in 2014 to essentially achieve its current ultimate target level of 60% equities, 30% fixed maturities and 10% real estate funds. This allocation plan is reviewed annually and target allocation changes are made as appropriate.
The following table presents for each hierarchy level the Chaucer defined benefit plan’s investment assets that are measured at fair value at December 31, 2014 and 2013.
The Company recognizes the current net underfunded status of its plans in its Consolidated Balance Sheets. Changes in the funded status of the plans are reflected as components of accumulated other comprehensive loss or income. The components of accumulated other comprehensive loss or income are reflected as either a net actuarial gain or loss or a net prior service cost.
The following table reflects the benefit obligations, fair value of plan assets and funded status of the plans at December 31, 2014 and 2013.
Contributions include $0.4 million of Chaucer employee contributions during 2014 and 2013. All other contributions for all plans were made by the Company.
The following table reflects the total amounts recognized in accumulated other comprehensive income relating to both the U.S. defined benefit pension plans and the Chaucer pension plan as of December 31, 2014 and 2013.
The unrecognized net actuarial gains (losses) which exceed 10% of the greater of the projected benefit obligation or the fair value of plan assets are amortized as a component of net periodic pension cost over the next five years. The following table reflects the total estimated amount of actuarial losses that will be amortized from accumulated other comprehensive income into net periodic pension cost in 2014:
In accordance with ERISA guidelines, the Company is not required to fund its U.S. qualified benefit plan in 2015. The Company expects to contribute $3.5 million to its U.S. non-qualified pension plan to fund 2015 benefit payments and $1.3 million to the Chaucer pension plan. At this time, no additional discretionary contributions are expected to be made to the plans during 2015 and the Company does not expect that any funds will be returned from the plans to the Company during 2015.
The benefit payments are based on the same assumptions used to measure the Company’s benefit obligations at the end of 2014. Benefit payments related to the U.S. qualified plan and the Chaucer plan will be made from plan assets, whereas those payments related to the non-qualified plans will be provided for by the Company. Expected benefits related to the Chaucer pension plan were converted to U.S. dollars at an exchange rate of 1.56.
In addition to the defined benefit plans, THG provides a defined contribution 401(k) plan for its U.S. employees, whereby the Company matches employee elective 401(k) contributions, up to a maximum of 6% of eligible compensation in 2014, 2013, and 2012. The Company’s expense for this matching provision was $19.9 million, $18.3 million and $17.9 million for 2014, 2013 and 2012, respectively. In addition to this matching provision, the Company can elect to make an annual contribution to employees’ accounts. Additional contributions amounted to $2.1 million and $2.8 million for the 2014 and 2013 plan years, respectively. There were no additional contributions in 2012.
Employers are required to measure the funded status of their plans as of the date of their year-end statement of financial position. As such, the Company has utilized a measurement date of December 31, 2014 and 2013, to determine its postretirement benefit obligations, consistent with the date of its Consolidated Balance Sheets. Weighted average discount rate assumptions used to determine postretirement benefit obligations and periodic postretirement costs are as follows:
The amount reclassified from accumulated other comprehensive income for the pension and postretirement benefits was allocated approximately 40% to loss adjustment expenses and 60% to other operating expenses for each of the years ended December 31, 2014, 2013 and 2012. In 2014, $12.1 million of this amount represented the accelerated recognition of unamortized losses due to the settlement of pension plan obligations.
Cash received for options exercised for the years ended December 31, 2014, 2013 and 2012 was $10.9 million, $24.4 million and $2.3 million, respectively. The intrinsic value of options exercised for the years ended December 31, 2014, 2013 and 2012 was $10.6 million, $19.9 million and $1.2 million, respectively.
The excess tax expense realized from options exercised for the years ended December 31, 2014, 2013, and 2012 was $5.9 million, $9.0 million, and $0.4 million, respectively. The aggregate intrinsic value at December 31, 2014 for shares outstanding and shares exercisable was $55.2 million and $20.2 million, respectively. At December 31, 2014, the weighted average remaining contractual life for shares outstanding and shares exercisable was 6.9 years and 4.4 years, respectively. Additional information about employee options outstanding and exercisable at December 31, 2014 is included in the following table:
The fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model. For all options granted through December 31, 2014, the exercise price equaled the market price on the grant date. Compensation cost related to options is based upon the grant date fair value and expensed on a straight-line basis over the service period for each separately vesting portion of the option as if the option was, in substance, multiple awards.
The expected dividend yield is based on the Company’s dividend payout rate(s), in the year noted. Expected volatility is based generally on the Company’s historical daily stock price volatility. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The expected term of options granted represents the period of time that options are expected to be outstanding and is derived primarily using historical exercise, forfeit and cancellation behavior, along with certain other factors expected to differ from historical data.
The fair value of shares that vested during the years ended December 31, 2014 and 2013 was $7.8 million and $2.3 million, respectively. As of December 31, 2014, the Company had unrecognized compensation expense of $4.8 million related to unvested stock options that is expected to be recognized over a weighted average period of 1.4 years.
In 2014, 2013 and 2012, the Company granted market-based awards totaling 56,625, 76,175, and 92,400, respectively, to certain members of senior management, which are included in the table above as performance and market-based restricted stock activity. The vesting of these stock units is based on the relative total shareholder return (“TSR”) of the Company. This metric is generally based on relative TSR for a three year period as compared to a Property and Casualty Index of peer companies. The fair value of market based awards was estimated at the date of grant using a valuation model. These units have the potential to range from 0% to 150% of the shares disclosed. Performance-based restricted stock units are based upon the achievement of the performance metric at 100%. These units have the potential to range from 0% to 200% of the shares disclosed, which varies based on grant year and individual participation level. Increases above the 100% target level are reflected as granted in the period in which performance-based stock unit goals are achieved. Decreases below the 100% target level are reflected as forfeited.
In 2014, performance and market-based stock units of 2,888 were included as granted due to completion levels in excess of 100% for units granted in 2012. The weighted average grant date fair value of these awards was $43.31. In 2013, performance-based stock units of 8,244 were included as forfeited due to completion levels less than 100% for units granted in 2011. The weighted average grant date fair value for these awards was $46.47. In 2012, performance-based stock units of 31,750 were included as forfeited due to completion levels of less than the threshold achievement level for shares granted in 2010. The weighted average grant date fair value for these awards was $42.15.
The intrinsic value, which is equal to the fair value for restricted stock and for restricted stock units that vested during the years ended December 31, 2014, 2013 and 2012 was $4.2 million, $1.8 million and $1.7 million, respectively. The intrinsic value for performance-based restricted stock units that vested in 2014 was $0.3 million. For performance-based restricted stock units that would have vested in 2013 and 2012, there was no intrinsic value since these awards were forfeited due to the aforementioned completion levels of less than threshold. Forfeitures in 2014 related to the above mentioned market-based restricted stock units.
Diluted earnings per share during 2014, 2013 and 2012 excludes 0.7 million, 0.1 million and 1.8 million, respectively, of common shares issuable under the Company’s stock compensation plans, because their effect would be antidilutive.
Pursuant to Michigan’s statute, the maximum dividends and other distributions that an insurer may pay in any twelve month period, without prior approval of the Michigan Insurance Commissioner, is limited to the greater of 10% of policyholders’ surplus as of December 31 of the immediately preceding year or the statutory net income less net realized gains, for the immediately preceding calendar year. Citizens declared dividends to its parent, Hanover Insurance, totaling $66.0 million, $68.0 million and $70.0 million in 2014, 2013 and 2012, respectively. Citizens cannot pay a further dividend to its parent without prior approval until December 2015, at which time the maximum dividend payable without prior approval would be $63.4 million.
Dividend payments from Chaucer to its parent are regulated by U.K. law. Dividends from Chaucer are dependent on dividends from its subsidiaries. Annual dividend payments from Chaucer are limited to retained earnings that are not restricted by capital and other requirements for business at Lloyd’s. Also, Chaucer must provide advance notice to the U.K.’s Prudential Regulation Authority (“PRA”), one of the successors to the Financial Services Authority, of certain proposed dividends or other payments from PRA regulated entities. Dividend payments to THG from Chaucer entities totaled $68.7 million and $13.9 million in 2014 and 2013, respectively. No dividends were declared by Chaucer in 2012.
The Company’s primary business operations include insurance products and services provided through four operating segments. The domestic operating segments are Commercial Lines, Personal Lines and Other, and the Company’s international operating segment is Chaucer. Commercial Lines includes commercial multiple peril, commercial automobile, workers’ compensation, and other commercial coverages, such as specialty program business, inland marine, management and professional liability and surety. Personal Lines includes personal automobile, homeowners and other personal coverages. Chaucer includes marine and aviation, energy, property, U.K. motor, and casualty and other coverages (which includes international liability, specialist coverages, and syndicate participations). Included in Other are Opus Investment Management, Inc., which markets investment management services to institutions, pension funds and other organizations; earnings on holding company assets; and, a discontinued voluntary pools business. The separate financial information is presented consistent with the way results are regularly evaluated by the chief operating decision maker in deciding how to allocate resources and in assessing performance.
The Company reports interest expense related to debt separately from the earnings of its operating segments. This consists of interest on the Company’s senior debentures, subordinated debentures, collateralized borrowings with the Federal Home Loan Bank of Boston, and letter of credit facility. Management evaluates the results of the aforementioned segments based on operating income before taxes which also excludes interest expense on debt. Operating income before taxes excludes certain items which are included in net income, such as net realized investment gains and losses (including net gains and losses on certain derivative instruments). Such gains and losses are excluded since they are determined by interest rates, financial markets and the timing of sales. Also, operating income before taxes excludes net gains and losses on disposals of businesses and real estate assets, gains and losses related to the repayment of debt, discontinued operations, costs to acquire businesses, restructuring costs, the cumulative effect of accounting changes and certain other items. Although the items excluded from operating income before taxes may be important components in understanding and assessing the Company’s overall financial performance, management believes that the presentation of operating income before taxes enhances an investor’s understanding of the Company’s results of operations by highlighting net income attributable to the core operations of the business. However, operating income before taxes should not be construed as a substitute for income before income taxes and operating income should not be construed as a substitute for net income.
Long-lived assets located outside the U.S. were not material for the years ended December 31, 2014 or 2013. The Company does not have revenue from transactions with a single agent or broker amounting to 10 percent or more of its consolidated revenue.
Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company; consequently, allowances are established for amounts deemed uncollectible. The Company determines the appropriate amount of reinsurance based on evaluations of the risks accepted and analyses prepared by consultants and on market conditions (including the availability and pricing of reinsurance). The Company also believes that the terms of its reinsurance contracts are consistent with industry practice in that they contain standard terms with respect to lines of business covered, limit and retention, arbitration and occurrence. The Company believes that its reinsurers are financially sound. This belief is based upon an ongoing review of its reinsurers’ financial statements, reported financial strength ratings from rating agencies, reputations in the marketplace, and the analysis and guidance of THG’s reinsurance advisors.
As a condition to conduct certain business in various states, the Company is required to participate in residual market mechanisms, facilities and pooling arrangements such as the Michigan Catastrophic Claims Association (“MCCA”). The Company is subject to concentration of risk with respect to reinsurance ceded to the MCCA. Funding for MCCA comes from assessments against automobile insurers based upon their share of insured automobiles in the state. Insurers are allowed to pass along this cost to Michigan automobile policyholders. The Company ceded to the MCCA premiums earned and losses and LAE incurred of $73.4 million and $99.2 million in 2014, $72.2 million and $76.6 million in 2013 and $74.0 million and $99.9 million in 2012, respectively. MCCA, which represented 39.7% of the total reinsurance receivable balance at December 31, 2014, is the Company’s only reinsurer representing at least 10% of its reinsurance assets. Reinsurance recoverables related to MCCA were $899.5 million and $867.0 million at December 31, 2014 and 2013, respectively. Because the MCCA is supported by assessments permitted by statute, and there have been no significant uncollectible balances from MCCA identified during the three years ending December 31, 2014, the Company believes that it has no significant exposure to uncollectible reinsurance balances from this entity.
As part of an ongoing process, reserves have been re-estimated for all prior accident years and were decreased by $99.1 million, $76.3 million and $15.8 million in 2014, 2013 and 2012, respectively. For the years ended December 31, 2014, 2013 and 2012, these amounts include favorable loss and LAE reserve development of $104.6 million, $94.6 million and $72.6 million, respectively for Chaucer. Chaucer’s favorable development during 2014 was primarily the result of lower than expected losses in the marine and aviation lines, primarily in the 2011 through 2013 accident years, within casualty and other lines, specialty liability lines, primarily in the 2010 and 2013 accident years, and the property line, primarily in the 2010 through 2013 accident years. Chaucer’s favorable development was also partially attributable to the favorable impact of foreign exchange rate movements on prior years’ loss reserves. For Commercial and Personal Lines, the unfavorable loss and LAE development during 2014 was primarily the result of higher than expected large losses within the commercial automobile coverages, which includes the AIX Holdings, Inc. (“AIX”) program business, primarily related to liability coverage in the 2009 through 2012 accident years. Partially offsetting the unfavorable development was lower than expected losses within the personal automobile line, primarily related to the 2013 accident year, lower than expected losses within the workers’ compensation line, primarily related to the 2007 through 2012 accident years, and lower than expected losses within the commercial multiple peril line, primarily related to the 2012 and 2013 accident years.
The $15.8 million favorable loss and LAE reserve development during the year ended December 31, 2012 included favorable loss and LAE reserve development of $72.6 million for Chaucer. Chaucer’s favorable development during 2012 was primarily the result of lower than expected losses in the energy line, primarily in the 2008 through 2011 accident years, marine and aviation lines, primarily in the 2007 through 2011 accident years, casualty lines, primarily in the 2010 and 2011 accident years, and the property lines, primarily in the 2009 through 2011 accident years. For Commercial and Personal Lines, the unfavorable loss and LAE development during 2012 was primarily the result of higher than expected losses within other commercial lines, primarily in the contract surety line due to the challenging macroeconomic environment for contractors, and to a lesser extent, the AIX program business, primarily related to unexpected severity in commercial automobile liability, commercial multiple peril and general liability in a limited number of programs, and from higher than expected large losses within the commercial automobile line, primarily related to liability coverage in the 2011 accident year. In addition, the Company experienced higher than expected losses within the personal automobile line, primarily related to bodily injury severity in the 2010 and 2011 accident years, and higher than expected homeowners property losses from non-catastrophe weather related activity in the 2011 accident year. Partially offsetting the unfavorable development was lower than expected losses within the commercial multiple peril line, related to the 2008 through 2011 accident years.
Loss and LAE reserves related to asbestos and environmental damage liability, primarily in other commercial lines, were $60.6 million, $61.9 million and $60.5 million as of December 31, 2014, 2013 and 2012, respectively. Ending loss and LAE reserves for all direct business written by the Company related to asbestos and environmental damage liability, included in the reserve for losses and LAE, were $10.1 million, $11.5 million and $9.8 million, net of reinsurance of $21.4 million, $20.6 million and $20.4 million as of December 31, 2014, 2013 and 2012, respectively. As a result of the Company’s historical direct underwriting mix of Commercial Lines policies toward smaller and middle market risks, past asbestos and environmental damage liability loss experience has remained minimal in relation to the Company’s total loss and LAE incurred experience. In addition, the Company has established gross loss and LAE reserves for its run-off voluntary assumed reinsurance pool business with asbestos and environmental damage liability of $29.1 million, $29.8 million and $30.3 million at December 31, 2014, 2013 and 2012, respectively. These reserves relate to pools in which the Company has terminated its participation; however, the Company continues to be subject to claims related to years in which it was a participant. Because of the inherent uncertainty regarding the types of claims in these pools, the Company cannot provide assurance that its reserves will be sufficient.
The minimum statutory capital and surplus necessary to satisfy the Company’s regulatory requirements was $374.6 million, $354.5 million and $329.0 million, which equals the Authorized Control Level at December 31, 2014, 2013 and 2012, respectively.