Capitalized terms used in this Item 7 and not otherwise defined have the meanings ascribed to such terms under the caption “Important Defined Terms Used in this Form 10-K” which immediately precedes Part I of this Form 10-K. This discussion should be read in conjunction with the consolidated financial statements and notes thereto included in Item 8 of this Form 10-K and the narrative description of our business contained in Item 1 of this Form 10-K.
Our reportable insurance segments are personal insurance, business insurance and specialty insurance. These insurance segments are aligned with the reporting lines to our principal operating decision makers. Investment operations is also a reportable segment. See “Personal and Business Insurance” and “Specialty Insurance” in Item 1 of this Form 10-K for more information about our insurance segments.
Since 2012, a number of issues have significantly impacted our underwriting results. These issues include declining policy counts and premium for our homeowners and personal auto products, deteriorating personal and commercial auto results and adverse development within our programs unit. We have identified the primary causes of these issues and have begun taking corrective action. The actions we have taken include the realignment of associates within the personal and business insurance segments, enhancements to our underwriting and pricing models, improved pricing segmentation and identification and mitigation of underwriting leakage. While much work is still to be done, management believes these actions are the right steps to return these product lines to profitable growth.
Personal insurance segment - Our homeowners line of business was profitable in 2015, but we continued to experience declines in both premiums and policy counts. We saw a slight increase in new business in the second half of 2015 and we expect this trend to continue as we execute our plans to grow profitably in this line. Personal auto results deteriorated in 2015 when compared to 2014. We have identified the primary contributors to these poor results and believe the corrective actions we are taking will drive improved personal auto underwriting results.
Other personal lines, which include our farm & ranch products, experienced profitable growth in 2015. We introduced new front end quoting technology for our farm and ranch products during the fourth quarter of 2015 and experienced a significant increased quote volume as a result. We expect quote volume for these products to increase further in 2016.
During 2015, we accelerated our previously disclosed transition plan for a new technology platform for certain products within our personal and business insurance segments. The new platform is expected to enable us to offer new products utilizing a new rating plan. In addition, the platform incorporates advanced data analytics, which should provide our agents with the ability to submit, rate, quote, bind, issue and bill policies through an automated and integrated platform. We plan to introduce the new
by any party by giving twelve months’ notice to the other parties and their respective domiciliary insurance departments. None of our Pooled Companies currently intends to terminate the Pooling Arrangement.
The following table sets forth certain key performance indicators we use to monitor our operations for the years ended December 31, 2015, 2014 and 2013:
Our 2015 net income was $51.2 million compared to 2014 and 2013 net income of $107.4 million and $60.8 million, respectively. Our 2014 net income included a non-cash income tax benefit of $82.6 million related to the reversal of a valuation allowance against our net deferred tax assets.
In the following discussion of the results of our insurance segments, we sometimes refer to GAAP financial measures in the context of “as reported” and to non-GAAP financial measures in the context of “pro forma.” These pro forma, or non-GAAP financial measures, may (i) exclude the impact of the HO QS Arrangement cession for the years ended December 31, 2014 and 2013, and (ii) exclude the one-time impact of the unearned premium transfer associated with the termination of the HO QS Arrangement at December 31, 2014. We believe the use of these non-GAAP financial measures will enable investors to (a) better understand the impact of the reinsurance arrangement cession on our reported results for the years ended December 31, 2014 and 2013, and (b) perform a meaningful comparison of our results of operations for the years ended December 31, 2015, 2014 and 2013. We have also included Reconciliation Tables 1-8 and Tables 1-6 for readers to better understand the use and calculation of these non-GAAP financial measures.
See “Liquidity and Capital Resources - Reinsurance Arrangements” included in this Item 7 for a more detailed discussion of the HO QS Arrangement.
See additional pro forma reconciliation tables for the HO QS Arrangement cession on our homeowners line of business at Reconciliation Tables 5-8.
The following table sets forth certain key performance indicators for our insurance segments for the years ended December 31, 2015, 2014 and 2013:
The following table sets forth the SAP loss and ALAE ratios by major product line of business for our personal insurance segment with the catastrophe and non-catastrophe impact shown separately for the years ended December 31, 2015, 2014 and 2013:
Pricing/Rates - beginning in the fourth quarter of 2015, our personal lines product teams initiated a 90-day rate review process. The objective of this process is to evaluate the adequacy and competitiveness of our rates as well as identify opportunities to reduce or eliminate underwriting leakage. This process is two-fold and consists of (i) a review of existing rate filings in all of our states and (ii) a review of existing forms and available discounts. We have and will continue to implement rate and policy form changes deemed to be appropriate and supportive of our overall objective of profitable growth; and,
The following tables set forth, on a SAP and pro forma basis, certain of our key performance indicators for the homeowners line of business before and after the impact of the HO QS Arrangement cession for the year ended December 31, 2014 and 2013:
The following table sets forth the net written premiums by major product line of business for our business insurance segment for the years ended December 31, 2015, 2014 and 2013.
During 2015, the following efforts were initiated with the objective of improving the competitiveness of our business insurance products while at the same time improving underwriting results:
Technology - in addition to our personal lines products, our technology transition plan encompasses certain products within our business insurance segment, primarily business owners’ policy and small commercial auto business, which we anticipate introducing to our business insurance agents beginning in late 2016;
Claims - in connection with an overall re-alignment of the claims unit, a dedicated commercial auto claims unit was created to provide more effective and efficient handling of commercial auto claims. In addition, processes were initiated to evaluate our claims handling processes, including coverage interpretation and vendor utilization in order to identify opportunities to reduce or eliminate claims leakage.
The business insurance segment’s SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2015 was 60.6% compared to 52.8% and 50.8% in 2014 and 2013, respectively (Table 4). The 7.8 point increase in the 2015 ratio when compared to 2014 (Table 4) was primarily due to commercial auto, other & product liability and commercial multi-peril lines ratio increases of 24.9 points, 15.6 points and 3.6 points, respectively (Table 4). The increase in the commercial auto ratio was due to an increase in frequency and severity loss trends in third party liability and physical damage coverages when compared to 2014. The elevated severity trends in third party liability coverages also contributed to adverse development of prior accident year losses. The increase in the other & product liability ratio was primarily due to less favorable development of prior accident year losses and an increase in the severity of losses during the current accident year when compared to 2014. The increase in the commercial multi-peril ratio was due to an increase in the severity of losses during the current accident year when compared to 2014. Partially offsetting these increases was an 8.2 point improvement in the fire & allied lines ratio when compared to 2014 (Table 4), due to fewer and less severe losses, and an elevated level of large fire losses during the first six months of 2014 as well as the extreme cold weather during the first quarter of 2014.
The following table sets forth the SAP loss and LAE ratios for our specialty insurance segment with the catastrophe and non-catastrophe impact shown separately for the years ended December 31, 2015, 2014 and 2013:
The specialty insurance segment’s SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2014 increased 33.2 points when compared to 2013 (Table 6). The increase was due to reserve strengthening for terminated RED program business which is in run-off. Beginning in the third quarter 2013, we increased our involvement in managing litigated and higher severity RED program claim files. During the third quarter 2014, we assumed full file management of claim files for certain terminated RED programs from the third party administrators that had been managing the claims and performed a detailed, ground up analysis of those files, which we completed in the fourth quarter 2014. For the year ended December 31, 2014, RED reserves were strengthened by $96.7 million, which included the net cost of the ADC reinsurance agreement, compared to reserve strengthening in 2013 of $21.3 million.
The E&S property unit’s 2015 SAP non-catastrophe loss and ALAE ratio improved 10.0 points when compared to 2014 (Table 6), primarily due to lower current year losses. The E&S property unit’s 2014 SAP non-catastrophe loss and ALAE ratio improved 7.3 points when compared to 2013 (Table 6), primarily due to prior year rate actions emerging in earned premiums and favorable prior accident year loss development.
The E&S casualty unit’s 2015 SAP non-catastrophe loss and ALAE ratio increased 23.1 points, when compared to 2014 (Table 6), primarily due to (i) a shift in the business mix attributable to the Partners General Agency acquisition in the second quarter of 2014, and (ii) adverse development of prior accident year losses during 2015 and favorable development of prior accident year losses during 2014. The E&S casualty unit’s 2014 SAP non-catastrophe loss and ALAE ratio improved 10.4 points, when compared to 2013 (Table 6), primarily due to prior year rate actions emerging in earned premiums.
As shown above, the 2015 loss and loss expenses attributable to prior years was $10.0 million, or an unfavorable development in the estimated ultimate liability for prior years’ claims.
The business insurance segment’s non-catastrophe loss and ALAE reserves developed adversely in 2015 compared to favorable development in 2014 and 2013, respectively, primarily due to adverse development in commercial auto and commercial multi-peril partially offset by favorable development in other lines within the segment, principally other & product liability and workers’ compensation. Similar to the development within personal auto, the adverse development of non-catastrophe loss and ALAE reserves for commercial auto in 2015 was due primarily to higher bodily injury severity trends when compared to 2014 and 2013. For the year ended December 31, 2014, the business insurance segment’s non-catastrophe loss and ALAE reserves developed favorably by $22.3 million, driven primarily by commercial auto, other & product liability and workers’ compensation. The favorable development within these lines was attributable to lower than expected severity emerging from prior accident years.
In the specialty insurance segment, the non-catastrophe loss and ALAE reserves accounted for $7.1 million of adverse development, which was due to programs and E&S casualty with unfavorable development of $9.7 million and $2.7 million, respectively. Unfavorable development in programs was due to higher than expected severity in programs with commercial auto exposure. Partially offsetting the unfavorable development was favorable development of $5.3 million in the E&S property unit due to lower than anticipated severity emerging from accident year 2014.
The following table sets forth a tabular presentation of the development of the ultimate liability by accident year for the year ended December 31, 2014:
In the personal and business insurance segments, the non-catastrophe loss and ALAE reserves contributed $30.6 million of favorable development related to the prior four accident years, primarily in workers' compensation, other & product liability, commercial auto and homeowners. The favorable workers' compensation line development was primarily attributable to better than anticipated severity emerging across all accident years, with approximately one third coming from accident year 2012. The favorable development in the other & product liability, commercial auto and homeowners lines was due to lower than anticipated severity in the casualty lines.
In the specialty insurance segment, the non-catastrophe loss and ALAE reserves contributed $22.7 million of adverse development related to the prior three accident years, which was primarily due to RED reserve strengthening.
The following table sets forth loss and loss expenses payable by major line of business at December 31, 2015 and 2014:
Our acquisition and operating expenses were $426.8 million in 2015 compared to $361.9 million and $354.8 million in 2014 and 2013, respectively. Acquisition and operating expenses for 2015 were flat compared to pro forma 2014 (Reconciliation Table 1). In connection with management’s overall expense initiatives and organizational goals, during the fourth quarter of 2015, we recognized $6.8 million of severance expenses for (i) an early retirement incentive offered to eligible employees and (ii) headcount reductions within our underwriting, claims and information technology departments. The severance expenses recognized during the fourth quarter of 2015 were offset by lower bonus and contingent commission expenses. The increase from 2013 to 2014 was primarily a result of (i) $4.6 million of employee severance expenses recognized as a result of the reorganization of our IT department and (ii) increased contingent commissions and incentive compensation expenses. Partially offsetting these increases was the recognition of $19.0 million of profit commission in 2014 in accordance with the terms of the HO QS Arrangement.
We have investment policy guidelines with respect to purchasing fixed maturity investments for our insurance subsidiaries which preclude investments in bonds that are rated below investment grade by a recognized rating service. Our fixed maturity portfolio is composed of high quality, investment grade issues, comprised mostly of debt issues rated A or higher. We obtain investment ratings from Moody’s, Standard & Poor’s and Fitch. If there is a split rating, we assign the lowest rating obtained. At December 31, 2015, there were no fixed maturity investments rated below investment grade in our available-for-sale investment portfolio.
The following table sets forth the composition of our investment portfolio at carrying value at December 31, 2015 and 2014:
Our primary market risk exposures are to changes in market prices for equity securities and changes in interest rates and credit ratings for fixed maturity securities. Our fixed maturity securities are subject to interest rate risk whereby the value of the securities varies as market interest rates change. We manage this risk by closely monitoring the duration of the fixed maturity portfolio. The duration of the fixed maturity portfolio was approximately 4.85 and 4.32 as of December 31, 2015 and 2014, respectively. The following table sets forth our interest rate risk and the effects of a parallel change in interest rates on the fair value of the available-for-sale fixed maturity portfolio at December 31, 2015:
There are no mortgage backed securities in our fixed maturity portfolio which may be labeled sub-prime mortgage backed securities. We invest only in mortgage backed securities issued by a federal agency or that are U.S. Government guaranteed. Specifically, at December 31, 2015, approximately $457.1 million, or 22.9%, of our fixed maturity available-for-sale investment portfolio was in either GNMA pools, which are guaranteed by the full faith and credit of the U.S. Government, or FNMA or Freddie Mac pools.
At December 31, 2015, our fixed maturity investment portfolio included obligations of states and political subdivisions with a total carrying value of $824.8 million, with $123.8 million of these securities, or 15.0% of our municipal securities portfolio (“Muni Portfolio”), enhanced by third party monoline insurers (a “Credit Enhancement”) for the payment of principal and interest in the event of an issuer default. A Credit Enhancement is not a primary consideration to us when purchasing a municipal security, as we consider the underlying credit quality of the security as the primary rating factor in our evaluation process. At December 31, 2015, 70.5% of the total $824.8 million of municipal securities in our investment portfolio were rated AA or better, without the benefit of a Credit Enhancement. We do not believe that a loss of a Credit Enhancement would have a material adverse impact on our results of operations, financial position or liquidity, due to the underlying strength of the issuers of the securities, as well as our ability and intent to hold the securities. In addition, at December 31, 2015, we had no direct investment in any guarantor including any bond insurer.
We believe our Muni Portfolio is well diversified by issuer and state. We have 18.5% invested in securities which have been either pre-refunded or escrowed to maturity bonds. No single issuer comprises more than 5.0% of our Muni Portfolio. For the bonds that are not in the pre-refunded category, no more than 12.0% is concentrated in any one state. We believe our Muni Portfolio is invested within the strongest sectors of the municipal bond market. Revenue bonds represent 51.4% of our Muni Portfolio and state and local government general obligation bonds make up 18.3% of our Muni Portfolio. Our credit research is an important part of our investment management process, and we continually monitor all holdings for any signs of deterioration. We believe that our municipal holdings will maintain their high credit quality and that the issuers will be able to make all principal and interest payments as they come due.
At December 31, 2015, our small-cap and large-cap equity portfolios had a beta of 0.41 and 1.02, respectively, using the Russell 2000 and the S&P 500 Index as benchmarks, respectively. Beta estimates the degree the portfolio’s price will fluctuate based on a given movement in the market index. The following tables set forth what changes might occur in the value of the small-cap and large-cap equity portfolios given a change in the S&P 500 Index at December 31, 2015:
The above analysis is limited in that it does not take into account any actions that might be taken by us in response to these changes. As a result, the actual impact of a change in equity market prices and the resulting equity values may differ significantly from what is shown in the table. By investing in mostly large-cap issues we hope to limit liquidity risk in the equity portfolio. The small-cap and large-cap equity portfolios do not have any direct exposure to exchange rate risk since we do not directly hold any foreign stocks. We constantly monitor the equity portfolio holdings for any credit risk issues that may arise. We do not invest in any commodity futures or commodity oriented mutual funds.
The following table sets forth the components of net investment income for the years ended December 31, 2015, 2014 and 2013:
When a fixed maturity security has been determined to have an other-than-temporary decline in fair value, the impairment charge is separated into an amount representing the credit loss, which is recognized in earnings, and the amount related to non-credit factors, which is recognized in accumulated other comprehensive income. See “Critical Accounting Policies - Investments” included in this Item 7 for OTTI impairment indicators. Future increases or decreases in fair value, if not other-than-temporary, are included in accumulated other comprehensive income (loss). We did not recognize any impairments on our fixed maturity portfolio during 2015, 2014, or 2013.
When an equity security or other invested asset has been determined to have a decline in fair value that is other-than-temporary, we adjust the cost basis of the security to fair value. See “Critical Accounting Policies - Investments” included in this
Item 7 for OTTI impairment indicators. This results in a charge to earnings as a realized loss, which is not reversed for subsequent recoveries in fair value. Future increases or decreases in fair value, if not other-than-temporary, are included in accumulated other comprehensive income (loss).
The following table sets forth the realized losses related to OTTI on our investment portfolio recognized for the years ended December 31, 2015, 2014 and 2013:
Based upon our review of our investment portfolio at December 31, 2015, we determined that there were no individual investments with an unrealized holding loss that had a fair value significantly below cost continually for more than one year. The following table sets forth detailed information on our available-for-sale investment portfolio by lot at fair value for our gross unrealized holding gains (losses) at December 31, 2015:
The following table sets forth our unrealized holding gains by investment type, net of deferred tax that was included as a component of accumulated comprehensive income at December 31, 2015 and 2014, and the change in unrealized holding gains, net of deferred tax, for the year ended December 31, 2015:
We primarily use one independent nationally recognized pricing service in developing fair value estimates. We obtain one price per security, and our processes and control procedures are designed to ensure the value is accurately recorded on an unadjusted basis. Through discussions with the pricing service, we gain an understanding of the methodologies used to price the different types of securities, that the data and the valuation methods utilized are appropriate and consistently applied, and that the assumptions are reasonable and representative of fair value. To validate the reasonableness of the valuations obtained from the pricing service, we compare to other fair value pricing information gathered from other independent pricing sources. See Note 3, “Fair Value of Financial Instruments” to our consolidated financial statements included in Item 8 of this Form 10-K for a presentation of our available-for-sale investments within the fair value hierarchy at December 31, 2015.
As of December 31, 2015, Level 3 assets as a percentage of total assets were 0.1%, which we have determined to be insignificant.
For the year ended December 31, 2015, the federal income tax expense was $16.1 million compared to an income tax benefit of $80.6 million for 2014 and an income tax expense of $0.5 million for 2013. The change from 2014 to 2015 was primarily due to the $82.6 million of deferred tax benefit resulting from the reversal of the valuation allowance against net deferred tax assets at December 31, 2014, as well as greater taxable income in 2015.
We generally manage our cash flows through current operational activity and maturing investments, without a need to liquidate any of our other investments. However, should our written premiums decline or paid losses increase significantly, or a combination thereof, our cash flows from operations could be impacted requiring us to liquidate investments. This action was not necessary in 2015, 2014 or 2013.
Net cash used in investing was $167.7 million and $56.5 million and $23.0 million in 2015, 2014 and 2013, respectively. The following factors significantly contributed to the fluctuations between those years:
State Auto P&C has a credit facility (the “SPC Credit Facility”) with a syndicate of lenders that provides State Auto P&C with a $100.0 million five-year revolving credit facility maturing in July 2018. During the term of the SPC Credit Facility, State Auto P&C has the right to increase the total facility to a maximum amount of $150.0 million, provided that no event of default has occurred. The SPC Credit Facility is available for general corporate purposes and provides for interest-only payments during its term, with principal and interest due in full at maturity. Interest is based on LIBOR or a base rate plus a calculated margin amount. All advances under the SPC Credit Facility are to be fully secured by a pledge of specific investment securities of State Auto P&C. The SPC Credit Facility includes certain covenants and requirements, including financial requirements that State Auto Financial maintain a minimum net worth and a certain debt to capitalization ratio. As of December 31, 2015, State Auto P&C had not made any borrowings under the SPC Credit Facility and State Auto P&C and State Auto Financial were in compliance with all covenants and requirements of the SPC Credit Facility.
State Auto Financial’s Delaware business trust subsidiary (the “Capital Trust”) has outstanding $15.0 million liquidation amount of capital securities, due 2033. In connection with the Capital Trust’s issuance of the capital securities and the related purchase by State Auto Financial of all of the Capital Trust’s common securities (liquidation amount of $0.5 million), State Auto Financial has issued to the Capital Trust $15.5 million aggregate principal amount of unsecured Floating Rate Junior Subordinated Debt Securities due 2033 (the “Subordinated Debentures”). The sole assets of the Capital Trust are the Subordinated Debentures and any interest accrued thereon. Interest on the Capital Trust’s capital and common securities is payable quarterly at a rate equal to the three-month LIBOR rate plus 4.20%, adjusted quarterly. The applicable interest rates for December 31, 2015 and 2014 were 4.61% and 4.44%, respectively.
Members of the State Auto Group maintain a property catastrophe excess of loss reinsurance agreement, covering property catastrophe related events affecting at least two risks. As of June 1, 2015, this property catastrophe reinsurance agreement renewed. Under this agreement, the State Auto Group retains the first $55.0 million of catastrophe loss, each occurrence, with a 5.0% co-participation on the next $285.0 million of covered loss, each occurrence. The reinsurers are responsible for 95% of the excess over $55.0 million up to $340.0 million of covered losses, each occurrence. Under this agreement, our companies are responsible for losses above $340.0 million.
At June 1, 2015, the State Auto Group renewed the property per risk excess of loss reinsurance agreement. This reinsurance agreement provides that the State Auto Group is responsible for the first $1.0 million of each covered loss for E&S property and programs units, and the first $3.0 million of each covered loss for other property business. The State Auto Group is also responsible for an additional $2.0 million in aggregate retention per treaty year for losses exceeding $3.0 million. The reinsurers are responsible for 75.0% of the loss in excess of $1.0 million for the E&S property and programs units and 100.0% of the loss excess of $3.0 million for other property business up to $20.0 million of covered loss. The rates for this reinsurance agreement are negotiated annually.
Also, certain unusual claim situations involving bodily injury liability, property damage, uninsured motorist and personal injury protection are covered by an arrangement that provides for $30.0 million of coverage in excess of $10.0 million retention for each loss occurrence. This reinsurance sits above the $8.0 million excess of $2.0 million arrangement. Policies underwritten by the E&S casualty and programs units are not subject to this casualty excess of loss reinsurance agreement.
The following table sets forth the statutory leverage ratios for our insurance subsidiaries at December 31, 2015, 2014 and 2013:
State Auto P&C, Milbank and SA Ohio are subject to regulations and restrictions under which payment of dividends from statutory surplus can be made to State Auto Financial during the year without prior approval of regulatory authorities. Under the insurance regulations of Iowa and Ohio (the states of domicile), the maximum amount of dividends that the Company may pay out of earned surplus to shareholders within a twelve month period without prior approval of the Department is limited to the greater of 10% of the most recent year-end policyholders’ surplus or net income for the twelve month period ending the 31st day of December of the previous year-end. Pursuant to these rules, $81.4 million is available for payment to State Auto Financial from its insurance subsidiaries in 2015 without prior approval. State Auto Financial received dividends from its insurance subsidiaries in the amount of $15.0 million, $20.0 million and $10.0 million in 2015, 2014 and 2013, respectively.
The financial strength rating for the State Auto Group and expresses the opinion of the rating agency as to the ability of the State Auto Group to meet its ongoing obligations to policyholders. The A.M. Best financial strength rating influences our ability to write insurance business as agents and policyholders generally prefer higher rated companies. Lower rated companies may be required to compete for agents and policyholders by offering higher commissions or lower premiums and expanded coverage, or a combination thereof.
Claim Counts and Severities Method: The Counts and Severities Method calculations are very similar to the other methods. The incurred claim counts reported to date are projected to an ultimate number. Similarly, the incurred loss severities are projected to an ultimate value. The ultimate incurred count is multiplied by the ultimate incurred severity, for each accident year, to arrive at the ultimate incurred loss. Finally, as with the other loss development methods, an estimate of the IBNR reserve is calculated by subtracting the reported losses from the estimated ultimate losses.
Reserve ranges provide a quantification of the variability in the loss reserve projections. The primary determinant in estimating the loss reserve range boundaries are the variances measured within the historical reserving data for the various lines of business. MBE of loss reserves considers the expected variation to establish an appropriate position within a range. At December 31, 2015, MBE loss and ALAE reserves for the STFC Pooled Companies’ share of the Pooled Companies’ reserves were $1,037.2 million, within an estimated range of $897.2 million to $1,065.8 million.
An important assumption underlying the loss reserve estimation methods for casualty lines is that the loss cost trends implicitly built into the loss and ALAE patterns will continue into the future. To estimate the sensitivity of reserves to an unexpected change in inflation, projected calendar year payment patterns were applied to the December 31, 2015, other & product liability loss and ALAE reserve to generate estimated annual incremental loss and ALAE payments for each subsequent calendar year. Then, for purposes of sensitivity testing, an additional annual loss cost trend of 10% was added to the trend implicitly embedded in the estimated payment pattern, and revised incremental loss and ALAE payments were calculated. This type of inflationary increase could arise from a variety of sources including tort law changes, development of new medical procedures, social inflation, and other inflationary changes in costs beyond assumed levels.
The estimated cumulative impact that this additional, unexpected 10% increase in the loss cost trend would have on our results of operations over the lifetime of the underlying claims in other & product liability is an increase of $70.2 million on reserves, or a $45.6 million reduction to net income, assuming a tax rate of 35%. Inflation changes have much more impact on the longer tail commercial lines like other & product liability and workers’ compensation, and much less impact on the shorter tail personal lines’ reserves.
The following table sets forth a reconciliation of MBE of our direct loss and ALAE reserve to our net loss and loss expenses payable at December 31, 2015 and 2014. The STFC Pooled Companies net additional share of transactions assumed from State Auto Mutual through the Pooling Arrangement for the years ended December 31, 2015 and 2014, respectively, has been reflected in the table below as assumed by STFC Pooled Companies.
The accumulated benefit obligation (“ABO”) of a defined benefit pension plan represents the actuarial present value of benefits attributed by the pension benefit formula to employee service rendered prior to the measurement date and based on current and past compensation levels, while the projected benefit obligation (“PBO”) is the ABO plus a factor for future compensation levels. The ABO, which considers current compensation levels only, provides information about the obligation an employer would have if the plan were discontinued at the measurement date. At December 31, 2015, our share of the State Auto Group’s ABO and PBO was $263.1 million and $281.3 million, respectively. At December 31, 2015, STFC’s share of the defined benefit pension plan’s fair value of the assets was $204.4 million, which resulted in an underfunded status within our balance sheet of $76.9 million. On a cash flow basis, we target an annual contribution level that meets at least the targeted normal cost plus any shortfall amortizations of the plan, as defined by ERISA. Currently, we expect to make a cash contribution to the pension plan up to $13.0 million in 2016.
The unfunded status on the pension plan and supplemental executive retirement plan decreased from $93.7 million at December 31, 2014, to $83.7 million at December 31, 2015. Primarily influencing the change from year to year are actuarial gains and losses arising from factors that include (i) changes in the discount rate, (ii) expected to actual demographic changes, such as retirement age, mortality, turnover, rate of compensation changes, and (iii) changes in returns on our plan assets.
For 2015, we recognized a federal income tax expense of $16.1 million compared to federal income tax benefit of $80.6 million for 2014 and a federal income tax expense of $0.5 million for 2013. The income tax benefit in 2014 was primarily due to the reversal of our deferred tax asset valuation allowance, which resulted in an income tax benefit of $82.6 million.
The principal positive evidence that led us to determine at December 31, 2014 that the valuation allowance against our net deferred tax assets was no longer necessary included (i) three consecutive years of pre-tax income; (ii) cumulative three-year pre-tax income of $98.7 million through December 31, 2014; and (iii) expected future pre-tax income. Since the establishment of the valuation allowance in the second quarter of 2011, our homeowners line underwriting results, a key contributor to the initial establishment of the valuation allowance, have significantly improved. The improvement in our homeowners underwriting results is attributable to actions undertaken by management, including rate increases, deductible expansion, and changes in the geographic mix, among others. See the “Personal Insurance Segment” discussion included in this Item 7 for further information. Since 2011, underwriting results have also been impacted by our RED underwriting results, which included reserve strengthening in 2012, 2013 and 2014. Due to the actions taken in 2014, including the reserve strengthening and the placement of the ADC reinsurance agreement, which provides $40.0 million of adverse development cover over carried Loss and LAE reserves for the RED restaurant program, along with the fact that the RED program business has been terminated and is in run-off, future underwriting results are not expected to be materially impacted by RED underwriting results. See the “Specialty Insurance Segment” discussion included in this Item 7 for further information.
Management anticipates generating taxable income over the next three years that will allow for the realization of all of our net operating loss (“NOL”) carryforwards prior to the end of 2017. The NOL carryforwards do not begin to expire until 2030 and will not fully expire until 2032.
We have audited the accompanying consolidated balance sheets of State Auto Financial Corporation and subsidiaries as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2015. Our audits also included the financial statement schedules listed in the Index at Item 15(a)(2). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), State Auto Financial Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated March 2, 2016 expressed an unqualified opinion thereon.
We have audited State Auto Financial Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). State Auto Financial Corporation’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of State Auto Financial Corporation and subsidiaries as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2015, and our report dated March 2, 2016, expressed an unqualified opinion thereon.
State Auto Financial is a majority-owned subsidiary of State Automobile Mutual Insurance Company (“State Auto Mutual”), an Ohio corporation. State Auto Financial and its subsidiaries are referred to herein as the “Company.” All intercompany balances and transactions have been eliminated in consolidation.
The Company markets its insurance products throughout the United States primarily through independent agencies, which include retail agencies and wholesale brokers. The Company’s principal lines of insurance include personal and commercial automobile, homeowners, commercial multi-peril, workers’ compensation, general liability and fire insurance. State Auto P&C, Milbank and SA Ohio are chartered and licensed property and casualty insurers. As such, they are subject to the regulations of the applicable Departments of Insurance of their respective states of domicile (the “Departments”) and the regulations of each state in which they operate. These property and casualty insurance companies undergo periodic financial examination by the Departments and insurance regulatory agencies of the states that choose to participate. A large portion of the Company’s revenues are derived from a reinsurance pooling agreement with State Auto Mutual and its affiliates. The underwriting activity and geographic distribution of State Auto Mutual and its affiliates is generally the same as the underwriting activity and geographic distribution of the Company.
The Company’s insurance subsidiaries, domiciled in Ohio and Iowa, are required to prepare statutory basis financial statements in accordance with the accounting practices prescribed or permitted by the insurance departments of the states of domicile. Prescribed statutory accounting practices are those practices that are incorporated directly or by reference in state laws, regulations, and general administrative rules applicable to all insurance enterprises domiciled in a particular state. The Ohio and Iowa Departments of Insurance require insurers domiciled in their respective states to prepare statutory financial statements in accordance with National Association of Insurance Commissioners’ (“NAIC”) statutory accounting practices. Permitted statutory accounting practices are those practices that differ either from state-prescribed statutory accounting practices or NAIC statutory
Investments in fixed maturities, equity securities and certain other invested assets are classified as available-for-sale and are carried at fair value. The unrealized holding gains and losses, net of applicable deferred income taxes, are shown as a separate component of stockholders’ equity as a part of accumulated other comprehensive loss and, as such, are not included in the determination of net income. Realized gains and losses on the sales of investments are computed using the first-in, first-out method.
The following table sets forth net deferred acquisition costs for the years ended December 31, 2015, 2014 and 2013:
Losses and loss expenses payable are based on formula and case-basis estimates for reported claims and on estimates, based on experience and perceived trends, for unreported claims and loss expenses. The liability for unpaid losses and loss expenses, net of estimated salvage and subrogation recoverable of $24.7 million and $23.8 million at December 31, 2015 and 2014, respectively, has been established to cover the estimated ultimate cost to settle insured losses. The amounts are based on estimates of future rates of inflation and other factors, and accordingly, there can be no assurance that the ultimate liability will not vary materially from such estimates. The estimates are continually reviewed and adjusted as necessary; such adjustments are included in current operations (see Note 4). Anticipated salvage and subrogation is estimated using historical experience. As such, losses and loss expenses payable represent management’s best estimate of the ultimate liability related to reported and unreported claims.
In January 2016, the FASB issued guidance to improve certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Specifically the guidance (i) requires equity investments to be measured at fair value with changes in fair value recognized in earnings, (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminates the requirement to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost, (iv) requires the use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) requires an entity to present separately in other comprehensive income the portion of the total change in fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option, (vi) requires separate presentation of financial assets and liabilities by measurement category and form on the balance sheet or the notes to the financial statements, and (vii) clarifies that the need for a valuation allowance on a deferred tax asset related to an available for sale security should be evaluated with other deferred tax assets. The guidance is effective beginning January 1, 2018 and the Company is currently evaluating the impact on the financial statements.
The following tables set forth the cost or amortized cost and fair value of available-for-sale securities by lot at December 31, 2015 and 2014:
The following tables set forth the Company’s gross unrealized losses and fair value on its investments by lot, aggregated by investment category and length of time for individual securities that have been in a continuous unrealized loss position at December 31, 2015 and 2014:
The following table sets forth the realized losses related to other-than-temporary impairments on the Company’s investment portfolio recognized for the years ended December 31, 2015, 2014 and 2013:
The following table sets forth the amortized cost and fair value of available-for-sale fixed maturities by contractual maturity at December 31, 2015:
At December 31, 2015, State Auto P&C had fixed maturity securities, with a carrying value of approximately $85.0 million, that were pledged as collateral for the FHLB Loan (as defined in Note 7). In accordance with the terms of the FHLB Loan, State Auto P&C retains all rights regarding these securities, which are included in the “U.S. government agencies mortgage-backed securities” classification of the Company’s fixed maturity securities portfolio.
Fixed maturities with fair values of approximately $8.8 million were on deposit with insurance regulators as required by law at December 31, 2015 and 2014, respectively.
Proceeds on sales of available-for-sale securities in 2015, 2014 and 2013 were $326.2 million, $263.3 million and $220.4 million, respectively.
The Company utilizes one nationally recognized pricing service to estimate the majority of its available-for-sale investment portfolio’s fair value. The Company obtains one price per security. The Company’s processes and control procedures are designed to ensure the price is accurately recorded on an unadjusted basis. Through discussions with the pricing service, the Company obtains an understanding of the methodologies used to price the different types of securities, that the data and the valuation methods utilized are appropriate and consistently applied, and that the assumptions are reasonable and representative of fair value. To validate the reasonableness of the valuations obtained from the pricing service, the Company compares the valuations received to other fair value pricing from other independent pricing sources. At December 31, 2015 and 2014, the Company did not adjust any of the prices received from the pricing service.
Included in other invested assets are two international funds (“the funds”) that invest in equity securities of foreign issuers and are managed by third party investment managers. The funds had a fair value of $77.0 million and $72.9 million at December 31, 2015 and 2014, respectively, which was determined using each fund’s net asset value. The Company employs procedures to assess the reasonableness of the fair value of the funds including obtaining and reviewing each fund’s audited financial statements. There are no unfunded commitments related to the funds. The Company may not sell its investment in the funds; however, the Company may redeem all or a portion of its investment in the funds at net asset value per share with the appropriate prior written notice. The funds are disclosed in Level 2 within the hierarchy due to the Company’s ability to redeem its investment in the funds at net asset value per share at the measurement date.
The following tables set forth the Company’s available-for-sale investments within the fair value hierarchy at December 31, 2015 and 2014:
Included in notes payable are the FHLB Loan and Subordinated Debentures. The Company estimates the fair value of the FHLB Loan by discounting cash flows using a borrowing rate currently available to the Company for a loan with similar terms. This has been placed in Level 3 of the fair value hierarchy. The carrying amount of the Subordinated Debentures approximates its fair value as the interest rate adjusts quarterly and has been disclosed in Level 3.
The Company recorded adverse development related to prior years’ loss and loss expense reserves in 2015 and 2014 of $10.0 million and $45.1 million, respectively, compared to favorable development in 2013 of $21.2 million. Favorable development of unallocated loss adjustment expenses and catastrophe reserves were approximately $6.2 million and $0.7 million, respectively, of the 2015 development. The personal and business insurance segments non-catastrophe loss and ALAE reserves contributed $9.8 million of unfavorable development. The personal insurance segment contributed $9.4 million of the adverse development, driven by personal auto which developed unfavorably by $11.0 million, primarily due to higher than anticipated bodily injury severity from the prior two accident years. The business insurance segment contributed $0.4 million of unfavorable development, driven by commercial auto which developed unfavorably by $10.5 million, also due to higher than anticipated bodily injury severity from the prior two accident years. The unfavorable development was partially offset by favorable development in workers’ compensation and other & product liability of $5.1 million and $3.8 million, respectively. Favorable development in these lines was driven by lower than anticipated severity emerging from multiple accident years. The specialty insurance segment non-catastrophe loss and ALAE reserves accounted for $7.1 million of adverse development, which was driven by programs and E&S casualty with unfavorable development of $9.7 million and $2.7 million, respectively. Unfavorable development in programs was driven by higher than expected severity in programs with commercial auto exposures. Somewhat offsetting the unfavorable development was favorable development of $5.3 million in the E&S property unit driven by lower than anticipated severity emerging from accident year 2014.
Favorable development of unallocated loss adjustment expenses contributed approximately $12.5 million of the 2014 development, while favorable development of catastrophe reserves was approximately $5.2 million, which was slightly lower than 2013. The personal and business insurance segments non-catastrophe loss and ALAE reserves accounted for $28.7 million of favorable development. The personal insurance segment contributed $6.4 million of favorable development, primarily from accident year 2013. The business insurance segment contributed $22.3 million of favorable development, driven by the other & product liability, workers’ compensation and commercial auto lines with $11.9 million, $5.6 million and $5.3 million of favorable development, respectively. The favorable development in these lines was driven by the emergence of lower than anticipated claim severity from accident years 2013 and prior. Somewhat offsetting the favorable development was adverse development of $2.1 million in the commercial multi-peril line, driven by third party liability coverage. The specialty insurance segment non-catastrophe loss and ALAE reserves accounted for $91.5 million of adverse development, driven by RED reserve strengthening of $96.7 million related to a large restaurant program and a commercial auto trucking program. Somewhat offsetting the unfavorable development was favorable development of $3.9 million in the E&S property unit and $3.1 million in the E&S casualty unit. These results were driven by better than anticipated severity emerging from the 2012 and 2013 accident years.
Favorable development of unallocated loss adjustment expenses contributed approximately $8.0 million of the 2013 development, while $5.4 million was attributable to favorable development on catastrophe reserves, which is lower than 2012, but, in line with the Company’s historical favorable development. The personal and business insurance segments non-catastrophe
loss and ALAE reserves accounted for $30.5 million of favorable development driven by the workers’ compensation, other & product liability, commercial auto and homeowners lines with $12.3 million, $8.3 million, $8.0 million and $2.9 million of favorable development, respectively. The favorable development in workers’ compensation was driven by better than anticipated severity emerging across all accident years, with approximately one third coming from accident year 2012. The favorable development in the other & product liability, commercial auto and homeowners lines was driven by the emergence of lower than anticipated claim severity. Somewhat offsetting the favorable development was adverse development in the personal auto line, specifically the no-fault coverage. The specialty insurance segment non-catastrophe loss and ALAE reserves accounted for $22.7 million of adverse development, primarily driven by RED reserve strengthening of $21.3 million related to a large restaurant program and a commercial auto trucking program.
The insurance subsidiaries of State Auto Financial, including State Auto Property & Casualty Insurance Company (“State Auto P&C”), Milbank Insurance Company and State Auto Insurance Company of Ohio (collectively referred to as the “STFC Pooled Companies”) participate in a quota share reinsurance pooling arrangement (“the Pooling Arrangement”) with State Auto Mutual which includes Meridian Citizens Mutual Insurance Company (merged with State Auto Mutual at the close of business on July 2, 2014), and its subsidiaries and affiliates, State Auto Insurance Company of Wisconsin, Meridian Security Insurance Company, Patrons Mutual Insurance Company of Connecticut, Rockhill Insurance Company, Plaza Insurance Company, American Compensation Insurance Company and Bloomington Compensation Insurance Company, (collectively referred to as the “Mutual Pooled Companies”). State Auto P&C, Milbank and SA Ohio are referred to as the “STFC Pooled Companies,” State Auto Mutual, SA Wisconsin, Meridian Security and Patrons Mutual are referred to as the “Mutual Pooled Companies,” and RIC, Plaza, American Compensation and Bloomington Compensation are referred to as the “Rockhill Insurers.” The STFC Pooled Companies, the Mutual Pooled Companies and the Rockhill Insurers are collectively referred to as the “State Auto Group.”
In general, under the Pooling Arrangement, the STFC Pooled Companies and the Mutual Pooled Companies other than State Auto Mutual cede to State Auto Mutual all of their insurance business and assume from State Auto Mutual an amount equal to their respective participation percentages in the Pooling Arrangement. All premiums, losses and loss expenses and underwriting expenses are allocated among the participants on the basis of each Company’s participation percentage in the Pooling Arrangement. The Pooling Arrangement provides indemnification against loss or liability relating to insurance risk and has been accounted for as reinsurance.
The Pooling Arrangement does not relieve each individual pooled subsidiary of its primary liability as the originating insurer; consequently, there is a concentration of credit risk arising from business ceded to State Auto Mutual. As the Pooling Arrangement provides for the right of offset, the Company has reported losses and loss expenses payable and prepaid reinsurance premiums to State Auto Mutual as assets only in situations when net amounts ceded to State Auto Mutual exceed net amounts assumed. All parties that participate in the Pooling Arrangement have an A.M. Best rating of A- (Excellent).
The following table sets forth the reinsurance transactions on the Company’s balance sheets for the Pooling Arrangement between the STFC Pooled Companies and State Auto Mutual at December 31, 2015 and 2014:
The following table sets forth the reinsurance transactions on the Company’s income statements for the Pooling Arrangement between the STFC Pooled Companies and State Auto Mutual for the years ended December 31, 2015, 2014 and 2013:
In May 2003, State Auto Financial formed a Delaware business trust (the “Capital Trust”) to issue $15.0 million of mandatorily redeemable preferred capital securities to a third party and $0.5 million of common securities to State Auto Financial (the capital and common securities are collectively referred to as the “Trust Securities”). The Capital Trust loaned $15.5 million, the proceeds from the issuance of its Trust Securities, to State Auto Financial in the form of Floating Rate Junior Subordinated Debt Securities due in 2033 (the “Subordinated Debentures”). The Subordinated Debentures and interest accrued thereon are the Capital Trust’s only assets. Interest on the Trust Securities is payable quarterly at a rate equal to the three-month LIBOR rate plus 4.20% adjusted quarterly (total 4.61% at December 31, 2015). Because the interest rate and interest payment dates on the Subordinated Debentures are the same as the interest rate and interest payment dates on the Trust Securities, payments from the Subordinated Debentures finance the distributions paid on the Trust Securities. State Auto Financial has the right to redeem the Subordinated Debentures, in whole or in part, on or after May 2008. State Auto Financial has unconditionally and irrevocably guaranteed payment of any required distributions on the capital securities, the redemption price when the capital securities are to be redeemed, and any amounts due if the Capital Trust is liquidated or terminated. State Auto Financial’s equity interest in the Capital Trust is included in other invested assets. In accordance with the Consolidation Topic of the FASB ASC 810, State Auto Financial determined that the business trust is a variable interest entity for which it is not the primary beneficiary and therefore, does not consolidate the Capital Trust with the Company.
Under these agreements, the Company earned interest of $4.9 million for each of the three years ended December 31, 2015, 2014 and 2013, respectively. See Note 3 for the notes receivable fair value discussion.
Stateco provides State Auto Mutual and its affiliates investment management services. Investment management income is recognized quarterly based on a percentage of the average fair value of investable assets and the equity portfolio performance of each company managed. Revenue related to these services amounted to $1.8 million, $1.5 million and $1.6 million in 2015, 2014 and 2013, respectively, and is included in other income (affiliates) on the consolidated statements of income.
The following table sets forth the tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities at December 31, 2015 and 2014:
At December 31, 2015, the tax benefit of the net operating loss (“NOL”) carryforward was $41.8 million. The NOL carryforwards do not begin to expire until 2030 and will not fully expire until 2032.
At December 31, 2015, the Company carried no balance for uncertain tax positions. The Company had no accrual for the payment of interest and penalties at December 31, 2015 or 2014.
No assets are expected to be returned during the fiscal year ending December 31, 2016.
The following table sets forth the Company’s share of amortization expected to be recognized for the year ending December 31, 2016:
The postretirement plan’s gross benefit payments for 2015 were $1.2 million, including the prescription drug benefits. The postretirement plan’s subsidy related to Medicare Prescription Drug Improvement and Modernization Act of 2003 was $0.3 million for 2015 and estimates future annual subsidies to be approximately $0.3 million.
The following table sets forth the weighted average assumptions used to determine the benefit plans’ net periodic cost for the years ended December 31, 2015, 2014 and 2013:
The following table sets forth the assumed health care cost trend rates used for the years ended December 31, 2015, 2014 and 2013:
The assumed health care cost trend rates have a significant effect on the amounts reported for the postretirement plan. The following table sets forth the effects of a one percentage point change in assumed health care cost trend rates for the year ended December 31, 2015:
Effective January 1, 2014, the Investment Committee approved a change to a liability driven investment (LDI) for the pension plan assets. The primary goal of the LDI strategy is to shift the asset allocation to more closely align with the plan liability, thereby reducing the volatility of the funded status. The implementation of the LDI strategy will occur over a period of time and the actual asset allocation at any point in time is dependent upon the funded status and the level of interest rates. This glide path helps to balance interest rate risk, curve steepness risk, and credit spread risk, as incremental changes are made to the allocation over time. The new allocation strategy reduces exposure to equity holdings and increases exposure to long duration fixed income. This change will result in lower volatility for the plan assets. By moving more of the plan’s assets to long duration fixed income, the duration of the assets will increase to more closely match the duration of the plan’s liabilities. While the LDI approach is new for the pension plan, the investment policy objective is unchanged.
See Note 3 for the valuation methods used by the Company for each type of financial instrument the plans hold that are carried at fair value. There were no transfers between level categorizations during the years ended December 31, 2015 and 2014.
The following tables set forth the Company’s share of pension plan’s available-for-sale securities within the fair value hierarchy at December 31, 2015 and 2014:
During 2015, the postretirement plan assets were sold in order to pay retiree medical costs. The following table sets forth the Company’s share of the postretirement plan’s available-for-sale securities within the fair value hierarchy at December 31, 2014:
The Company maintains a defined contribution plan that covers substantially all employees of the Company. The Company matches the first 1% of contributions of participants’ salary at the rate of one dollar for each dollar contributed. Participant contributions of 2% to 6% are matched at a rate of 50 cents for each dollar contributed. In addition, the Company contributes a percentage of the employee’s annual income for those employees hired on or after January 1, 2010, and for those employees hired prior to January 1, 2010 who chose to freeze their existing accrued pension benefit effective June 30, 2010. The Company’s share of the expense under the plan totaled $5.1 million, $5.1 million and $4.6 million for 2015, 2014 and 2013, respectively.
The following tables set forth the reclassifications out of accumulated other comprehensive income, by component, to the Company’s consolidated statement of income for the years ended December 31, 2015, 2014 and 2013:
The Company’s insurance subsidiaries are subject to risk-based capital (“RBC”) requirements that have been adopted by individual states. These requirements subject insurers having statutory capital less than that required by the RBC calculation to varying degrees of regulatory action, depending on the level of capital inadequacy. The RBC formulas specify various weighting factors to be applied to financial balances or various levels of activity based on the perceived degree of risk. Regulatory compliance is determined by a ratio of total adjusted capital to authorized control level RBC. Generally no remedial action is required by an insurance company if its adjusted statutory surplus exceeds 200% of the authorized level RBC. As of December 31, 2015, each of the Company’s insurance subsidiaries maintained adjusted statutory surplus in excess of 450% of the authorized control level RBC.
As of December 31, 2015, there was $0.9 million of total unrecognized compensation cost related to non-vested restricted share compensation arrangements. The remaining cost is expected to be recognized over a period of three years.
During 2015 and 2014, common shares valued at approximately $567,000 and $51,000, respectively, were distributed by the Company under the RSU Plan.
Intrinsic value for stock options is defined as the difference between the current market value and the grant price. For the years ended December 31, 2015, 2014 and 2013, the total intrinsic value of stock options exercised was $2.6 million, $0.5 million and $0.5 million, respectively. The tax benefit for tax deductions from share-based awards totaled $0.3 million, $0, and $0 for the years ended December 31, 2015, 2014 and 2013, respectively.
Compensation expense recognized during 2015, 2014 and 2013 was $4.5 million, $3.6 million and $4.1 million, respectively. Share-based compensation is recognized as a component of loss and loss adjustment expense and acquisition and operating expense in a manner consistent with other employee compensation. As of December 31, 2015, there was $2.6 million of total unrecognized compensation cost related to option-based compensation arrangements granted under the plans. The remaining cost is expected to be recognized over a period of three years.
The following table sets forth the options to purchase shares of common stock and the restricted share units (“RSU award”) provided to each outside director of the Company, that were not included in the computation of diluted earnings per common share because the exercise price of the options, or awards, was greater than the average market price or their inclusion would have been antidilutive for the years ended December 31, 2015, 2014 and 2013: