Certain statements in this document are “forward-looking statements” as that term is defined in the Private Securities Litigation Reform Act of 1995 (PSLRA). These forward-looking statements are made pursuant to the safe harbor provisions of the PSLRA and include statements regarding our loss reserve and reinsurance recoverable estimates; asbestos and toxic waste liabilities and related developments; the impact of the economy on our business; the impact of changes to our reinsurance program in 2013 and the cost of reinsurance in 2014; the adequacy of the rates at which we renewed and wrote new business; premium volume, pricing and competition in 2014; property and casualty investment income during 2014; cash flows generated by our fixed income investments; currency rate fluctuations; the repurchase of common stock under our share repurchase program; our capital adequacy and funding of liquidity needs; the funding and timing of loss payments; and the redemption of our capital securities. Forward-looking statements are made based upon management’s current expectations and beliefs concerning trends and future developments and their potential effects on us. These statements are not guarantees of future performance. Actual results may differ materially from those suggested by forward-looking statements as a result of risks and uncertainties, which include, among others, those discussed or identified from time to time in our public filings with the Securities and Exchange Commission and those associated with:
the impact of legislative, regulatory, judicial and similar developments on companies we insure, particularly with respect to our longer tail lines of business;
Operating income was $2.1 billion in 2013, $1.4 billion in 2012 and $1.5 billion in 2011. The higher operating income in 2013 compared with 2012 was due to substantially higher underwriting income in our property and casualty insurance business, offset in part by a decrease in property and casualty investment income. The modestly lower operating income in 2012 compared with 2011 was due primarily to lower property and casualty investment income. The underwriting income of our property and casualty insurance business was similar in both 2012 and 2011. Management uses operating income, a non-GAAP financial measure, among other measures, to evaluate its performance because the realization of investment gains and losses in any period could be discretionary as to timing and can fluctuate significantly, which could distort the analysis of operating trends.
During 2013, 2012 and 2011, we experienced overall favorable development of $712 million, $614 million and $767 million, respectively, on loss reserves established as of the previous year end. In each year we experienced favorable prior year loss development in each segment of our insurance business.
We classify business as written in the United States or outside the United States based on the location of the risks associated with the underlying policies. The method of determining location of risk varies by class of business. Location of risk for property classes is typically based on the physical location of the covered property, while location of risk for liability classes may be based on the main location of the insured, or in the case of the workers’ compensation class, the primary work location of the covered employee.
Growth in net premiums written in the United States in 2013 occurred in each segment of our insurance business, with the most significant growth occurring in our personal insurance segment. Net premiums written in the United States increased modestly in our commercial insurance segment as well as in our specialty insurance segment, of which the predominant component is our professional liability business. Growth in our personal insurance segment was attributable to new business, strong retention of existing business as well as higher rates and insured exposures upon renewal. Growth in our commercial insurance segment and our professional liability business, while reflecting higher rates and continued strong retention, remained constrained by our underwriting actions and judicious approach to new business in the highly competitive market.
professional liability classes, continuing a trend that began during 2011, the positive trend had a more significant impact on growth in our commercial insurance business.
Net premiums written outside the United States were flat in 2013, as modest growth in our specialty insurance segment was offset by a slight decrease in our personal insurance segment, due to the negative effect of foreign currency translation. Net premiums written in our commercial insurance segment were flat.
Average renewal rates for our personal insurance business outside the United States were modestly higher in 2013 and close to flat in 2012 compared with expiring rates. We continued to retain a high percentage of our customers in both years.
Overall, average renewal rates outside the United States were up slightly in 2013 and 2012 in both the commercial and professional liability components of our business in comparison to expiring rates. The amounts of coverage purchased or the insured exposures were down modestly in our commercial business in 2013 and remained flat in 2012 compared with the respective prior year. For our professional liability business, the amounts of coverage purchased were down modestly in both years. We continued to retain a high percentage of our existing commercial and professional liability business in both years. Retention levels in 2013, as compared with 2012, were similar in our commercial insurance business, but increased modestly in our professional liability business. Renewal retention levels for both our commercial and professional liability business were lower in 2012 than those in 2011. In 2013, the overall level of new business was up slightly in our commercial insurance business but down in the professional liability business compared with 2012. The overall level of new business was down in 2012 compared with 2011 for both our commercial and professional liability business.
We expect that a positive pricing environment in the United States, which began in 2011 and continued throughout 2012 and 2013, will continue into 2014. However, the rate increases in 2014 in some of our commercial and professional liability classes may not be at the same levels we achieved in 2013, as portions of our business have approached rate adequacy during this period, as well as due to competitive market conditions. Outside the United States, we expect that a slightly positive pricing environment will continue in 2014. While there have been signs in recent years that areas of the global economy have been improving, the improvement has been inconsistent across geographies and industries. If the economies in the United States and other countries in which we operate improve in 2014, that should have a positive impact on premiums, although there is typically a lag between an economic recovery and any resulting growth in premiums. We expect our net written premiums overall will be modestly higher in 2014 compared with 2013, assuming average foreign currency to U.S. dollar exchange rates in 2014 remain similar to 2013 year-end levels.
For property risks in the United States and Canada we purchase traditional catastrophe reinsurance, including our primary treaty, which we refer to as our North American catastrophe treaty, as well as supplemental catastrophe reinsurance that provides additional coverage for our exposures in the northeast United States. For certain exposures in the United States, we have also arranged for the purchase of multi-year, collateralized reinsurance funded through the issuance of collateralized risk-linked securities, known as catastrophe bonds. For events outside the United States, we also purchase traditional catastrophe reinsurance.
For hurricane and severe thunderstorm events along the southern U.S. coastline, the $150 million catastrophe bond arrangement provides additional coverage of approximately 50% of homeowners-related hurricane and severe thunderstorm losses (net of recoveries from other available reinsurance) between $860 million and $1.16 billion.
In addition to our major property catastrophe and property per risk treaties, we purchase several smaller property treaties that only provide coverage for specific classes of business or locations having concentrations of risk.
Our major, traditional property reinsurance treaties expire on April 1, 2014. Due to the decrease in catastrophe losses incurred by the industry in 2013, particularly in the United States, we expect that reinsurance rates for property risks will decline in 2014. The final structure of our reinsurance program and amount of coverage purchased, including the mixture of traditional catastrophe reinsurance and collateralized reinsurance coverage funded through the issuance of collateralized risk linked securities, is still being determined and will affect our total reinsurance costs in 2014.
Underwriting results were highly profitable in 2013 and profitable in 2012 and 2011. The combined loss and expense ratio for our overall property and casualty insurance business was as follows:
The loss ratio was lower in 2013 compared with 2012 due primarily to a substantially lower impact of catastrophes and, to a lesser extent, a lower current accident year loss ratio excluding catastrophes. The current accident year loss ratio excluding catastrophes was lower in 2013 for each of our insurance segments. The loss ratio in 2012 was similar to 2011, as a lower amount of favorable prior year loss development and a slightly higher impact of catastrophes in 2012 were offset by a decrease in the current accident year loss ratio excluding catastrophes. The decrease in 2012 in the current accident year loss ratio excluding catastrophes was driven by better results in our personal and commercial insurance segments.
While the loss ratio in each of the last three years included an adverse impact from catastrophes, which were particularly significant in 2012 and 2011, it also reflected favorable loss experience excluding catastrophes that we believe resulted from our disciplined underwriting in recent years. The loss ratio in each of the last three years also benefited from relatively moderate loss trends and the positive impact on premiums earned of rate increases in most classes of business. Results in all three years also benefited from favorable prior year loss development. For more information on prior year loss development, see “Property and Casualty Insurance - Loss Reserves, Prior Year Loss Development.”
Our underwriting profitability in any given period will be affected by the impact of catastrophes in that period. We define a catastrophe as an event that is estimated to cause $25 million or more in industry-wide insured property losses and affects a significant number of policyholders and insurers.
The individually significant events that contributed to catastrophe costs, including losses and any related reinsurance reinstatement premiums, during the years ended December 31, 2013, 2012 and 2011 were as follows:
At the end of 2012, we estimated that net losses from Storm Sandy were $829 million and our reinsurance reinstatement premium costs related to the storm were $53 million. Our estimated gross losses from Storm Sandy were about $1.1 billion, with almost all of the losses from property claims, both commercial and homeowners, and only a modest impact from automobile and other claims. Our net losses of $829 million were lower than the gross amount due primarily to our traditional property catastrophe treaty and, to a much lesser extent, per risk and quota share reinsurance treaties as well as facultative reinsurance placed on an individual risk basis. During 2013, a large percentage of our claims related to Storm Sandy were settled. Our overall estimate of net losses related to Storm Sandy did not change significantly during 2013. We do not expect that any change to our estimate of ultimate net losses related to Storm Sandy in the future would have a material effect on the Corporation’s consolidated financial condition or liquidity.
The only reinsurance recoverable we had from our primary catastrophe reinsurance treaties during the three year period ended December 31, 2013 was that related to Storm Sandy because there was no other individual catastrophe event for which our losses exceeded our initial retention under the treaties.
Net premiums written from personal insurance, which represented 35% of our premiums written in 2013, increased by 5% in 2013 and 4% in 2012 compared with the respective prior year. Net premiums written for the classes of business within the personal insurance segment were as follows:
Growth in net premiums written in our personal insurance business in 2013 occurred in all classes of this business, driven by growth inside the United States. Net premiums written outside the United States decreased slightly in 2013, due to the negative impact of foreign currency translation. Overall growth in net premiums written in our personal insurance business in 2012 occurred both inside and outside the United States, but growth was more significant in the United States than growth outside the United States, which reflected the negative impact of foreign currency translation. The overall growth in our personal insurance business in both years was attributable to new business, strong retention of existing business as well as higher rates and higher insured exposures upon renewal. Personal automobile premiums increased significantly in 2013 and slightly in 2012 compared with the respective preceding year. Premium growth in our personal automobile business in 2013 was more significant in the United States. Growth in the United States in 2013 was attributable to existing personal lines customers adding automobile coverage, higher average renewal rates as well as new customers. Growth for personal automobile business written outside the United States was modest in 2013 and near flat in 2012, with both years reflecting a negative impact of foreign currency translation. Approximately 40% of our personal automobile net premiums written in 2013 were written outside the United States, with more than half written in Brazil. Premiums from our homeowners business increased modestly in both years, driven by growth inside the United States. Net premiums written outside the United States for our homeowners business decreased modestly in 2013 after increasing slightly in 2012, compared with the respective prior year. Growth both inside and outside the United States in both years reflected higher renewal rates as well as increases in coverage on existing policies. Premiums from our other personal business, which includes accident and health, excess liability and yacht coverages, increased significantly in both 2013 and 2012. In our excess liability business, which is predominantly written in the United States, growth occurred in both years, but more so in 2012. Growth also occurred in both years in our accident and health business. In 2013, growth in our accident and health business was significant inside the United States, but premiums written for this business decreased outside the United States due to the non-renewal of a large account. In 2012, growth in our accident and health business occurred both inside and outside the United States.
Our personal automobile results were profitable in each of the past three years. Results in all three years benefited from moderate claim frequency and favorable prior year loss development.
Homeowners results were highly profitable in 2013, profitable in 2012 and breakeven in 2011. The more profitable results in 2013 compared with 2012 were due in large part to a lower impact from catastrophes and, to a lesser extent, a lower current accident year loss ratio excluding catastrophes. The more profitable results in 2012 compared with 2011 were due to a lower current accident year loss ratio excluding catastrophes, due in part to lower non-catastrophe weather-related losses. The impact of catastrophes accounted for 11.5 percentage points of the combined loss and expense ratio for this class in 2013 compared with 21.0 percentage points in 2012 and 20.6 percentage points in 2011.
Our other personal business produced similarly profitable results in each of the past three years. Results for our excess liability business were profitable in all three years, but modestly less so in 2012. Results for this component of our other personal business benefited from favorable prior year loss development in each year, mainly as a result of better than expected claim severity. Our accident and health business produced slightly profitable results in 2013 and 2012 compared with near breakeven results in 2011. Our yacht business was highly profitable in each of the past three years.
Net premiums written from commercial insurance, which represented 43% of our premiums written in 2013, increased by 2% in both 2013 and 2012 compared with the respective prior year. Net premiums written for the classes of business within the commercial insurance segment were as follows:
overall rate environment in the commercial insurance business in the United States, which began in 2011, continued throughout 2012 and 2013. Average renewal rates in the United States were up significantly in both 2013 and 2012, with increases occurring in all major classes of our business. Average renewal rates outside the United States increased only slightly in both 2013 and 2012.
Multiple peril results were highly profitable in 2013 compared with profitable results in 2012 and slightly unprofitable results in 2011. The more profitable results in 2013 compared with 2012 were due primarily to a lower impact of catastrophes in the property component of this business. Results for the liability component were similarly profitable in both 2013 and 2012. The profitable results in 2012 compared with the unprofitable results in 2011 were due primarily to a lower impact of catastrophes and a lower current accident year loss ratio excluding catastrophes in the property component of this business, offset in part by less profitable results in the liability component. The impact of catastrophes accounted for 3.3 percentage points of the combined loss and expense ratio for the multiple peril class in 2013 compared with 10.9 percentage points in 2012 and 15.1 percentage points in 2011. The property component reflected moderate non-catastrophe losses in all three years.
Results for our casualty business were profitable in each of the past three years, but decreasingly so in each successive year. Results for the automobile component of our casualty business were modestly profitable in 2013 compared with near breakeven results in 2012 and profitable results in 2011. Automobile results were more profitable in 2011 compared with 2012 and 2013 mainly due to a higher amount of favorable prior year loss development. Results for the primary liability component of the casualty business were unprofitable in 2013 and 2012 compared with profitable results in 2011. Primary liability results deteriorated in 2013 and 2012 compared with 2011 partly due to an increase in the frequency of large reported losses, many of which related to prior accident years. Conversely, results in 2011 benefited from a significant amount of favorable prior year loss development. Results for the excess
liability component were highly profitable in each of the past three years, but more so in 2012. Excess liability results in all three years benefited from substantial favorable prior year loss development mainly due to lower than expected claim severity. Results for our casualty business were adversely affected in each of the last three years by incurred losses related to toxic waste claims and asbestos claims. Our analysis of these exposures resulted in increases in the estimate of our ultimate liabilities. Such losses represented 5.1 percentage points of the combined ratio for this business in 2013, 3.4 percentage points in 2012 and 4.0 percentage points in 2011.
Workers’ compensation results were profitable in each of the past three years, but more so in 2013 due to a lower current accident year loss ratio compared with 2012 and 2011. Results in each year reflected improved pricing and our disciplined risk selection during the past several years. Results in 2013 and 2011 benefited from modest favorable prior year loss development.
Net premiums written in our professional liability business increased by 2% in 2013 and decreased by 5% in 2012 compared with the respective prior year. Net premiums written increased modestly in 2013, both inside and outside the United States. Net premiums written decreased in 2012, both inside and outside the United States, but to a greater extent outside the United States. Premium growth in 2013 was due in part to the positive effect of our decision to not renew a reinsurance treaty that expired July 1, 2013. Premium growth in our professional liability business remained constrained in both years by our focus on profitability in the pricing of renewal policies and the limited opportunities to write suitably-priced new business, in what has remained a highly competitive market place. Nevertheless, beginning in late 2011 and continuing through 2013, the overall rate environment improved, particularly in the United States. During this period, we pursued rate increases to improve the profitability of our professional liability business. Retention levels for this business remained strong. Retention levels were similar in 2013 and 2012 inside the United States but were modestly lower compared with those in the preceding years as a result of our rate increase initiative. Retention levels increased modestly in 2013 outside the United States following a modest decline in 2012. New business increased in 2013 but declined in 2012 in the United States. New business declined outside the United States in both years. Renewal retention levels and new business volume reflected the selective reduction of our exposure in some customer segments where rate levels were not attractive, as well as our commitment to maintaining underwriting discipline in this environment.
Average renewal rates for our professional liability business were up significantly in the United States in both 2013 and 2012. The most significant increases in both years occurred in the directors and officers liability and employment practices liability lines of business. Average renewal rates outside the United States were up slightly in both years.
Our specialty insurance business produced highly profitable underwriting results in 2013 and 2011 compared with profitable results in 2012. The combined loss and expense ratios for the classes of business within the specialty insurance segment were as follows:
issued bonds to them. We therefore may experience an increase in filed claims and may incur high severity losses, especially in light of ongoing economic conditions. Such losses would be recognized if and when claims are filed and determined to be valid, and could have a material adverse effect on the Corporation’s results of operations.
As this business is in runoff, net premiums written from our reinsurance assumed business were not significant during the past three years. Results for this business were profitable in each of the past three years, but less so in 2013. The profitable results in each year were due to favorable prior year loss development.
Our property and casualty subsidiaries have exposure to losses caused by natural perils such as hurricanes and other windstorms, earthquakes, severe winter weather and brush fires as well as from man-made catastrophic events such as terrorism. The frequency and severity of catastrophes are inherently unpredictable.
The extent of losses from a natural catastrophe is a function of both the total amount of insured exposure in an area affected by the event and the severity of the event. We regularly assess our concentrations of risk in natural catastrophe exposed areas globally and have strategies and underwriting standards to manage these exposures through individual risk selection, subject to regulatory constraints, and through the purchase of catastrophe reinsurance coverage. We use catastrophe modeling and a risk concentration management tool to monitor and control our accumulations of potential losses in natural catastrophe exposed areas in the United States, such as California and the gulf and east coasts, as well as in natural catastrophe exposed areas in other countries. The information provided by the catastrophe modeling and the risk concentration management tool has resulted in our non-renewing some accounts and refraining from writing others.
Catastrophe modeling generally relies on multiple inputs based on experience, science, engineering and history, and the selection of those inputs requires a significant amount of judgment. The modeling results may also fail to account for risks that are outside the range of normal probability or are otherwise unforeseen. Because of this, actual results may differ materially from those derived from our modeling exercises.
Actual results may differ materially from those suggested by the model. The risk concentration management tool referred to above also enables us to identify locations and geographic areas that are exposed to risk accumulations. The information provided by the terrorism model and the risk concentration management tool has resulted in our non-renewing some accounts, subject to regulatory constraints, and refraining from writing others.
Our loss reserves include case estimates for claims that have been reported and estimates for claims that have been incurred but not reported at the balance sheet date as well as estimates of the expenses associated with processing and settling all reported and unreported claims, less estimates of anticipated salvage and subrogation recoveries. Estimates are based upon past loss experience modified for current trends as well as prevailing economic, legal and social conditions. Our loss reserves are not discounted to present value.
Incurred but not reported (IBNR) reserve estimates are generally calculated by first projecting the ultimate cost of all claims that have occurred and then subtracting reported losses and loss expenses. Reported losses include cumulative paid losses and loss expenses plus case reserves. The IBNR reserve includes a provision for claims that have occurred but have not yet been reported to us, some of which are not yet known to the insured, as well as a provision for future development on reported claims. A relatively large proportion of our net loss reserves, particularly for long tail liability classes, are reserves for IBNR losses. In fact, about 70% of our aggregate net loss reserves at December 31, 2013 were for IBNR losses.
Loss reserves, net of reinsurance recoverable, decreased by $678 million or 3% in 2013. Loss reserves related to our insurance business decreased by $618 million, including $526 million related to catastrophe losses and $96 million related to the effect of foreign currency translation, due to a stronger U.S. dollar at December 31, 2013 compared with December 31, 2012. Loss reserves related to our reinsurance assumed business, which is in runoff, decreased by $60 million.
Total gross loss reserves related to our insurance business decreased by $714 million in 2013, all of which was a decrease in IBNR reserves. The overall decrease in gross IBNR reserves was due in large part to decreases in the reserves of the property classes of business, particularly homeowners and property and marine, primarily as a result of case and paid activity on catastrophe-related claims, especially from Storm Sandy. A significant decrease in gross IBNR reserves also occurred in the professional liability classes, due to reported loss activity, favorable prior year loss development and reduced exposures. Increases in gross IBNR reserves occurred in the casualty and workers’ compensation classes, where case reserves increased as well, partly due to increased exposures. Reinsurance recoverable related to our insurance business decreased by $96 million in 2013, driven in large part by recoveries received from reinsurers related to Storm Sandy in the homeowners and property and marine classes of business.
Most of our loss reserves relate to long tail liability classes of business. Long tail classes include directors and officers liability, errors and omissions liability and other professional liability coverages, commercial primary and excess liability, workers’ compensation and other liability coverages. For many liability claims significant periods of time, ranging up to several years or even decades, may elapse between the occurrence of the loss, the reporting of the loss to us and the settlement of the claim. As a result, loss experience in the more recent accident years for the long tail liability classes has limited statistical credibility because a relatively small proportion of losses in these accident years are reported claims and an even smaller proportion are paid losses.
Senior management meets with our actuaries at the end of each quarter to review the results of the latest loss reserve analysis. Based on this review, management determines the carried reserve for each
In addition, we must consider the uncertain effects of emerging or potential claims and coverage issues that arise as legal, judicial and social conditions change. These issues have had, and may continue to have, a negative effect on our loss reserves by either extending coverage beyond the original underwriting intent or by increasing the number or size of claims. Examples of such issues include professional liability claims arising out of the recent crisis in the financial markets, directors and officers liability and errors and omissions liability claims arising out of accounting and other corporate malfeasance, and exposure to claims asserted for bodily injury as a result of long term exposure to harmful products or substances. As a result of issues such as these, the uncertainties inherent in estimating ultimate claim costs on the basis of past experience have grown, further complicating the already complex loss reserving process.
Reserves for the professional liability classes other than fidelity were $6.4 billion, net of reinsurance, at December 31, 2013. Based on a review of our loss experience, if the loss development factor for each accident year changed such that the cumulative loss development factor for the most recent accident year changed by 10%, we estimate that the net reserves for professional liability classes other than fidelity would change by approximately $625 million, in either direction. This degree of change in the reported loss development pattern is within the historical variation around the averages in our data.
Reserves Relating to Asbestos and Toxic Waste Claims. The estimation of loss reserves relating to asbestos and toxic waste claims on insurance policies written many years ago is subject to greater uncertainty than other types of claims due to inconsistent court decisions as well as judicial interpretations and legislative actions that in some instances have tended to broaden coverage beyond the original intent of such policies and in others have expanded theories of liability. The insurance industry as a whole is engaged in extensive litigation over coverage, accident year allocation and liability issues and is thus confronted with a continuing uncertainty in its efforts to quantify these exposures.
We believe that the loss reserves carried at December 31, 2013 for asbestos and toxic waste claims were adequate. However, given the judicial decisions and legislative actions that have broadened the scope of coverage and expanded theories of liability in the past and the possibilities of similar interpretations in the future, it is possible that our estimate of loss reserves relating to these exposures may increase in future periods as new information becomes available and as claims develop.
Approximately 100 manufacturers and distributors of asbestos products have filed for bankruptcy protection as a result of asbestos related liabilities. A bankruptcy sometimes involves an agreement to a plan between the debtor and its creditors, including the creation of a trust to pay current and future asbestos claimants for their injuries. Although the debtor is negotiating in part with its insurers’ money, insurers are generally given only limited opportunity to be heard. In addition to contributing to the overall number of claims, bankruptcy proceedings not only result in increased settlement demands against remaining solvent defendants, but also create the potential for recoveries from multiple trusts by the same claimant for the same alleged injuries.
A number of states have implemented legislative and judicial reforms that focus the courts’ resources on the claims of the most seriously injured. Those who allege serious injury and can present credible evidence of their injuries are receiving priority trial settings in the courts, while
Our actuaries and claim personnel perform periodic analyses of our asbestos related exposures. The analyses performed in each of the past three years noted modest adverse developments mostly related to a small number of existing insureds and a slower than expected decline in the number of insureds
At December 31, 2013, $334 million of the net asbestos loss reserves were IBNR reserves.
In establishing our toxic waste reserves, we evaluate the exposure presented by each insured. As part of this evaluation, we consider a variety of factors including: the probable liability, available insurance coverage, allocation of potential loss to the appropriate accident year, past settlement values of similar claims, relevant judicial interpretations, applicable coverage defenses as well as facts that are unique to each insured.
In each of the past three years, the analysis of our toxic waste exposures indicated that some of our insureds had become responsible for the remediation of additional polluted sites and that, as clean up standards continue to evolve as a result of technology advances, the estimated cost of remediation of certain sites had increased. Defense costs associated with some of these cases have also increased. Based on these developments, we increased our net toxic waste loss reserves by $55 million in both 2013 and 2012 and $50 million in 2011.
At December 31, 2013, $214 million of the net toxic waste loss reserves were IBNR reserves.
Reinsurance Recoverable. Reinsurance recoverable is the estimated amount recoverable from reinsurers related to the losses we have incurred. At December 31, 2013, reinsurance recoverable included $142 million recoverable with respect to paid losses and loss expenses, which is included in other assets, and $1.8 billion recoverable on unpaid losses and loss expenses, including reinsurance losses incurred but not reported. Approximately $155 million of reinsurance recoverable on unpaid losses and loss expenses at December 31, 2013 related to losses associated with Storm Sandy. None of the reinsurance recoverable on unpaid losses and loss expenses is currently due for collection from reinsurers.
Ceded reinsurance contracts do not relieve us of our primary obligation to our policyholders. Consequently, an exposure exists with respect to reinsurance recoverable to the extent that any reinsurer is unable to meet its obligations or disputes the liabilities we believe it has assumed under the reinsurance contracts.
We are selective in regard to our reinsurers, placing reinsurance with only those reinsurers that we believe have strong balance sheets and superior underwriting ability. We monitor the financial strength of our reinsurers and our concentration of risk with reinsurers on an ongoing basis. We obtain collateral from certain of our reinsurers in the form of letters of credit, trust agreements and cash advances, in order to mitigate potential collectibility exposure. The total amount of collateral held at December 31, 2013 related to reinsurance recoverable on paid and unpaid losses and loss expenses was $584 million. As of December 31, 2013, the largest amount of reinsurance recoverable on paid and unpaid losses and loss expenses from any individual reinsurer represented one percent of shareholders’ equity. Nevertheless, in recent years, certain of our reinsurers have experienced financial difficulties or exited the reinsurance business. In addition, we may become involved in coverage disputes with our reinsurers. A provision for estimated uncollectible reinsurance is recorded based on periodic evaluations of balances due from reinsurers, the financial condition of the reinsurers, coverage disputes and other relevant factors, including collateral held.
Changes in loss reserve estimates are unavoidable because such estimates are subject to the outcome of future events. Loss trends vary and time is required for changes in trends to be recognized and confirmed. Reserve changes that increase previous estimates of ultimate cost are referred to as unfavorable or adverse development or reserve strengthening. Reserve changes that decrease previous estimates of ultimate cost are referred to as favorable development or reserve releases.
During 2013, we experienced overall favorable prior year development of $712 million, which represented 3.2% of the net loss reserves as of December 31, 2012. This compares with favorable prior year development of $614 million during 2012, which represented 2.9% of the net loss reserves at December 31, 2011, and favorable prior year development of $767 million during 2011, which represented 3.7% of the net loss reserves at December 31, 2010. Such favorable development was reflected in operating results in these respective years.
We experienced favorable development of about $265 million in the aggregate, including $30 million related to catastrophes, in the personal and commercial property classes, mostly related to the 2012 and 2011 accident years. The severity and frequency of late developing property claims that emerged during 2013 were lower than expected, including those related to catastrophes, and the development of existing case reserves was more favorable than expected. Because the incidence of large property losses is subject to a considerable element of fortuity, reserve estimates for these claims are based on an analysis of past loss experience on average over a
We experienced favorable development of about $160 million in the aggregate in the personal and commercial liability classes. The most significant favorable development occurred in the excess liability classes, particularly in accident years 2010 and prior. There was some offsetting adverse development in other liability classes, most notably due to $106 million of incurred losses related to asbestos and toxic waste claims in older accident years. Overall, prior period liability claims were lower than expected, particularly the severity of such claims, and the effects of underwriting changes that affected these years have been more positive than expected. These factors were reflected in the determination of the carried loss reserves for these classes at December 31, 2013.
We experienced favorable development of about $30 million in the surety business due to lower than expected loss emergence in recent accident years. Loss reserve estimates at the end of 2012 included an expectation of more late reported losses than actually occurred in 2013. However, since the experience in this business is volatile and we would still expect such losses to occur over time, the favorable development in 2013 was given only modest weight in the determination of carried loss reserves for this class at December 31, 2013.
We experienced favorable development of about $250 million in the aggregate in the personal and commercial liability classes. The most significant favorable development occurred in accident years 2006 to 2009, which more than offset adverse development in accident years 2002 and prior, which included $83 million of incurred losses related to asbestos and toxic waste claims. The overall frequency and severity of prior period liability claims were lower than expected and the effects of underwriting changes that affected these years have been more positive than expected, especially in the commercial excess liability class.
We experienced favorable development of about $355 million in the aggregate in the personal and commercial liability classes. Favorable development in the more recent accident years, particularly in accident years 2004 to 2009, more than offset adverse development in accident years 2001 and prior, which included $72 million of incurred losses related to asbestos and toxic waste claims. The overall frequency and severity of prior period liability claims were lower than expected and the effects of underwriting changes that affected these years have been more positive than expected, especially in the commercial excess liability class.
We experienced overall favorable development of about $310 million in the professional liability classes other than fidelity. The most significant amount of favorable development occurred in the directors and officers liability class, particularly from our business outside the United States, with additional favorable development in the fiduciary liability class, partially offset by adverse development in the errors and omissions liability class. The aggregate reported loss activity related to accident years 2008 and prior was less than expected.
We experienced favorable development of about $15 million in the surety business due to lower than expected loss emergence in recent accident years.
the ten year period illustrates the uncertainty of the loss reserving process. Conditions and trends that have affected reserve development in the past will not necessarily recur in the future. It is not appropriate to extrapolate future favorable or unfavorable reserve development based on amounts experienced in prior years.
Property and casualty investment income before taxes decreased by 6% in 2013 compared with 2012 and decreased by 5% in 2012 compared with 2011. In 2013, the decrease was due to a decline in the average yield of our property and casualty subsidiaries’ investment portfolio, partially offset by the impact of an increase in our average invested assets. In 2012, the decrease was primarily due to a decline in the average yield of our investment portfolio. In 2013 and 2012, the decrease in the average yield of our investment portfolio primarily resulted from lower reinvestment yields on securities that we purchased to replace fixed maturity securities that matured, were redeemed by the issuer or were sold during the year. While the property and casualty subsidiaries generated substantial operating cash during each of the past three years, average invested assets in the three years were impacted by substantial dividends distributed by the property and casualty subsidiaries to Chubb during the period. Growth in property and casualty investment income before taxes was limited as a result of our property and casualty subsidiaries holding only a slightly higher amount of average invested assets in 2013 compared with 2012 and holding a similar amount of average invested assets in 2012 compared with 2011.
The effective tax rate on our investment income was 18.2% in 2013 compared with 18.8% in 2012 and 19.0% in 2011. The effective tax rate fluctuates as the proportion of tax exempt investment income relative to total investment income changes from period to period.
We expect that property and casualty investment income after taxes will decline in 2014, assuming the average yield on fixed maturity securities available in the market and the average foreign currency to U.S. dollar exchange rates in 2014 are both similar to 2013 year-end levels. This expected decline results from the effect of investing funds from securities that matured in 2013 in securities with yields lower than the yields of the maturing securities, and the expectation that this pattern will continue in 2014. The expected decline in property and casualty investment income after taxes in 2014 reflects an assumption that average invested assets in 2014 will be similar to the level in 2013, based on our expectations of cash flows during the year.
Corporate and other comprises investment income earned on corporate invested assets, interest expense and other expenses not allocated to our operating subsidiaries and the results of our non-insurance subsidiaries.
Corporate and other produced a loss before taxes of $237 million in 2013 and 2012 compared with a loss of $246 million in 2011. Corporate and other loss was the same in 2013 and 2012 as a decline in interest expense resulting from the repayment of $275 million of outstanding notes upon maturity in April 2013 was offset by a decline in investment income. The lower loss in 2012 compared with 2011 was primarily due to lower interest expense resulting from the repayment of $400 million of outstanding notes upon maturity in November 2011.
During each of the last three years, the fair value of some of our investments were at a level below our cost. Some of these investments were deemed to be other than temporarily impaired. In 2013 and 2012, about 85% and 65%, respectively, of the other-than-temporary impairment losses recognized for equity securities related to issuers in the financial services industry. The remainder of the other-than-temporary impairment losses in 2013 and 2012 and the other-than-temporary impairment losses in 2011 related to issuers that were not concentrated within any individual industry or sector.
Information related to investment securities in an unrealized loss position at December 31, 2013 and 2012 is included in Note (2)(b) of the Notes to Consolidated Financial Statements.
Capital resources provide protection for policyholders, furnish the financial strength to support the business of underwriting insurance risks and facilitate continued business growth. At December 31, 2013, the Corporation had shareholders’ equity of $16.1 billion and total debt of $3.3 billion.
In April 2013, Chubb repaid $275 million of outstanding 5.2% notes upon maturity.
In December 2010, the Board of Directors authorized the repurchase of up to 30,000,000 shares of common stock. In January 2012, the Board of Directors authorized the repurchase of up to $1.2 billion of Chubb’s common stock. In January 2013, the Board of Directors authorized the repurchase of up to $1.3 billion of Chubb’s common stock, which authorization replaced the January 2012 authorization.
Pursuant to these authorizations, Chubb repurchased shares of its common stock in open market transactions as follows: in 2011, repurchased 27,582,889 shares at a cost of $1,718 million; in 2012, repurchased 13,094,640 shares at a cost of $935 million; and in 2013, repurchased 14,887,701 shares at a cost of $1,300 million.
Financial strength ratings assess an insurer’s ability to meet its financial obligations to policyholders. The following table presents our property and casualty subsidiaries’ financial strength ratings as determined by the major independent rating organizations as of February 26, 2014.
(a) Junior subordinated capital securities of $1 billion bear interest at a fixed rate of 6.375% through April 14, 2017 and at a rate equal to the three-month LIBOR rate plus 2.25% thereafter. For purposes of the above table, interest after April 14, 2017 was calculated using the three-month LIBOR rate as of December 31, 2013. The table includes future interest payments through the scheduled maturity date, April 15, 2037. Interest payments for the period from the scheduled maturity date through the final maturity date, March 29, 2067, would increase the contractual obligation by $748 million. It is our expectation that the capital securities will be redeemed at the end of the fixed interest rate period.
In 2013, market yields on fixed maturity investments increased, resulting in a decrease in the fair value of many of our fixed maturity investments. In 2012, market yields on fixed maturity investments declined, resulting in an increase in the fair value of many of our fixed maturity investments.
Fair values of financial instruments are determined by management using valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Fair values are generally measured using quoted prices in active markets for identical assets or liabilities or other inputs, such as quoted prices for similar assets or liabilities that are observable, either directly or indirectly. In those instances where observable inputs are not available, fair values are measured using unobservable inputs for the asset or liability. Unobservable inputs reflect our own assumptions about the assumptions that market participants would use in pricing the asset or liability and are developed based on the best information available in the circumstances. Fair value estimates derived from unobservable inputs are affected by the assumptions used, including the discount rates and the estimated amounts and timing of future cash flows. The derived fair value estimates cannot be substantiated by comparison to independent markets and are not necessarily indicative of the amounts that would be realized in a current market exchange.
The methods and assumptions used to estimate the fair values of financial instruments are as follows:
Fair values of fixed maturities are determined by management, utilizing prices obtained from a third party, nationally recognized pricing service or, in the case of securities for which prices are not provided by a pricing service, from third party brokers. For fixed maturities that have quoted prices in active markets, market quotations are provided. For fixed maturities that do not trade on a daily basis, the pricing service and brokers provide fair value estimates using a variety of inputs including, but not limited to, benchmark yields, reported trades, broker/dealer quotes, issuer spreads, bids, offers, reference data, prepayment rates and measures of volatility. Management reviews on an ongoing basis the reasonableness of the methodologies used by the relevant pricing service and brokers. In addition, management, using the prices received for the securities from the pricing service and brokers, determines the aggregate portfolio price performance and reviews it against applicable indices. If management believes that significant discrepancies exist, it will discuss these with the relevant pricing service or broker to resolve the discrepancies.
The methods and assumptions used to estimate the fair value of the Corporation’s pension plan and other postretirement benefit plan assets, other than assets invested in pooled funds, are similar to the methods and assumptions used for our other financial instruments. The fair value of pooled funds is based on the net asset value of the funds. At December 31, 2013 and December 31, 2012, approximately 99% of the pension plan and other postretirement benefit plan assets were categorized as Level 1 or Level 2 in the fair value hierarchy.