Our reportable insurance segments are personal insurance and commercial insurance. These insurance segments are managed separately from each other due to the differences in the types of customers they serve, products they provide or services they offer. Investment operations is also a reportable segment. As previously reported, we have exited our specialty business, which has resulted in the elimination of our specialty insurance segment. As a result, effective January 1, 2019, the specialty insurance business is no longer a reportable segment as it no longer is material to our results and is disclosed as
"specialty run-off." See “Personal and Commercial Insurance” in Item 1 of this Form 10-K for more information about our insurance segments.
We evaluate the performance of our insurance segments using industry financial measurements determined under SAP and certain measures determined under GAAP. We evaluate our investment operations segment based on investment returns of assets managed. Financial information about our segments for 2020 is set forth in this Item 7 and in Note 18 to our consolidated financial statements included in Item 8 of this Form 10-K.
The impact of COVID-19 on our future results of operations and financial condition are highly uncertain at this time and outside of our control. The scope, duration and magnitude of the effects of the on-going COVID-19 pandemic continue to evolve rapidly and in ways that are difficult or impossible to anticipate. For discussions on how COVID-19 affected our operations, see the "Results of Operations" included in this Item 7. For a discussion of the most significant risks and uncertainties that could impact our results of operations, financial position, liquidity or cash flows as a result of the COVID-19 pandemic, see “Part I - Item 1A. Risk Factors” included in this Form 10-K.
2020 was a year in which our results were negatively impacted by catastrophe losses with improved non-cat loss and LAE and expense ratios. Our 2020 personal and commercial insurance segments statutory combined ratio of 103.6% included 14.0 points of catastrophe losses, which was 6.4 points higher than our five-year average. Our net premium growth of 10.7% was above the industry average.
Our Claims and Risk Engineering (CARE) organization works to deliver exceptional service not only to customers affected by catastrophes throughout the year, but to those who, every day, reach out to us for help. In 2020, the CARE team began to introduce customer service enhancements via our digital platform that will continue throughout 2021. Continuing to improve the customer experience is central to CARE’s strategy going forward.
Improvements in customer and agent experience are being delivered through State Auto Connect. Since its launch in 2016, we have rebuilt all nine of our product lines, concluding with the launch of workers’ compensation in the fourth quarter of 2020. In 2019, we focused on providing a more stable technology experience for agents and policyholders, which we delivered in 2020. In addition, our investments in improving the technology experience for our associates enabled us to quickly move to a remote work environment at the beginning of the COVID-19 pandemic.
The STFC Pooled Companies and the Mutual Pooled Companies participate in a quota share reinsurance pooling arrangement referred to as the “Pooling Arrangement.” Under the Pooling Arrangement, State Auto Mutual assumes premiums, losses and expenses from each of the Pooled Companies and in turn cedes to each of the Pooled Companies a specified portion
•A decline in claim frequency in personal auto and commercial auto due to a reduction in miles driven as a result of people working remotely and staying at home more because of COVID-19 concerns,
•Increased workers' compensation claims for businesses in the medical field, such as nursing homes and hospitals, due to employees being exposed to COVID-19 in the course of their employment, and
•Increased legal defense costs in small commercial package and middle market commercial due to litigation involving business interruption insurance claims.
•The SAP catastrophe loss and ALAE ratio was 14.9%, or $206.2 million. The year ended December 31, 2020 was impacted by (i) a first quarter wind and hail storm, including tornadoes, in Tennessee that primarily impacted the middle market line of business, (ii) widespread second quarter wind and hail events in the South and Midwest that primarily impacted the homeowners line of business, (iii) a Midwest derecho in August, with approximately 75% of the losses occurring in Iowa, as well as widespread wind and hail events in the third quarter, and (iv) adverse development of prior accident year losses of $12.4 million in E&S property related to hurricane Irma in the third quarter. Approximately 50% of the catastrophe losses for the year were in our homeowners line of business.
◦Non-catastrophe losses and ALAE included 3.7 points of favorable development relating to prior years, or $51.5 million. The commercial insurance segment contributed $78.4 million of favorable development which was partially offset by $21.7 million of adverse development from the personal insurance segment and $5.2 million of adverse development from specialty run-off primarily due to an adverse court decision relating to an E&S casualty claim from 2016.
•The SAP catastrophe loss and ALAE ratio was 8.0%, or $100.5 million. 2019 was impacted by (i) severe wind and hail storms, approximately half of which occurred in Texas, and (ii) adverse development of prior accident year catastrophe losses in the specialty run-off business relating to Hurricanes Irma and Harvey.
One of the more significant differences between GAAP and SAP is that SAP requires all underwriting expenses to be expensed immediately and not deferred over the same period that the premium is earned. In converting SAP underwriting results to GAAP underwriting results, acquisition costs are deferred and amortized over the periods the related written premiums are earned. For a discussion of deferred acquisition costs, see Note 1f of the "Notes to Consolidated Financial Statements" in Item 8.
In response to the COVID-19 pandemic and its impact on our personal auto policyholders, in April 2020, we announced our "In This Together" plan that provides a one-time 5% discount at renewal on a personal auto policyholder's entire policy term premium, which will be applied at an upcoming renewal for active personal auto policies in force as of the renewal date. The plan was approved by 26 of our 28 personal lines states with renewal effective dates beginning mid-July. As of December 31, 2020, this reduced the personal auto net written premiums by approximately $4.2 million.
The personal insurance segment's SAP catastrophe loss ratio for the year ended December 31, 2020 increased 5.1 points compared to 2019 (Tables 1 - 2), driven by an increase in the frequency and severity of wind and hail events, which primarily impacted the homeowners line of business. Approximately 40% of our 2020 reported catastrophe losses occurred in Texas. During 2019, catastrophe losses were primarily related to wind and hail storms, with over half of the reported losses occurring in Texas.
The homeowners SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2020 improved 1.9 points when compared to the same 2019 period (Tables 1 - 2). The 2020 improvement was primarily driven by lower claim frequency in the current accident year. Partially offsetting this improvement was adverse development of prior accident year losses, primarily driven by higher than expected severity for 2019 property and third-party liability claims.
Commercial auto has been written on State Auto Connect since 2018, and in January 2019, we finished the rollout of State Auto Connect for small commercial package. Our farm and ranch product launched on State Auto Connect during the first quarter of 2020 and is now live in 27 states. Eight of the 27 states are states that we previously were not writing policies for farm & ranch products. The rollout of the State Auto Connect platform in farm & ranch's remaining states will continue throughout 2021. Our middle market commercial product launched on State Auto Connect in March 2020 and is currently live in 16 states, with subsequent state rollouts scheduled throughout 2021. Finally, our workers' compensation product launched on State Auto Connect in the fourth quarter of 2020 and is currently live in eight states with subsequent state rollouts scheduled throughout 2021.
The commercial insurance segment's net written premiums for the year ended December 31, 2020 increased 12.7% compared to 2019 (Tables 3 - 4), primarily driven by (i) new business growth and rate increases in commercial auto, (ii) new business growth in farm & ranch, and (iii) rate increases in middle market commercial. The 2020 increase was partially offset by a decrease in net written premiums in workers’ compensation due to (i) a decline in new business as a result of COVID-19, (ii) a strategic decision to not renew and no longer write nursing home policies, and (iii) continued intense competition in this market.
The commercial insurance segment's SAP catastrophe loss and ALAE ratio for the year ended December 31, 2020 increased 9.5 points compared to 2019 (Tables 3 - 4), with most of the catastrophe losses impacting middle market commercial, small commercial package, and farm & ranch. The 2020 cat loss and ALAE ratio was impacted (i) an increase in the severity of weather events when compared to 2019, (ii) a severe wind and hail storm, including tornadoes, in Tennessee, which contributed 4.4 points to the cat loss and ALAE ratio, of which 2.7 points were from three large losses in Nashville, (iii) the Midwest
derecho in August which contributed 1.4 points to the cat loss and ALAE ratio, and (iv) property losses resulting from the civil unrest which added 1.1 points to the cat loss and LAE ratio.
The commercial insurance segment's SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2020 improved 5.3 points compared to 2019. (Tables 3 - 4).
The workers' compensation SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2020 increased 0.5 points when compared to 2019. The 2020 current accident year was impacted by increased claims for businesses in the medical field (e.g. nursing homes, hospitals) due to the COVID-19 pandemic, which added 10.0 points to the non-cat loss ratio, which were partially offset by a decline in claim frequency due to reduced business and employment activity in response to the COVID-19 pandemic. The 2020 current accident year ratio was also impacted by a large loss in the third quarter that added 2.5 points to the non-cat loss ratio. Partially offsetting the increase in the non-cat loss ratio was greater favorable development of prior accident year losses primarily due to lower than anticipated severity across multiple accident years. The 2019 non-cat loss and ALAE ratio was impacted by favorable development of prior accident year losses primarily due to lower than anticipated severity from multiple accident years. The 2019 current accident year reflected (i) elevated claim frequency and severity, and (ii) a single large loss that added 3.5 points to the loss ratio.
The following table sets forth a tabular presentation of the development of the ultimate liability by accident year for the year ended December 31, 2020:
The loss and loss expenses payable at December 31, 2020 decreased $26.8 million from the loss and loss expenses payable at December 31, 2019, due to the run-off of specialty business partially offset by (i) a higher level of catastrophe losses in the commercial and personal insurance segments discussed above, (ii) growth in the homeowners and commercial auto lines, and (iii) adverse development of prior accident years for personal auto driven by higher than expected severity for bodily injury claims.
Our investment portfolio and the investment portfolios of other members of the State Auto Group are managed by our subsidiary, Stateco. Stateco utilizes its own personnel to invest in fixed maturities, U.S. large-cap equities, U.S. small-cap equity funds, international equity funds, and exchange traded funds ("ETF"). In addition, Stateco uses an outside investment manager who invests in international funds and one outside manager who invests in fixed maturities. The Investment and Finance Committee (the “Committee”) of our Board of Directors establishes the investment policies to be followed by Stateco. Our primary investment objectives are to maintain adequate liquidity and capital to meet our responsibilities to policyholders, grow long term economic surplus to increase our capital position, maintain a consistent level of income to support operations and manage investment risk. Our current investment strategy does not rely on the use of derivative financial instruments.
We have investment policy guidelines with respect to purchasing fixed maturity investments for our insurance subsidiaries which preclude purchases of 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 nationally recognized ratings agencies. If there is a split rating, we assign the lowest rating obtained.
Our externally managed equity portfolio invests in international funds. External managers are permitted to manage the portfolios according to their own respective portfolio objectives. In selecting our outside investment managers we confirm that their portfolio objectives, including risk tolerance, are acceptable to us; however, there may be slight differences in their objectives when compared to how we manage our large-cap equity holdings.
The following table sets forth the composition of our investment portfolio at carrying value at December 31, 2020 and 2019:
At December 31, 2020, our equity portfolio consisted of approximately 37 different large-cap stocks and 14 mutual and exchange traded funds. The largest single fund holding was 17.7% of the equity portfolio based on fair value and the top ten positions accounted for 65.8% of the equity portfolio. At December 31, 2019, our equity portfolio consisted of approximately 38 different large-cap stocks and 17 mutual and exchange traded funds. The largest single fund holding was 18.7% of the equity portfolio based on fair value and the top ten positions accounted for 68.6% of the equity portfolio.
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 4.72 and 4.17 as of December 31, 2020 and 2019, 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, 2020:
We believe that the fixed maturity portfolio’s exposure to credit risk is minimal as approximately 86.7% of the bonds we own are rated A or better. We do not intend to change our investment policy or the quality of our fixed maturity investments. The fixed maturity portfolio is managed in a laddered-maturity style and considers business mix and liability payout patterns to ensure adequate cash flow to meet claims as they are presented. We also manage liquidity risk by maintaining sufficient cash balances, owning some agency and U.S. Treasury securities at all times, purchasing bonds of major issuers, and purchasing bonds that are part of a medium or large issue. The fixed maturity portfolio does not have any direct exposure to either exchange rate risk or commodity risk. We do not rely on the use of derivative financial instruments. We categorize our fixed maturities as available-for-sale in order to provide us greater flexibility in managing our portfolio. We do not maintain a trading portfolio.
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, 2020, approximately $660.7 million, or 29.5%, 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.
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, 2020 and 2019, and the change in unrealized holding gains, net of deferred tax, for the year ended December 31, 2020:
For the year ended December 31, 2020, the federal income tax expense was $1.3 million compared to $19.7 million for 2019. Our effective tax rate for 2020 was 8.8% compared with 18.7% in 2019. The change in our effective tax rate in 2020 when compared to 2019 was primarily due to the relationship of taxable to non-taxable income. Taxable income was lower in 2020 due to (i) less recognized gains on equity securities in 2020 compared 2019, and (ii) an increase in the underwriting loss in 2020 when compared to 2019. Non-taxable income, which is primarily tax exempt interest and a portion of our dividend income, remained comparable.
See Note 11, “Federal Income Taxes” to our consolidated financial statements included in Item 8 of this Form 10-K for a reconciliation between our actual federal income tax expense (benefit) and the amount computed at the indicated statutory rate for the years ended December 31, 2020 and 2019.
Our insurance subsidiaries must have adequate liquidity to ensure that their cash obligations are met. However, as discussed below, the STFC Pooled Companies do not have the day-to-day liquidity concerns normally associated with an insurance company due to their participation in, and the terms of, the Pooling Arrangement. In addition, State Auto P&C’s $100.0 million open line of credit with the Federal Home Loan Bank of Cincinnati (the “FHLB”) is available for general corporate purposes, which includes funding for any of our liquidity needs. See “Liquidity and Capital Resources - Borrowing Arrangements" included in this Item 7.
We are exposed to third-party credit risk both directly through its cessions to reinsurers and indirectly through its participation in the Pooling Arrangement. In addition to exposure to credit risk on reinsurance recoverables, we are also exposed to credit risk on amounts due from insureds and agents. When settling the intercompany balances, State Auto Mutual provides the STFC Pooled Companies with full credit for the net premiums written and net losses paid during the quarter.
While the total amount due to State Auto Mutual from policyholders and agents is significant, the individual amounts due are relatively small at the policyholder and agency level. The State Auto Group mitigates its exposure to this credit risk through its in-house collections unit for both personal and commercial accounts which is supplemented by third party collection service providers. In addition to reliance upon recent and historical collection trends, determination of the allowance for uncollectible premiums receivable at December 31, 2020 included consideration of other factors, including macro-economic conditions and trends, in particular the estimated impact of COVID-19. Credit risk is partially mitigated by the State Auto Group's ability to cancel the policy if the policyholder does not pay the premium. Pursuant to the Pooling Arrangement, bad debt expense for uncollectible premiums for the pool is allocated to pool members on the basis of pool participation and is included in the quarterly settlement of intercompany balances. This is included in "other expenses" on the consolidated statements of income and reflected in “due to/from affiliates” on our consolidated balance sheets.
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 2020 or 2019.
State Auto P&C has an Open Line of Credit Commitment (the "OLC") with the FHLB that provides State Auto P&C with a $100.0 million one-year open line of credit available for general corporate purposes. The OLC matures in April 2021. Draws under the OLC are to be funded with a daily variable rate advance with a term of no more than 180 days with interest payable monthly. All advances under the OLC are fully secured by a pledge of specific investment securities of State Auto P&C. As of December 31, 2020, no advances had been made under the OLC.
The following table sets forth our notes payable at December 31, 2020:
Related to our notes payable, our primary market risk exposure is to the change in interest rates and our credit rating. For a discussion regarding our credit ratings see “Liquidity and Capital Resources - Credit and Financial Strength Ratings” included in this Item 7. Based upon the notes payable carrying value at December 31, 2020, we had $15.3 million notes payable with variable interest and $85.3 million and $21.5 million of notes payable with interest fixed at 3.96% and 1.37%, respectively, which equated to approximately 12.5% variable interest debt and 87.5% fixed interest debt. Our decision to obtain fixed versus variable interest rate debt is influenced primarily by the following factors: (a) current market interest rates; (b) anticipated future market interest rates; (c) availability of fixed versus variable interest instruments; and (d) our currently existing notes payable fixed and variable interest rate position. See our contractual obligations table included in “Liquidity and Capital Resources -Contractual Obligations” included in this Item 7.
The following table sets forth our significant contractual obligations at December 31, 2020:
The cost of leases and other purchase obligations of State Auto Mutual are allocated to us through the Pooling Arrangement.
At December 31, 2020 and 2019, each of our insurance subsidiaries was in compliance with statutory requirements relating to capital adequacy.
The following table sets forth the statutory leverage ratios for our insurance subsidiaries at December 31, 2020 and 2019:
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 we 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, $91.0 million is available for payment to State Auto Financial from its insurance subsidiaries in 2021 without prior approval. State Auto Financial received dividends from its insurance subsidiaries in the amount of $15.0 million and $10.0 million in 2020 and 2019.
Our management considers how its overall strategy and decisions may influence the rating agencies’ evaluation of our credit strength and capital position, which may in turn directly impact the credit and financial strength ratings assigned by those agencies. In its decision-making process with respect to significant transactions, such as reinsurance, financing and investing activities, and acquisitions, management takes into consideration the potential impact these decisions will have on our earnings volatility and capital position.
We consider inflation when estimating liabilities for losses and loss expenses, particularly for claims having a long period between occurrence and final settlement. The liabilities for losses and loss expenses are management’s best estimates of the
Our significant accounting policies are more fully described in Note 1 of the notes to our consolidated financial statements included in Item 8 of this Form 10-K. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet, revenues and expenses for the period then ended and the financial entries in the accompanying notes to the financial statements. Such estimates and assumptions could change in the future as more information becomes known, which could impact the amounts reported and disclosed in this Item 7. We have identified the policies and estimates described below as critical to our business operations and the understanding of the results of our operations.
Our loss reserves reflect all unpaid amounts for claims that have been reported, as well as for claims that have not yet been reported. Our loss reserves are not discounted to present value.
Management’s determination of ultimate losses incorporates information and analysis provided by several disciplines within our Company, including accounting, claims, product and actuarial. While all of the information is considered, the actuarial analysis is the primary piece of information used in determining ultimate losses. Our actuarial personnel conduct quarterly reviews of loss development information to assist management in making estimates of ultimate losses. The actuarial analysis provides two key pieces of information, the actuarial central estimate (“ACE”) and a range of reasonable estimates of ultimate losses. Management’s selections have resulted in reported loss reserves exceeding the ACE while being within the range of reasonable estimates as provided by the actuarial analysis. In addition to the actuarial analysis and information provided by other disciplines, management’s assessment in making their determination of ultimate losses considers a number of factors including inflation, legal developments, recent changes in the volume or type of business written, changes in claim handling practices, general economic conditions, and the accuracy of past estimates. While a variety of factors are considered, there is no single method for determining the ultimate losses, and thus, our loss reserves. When unanticipated changes in the various factors do occur, those changes are incorporated in subsequent valuations of our loss reserves.
Our actuarial personnel conduct quarterly reviews to determine the ACE of ultimate losses. The reviews include performing calculations using a number of actuarial methods. The methods most commonly relied upon are discussed below. Determining the ACE of ultimate losses also requires considerable judgment in interpreting historical and statistical information. Metrics such as average claim severity and loss ratio are evaluated to assess the reasonableness of the ultimate losses. In addition, metrics such as outstanding amounts (case plus formula reserves) per claim and the level of claim closure are evaluated to assess the assumptions underlying various reserving methods.
the claim, the more the ultimate settlement amount can vary. The most commonly relied upon reserving methods, and their strengths and weaknesses, are described below.
Paid Loss Development Method: The Paid Loss Development Method uses calculations that are similar to the Incurred Loss Development Method. The key difference is that the data used in the Paid Loss Development Method exclude outstanding amounts, so only paid losses are used. With this method, a payment pattern is estimated to project ultimate losses for each accident year. An important underlying assumption is that claims are settled at a consistent rate over time. Case reserves and the rate at which claims are reported, except to the extent that the reporting pattern influences the settlement pattern, are not relevant to the results of this method. This method’s advantage is that the estimates of ultimate loss are independent of case reserve adequacy and are unaffected by changes in case reserving practice. The disadvantages are that (i) not all of the available information is used because outstanding amounts are not considered, (ii) in some cases the payment patterns require the application of very large development factors to relatively small payment amounts for less mature accident years, and (iii) changes in the claims settlement rate will distort the projections.
Claim Counts and Severities Method: The Counts and Severities Methods are best suited for lines of business with a large number of claims and a low average claim amount. They are primarily relied upon for certain auto coverages. With these methods, a pattern of claims to be closed in the future is estimated, and the corresponding average dollar amount of those claims, adjusted for inflation, is estimated. Future payments for each accident year are calculated as the total future claims to be closed times the corresponding average dollar amounts. Advantages of these methods include the advantages noted above for the Paid Loss Development Method. In addition, these methods also have the advantage of being responsive to changes in the claims settlement rate. Disadvantages are that not all available information is used because outstanding amounts are not considered, and that estimates derived using these methods can be sensitive to the implied level of inflation.
Incurred Bornhuetter-Ferguson Method: The Incurred Bornhuetter-Ferguson Method is a weighted average of the Expected Loss Ratio Method and the Incurred Loss Development Method, using the percentage of losses reported to date as the weight applied to the Incurred Loss Development Method. This method is particularly useful where there is a low volume of data in the more recent accident years or where the experience is volatile. In more mature accident years, this method generally produces estimates that are similar to the Incurred Loss Development Method.
Paid Bornhuetter-Ferguson Method: The Paid Bornhuetter-Ferguson Method is a weighted average of the Expected Loss Ratio Method and the Paid Loss Development Method, using the percentage of losses paid to date as the weight applied to the Paid Loss Development Method. In less mature accident years, in which payment activity is relatively low, this method generally produces estimates that are similar to the Expected Loss Ratio Method.
short-tail business the Incurred Loss Development Method may be most heavily relied upon if the projections are stable, the data is credible, historical case reserve adequacy is consistent and the resulting loss ratios and loss severities are reasonable. For long-tail business the Expected Loss Ratio Method may be most heavily relied upon for less mature accident years where the data is not credible. For more mature accident years, where the data is more credible, greater reliance may be placed on the Incurred Loss Development Method. There is considerable judgment applied in the analysis of the historical patterns and in integrating knowledge about the business, such as change in underwriting, pricing and claims functions.
The actuarial range of reasonable estimates of ultimate losses is derived based on the variability of the loss reserve projections. The primary determinants in estimating the loss reserve range boundaries are the variances measured within the historical reserving data for the various lines of business. Therefore, the actuarial range reflects likely outcomes, and does not reflect all possible outcomes.
In addition to establishing loss reserves described above, actuarial estimates are established for ULAE reserves. Historical patterns of paid ULAE relative to paid losses (excluding allocated loss adjustment expenses) are analyzed along with historical claim counts including claims opened, claims closed and claims remaining open. The product of this analysis is an estimate of the relationship, or ratio, between ULAE and losses underlying the current loss reserves. This ratio is applied to the current outstanding loss reserves to estimate the required ULAE reserve. Consequently, this component of the loss expense reserve has a proportional relationship to the overall claim inventory and held loss reserves. The method assumes that the underlying claims process and mix of business do not change materially from period to period.
The potential impact of the loss reserve variability on net income can be illustrated using the range end points and carried reserve amounts listed above. For example, if ultimate losses reach a level corresponding to the high point of the range, $1,063.7 million, the reserve increase of $37.6 million corresponds to an after-tax decrease of $29.7 million in net income, assuming a tax rate of 21%. Likewise, should ultimate losses decline to a level corresponding to the low point of the range, $919.3 million, the $106.8 million reserve decrease would add $84.4 million of after-tax net income. The loss reserve range noted above represents a range of reasonably likely reserves, not a range of all possible reserves. Therefore, the ultimate losses could reach levels corresponding to reserve amounts outside the range provided.
Several factors, which attempt to anticipate future events, are used in calculating the expense and liability related to the benefit plans. Key factors include assumptions about the expected rates of return on plan assets, discount rates, and health care cost trend rates. We consider market conditions, including changes in investment returns and interest rates, in making these assumptions. The actuarial assumptions used by us in determining benefit obligations may differ materially from actual results due to changing market and economic conditions, higher or lower turnover and retirement rates, or longer or shorter life spans
For the December 31, 2020 and 2019 valuations, the Adjusted RP-2014 mortality table was used as a baseline for the mortality assumption and to project future mortality rates. Incorporated into the table are rates projected generationally using Scale MP-2017 to reflect mortality improvement (Scale MP-2016 was used at the beginning of the year). The January 1, 2020 and 2019 actuarial reports of the benefit plans included these revised mortality assumptions.
To calculate the State Auto Group’s December 31, 2020 benefit obligation for each of the benefit plans, we used a discount rate of 2.32% based on an evaluation of the expected future benefit cash flows of our benefit plans used in conjunction with the FTSE Pension Discount Curve at the measurement date. A lower discount rate, all else being equal, results in a higher present value benefit obligation. To calculate our benefit obligation at December 31, 2020 and net periodic benefit cost for the year ended December 31, 2021, a discount rate of 1.95% and an expected long-term rate of return on plan assets of 6.25% were used. We selected an expected long-term rate of return on our plan assets by considering the mix of investments and stability of investment portfolio along with actual investment experience during the lifetime of the plans. Our assumptions regarding the discount rate and expected return on plan assets could have a significant effect on the amounts related to our benefit obligations and net periodic benefit cost depending on the degree of change between reporting periods.
Effective January 1, 2020, we changed the funding of our postretirement benefit plan from self-insured to a fully-insured group Medicare advantage program. The group Medicare advantage program is less than half the cost of the self-insured plan. As a result, the postretirement benefit plan's liability decreased $13.9 million for the year ended December 31, 2019.
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, 2020, our ABO and PBO were $522.8 million and $549.6 million, respectively. At December 31, 2020, our defined benefit pension plan’s fair value of the assets was $506.7 million, which resulted in an underfunded status within our balance sheet of $42.9 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 $15.0 million in 2021.
See Note 12, “Pension and Postretirement Benefit Plans,” to our consolidated financial statements included in Item 8 of this Form 10-K for further disclosures regarding our benefit plans.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Annual Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
As described in Notes 1 and 5 to the consolidated financial statements, as of December 31, 2020, the Company’s losses and loss expenses payable (“loss reserves”) were $1,050.4 million. Loss reserves reflect the estimated ultimate unpaid liability for losses and loss expenses with respect to reported and unreported claims incurred as of the end of each accounting period. Loss reserves are estimated using various standard actuarial projection methods and assumptions based on historical reporting and settlement patterns, expected loss ratios, trends in claims severity and frequency, and other factors. Estimates are refined as part of a regular, ongoing process as historical loss experience develops and additional claims are reported and settled.
The principal considerations for our determination that performing procedures relating to the valuation of loss reserves is a critical audit matter are the significant judgment by management when developing their estimate of loss reserves, which in turn led to a high degree of auditor judgment, subjectivity and effort in performing procedures and evaluating audit evidence related to the various actuarial projection methods and significant assumptions based on historical reporting and settlement patterns and expected loss ratios. Also, the audit effort involved the use of professionals with specialized skill and knowledge.
We have audited the accompanying consolidated balance sheet of State Auto Financial Corporation and subsidiaries (the Company) as of December 31, 2019, the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the two years in the period ended December 31, 2019, and the related notes and financial statement schedules listed in the Index at Item 15(a)(2) (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2019, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of losses and loss expenses payable. In connection with the determination of losses and loss expenses payable, management uses historical data, current business conditions and assumptions about future conditions to formulate estimates of the ultimate cost to settle claims. These estimates by their nature are subject to uncertainties for various reasons.
Investments in fixed maturities are classified as available-for-sale and are carried at fair value. On January 1, 2020, the Company adopted ASU 2016-13 Financial Instruments - Credit Losses (ASC 326): Measurement of Credit Losses on Financial Instruments on a prospective basis for its fixed maturities. The updated and prior policy for the available-for-sale fixed maturities are outlined below.
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 income 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.
Losses and loss expenses payable reflect the estimated ultimate unpaid liability for losses and loss expenses with respect to reported and unreported claims incurred as of the end of each accounting period. Loss reserves are estimated using various standard actuarial projection methods and assumptions based on historical reporting and settlement patterns, expected loss ratios, trends in claims severity and frequency and other factors. There can be no assurance that the ultimate liability will not vary materially from such estimates. Estimates are refined as part of a regular, ongoing process as historical loss experience develops and additional claims are reported and settled, and such adjustments are included in current operations (see Note 5). Anticipated salvage and subrogation is estimated using historical experience. The liability for unpaid losses and loss expenses, net of estimated salvage and subrogation recoverable of $28.7 million and $28.2 million at December 31, 2020 and 2019, respectively, represents management’s best estimate of the ultimate liability related to reported and unreported claims.
Premiums are recognized as earned pro rata over the policy period. Unearned premiums represent the portion of premiums written relative to the unexpired terms of coverage. Premiums receivable represents the billed and due premium written directly by the STFC Pooled Companies.
Under the terms of the Pooling Arrangement, each period State Auto Mutual collects all premiums from policyholders and pays all losses and expenses associated with the insurance business produced by the STFC Pooled Companies and the other pool participants, and then it settles the intercompany balances generated by these transactions with the pool participants within 60 days following each quarter end. When settling the intercompany balances, State Auto Mutual provides the pool participants with full credit for their share of the Pooled Companies net premiums written during the quarter. Description and disclosure of the allowance for uncollectible premiums receivable balance is disclosed in Note 9.
On January 1, 2020, the Company adopted ASU 2016-13 Financial Instruments - Credit Losses (ASC 326): Measurement of Credit Losses on Financial Instruments, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (CECL) methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost. This includes the Company's direct third party reinsurance recoverables, and the Company's share of the State Auto Group's third party reinsurance recoverables assumed via the Pooling Arrangement (as defined in Note 9). In addition, ASC 326 made changes to the accounting for available-for-sale fixed maturities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available-for-sale fixed maturities management does not intend to sell or believes that it is more likely than not they will not be required to sell.
On August 28, 2018, the FASB issued ASU 2018-14, which amends ASC 715 to add, remove, and clarify disclosure requirements related to defined benefit pension and other postretirement plans. The ASU is effective for fiscal years beginning after December 15, 2020 and will be effective January 1, 2021. The Company has early-adopted these disclosure updates in this Form 10-K.
In December 2019, the FASB issued ASU 2019-12 which updated guidance for the accounting for income taxes. The updated guidance is intended to simplify the accounting for income taxes by removing several exceptions contained in existing guidance and amending other existing guidance to simplify several other income tax accounting matters. The effective date of ASU 2019-12 is for interim and annual periods beginning after December 15, 2020. Early adoption is permitted. The ASU has not yet been adopted; however, it is not expected to have a material impact on the Company’s results of operations, consolidated financial position or cash flows.
In March 2020, the FASB issued ASU 2020-04 to address constituents’ concerns about certain accounting consequences that could result from the global markets’ anticipated transition away from the use of the London Interbank Offered Rate (LIBOR) and other interbank offered rates to alternative reference rates. ASU 2020-04 was effective upon issuance through December 31, 2022. The ASU has not yet been adopted; however, it is not expected to have a material impact on the Company's results of operations, consolidated financial position, or cash flows.
The Company changed the funding of its postretirement benefit plan effective January 1, 2020. As a result, the reported pension and postretirement benefits liability was reduced and reported stockholders' equity increased by recording additional pre-tax actuarial gain within accumulated other comprehensive income (loss) for the period ended December 31, 2019. There was no income statement impact for this change.
The effect of the revisions on the Company's previously issued financial statements are provided in the tables below. Amounts throughout the consolidated financial statements and notes thereto have been adjusted to incorporate the revised amounts, where applicable. The following tables reconcile selected lines from the Company’s year-end 2019 consolidated balance sheet and year-end 2019 and 2018 consolidated statements of income, consolidated statements of comprehensive income and consolidated statements of cash flow from the previously reported amounts to the revised amounts.
The following tables set forth the cost or amortized cost and fair value of investments by lot at December 31, 2020 and 2019:
The Company reviewed its investments at December 31, 2020 and determined that no credit impairment existed in the gross unrealized holding losses, due to the reasons discussed below:
•Corporate securities: Corporations in various industries issued these securities. The decline in fair values was attributable to changes in interest rates and not credit quality. The Company reviewed the issuers of these securities to identify any significant adverse change in financial condition, a change in the quality of credit enhancement (if any), a ratings decrease, or negative outlook assignment from a major credit rating agency, and any failure to make interest or principal payments. After these reviews, the Company determined that the decline in fair values was attributable to changes in interest rates and not credit quality. The Company does not intend to sell these securities and it is likely that it will not do so before their anticipated recovery. Therefore, the Company does not consider these impaired securities.
Fixed maturities with fair values of approximately $9.7 million and $9.3 million were on deposit with insurance regulators as required by law at December 31, 2020 and 2019, respectively.
The Company’s current investment strategy does not rely on the use of derivative financial instruments.
The Company utilizes a nationally recognized third party pricing service to estimate fair value measurements for the majority of its fixed maturities. The fair value estimate of the Company’s fixed maturity investments are determined by evaluations that are based on observable market information rather than market quotes. Inputs to the evaluations include, but are not limited to, market prices from recently completed transactions and transactions of comparable securities, interest rate yield curves, credit spreads, and other market-observable information. The fixed maturity portfolio pricing obtained from the pricing service is reviewed for reasonableness. The Company regularly selects a sample of security prices which are compared to one or more alternative pricing sources for reasonableness. Any significant discrepancies with the pricing are returned to the pricing service for further explanation and, if necessary, adjustments are made. To date, the Company has not identified any significant discrepancies in the pricing provided by its third party pricing service. Investments valued using these inputs include U.S. treasury securities and obligations of U.S. government agencies, obligations of states and political subdivisions, corporate securities (except for a security discussed below), and U.S. government agencies' mortgage-backed securities. All unadjusted estimates of fair value for fixed maturities priced by the pricing service are included in the amounts disclosed in Level 2 of the hierarchy. If market inputs are unavailable, then no fair value is provided by the pricing service. For these securities, fair value is determined either by requesting brokers who are knowledgeable about these securities to provide a quote; or the Company internally determines the fair values by employing widely accepted pricing valuation models, and depending on the level of observable market inputs, renders the fair value estimate as Level 2 or Level 3.
In May 2019, the Company refinanced its two prior credit agreements with State Auto Mutual at an interest rate of 4.05%, with principal payable in May 2029. The Company estimates the fair value of the notes receivable from affiliates using market quotations for U.S. treasury securities with similar maturity dates and applies an appropriate credit spread. This has been placed in Level 2 of the fair value hierarchy.
Included in notes payable are the FHLB Loans (as defined in Note 10) and Subordinated Debentures. The Company estimates the fair value of the FHLB Loans by discounting cash flows using a borrowing rate currently available to the Company for a loan with similar terms. The FHLB Loans have 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 favorable development related to prior years’ loss and loss expense reserves in 2020 of $35.6 million. Favorable development of prior accident years' non-catastrophe loss and ALAE reserves was due to $78.4 million of favorable development in the commercial insurance segment. In the commercial insurance segment, all products developed favorably, with workers' compensation, small commercial package and middle market commercial contributing $24.9 million, $23.0 million and $16.7 million, respectively. Partially offsetting the favorable development was adverse development in the personal insurance segment and specialty run-off, which contributed $21.7 million and $5.2 million, respectively. The adverse development in the personal insurance segment was primarily driven by personal auto, which contributed $20.3 million of adverse development. The personal auto adverse development was driven by higher than expected severity of bodily injury claims from multiple accident years. The specialty run-off adverse development primarily related to an adverse court decision for an E&S casualty claim from 2016. Partially offsetting the favorable development of prior years' non-catastrophe loss and ALAE reserves was adverse development in catastrophe loss and ALAE reserves of $13.4 million driven by $12.4 million of adverse development in E&S property related to Hurricane Irma.
•average annual percentage payout of incurred claims by age, net of reinsurance.
The personal insurance segment generally consists of only short-tail business, whereas the commercial insurance segment and specialty run-off have both short and long-tail business. The Company determined that these disaggregated groupings have more homogeneous risk characteristics with similar development patterns and are generally subject to similar trends.
The change in incurred losses and loss adjustment expenses for prior accident years was due to lower than expected emergence in the workers’ compensation product, primarily driven by lower than expected severity from multiple accident years.
The change in incurred losses and loss adjustment expenses for prior accident years was due to increases in estimates for claims related to Hurricane Irma.
The following table sets forth the effect of the Company’s external reinsurance on its balance sheets at December 31, 2020 and 2019, prior to the reinsurance transaction with State Auto Mutual under the Pooling Arrangement, as discussed in Note 9a:
The following table sets forth the effect of the Company’s external reinsurance on its income statements for the years ended December 31, 2020, 2019 and 2018, prior to the reinsurance transaction with State Auto Mutual under the Pooling Arrangement, as discussed in Note 9a:
The following table sets forth the changes in the Company's share of the allowance for uncollectible premiums receivable for the twelve months ended December 31, 2020:
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 income statements for the Pooling Arrangement between the STFC Pooled Companies and State Auto Mutual for the years ended December 31, 2020, 2019 and 2018:
Premiums are recognized as earned pro rata over the policy period. Unearned premiums represent the portion of premiums written relative to the unexpired terms of coverage.
Under the terms of the Pooling Arrangement, each period State Auto Mutual collects all premiums from policyholders and pays all losses and expenses associated with the insurance business produced by the STFC Pooled Companies and the other
pool participants, and then it settles the intercompany balances generated by these transactions with the pool participants within 60 days following each quarter end. When settling the intercompany balances, State Auto Mutual provides the pool participants with full credit for their share of the Pooled Companies net premiums written during the quarter.
In May 2009, the Company entered into two separate credit agreements with State Automobile Mutual Insurance Company pursuant to which it loaned State Auto Mutual $70.0 million at an interest rate of 7.00%. In May 2019, the Company refinanced the two credit agreements with State Auto Mutual at an interest rate of 4.05%, with principal payable in May 2029. There is no prepayment penalty, and no collateral was given as security for the payment for these loans.
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 $2.0 million, $2.1 million and $2.0 million in 2020, 2019 and 2018, respectively, and is included in other income (affiliates) on the consolidated statements of income.
State Auto Financial’s subsidiary, State Auto P&C, is a member of the Federal Home Loan Bank of Cincinnati (the “FHLB”). On September 2, 2020 State Auto P&C retired its five-year term loan with the FHLB in the amount of $21.5 million and maturing September 2, 2021 and replaced it with a new ten-year term loan with the FHLB in the amount of $21.5 million (the "2020 FHLB Loan"). The 2020 FHLB Loan is at a fixed rate of interest of 1.37%, provides for interest-only payments during its term, with principal due in full at maturity, and may be prepaid without penalty after five years and each of the succeeding six months thereafter. The 2020 FHLB Loan is fully secured by a pledge of specific investment securities of State Auto P&C. State Auto P&C also has a fifteen-year $85.0 million loan (the "2018 FHLB loan") with a fixed interest rate of 3.96%. The 2018 FHLB loan provides for interest-only payments during its term, with principal due in full at maturity. Prepayment of the 2018 FHLB Loan would require a prepayment fee.
The 2018 and 2020 FHLB Loans are fully secured by a pledge of specific investment securities of State Auto P&C.
The Company has foreign tax credit carryforwards of $0.3 million which will expire in 2021. The Company believes it is more likely than not that the benefit from these foreign tax credit carryforwards will not be realized. In recognition of this risk, the Company has provided a valuation allowance of $0.3 million on the deferred tax assets related to these foreign tax credit carryforwards. The valuation allowance is included in the "other, net" line item in the table below.
The following table sets forth the reconciliation between actual federal income tax expense and the amount computed at the indicated statutory rate for the years ended December 31, 2020, 2019 and 2018:
In computing taxable income, property and casualty insurers are required to discount their unpaid loss reserves. During 2018, the Internal Revenue Service (IRS) released proposed regulations addressing the mechanics of the reserve discounting. Under those regulations and a related Revenue Procedure 2019-06 ("Rev. Proc. 2019-06"), the interest rate term was not to exceed seventeen and one-half years. The provisional amount was based on twenty years. After discounting the January 1, 2018 reserves using the Rev. Proc. 2019-06 published factors, the impact was $47.5 million on a pretax basis down from the initial estimate of $50.9 million for a tax-effected change of $0.7 million in the impact of the transitional amount.
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, 2020 and 2019:
At December 31, 2020, the tax benefit of the net operating loss (“NOL”) carryforward was $19.8 million. The NOL carryforwards do not begin to expire until 2032 and will not fully expire until 2040.
The Company provides a defined benefit pension plan for eligible employees hired prior to January 1, 2010 at which time the plan was closed to new participants. All Company employees participating in the plan are vested. The Company’s policy is to fund pension costs in accordance with the requirements of the Employee Retirement Income Security Act of 1974. Benefits are determined by applying factors specified in the plan to a participant’s defined average annual compensation.
The following table sets forth the amounts included in accumulated other comprehensive income (loss) that has not been recognized in net periodic cost at December 31, 2020 and 2019:
The following table sets forth the weighted average assumptions used to determine the benefit plans’ obligations at December 31, 2020 and 2019:
The following table sets forth the weighted average assumptions used to determine the benefit plans’ net periodic cost for the years ended December 31, 2020, 2019 and 2018:
The following table sets forth the assumed health care cost trend rates used for the years ended December 31, 2020, 2019 and 2018:
Included in the pension plan’s investments are two international funds (“the funds”) that invests in equity securities of foreign issuers and are managed by third party investment managers. The funds had a fair value of $47.3 million and $38.2 million at December 31, 2020 and 2019, respectively, which was determined using the funds' net asset value. In accordance with ASC 820-10, since these investments are measured at fair value using the net asset value per share practical expedient they have not been classified in the table below.
The actuarially prepared funding amount to the pension plan ranges from the minimum amount the Company would be required to contribute to the maximum amount that would be deductible for tax purposes. Contributed amounts in excess of the minimum amounts are deemed voluntary. Amounts in excess of the maximum amount would be subject to an excise tax and may not be deductible for tax purposes. The Company expects to contribute up to $15.0 million to the pension plan during 2021.
13. Other Comprehensive Income (Loss) and Accumulated Other Comprehensive Income (Loss)
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, 2020, each of the Company’s insurance subsidiaries maintained adjusted statutory surplus in excess of 400% of the authorized control level RBC.
The Company maintains share-based compensation plans for key employees and outside, or non-employee, directors. Since May 5, 2017, the share-based compensation plan for key employees has been the State Auto Financial Corporation 2017 Long-Term Incentive Plan (the “2017 LTIP”). The 2017 LTIP replaced the State Auto Financial Corporation 2009 Equity Compensation Plan (the “2009 Equity Plan”). The stock-based compensation plan for outside directors is the Outside Directors Restricted Share Unit Plan (the “RSU Plan”).
As of December 31, 2020, there was $4.4 million of total unrecognized compensation cost related to performance unit awards. The remaining cost is expected to be recognized over a period of 1.05 years.
The following table sets forth the Company’s total activity and related information for service-based restricted stock award activity for the years ended December 31, 2020, 2019 and 2018:
As of December 31, 2020, there was $0.5 million of total unrecognized compensation cost related to service-based restricted stock awards. The remaining cost is expected to be recognized over a period of 0.84 years.
The fair value of each stock option was estimated on the date of grant using the Black-Scholes closed-form pricing model. The pricing model requires assumptions such as the expected life of the option and expected volatility of the Company’s stock over the expected life of the option, which significantly impacts the assumed fair value. The Company used historical data to determine these assumptions
The following table sets forth information pertaining to the total options outstanding and exercisable at December 31, 2020:
Aggregate intrinsic value for total options outstanding and exercisable at December 31, 2020 was $0.4 million, respectively.
The Company also has a broad-based employee stock purchase plan under which employees of the Company may choose, at two different specified time intervals each year, to have up to 6% of their annual base earnings withheld to purchase the Company’s common shares. The purchase price of the common shares is 85% of the lower of its beginning-of-interval or end-of-interval market price. As of December 31, 2020, 3.8 million common shares had been purchased under this plan and 0.3 million common shares were available for purchase. This plan remains in effect until terminated by the Board of Directors.
The RSU Plan is an unfunded deferred compensation plan which currently provides each outside director with an award of 1,400 restricted share units (the “RSU award”) following each annual meeting of shareholders. The amount of the award may change from year to year, based on the provision described below. The RSU awards are fully vested six months after the date of grant. RSU awards are not common shares of the Company and, as such, no participant has any rights as a holder of common shares under the RSU Plan. RSU awards represent the right to receive an amount, payable in cash or common shares of the Company, as previously elected by the outside director, equal to the value of a specified number of common shares of the Company at the end of the restricted period. Such election may be changed within the constraints set forth in the RSU Plan. The restricted period for the RSU awards begins on the date of grant and expires on the date the outside director retires from or otherwise terminates service as a director of the Company. During the restricted period, outside directors are credited with dividends, equivalent in value to those declared and paid on the Company’s common shares, on all RSU awards granted to them. At the end of the restricted period, outside directors receive cash or common share distributions of their RSU awards either (i) in a single lump sum payment, or (ii) in annual installment payments over a 5- or 10-year period, as previously elected by the outside director. The administrative committee for the RSU Plan (currently the Company’s Compensation Committee) retains the right to increase the annual number of RSU awards granted to each outside director to as many as 10,000 or to decrease such annual number to not less than 500, without seeking shareholder approval, if such increase or decrease is deemed appropriate by the administrative committee to maintain director compensation at appropriate levels. No awards may be made under the RSU Plan after May 31, 2026. The Company accounts for the RSU Plan as a liability plan. There were 17,416 RSUs, 18,837 RSUs, and 23,080 RSUs granted in 2020, 2019 and 2018, respectively.
During 2020 and 2019, common shares valued at approximately $0.1 million and $1.2 million, respectively, were distributed by the Company under the RSU Plan.
Share-based compensation expense recognized during 2020, 2019 and 2018 was $0.9 million, $6.1 million and $11.1 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, 2020, there was $4.9 million of total unrecognized compensation cost related to compensation arrangements granted under the plans. The remaining cost is expected to be recognized over a period of 1.03 years.
The Company's reportable segments are: personal insurance, commercial insurance, and investment operations. The reportable insurance segments are business units managed separately because of the differences in the type of customers they serve, the products they provide or services they offer. The insurance segments market a broad line of property and casualty insurance products throughout the United States through independent insurance agencies, which include retail agents and wholesale brokers. The investment operations segment, managed by Stateco, provides investment services.
The personal insurance segment primarily provides personal automobile and homeowners to the personal insurance market. The commercial insurance segment primarily provides commercial automobile, commercial multi-peril, fire & allied, general liability, workers’ compensation insurance covering small-to-medium sized commercial exposures in the commercial insurance market. In addition, the commercial insurance segment provides farm & ranch insurance.
The following table sets forth financial information regarding the Company’s reportable segments for the years ended December 31, 2020, 2019 and 2018:
The Company is involved in lawsuits in the ordinary course of its business arising out of or otherwise related to its insurance policies. Additionally, from time to time the Company may be involved in lawsuits, including class actions, in the ordinary course of business but not arising out of or otherwise related to its insurance policies. These lawsuits are in various stages of development. The Company generally will contest these matters vigorously but may pursue settlement if appropriate. Based on currently available information, the Company does not believe it is reasonably possible that any such lawsuit or related lawsuits will be material to its results of operations or have a material adverse effect on its consolidated financial position or cash flows.