1 Data for 2011 has been restated to reflect the implementation of ASU 2010-26, Financial Services-Insurance (Topic 944): Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts, which was adopted on January 1, 2012.
3 Data for 2011 through 2014 has been restated to reflect the implementation of ASU 2015-03, Interest-Imputation of Interest (Topic 835-30): Simplifying the Presentation of Debt Issue Costs, which was adopted in the fourth quarter of 2015.
5 Operating income and operating return on average equity are non-GAAP measures. See the Glossary of Terms attached to this Form 10-K as Exhibit 99.1 for definitions of these items and see the “Financial Highlights of Results for Years Ended December 31, 2015, 2014, and 2013” section in
Financial Highlights of Results for Years Ended December 31, 2015, 2014, and 2013;
Significant periods of time can elapse between the occurrence of an insured loss, the reporting of the loss to the insurer, and the insurer’s payment of that loss. To recognize liabilities for unpaid losses and loss expenses, insurers establish reserves as balance sheet liabilities representing an estimate of amounts needed to pay reported and unreported net losses and loss expenses. We had accrued $3.5 billion of gross loss and loss expense reserves and $3.0 billion of net loss and loss expense reserves at December 31, 2015. At December 31, 2014, these gross and net reserves were $3.5 billion and $2.9 billion, respectively.
The following tables provide case and incurred but not reported (“IBNR”) reserves for losses and loss expenses, and reinsurance recoverable on unpaid losses and loss expenses as of December 31, 2015 and 2014:
In addition to the quarterly reserve analysis, a range of possible IBNR reserves is estimated annually and continually considered, among other factors, in establishing IBNR for each reporting period. Loss and loss expense trends are also considered, which include, but are not limited to, large loss activity, asbestos and environmental claim activity, large case reserve additions or reductions for prior accident years, and reinsurance recoverable issues. We also consider factors such as: (i) per claim information; (ii) company and industry historical loss experience; (iii) legislative enactments, judicial decisions, legal developments in the imposition of damages, and changes in political attitudes; and (iv) trends in general economic conditions, including the effects of inflation. Based on the consideration of the range of possible IBNR reserves, recent loss and loss expense trends, uncertainty associated with actuarial assumptions and other factors, IBNR is established and the ultimate net liability for losses and loss expenses is determined. Such an assessment requires considerable judgment given that
it is frequently not possible to determine whether a change in the data is an anomaly until sometime after the event. Even if a change is determined to be permanent, it is not always possible to reliably determine the extent of the change until sometime later. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of reserves because the eventual deficiency or redundancy is affected by many factors. The changes in these estimates, resulting from the continuous review process and the differences between estimates and ultimate payments, are reflected in the Consolidated Statements of Income for the period in which such estimates are changed. Any changes in the liability estimate may be material to the results of operations in future periods. In addition to our internal review, statutory regulation requires us to have a Statement of Actuarial Opinion issued annually on our statutory reserve adequacy. We engage an independent actuary to issue this opinion based on their independent review.
We have estimated a range of reasonably possible reserves for net loss and loss expense claims to be $2,694 million to $3,136 million at December 31, 2015, which compares to $2,645 million to $3,061 million at December 31, 2014. These ranges reflect low and high reasonable reserve estimates, which were selected primarily by considering the range of indications calculated using generally accepted actuarial techniques. Such techniques assume that past experience, adjusted for the effects of current developments and anticipated trends, are an appropriate basis for predicting future events. Although these ranges reflect likely scenarios, it is possible that the final outcomes may fall above or below these amounts. The ranges do not include a provision for potential increases or decreases associated with asbestos, environmental, and other continuous exposure claims, as traditional actuarial techniques cannot be effectively applied to these exposures.
Section IV shows the re-estimated gross liability and re-estimated reinsurance recoverables through December 31, 2015.
Section V shows the cumulative gross and net (deficiency)/redundancy representing the aggregate change in the liability from the original balance sheet dates and the re-estimated liability through December 31, 2015.
Major developments related to loss and loss expense reserve estimates and uncertainty
For the past ten years, the Insurance Subsidiaries have experienced favorable prior accident year loss and loss expense development. Over the past three years, contributions to the favorable emergence have come from different lines of business at different points in time. The greater contributions have generally come from the longer tailed casualty lines, primarily due to their associated volume of reserves and the inherent uncertainty of the longer claims settlement process.
A more detailed discussion of recent developments, by line of business, follows.
At December 31, 2015, our general liability line of business had recorded reserves, net of reinsurance, of $1.1 billion, which represented 36% of our total net reserves. In 2015, this line experienced favorable development of $51.0 million, attributable mainly to accident years 2013 and prior. This was primarily driven by severities that continued to develop lower than expected, within both the premises and operations and products liability coverages. In addition, the reduction in frequencies exhibited in recent accident years continued into accident year 2015.
During 2014, this line experienced favorable development of $43.9 million, which was partially driven by lower severities in the 2010 through 2012 accident years, within both the premises and operations and products liability coverages. In addition, accident years 2011 and 2012 continued to show lower than expected claim counts.
At December 31, 2015, our workers compensation line of business recorded reserves, net of reinsurance, of $1.0 billion, which represented 34% of our total net reserves. During 2015, this line experienced favorable development of $37.0 million driven by virtually all prior accident years. During 2014, this line experienced no development on prior accident years. The results over the past two years represent a significant change compared to 2013, during which this line experienced unfavorable development of $23.5 million driven mainly by assisted living facility-type claims. During 2015, this line showed a significant reduction in paid and reported loss amounts, due, in part, to: (i) lower medical inflation than originally anticipated; (ii) our proactive underwriting actions in recent years; and (iii) various significant claims initiatives that we implemented, including the centralization of our workers compensation claim handling in Charlotte, North Carolina, more favorable Preferred Provider Organizations ("PPO") contracts, greater PPO penetration, and more proactive case management in the areas of medical, pharmaceutical, and physical therapy treatments. Jurisdictionally trained and aligned medical only and lost-time adjusters manage non-complex workers compensation claims within our footprint. Claims with high exposure and/or significant escalation risk are referred to the workers compensation strategic case management unit.
In addition to the uncertainties associated with actuarial assumptions and methodologies described above, the workers compensation line of business can be impacted by a variety of issues, such as the following:
In 2014, this line experienced favorable development of $4.1 million, driven by bodily injury liability for accident years 2012 and prior.
uncertainty than the comparable traditional lines of business. As our own experience matures, we will continue to place greater weight upon it, and less weight upon the surrogate patterns.
Some of the development seen during 2015 was attributable to late emerging claims. In order to better assess this potential, and mitigate its impact on future results, we have taken the following actions within the E&S Claims operations:
Effective January 1, 2015, the E&S Claims operation began reporting through our Corporate Claims division in Charlotte, North Carolina.
Potential complex liability claims are now systematically identified and referred to our CCU. In cases where the CCU agrees these claims are complex in nature, all future handling of the claims is assumed by the CCU.
For property claims, similar corporate oversight and referrals are being implemented via our corporate Large Loss Unit.
We believe that the actions above will not only lead to earlier identification of severe claims, but also earlier claims resolutions with improved outcomes.
“Asbestos claims” are claims for bodily injury alleged to have occurred from exposure to asbestos-containing products. Our primary exposure arises from insuring various distributors of asbestos-containing products, such as electrical and plumbing materials. At December 31, 2015, asbestos claims constituted 29% of our $23.2 million net asbestos and environmental reserves, compared to 32% of our $23.0 million net asbestos and environmental reserves at December 31, 2014.
“Environmental claims” are claims alleging bodily injury or property damage from pollution or other environmental contaminants other than asbestos. These claims include landfills and leaking underground storage tanks. Our landfill exposure lies largely in policies written for municipal governments, in their operation or maintenance of certain public lands. In addition to landfill exposures, in recent years, we have experienced a relatively consistent level of reported losses in the homeowners line of business related to claims for groundwater contamination from leaking underground heating oil storage tanks in New Jersey. In 2007, we instituted a fuel oil system exclusion on our New Jersey homeowners policies that limits our exposure to leaking underground storage tanks for certain customers. At that time, existing customers were offered a one-time opportunity to buy back oil tank liability coverage. The exclusion applies to all new homeowners policies in New Jersey. These customers are eligible for the buy-back option only if the tank meets specific eligibility criteria.
Our asbestos and environmental claims are handled in our centralized and specialized asbestos and environmental claim unit. Case reserves for these exposures are evaluated on a claim-by-claim basis. The ability to assess potential exposure often improves as a claim develops, including judicial determinations of coverage issues. As a result, reserves are adjusted accordingly.
The discount rate enables us to state expected future cash flows at their present value on the measurement date. The purpose of the discount rate is to determine the interest rates inherent in the price at which pension benefits could be effectively settled. Our discount rate selection is based on high-quality, long-term corporate bonds. A higher discount rate reduces the present value of benefit obligations and reduces pension expense. Conversely, a lower discount rate increases the present value of benefit obligations and increases pension expense. For additional information regarding our discount rate selection, refer to Note 14. “Retirement Plans” in Item 8. “Financial Statements and Supplementary Data.” of this Form 10-K.
To determine if an impairment is other than temporary, we compare the present value of cash flows expected to be collected with the amortized cost of fixed income securities meeting certain criteria. In addition, this analysis is performed on all previously-impaired debt securities that continue to be held by us and all structured securities that were not of high-credit quality at the date of purchase. These impairment assessments may include, but are not limited to, discounted cash flow analyses (“DCFs”).
For structured securities, including commercial mortgage-backed securities (“CMBS”), residential mortgage-backed securities (“RMBS”), asset-backed securities (“ABS”), and collateralized debt obligations (“CDOs”), we also consider variables such as expected default, severity, and prepayment assumptions based on security type and vintage, taking into consideration information from credit agencies, historical performance, and other relevant economic and performance factors.
security considered as a “non-credit impairment.” As mentioned above, credit impairments are charged to earnings as a component of realized losses, while non-credit impairments are recorded to Other Comprehensive Income (“OCI”) as a component of unrealized losses.
The financial condition and near-term prospects of the issuer, including any specific events that may influence the issuer’s operations, coupled with our intention to hold the securities in the near term;
The appropriateness of the valuation methodology used regarding the underlying investments.
Reinsurance recoverables on paid and unpaid losses and loss expenses represent estimates of the portion of such liabilities that will be recovered from reinsurers. Each reinsurance contract is analyzed to ensure that the transfer of risk exists to properly record the transactions in the Financial Statements. Amounts recovered from reinsurers are recognized as assets at the same time and in a manner consistent with the paid and unpaid losses associated with the reinsured policies. An allowance for estimated uncollectible reinsurance is recorded based on an evaluation of balances due from reinsurers and other available information. This allowance totaled $5.7 million at December 31, 2015 and $6.9 million at December 31, 2014. We continually monitor developments that may impact recoverability from our reinsurers and have available to us contractually provided remedies if necessary. For further information regarding reinsurance, see the “Reinsurance” section below and Note 8. “Reinsurance” in Item 8. “Financial Statements and Supplementary Data.” of this Form 10-K.
Fluctuations in our GAAP combined ratio were driven by the following:
Favorable prior year casualty reserve development, the details of which are below:
We have a long history of delivering on our objectives and creating value for shareholders, but 2015 was our best statutory combined ratio since becoming listed on Nasdaq. We delivered a 92.4% statutory combined ratio, including 3.0 points of catastrophe losses and overall favorable prior year reserve development of 3.5 points. This compares to A.M. Best’s industry expectation of 98.0%, including 3.1 points of catastrophe losses and 1.7 points of overall favorable prior year reserve development, as reported in their February 2016 Review and Preview report.
Based on our view of the market and our strategies to outperform, we are providing the following guidance for 2016:
An ex-catastrophe combined ratio of approximately 91%, which assumes no prior year casualty reserve development;
Our Standard Commercial Lines segment, which represents 77% of our combined insurance segments' NPW, sells commercial lines insurance products and services to businesses, non-profit organizations, and local government agencies located primarily in 22 states in the Eastern and Midwestern U.S. and the District of Columbia through approximately 1,100 distribution partners in the standard marketplace.
The growth in NPW and NPE from 2013 through 2015 is primarily the result of the following:
NPE increases in 2015 and 2014 were consistent with the increases in NPW for their respective twelve-month periods ended December 31.
The GAAP loss and loss expense ratio improved 7.9 points in 2015 compared to 2014 and 1.6 points in 2014 compared to 2013 due to the following:
Favorable prior year casualty reserve development of 5.3 points in 2015, 3.2 points in 2014, and 0.8 points in 2013. For quantitative information on this development by line of business, see "Financial Highlights of Results for Years Ended December 2015, 2014, and 2013" above and for qualitative information about the significant drivers of this development, see the line of business discussions below.
Additionally, non-catastrophe property losses and catastrophe losses contributed to results as follows:
The fluctuations in the statutory combined ratios reflect: (i) earned rate above our expected claim inflation, which improved profitability by approximately 1 point in 2015 and 3 points in 2014; and (ii) changes in prior year development.
Property losses and prior year casualty reserve development are outlined below:
2013: Favorable development of 1.6 points driven by accident years 2006 through 2010 representing a continued trend of better than expected reported emergence, partially offset by increased severity in accident year 2012.
NPW increased in 2015 compared to 2014 due to: (i) an increase in direct new business; (ii) renewal pure price increases; and (iii) increased retention. NPW was lower in 2014 compared to 2013 due to: (i) reductions in new business; (ii) a focused effort to improve our hazard mix and reduce exposures on this line; and (iii) the impact of the sale of the SIG renewal rights. This business accounted for $4 million of NPW in 2013.
NPE increases in 2015 and 2014 were consistent with the fluctuations in NPW for their respective twelve-month periods ended December 31.
Lower expected loss costs for the current accident year that resulted in an improvement of 9.3-points in 2015, reflecting our ongoing focus on improving this competitive line of business through pricing and claims initiatives, as further discussed below.
Reductions in current and prior year loss costs in this line of business were primarily driven by continued lower frequencies and severities. We believe those trends are evidence of the significant claims and underwriting initiatives that we have undertaken on this line of business over the past two years. These initiatives include:
Referring claims with high exposure and/or significant escalation risk to our workers compensation Strategic Case Management Unit;
Using a more comprehensive approach for handling workers compensation claims, with an emphasis towards improving recovery times, allowing for earlier “return-to-work.” This involves elevated and proactive case management in the areas of medical, pharmaceutical, and physical therapy treatments; and
Working on improving the mix of business in this line with a focus on hazard grades A through D.
The decrease in the statutory combined ratio from 2013 to 2014 was driven by no prior year casualty reserve development in 2014 compared to unfavorable prior year development of 8.6 points in 2013 driven by the 2008 and prior accident years reflecting increases in severities for medical costs. These increases largely related to case reserve adjustments to assisted living facility claims, and our review of medical cost development over many years. Additionally, earned rate above our expected claim inflation improved profitability by approximately 2.5 points.
The fluctuation in the statutory combined ratios over the three-year period for this line are best understood by reviewing the fluctuations in non-catastrophe property losses and catastrophe losses. Quantitative information regarding these items is as follows:
Our Standard Personal Lines segment, which includes our flood business, represents approximately 14% of our combined insurance segments' NPW. We sell personal lines insurance products and services to individuals located primarily in 13 states through approximately 700 distribution partners. In addition, we have approximately 6,000 distribution partners selling our flood business.
Staffing additions, such as Standard Personal Lines Marketing Specialists, to support our growth initiatives;
In addition, declining premiums in this segment, which are driven by lower new business and targeted non-renewal actions we have taken on this book of business, have put pressure on the components of our combined ratio.
NPE increases in 2015 and 2014 were consistent with the increases in NPW for their respective twelve-month periods ended December 31, 2015.
As part of the consolidation of this segment into our overall operations, we integrated the E&S claims operation with our corporate claims operation during 2015. As part of that effort, we completed a review of all complex claims. As a result, we recorded adverse prior year casualty reserve development of $10 million in the fourth quarter of 2015, bringing the full year adverse prior year development to $16 million. We also recorded a $5 million adjustment to the 2015 current accident year.
Pool or share proportionately the underwriting profit and loss results of property and casualty insurance underwriting operations through reinsurance;
The following illustrates the pooling percentages by company as of December 31, 2015:
By entering into reinsurance treaties and arrangements, we are able to increase underwriting capacity and accept larger risks and a larger number of risks without directly increasing capital or surplus. Our reinsurance consists of traditional reinsurance and we do not purchase finite reinsurance. Under our reinsurance treaties, the reinsurer generally assumes a portion of the losses we cede to them in exchange for a portion of the premium. Amounts not reinsured are known as retention. Reinsurance does not legally discharge us from liability under the terms and limits of our policies, but it does make our reinsurer liable to us for the amount of liability we cede to them. Accordingly, we have counterparty credit risk from our reinsurers. We attempt to mitigate this credit risk by: (i) pursuing relationships with reinsurers rated “A-” or higher; or (ii) obtaining collateral to secure reinsurance obligations. Some of our reinsurance contracts include provisions that permit us to terminate or commute the reinsurance treaty if the reinsurer's financial condition or rating deteriorates. We monitor the financial condition of our reinsurers and we review the quality of reinsurance recoverables and reserves for uncollectible reinsurance. For additional information regarding our counterparty credit risk with our reinsurers, see Note 8. "Reinsurance" in Item 8. "Financial Statements and Supplementary Data." of this Form 10-K.
1 This amount represents reported and unreported gross losses estimated as of December 31, 2015.
We use the results of the Risk Management Solutions and AIR Worldwide models in our review of exposure to hurricane risk. Each of these third party vendors provide two views of the modeled results as follows: (i) a long-term view that closely relates modeled event frequency to historical hurricane activity; and (ii) a medium-term view that adjusts historical frequencies to reflect higher expectations of hurricane activity in the North Atlantic Basin. We believe that modeled estimates provide a range of potential outcomes and we review multiple estimates for purposes of understanding our catastrophic risk. The following table provides modeled hurricane results based on a blended view of the four models for the Insurance Subsidiaries' combined property book as of July 2015:
The property excess of loss treaty, which covers both our standard market and E&S business, was renewed on July 1, 2015 with an additional layer placed on January 1, 2016. The major terms of this treaty are consistent with the prior year. The details of the current year treaty are included in the table below.
- 95% of losses in excess of $225 million up to
All NBCR losses are excluded regardless of whether or not they are certified under TRIPRA. For non-NBCR losses, the treaty distinguishes between acts committed on behalf of foreign persons or foreign interests ("Foreign Terrorism") and those that are not. The treaty provides annual aggregate limits for Foreign Terrorism (other than NBCR) acts of $24 million for the first layer and $60 million for the second layer and for the third layer approximately $30 million in annual aggregate limits. Non-foreign terrorism losses (other than NBCR) are covered to the same extent as non-terrorism losses.
The primary objective of the investment portfolio is to maximize after-tax investment income while balancing risk and generating long-term growth in shareholder value. Our investment philosophy is predicated on investing with a long-term horizon, with significant emphasis on risk control, capital preservation, taxes, liquidity, and diversification. Our investments include high-quality fixed income securities, common stocks, and preferred securities designed to generate stable interest and dividend income and long-term capital appreciation, and alternative investments that seek to diversify the sources of risk and return of the overall portfolio.
The increase in our investment portfolio at December 31, 2015 compared with year-end 2014 was primarily driven by operating cash flow of $381.6 million, which resulted in investable cash flow of $352.3 million, partially offset by a decrease in unrealized gains of $54.5 million. Of this $54.5 million, $19.2 million was in our equity portfolio, which was impacted by the volatility in the stock market during the year. In addition, unrealized gains in our fixed income securities portfolio decreased by $35.3 million due to widening credit spreads as well as the impact of slightly higher interest rates.
Although interest rates on the 10-year U.S. Treasury Note rose by 10 basis points in 2015, the low interest rate environment continues to present a challenge to us in generating after-tax return, as new purchase yields are below the average yield on bonds that are currently maturing.
1 Preferred stock represented less than 1% of our portfolio at December 31, 2015. We did not hold any of these securities at December 31, 2014.
We have audited the accompanying consolidated balance sheets of Selective Insurance Group, Inc. and its subsidiaries (the “Company”) as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flow for each of the years in the three-year period ended December 31, 2015. In connection with our audits of the consolidated financial statements, we also have audited financial statement schedules I to V. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Selective Insurance Group, Inc. and its subsidiaries as of December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Selective Insurance Group, Inc. and its subsidiaries' internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 24, 2016, expressed an unqualified opinion of the Company’s internal controls over financial reporting.
Certain amounts in our prior years' Financial Statements and related notes have been reclassified to conform to the 2015 presentation. Such reclassifications had no effect on our net income, stockholders' equity, or cash flows.
Other investments may include alternative investments and other securities. Alternative investments are accounted for using the equity method. Our share of distributed and undistributed net income from alternative investments is included in "Net investment income earned" on our Consolidated Statement of Income. Other securities are primarily comprised of tax credit investments. Low income housing tax credits are accounted for under the proportional amortization method and all other tax credits are accounted for using the equity method. Under the proportional amortization method, our share of the investment’s performance is recorded in our Consolidated Statement of Income as a component of “Federal income tax expense.” Under the equity method, our share of distributed and undistributed net income is included in "Net investment income earned" on our Consolidated Statement of Income.
Our evaluation for OTTI of a fixed income security or a short-term investment may include, but is not limited to, the evaluation of the following factors:
Evaluation for OTTI of an equity security may include, but is not limited to, an evaluation of the following factors:
The financial condition and near-term prospects of the issuer, including any specific events that may influence the issuer's operations, coupled with our intention to hold the securities in the near-term;
If there is a decline in the fair market value of an other investment that we do not intend to hold, or if we determine the decline is other than temporary, we write down the carry value of the investment and record the charge through earnings as a component of realized losses.
We utilize a market approach for our Level 2 securities, using primarily matrix pricing models prepared by external pricing services. Matrix pricing models use mathematical techniques to value debt securities by relying on the securities relationship to other benchmark quoted securities, and not relying exclusively on quoted prices for specific securities, as the specific securities are not always frequently traded. As a matter of policy, we consistently use one pricing service as our primary source and secondary pricing services if prices are not available from the primary pricing service. In conjunction with our external investment portfolio managers, fixed income securities portfolio pricing is reviewed for reasonableness in the following ways: (i) comparing our pricing to other third-party pricing services as well as benchmark indexed pricing; (ii) comparing positions traded directly by the external investment portfolio managers to prices received from the third-party pricing services; (iii) comparing market value fluctuations between months for reasonableness; and (iv) reviewing stale prices. If further analysis is needed, a challenge is sent to the pricing service for review and confirmation of the price.
Less than 1% of our portfolio cannot be priced using our primary or secondary pricing service. At times, we may use non-binding broker quotes to value some of these securities. These prices are from various broker/dealers that use bid or ask prices, or benchmarks to indices, in measuring the fair value of a security. In conjunction with our external investment portfolio managers, these fair value measurements are reviewed for reasonableness. This review typically includes an analysis of price fluctuations between months with variances over established thresholds being analyzed further.
Goodwill results from business acquisitions where the cost of assets and liabilities acquired exceeds the fair value of those assets and liabilities. A quantitative goodwill impairment analysis is performed if our quarterly qualitative analysis indicates that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Goodwill is allocated to the reporting units for purposes of these analyses.
The internal reserve analysis is performed quarterly, and relies upon generally accepted actuarial techniques. Such techniques assume that past experience, adjusted for the effects of current developments and anticipated trends, are an appropriate basis for predicting future events. While the reserve analysis is the primary basis for determining IBNR reserves, other internal and external factors are considered. Internal factors include: (i) supplemental data regarding claim reporting and settlement trends; (ii) exposure estimates for reported claims, along with recent development on those estimates with respect to individual large claims and the aggregate of all claims; (iii) the rate at which new large or complex claims are being reported; and (iv) additional trends observed by claims personnel or reported to them by defense counsel. External factors considered include: (i) legislative enactments; (ii) judicial decisions; (iii) legal developments in the determination of liability and the imposition of damages; and (iv) trends in general economic conditions, including the effects of inflation.
The Insurance Subsidiaries' net premiums written (“NPW”) include direct insurance policy writings, plus reinsurance assumed and estimates of premiums earned but unbilled on the workers compensation and general liability lines of insurance, less reinsurance ceded. The estimated premium on the workers compensation and general liability lines is referred to as audit premium. We estimate this premium, as it is anticipated to be either billed or returned on policies subsequent to expiration based on exposure levels (i.e. payroll or sales). Audit premium is based on historical trends adjusted for the uncertainty of future economic conditions. Economic instability could ultimately impact our estimates and assumptions, and changes in our estimate may be material to the results of operations in future periods. Premiums written are recognized as revenue over the period that coverage is provided using the semi-monthly pro-rata method. Unearned premiums and prepaid reinsurance premiums represent that portion of premiums written that are applicable to the unexpired terms of policies in force.
We establish reserves for dividends to policyholders on certain policies, most significantly workers compensation policies. These dividends are based on the policyholders' loss experience. The dividend reserves are established based on past experience, adjusted for the effects of current developments and anticipated trends. The expense for these dividends is recognized over a period that begins at policy inception and ends with the payment of the dividend. We do not issue policies that entitle the policyholder to participate in the earnings or surplus of our Insurance Subsidiaries.
In addition, we have various capital leases for computer hardware and software. These leases are accounted for as an acquisition of an asset and an incurrence of an obligation. Depreciation is calculated using the straight-line method over the shorter of the estimated useful life of the asset or the lease term.
Two key assumptions, the discount rate and the expected return on plan assets, are important elements of expense and/or liability measurement. We evaluate these key assumptions annually unless facts indicate that a more frequent review is required. The discount rate enables us to state expected future cash flows at their present value on the measurement date. The purpose of the discount rate is to determine the interest rates inherent in the price at which pension benefits could be effectively settled. Our discount rate selection is based on high-quality, long-term corporate bonds. To determine the expected long-term rate of return on the plan assets, we consider the current and expected asset allocation, as well as historical and expected returns on each plan asset class. Other assumptions involve demographic factors such as retirement age, mortality, turnover, and rate of compensation increases.
In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”). ASU 2015-03 requires debt issuance costs to be netted against the related debt liability in the balance sheet rather than presented as a separate asset. However, ASU 2015-03 does not address the presentation or subsequent measurement of debt issuance costs related to line-of-credit arrangements. Therefore, in August 2015, the FASB issued ASU 2015-15, Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements - Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting (“ASU 2015-15”). ASU 2015-15 clarifies that, in the absence of authoritative guidance on line-of-credit arrangements within ASU 2015-03, the SEC would not object to the deferral and presentation of debt issuance costs as an asset and the subsequent amortization of the deferred costs over the term of the line-of-credit arrangement. We adopted this guidance retrospectively, effective in the fourth quarter of 2015. As such, all historical data in this Form 10-K has been restated to reflect the revised guidance, as follows:
In June 2014, the FASB issued ASU 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (“ASU 2014-12”). ASU 2014-12 requires that performance targets that affect vesting and could be achieved after the requisite service period be treated as performance conditions. The effective date for ASU 2014-12 is for interim and annual periods beginning after December 15, 2015. The amendments in ASU 2014-12 may be applied either prospectively to all awards granted or modified after the effective date or retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented and all modified awards thereafter. The adoption of ASU 2014-12 will not affect us, as we are currently recording expense consistent with the requirements of this accounting update.
In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 is intended to define management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and provide related footnote disclosures. ASU 2014-15 is effective for annual periods ending after December 15, 2016, and interim periods within annual periods beginning after December 15, 2016. Early application is permitted. As the requirements of this literature are disclosure only, ASU 2014-15 will not impact the our financial condition or results of operations.
In April 2015, the FASB issued ASU 2015-05, Customer's Accounting for Fees Paid in a Cloud Computing Arrangement (“ASU 2015-05”). ASU 2015-05 provides guidance to customers with cloud computing arrangements that include a software license. If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. ASU 2015-05 is effective for interim and annual reporting periods beginning after December 15, 2015. Early adoption is permitted. The amendments in ASU 2015-05 can be adopted either prospectively, to all arrangements entered into or materially modified after the effective date, or retrospectively. We do not expect a material impact on our financial condition or results of operations from the adoption of this guidance.
In May 2015, the FASB issued ASU 2015-07, Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) (“ASU 2015-07”). ASU 2015-07 provides guidance that investments for which the practical expedient is used to measure fair value at net asset value per share ("NAV") must be removed from the fair value hierarchy. Instead, those investments must be included as a reconciling line item so that the total fair value amount of investments in the disclosure is consistent with the amount on the balance sheet. ASU 2015-07 also includes disclosure requirements for investments for which the NAV practical expedient was used to determine fair value. ASU 2015-07 is effective for interim and annual reporting periods beginning after December 15, 2015. Early adoption is permitted. The amendments in ASU 2015-07 should be applied retrospectively to all periods presented. As the requirements of this literature are disclosure only, the application of this guidance will not impact our financial condition or results of operations.
Included in "Other assets" on the Consolidated Balance Sheet was $11.9 million at December 31, 2015 and $6.0 million at December 31, 2014 of cash received from the National Flood Insurance Program ("NFIP") which is restricted to pay flood claims under the Write Your Own ("WYO") Program.
Unrecognized holding gains and losses of HTM securities are not reflected in the Financial Statements, as they represent fair value fluctuations from the later of: (i) the date a security is designated as HTM either through purchase or transfer from AFS; or (ii) the date that an OTTI charge is recognized on an HTM security, through the date of the balance sheet. Our HTM securities had an average duration of 1.5 years as of December 31, 2015.
(d) The following tables summarize, for all securities in a net unrealized/unrecognized loss position at December 31, 2015 and December 31, 2014, the fair value and pre-tax net unrealized/unrecognized loss by asset class and by length of time those securities have been in a net loss position:
1 Gross unrealized losses include non-OTTI unrealized amounts and OTTI losses recognized in AOCI. In addition, this column includes remaining unrealized gain or loss amounts on securities that were transferred to an HTM designation in the first quarter of 2009 for those securities that are in a net unrealized/unrecognized loss position.
2 Unrecognized holding gains represent fair value fluctuations from the later of: (i) the date a security is designated as HTM; or (ii) the date that an OTTI charge is recognized on an HTM security.
At December 31, 2015, we had 609 securities in an aggregate unrealized/unrecognized loss position of $24.9 million, compared to 350 securities in an aggregate unrealized/unrecognized loss position of $10.6 million at December 31, 2014. Although the number of issues increased, the severity of impairment on these securities remained consistent at an average of 2% of amortized cost at December 31, 2015 and December 31, 2014. The primary driver behind the increase in the unrealized/unrecognized loss balance was our corporate fixed income securities portfolio, which was impacted by widening credit spreads.
(f) The following table summarizes our other investment portfolio by strategy and the remaining commitment amount associated with each strategy:
Distressed Debt: This strategy makes direct and indirect investments in debt and equity securities of companies that are experiencing financial and/or operational distress. Investments include buying indebtedness of bankrupt or financially troubled companies, small balance loan portfolios, special situations and capital structure arbitrage trades, commercial real estate mortgages and similar non-U.S. securities and debt obligations.
Our alternative investment strategies employ low or moderate levels of leverage and generally use hedging only to reduce foreign exchange or interest rate volatility. At this time, our alternative investment strategies do not include hedge funds. We cannot redeem our investments with the general partners of these investments; however, occasionally these partnerships can be traded on the secondary market. Once liquidation is triggered by clauses within the limited partnership agreements or at the funds’ stated end date, we will receive our final allocation of capital and any earned appreciation of the underlying investments, assuming we have not divested ourselves of our partnership interests prior to that time. We currently receive distributions from these alternative investments through the realization of the underlying investments in the limited partnerships. We anticipate that the general partners of these alternative investments will liquidate their underlying investment portfolios through 2028.
(h) We have pledged certain AFS fixed income securities as collateral related to: (i) our outstanding borrowing of $$60 million with the Federal Home Loan Bank of Indianapolis ("FHLBI"); (ii) our reinsurance obligations related to our 2011 acquisition of our E&S book of business; and (iii) our compliance with insurance laws by placing certain securities on deposit with various state and regulatory agencies. We retain all rights regarding all securities pledged as collateral.
The following table summarizes the market value of these securities at December 31, 2015:
(i) The components of pre-tax net investment income earned were as follows:
Realized gains and losses on the sale of investments are determined on the basis of the cost of the specific investments sold. Proceeds from the sale of AFS securities were $234.1 million in 2015, $259.0 million in 2014, and $135.9 million in 2013. Net realized gains in 2015, excluding OTTI charges, were driven by the sale of AFS securities due to a change in our dividend equity strategy from a quantitative, model-driven stock selection strategy to a fundamentally-based stock selection approach that incorporates an assessment of the sustainability and growth rate of a company's dividends and future cash flow. Net realized gains in 2014 and 2013, excluding OTTI charges, were driven by the sale of AFS equity securities due to the quantitative rebalancing of our dividend yield strategy holdings within our equity portfolio.
(a) The components of comprehensive income, both gross and net of tax, for 2015, 2014, and 2013 were as follows:
The Insurance Subsidiaries remain liable to policyholders to the extent that any reinsurer becomes unable to meet their contractual obligations. We evaluate and monitor the financial condition of our reinsurers under voluntary reinsurance arrangements to minimize our exposure to significant losses from reinsurer insolvencies. On an ongoing basis, we review amounts outstanding, length of collection period, changes in reinsurer credit ratings, and other relevant factors to determine collectability of reinsurance recoverables. The allowance for uncollectible reinsurance recoverables was $5.7 million at December 31, 2015 and $6.9 million at December 31, 2014.
The ceded premiums and losses related to our participation in the NFIP, under which 100% of our flood premiums, losses and loss expenses are ceded to the NFIP, are as follows:
In 2015, we experienced overall favorable loss development of $69.0 million, compared to $59.3 million in 2014, and $25.5 million in 2013. The following table summarizes the prior year development by line of business:
The casualty lines were driven largely by favorable development in accident years 2006 through 2010, with lower than expected severities in general liability and commercial automobile. Partially offsetting this favorable development was: (i) unfavorable development in our workers compensation line driven by assisted living claims; and (ii) unfavorable development in accident year 2012 in our commercial automobile lines of business driven by higher than expected severities.
(2) In the first quarter of 2009, Selective Insurance Company of the Southeast and Selective Insurance Company of South Carolina (“Indiana Subsidiaries”) joined, and invested in, the FHLBI, which provides them with access to additional liquidity. The Indiana Subsidiaries’ aggregate investment was $2.8 million at December 31, 2015 and $2.9 million at December 31, 2014. Our investment provides us the ability to borrow approximately 20 times the total amount of the FHLBI common stock purchased with additional collateral, at comparatively low borrowing rates.
Our Line of Credit was renewed effective December 1, 2015, with Wells Fargo Bank, National Association, as administrative agent, and Branch Banking and Trust Company, with a borrowing capacity of $30 million, which can be increased to $50 million with the approval of both lending partners. The Line of Credit provides the Parent with an additional source of short-term liquidity. The interest rate on our Line of Credit varies and is based on, among other factors, the Parent’s debt ratings. The Line of Credit expires on December 1, 2020. There have been no balances outstanding under this Line of Credit or the previous credit facility at December 31, 2015 or at any time during 2015. Our previous Line of Credit, which was in place from September 26, 2013 until December 1, 2015 had the same banking partners and similar terms and conditions as our current facility.
Investments - invests the premiums collected by our insurance operations, as well as amounts generated through our capital management strategies, which may include the issuance of debt and equity securities.
We have analyzed our tax positions in all open tax years, which as of December 31, 2015 were 2012 through 2014. The 2013 tax year is currently under audit. We do not have unrecognized tax expense or benefit as of December 31, 2015.
SICA offers a nonqualified deferred compensation plan ("Deferred Compensation Plan") to a group of management or highly compensated employees as a method of recognizing and retaining such employees. The Deferred Compensation Plan provides these employees the opportunity to elect to defer receipt of specified portions of compensation and to have such deferred amounts deemed to be invested in specified investment options. In addition to the employee deferrals, SICA may choose to make matching contributions to some or all of the participants in this plan to the extent the participant did not receive the maximum matching or non-elective contributions permissible under the Retirement Savings Plan due to limitations under the Internal Revenue Code or the Retirement Savings Plan. Expense recorded for these contributions was $0.2 million in 2015, 2014, and 2013.
SICA's primary pension plan is The Retirement Income Plan for Selective Insurance Company of America (the "Pension Plan"). This qualified, noncontributory defined benefit plan is closed to new entrants and existing participants will cease accruing benefits after March 31, 2016.
In addition to the Pension Plan, SICA also sponsors the Supplemental Excess Retirement Plan (the "Excess Plan") and a life insurance benefit plan (the "Retirement Life Plan"). Both of these plans are closed to new entrants and participants in the Excess Plan will cease accruing benefits after March 31, 2016. The Retirement Life Plan does not accrue benefits and this plan applies only to retirees who terminated employment with SICA on or before March 31, 2009. These are both unfunded plans with benefit obligations as of December 31, 2015 and December 31, 2014 of $8.5 million and $8.8 million, respectively, for the Excess Plan and $6.0 million and $6.4 million, respectively, for the Retiree Life Plan. Expense recorded for the Excess Plan was $0.8 million in 2015, $0.6 million in 2014, and $0.5 million in 2013. Expense recorded for the Retiree Life Plan was $0.3 million in 2015, $0.4 million in 2014, and $0.4 million in 2013.
The following tables provide details on the Pension Plan for 2015 and 2014:
Our latest measurement date was December 31, 2015 and we increased our expected return on plan assets to 6.37%, reflecting the current interest rate environment.
Assets of the Pension Plan are invested to ensure that principal is preserved and enhanced over time. Our return objective is to exceed the returns of the plan's policy benchmark, which is the return the plan would have earned if the assets were invested according to the target asset class weightings and earned index returns shown below. In 2016, we will continue to phase in adjustments to the asset allocation to steadily close the gap between the duration of the assets and the duration of the liabilities, provided certain improved funding targets are achieved.
The Pension Plan had no investments in the Parent’s common stock as of December 31, 2015 or 2014.
The techniques used to determine the fair value of the remaining invested assets are as follows:
Valuations for the majority of the investment funds utilize the market approach wherein the quoted prices in the active market for identical assets are used. These investment funds are traded in active markets at their net asset value per share. There are no restrictions on the redemption of these investments and we do not have any contractual obligations to further invest in any of the individual mutual funds. These investments are classified as Level 1 in the fair value hierarchy. Valuations of non-publicly traded investment funds are based upon the observable and verifiable market values of the underlying publicly traded securities and therefore are classified as Level 2 within the fair value hierarchy.
We presently anticipate contributing $11.7 million to the Pension Plan in 2016, none of which represents minimum required contribution amounts.
As of December 31, 2015, the following four plans are available for the issuance of share-based payment awards:
The Cash Incentive Plan, amended and restated effective as of May 1, 2014 (the "Cash Plan");
The following table provides information regarding the approval of these plans:
The types of awards that can be issued under each of these plans are as follows:
As of December 31, 2015, total unrecognized compensation expense related to unvested RSU awards granted under our stock plans was $5.0 million. That expense is expected to be recognized over a weighted-average period of 1.7 years. The total intrinsic value of RSUs vested was $10.3 million for 2015, $8.5 million for 2014, and $9.1 million for 2013. In connection with vested RSUs, the total value of the DEU shares that vested was $0.7 million during both 2015 and 2014 and $0.9 million in 2013.
The total intrinsic value of options exercised was $2.2 million during 2015, $0.8 million in 2014, and $1.3 million in 2013.
The liability recorded in connection with our Cash Plan was $26.5 million at December 31, 2015 and $21.9 million at December 31, 2014. The remaining cost associated with the CIUs is expected to be recognized over a weighted average period of 1.1 years. The CIU payments made were $10.2 million in 2015, $9.0 million in 2014, and $4.7 million in 2013.
A summary of ESPP and Agent Plan share issuances is as follows:
Rue Insurance placed insurance policies with the Insurance Subsidiaries. DPW associated with these policies were $9.6 million in 2015, $9.0 million in 2014, and $8.2 million in 2013. In return, the Insurance Subsidiaries paid standard market commissions to Rue Insurance of $1.7 million in 2015, $1.6 million in 2014, and $1.3 million in 2013 including supplemental commissions.
In addition, certain leases for rented premises and equipment are non-cancelable, and liability for payment will continue even though the space or equipment may no longer be in use. At December 31, 2015, the total future minimum rental commitments under non-cancelable leases were as follows:
The following table provides statutory data for each of our Insurance Subsidiaries:
The following table provides quantitative data regarding all Insurance Subsidiaries' dividends paid to the Parent in 2015 for debt service, shareholder dividends, and general operating purposes:
2 These ranges of high and low prices of the Parent’s common stock, as reported by the NASDAQ Global Select Market, represent actual transactions. Price quotations do not include retail markups, markdowns, and commissions. The range of high and low prices for common stock for the period beginning January 4, 2016 and ending February 12, 2016 was $29.27 to $34.00.