Cincinnati Financial Corporation also owns the Fairfield Executive Center, which is located on the northwest corner of our headquarters property. This four-story office building has approximately 124,000 square feet of available space. The property is carried in the financial statements at $7 million as of December 31, 2013, and is classified as land, building and equipment, net, for company use. Unaffiliated tenants occupy 6 percent. This property is used by all segments reported in the Consolidated Financial Statements and accompanying Notes.
of valuation gains from our fixed-maturity securities to the VCR. Those gains contributed between 2 percent and 3 percent annually to VCR during 2010 through 2012. While that contribution is not expected to occur in the subsequent five-year period, as evidenced in 2013, management believes the company will continue to produce strong underwriting results.
Premium growth - We believe over any five-year period our agency relationships and initiatives can lead to a property casualty written premium growth rate that exceeds the industry average. The compound annual growth rate of our net written premiums was 5.3 percent over the five-year period 2009 through 2013, higher than the 1.9 percent estimated growth rate for the property casualty insurance industry. The industry’s growth rate excludes its mortgage and financial guaranty lines of business. Our long-term target for profitable premium growth, for our property casualty and life insurance segments in aggregate, is to reach $5 billion of annual direct written premiums by the end of 2015. In 2013, our direct written premiums totaled $4.337 billion.
The board of directors is committed to rewarding shareholders directly through cash dividends and share repurchase authorizations. The board also has periodically declared stock dividends and splits. Through 2013, the company has increased the indicated annual cash dividend rate for 53 consecutive years, a record we believe is matched by only nine other publicly traded companies. The board regularly evaluates relevant factors in dividend-related decisions, and the 2013 increase reflects confidence in our strong capital, liquidity and financial flexibility, as well as progress through our initiatives to improve earnings performance. We discuss our financial position in more detail in Liquidity and Capital Resources.
Net income in 2013 rose $96 million or 23 percent compared with 2012, due primarily to the after-tax effects of property casualty underwriting results that improved by $62 million, including $105 million from lower natural
Property casualty net written premiums grew 12 percent in 2013 and earned premiums grew 11 percent, largely due to higher pricing and premium growth initiatives. That growth resembled the trend experienced in 2012. Trends and related factors are discussed in Commercial Lines, Personal Lines and Excess and Surplus Lines Insurance Results of Operations, respectively.
We discuss these strategic initiatives, along with related metrics to assess progress, in Item 1, Strategic Initiatives. Below is a review of highlights of our financial results for the past three years. Detailed discussion of these topics appears in Results of Operations and Liquidity and Capital Resources.
Our view of the shareholder value we can create over the next five years relies largely on three assumptions - each highly dependent on the external environment. First, we anticipate our average commercial and personal insurance prices will increase in excess of our loss cost trends. Second, we assume that the economy can maintain a growth track during 2014. Third, we assume that valuations of our marketable securities will vary within a typical range, based on historical trends. If those assumptions prove to be inaccurate, we may not be able to achieve our performance targets even if we accomplish our strategic objectives.
We discuss in our Item 1A, Risk Factors, many potential risks to our business and our ability to achieve our qualitative and quantitative objectives. These are real risks, but their probability of occurring may not be high. We also believe that our risk management programs generally could mitigate their potential effects, in the event they would occur. For the year 2014, we believe our value creation ratio could be below our long-term target for several reasons.
The slowly recovering economy continued to help increase the value of business and personal insurable assets owned by policyholders in 2013. If the economy falters, we may experience low or no premium growth for the property casualty industry. Property casualty written premium growth also may lag as some of our growth initiatives require more time to reach their full contribution.
The significant accounting policies used in the preparation of the financial statements are discussed in Item 8, Note 1 of the Consolidated Financial Statements. In conjunction with that discussion, material implications of uncertainties associated with the methods, assumptions and estimates underlying the company’s critical accounting policies are discussed below. The audit committee of the board of directors reviews the annual financial statements with management and the independent registered public accounting firm. These discussions cover the quality of earnings, review of reserves and accruals, reconsideration of the suitability of accounting principles, review of highly judgmental areas including critical accounting policies, audit adjustments and such other inquiries as may be appropriate.
For loss expenses that pertain primarily to salaries and other costs related to our claims department associates, also referred to as adjusting and other expense or AOE for statutory accounting, we calculate reserves based on an analysis of the relationship between paid losses and paid AOE. Reserves for AOE are allocated to company, line of business and accident year based on a claim count algorithm.
Our actuarial staff also devotes significant time and effort to the estimation of model and method parameters. The loss development and Bornhuetter-Ferguson methods require the estimation of numerous loss development factors. The Bornhuetter-Ferguson methods also involve the estimation of numerous ultimate loss ratios by accident year. Models from the probabilistic trend family require the estimation of development trends, calendar year inflation
Emergence of loss and defense and cost containment expenses on an accident year basis. Historical paid loss, reported loss and paid defense and cost containment expense data for the business lines we analyze contain patterns that reflect how unpaid losses, unreported losses and unpaid defense and cost containment expenses as of a financial statement date will emerge in the future on an accident year basis. Unless our actuarial staff or management identifies reasons or factors that invalidate the extension of historical patterns into the future, these patterns can be used to make projections necessary for estimating IBNR reserves. Our actuaries significantly rely on this assumption in the application of all methods and models mentioned above.
Exposure levels. Historical earned premiums, when adjusted to reflect common levels of product pricing and loss cost inflation, can serve as a proxy for historical exposures. Our actuaries require this assumption to estimate expected loss ratios and expected defense and cost containment expense ratios used by the Bornhuetter-Ferguson reserving methods. They may also use this assumption to establish exposure levels for recent accident years, characterized by “green” or immature data, when working with probabilistic trend family models.
Claims having atypical emergence patterns. Characteristics of certain subsets of claims, such as high frequency, high severity, or mass tort claims, have the potential to distort patterns contained in historical paid loss, reported loss and paid defense and cost containment expense data. When testing indicates this to be the case for a particular subset of claims, our actuaries segregate these claims from the data and analyze them separately. Subsets of claims that could fall into this category include hurricane claims or claims for other weather events where total losses we incurred were very large, individual large claims and asbestos and environmental claims.
Paid losses, reported losses and paid defense and cost containment expenses are subject to random as well as systematic influences. As a result, actual paid losses, reported losses and paid defense and cost containment expenses are virtually certain to differ from projections. Such differences are consistent with what specific models for our business lines predict and with the related patterns in the historical data used to develop these models. As a result, management does not closely monitor statistically insignificant differences between actual and projected data.
or dividends; signs indicating that the receivable carrying amount may not be recoverable; and changes in legal factors or in the business climate.
Our internal investment portfolio managers monitor their assigned portfolios. If a security is valued below cost or amortized cost, the portfolio managers undertake additional reviews. Such declines often occur in conjunction with events taking place in the overall economy and market, combined with events specific to the industry or operations of the issuing organization. Managers review quantitative measurements such as a declining trend in fair value, the extent of the fair value decline and the length of time the value of the security has been depressed, as well as qualitative measures such as pending events, credit ratings and issuer liquidity. We are even more proactive when these declines in valuation are greater than might be anticipated when viewed in the context of overall economic and market conditions. We provide information about valuation of our invested assets in Item 8, Note 2 of the Consolidated Financial Statements.
All securities valued below 100 percent of cost or amortized cost are reported to the asset impairment committee for evaluation. Securities valued between 95 percent and 100 percent of cost or amortized cost are reviewed but not monitored separately by the committee. When evaluating for OTTI, the committee considers the company’s intent and ability to retain a security for a period adequate to recover its cost. Because of the company’s financial strength and other factors discussed below, management may not impair certain securities even when they are fair valued below cost or amortized cost.
Securities that have previously been other-than-temporarily impaired are evaluated based on their adjusted cost or amortized cost and further written down, if deemed appropriate. We provide detailed information about securities fair valued in a continuous loss position at year-end 2013 in Item 7A, Application of Asset Impairment Policy.
Valuation of financial instruments, primarily securities held in our investment portfolio, is a critical component of our year-end financial statement preparation. Accounting Standards Codification (ASC) 820-10, Fair Value Measurements and Disclosures, defines fair value as the exit price or the amount that would be (1) received to sell an asset or (2) paid to transfer a liability in an orderly transaction between marketplace participants at the measurement date. When determining an exit price, we must, whenever possible, rely upon observable market data.
Over 99 percent of the $13.496 billion of securities in our investment portfolio, measured at fair value, are classified as Level 1 or Level 2. Financial assets that fall within Level 1 and Level 2 are priced according to observable data from identical or similar securities that have traded in the marketplace. Also within Level 2 are securities that are valued by outside services or brokers where we have evaluated the pricing methodology and determined that the inputs are observable.
Management ultimately determined the pricing for each Level 3 security that we considered to be the best exit price valuation. As of December 31, 2013, total Level 3 assets were less than 1 percent of our investment portfolio measured at fair value. Broker quotes are obtained for thinly traded securities that subsequently fall within the Level 3 hierarchy. We have generally obtained and evaluated two nonbinding quotes from brokers; our investment professionals determine our best estimate of fair value.
We have a defined benefit pension plan that was modified during 2008; refer to Item 8, Note 13, for additional information. Contributions and pension costs are developed from annual actuarial valuations. These valuations involve key assumptions including discount rates, expected return on plan assets and compensation increase rates, which are updated annually. Any adjustments to these assumptions are based on considerations of current market conditions. Therefore, changes in the related pension costs or credits may occur in the future due to changes in assumptions.
Key assumptions used in developing the 2013 benefit obligation for our qualified plan were a 5.15 percent discount rate and rates of compensation increases ranging from 2.75 percent to 3.25 percent. To determine the discount rate, a hypothetical diversified portfolio of actual domestic Aa rated bonds was chosen to provide payments approximately matching the plan’s expected benefit payments. A single interest rate was determined based on the anticipated yield of the constructed portfolio.
Key assumptions used in developing the 2013 net pension expense for our qualified plan were a 4.20 percent discount rate, a 7.50 percent expected return on plan assets and rates of compensation increases ranging from 2.75 percent to 3.25 percent.
In 2013, the net pension expense was $20 million. In 2014, we expect the net pension expense to be $10 million.
Holding all other assumptions constant, a 0.5 percentage-point decrease in the discount rate would decrease our 2014 income before income taxes by $1 million. A 0.5 percentage point decrease in the expected return on plan assets would decrease our 2014 income before income taxes by $1 million.
The fair value of the plan assets exceeded the accumulated benefit obligation by $23 million at year-end 2013 while the fair value of plan assets was $44 million less than the accumulated benefit obligation at year-end 2012. The fair value of the plan assets was $4 million less than the projected plan benefit obligation at year-end 2013 and $82 million less at year-end 2012. Market conditions and interest rates significantly affect future assets and liabilities of the pension plan. During the first quarter of 2014, we contributed $5 million to our qualified plan.
For property casualty policies, deferred acquisition costs are amortized over the terms of the policies. These costs are principally agent commissions, premium taxes and certain underwriting costs related to successful contract acquisition, which are deferred and amortized into net income as premiums are earned. We assess recoverability of deferred acquisition costs at the segment level, consistent with the ways we acquire, service, manage and measure profitability. Deferred acquisition costs track with the change in premiums. Our property casualty insurance operations consist of three segments, commercial lines, personal lines and excess and surplus lines.
We report as Other the noninvestment operations of the parent company and its noninsurer subsidiary, CFC Investment Company.
The table below highlights property casualty results of operations, with analysis and discussion in the sections that follow.
Other written premiums - primarily premiums ceded to our reinsurers as part of our reinsurance program - contributed $14 million to the $411 million of growth in 2013 net written premiums. The change in other written premiums included a relatively small increase in premiums ceded through reinsurance transactions and was offset by increases from other premium sources.
Combined ratio - The 2013 combined ratio improved 2.3 percentage points compared with 2012, including 5.4 points from lower catastrophe losses. Our recent-year initiatives to improve pricing precision and loss experience related to claims and loss control practices helped lower ratios for losses and loss expenses before catastrophe losses and prior year reserve development. We further discuss those ratios and ones related to reserve development in the sections that follow our discussion below in Catastrophe Losses Incurred.
Catastrophe loss trends are an important factor in assessing trends for overall underwriting results. Our 10-year historical annual average contribution of catastrophe losses to the combined ratio was 6.1 percentage points at December 31, 2013. Our five-year average was 7.7 percentage points. Incurred losses from a May 20-27, 2011, storm system that included Joplin, Missouri, represent the single-largest catastrophe event in our company’s history.
Loss and loss expenses include both net paid losses and reserve changes for unpaid losses as well as the associated loss expenses. Most of the incurred losses and loss expenses shown in the consolidated property casualty insurance results three-year highlights table are for the respective current accident years, and reserve development on prior accident years is shown separately. Since less than half of our consolidated property casualty current accident year incurred losses and loss expenses represents net paid amounts, the majority represents reserves for our estimate of ultimate losses and loss expenses. These reserves develop over time, and we re-estimate previously reported reserves as we learn more about the development of the related claims. The table below illustrates that development. For example, the 75.7 percent accident year 2012 loss and loss expense ratio reported as of December 31, 2012, developed favorably by 3.0 percentage points to 72.7 percent due to claims settling for less than previously estimated, or due to updated reserve estimates for unpaid claims, as of December 31, 2013. Accident years 2012 and 2011 have both developed favorably, as indicated by the progression over time for the ratios in the table.
Reserve development on prior accident years continued to net to a favorable amount in 2013. We recognized $147 million in favorable development in 2013, less benefit than $396 million in 2012 and $285 million in 2011. Of the $249 million decrease in 2013, compared with 2012, $156 million was attributable to re-estimates of IBNR. Approximately 57 percent of our reserve development on prior accident years recognized during 2013 occurred in our commercial casualty and workers’ compensation lines of business. In 2012, those lines of business were responsible for approximately 63 percent of the favorable reserve development. As discussed in Liquidity and Capital Resources, Property Casualty Loss and Loss Expense Obligations and Reserves, Consolidated Property Casualty Insurance Development of Estimated Reserves by Accident Year, those lines are considered long-tail lines with potential for revisions inherent in estimating reserves. Development recognized during 2011 was also primarily from our commercial casualty and workers’ compensation lines of business. Development by line of business is further analyzed in Consolidated Property Casualty Insurance Development of Estimated Reserves by Accident Year.
Consolidated property casualty commission expenses rose $70 million or 11 percent, with profit-sharing commissions for agencies rising by $5 million. In 2013, commission expenses as a percent of earned premiums resulted in a ratio that matched 2012. The 2013 ratio for other underwriting expenses was 0.2 percentage-points lower than 2012, reflecting an 11 percent increase in earned premiums that was higher than the 9 percent increase in those expenses.
Salaries, benefits and payroll taxes for our associates account for approximately half of our property casualty other underwriting expenses. Most of our associates either provide direct service to the property casualty portion of our agencies’ businesses or provide support to those associates. Since the end of 2009, the total number of associates, on a consolidated basis, declined slightly, reflecting careful management of our noncommission expenses. The total number of field associates providing direct service to agencies rose by 9 percent, reflecting our emphasis on providing excellent service in addition to territory expansion.
Premiums - Earned premiums and net written premiums each rose at a double-digit pace in 2013, primarily due to a $242 million increase in renewal written premiums, which continued to reflect improved pricing. Premium growth initiatives and higher pricing drove new business written premium growth of $39 million in 2013, also contributing to the increase in net written and earned premiums.
We continue to refine our use of predictive analytics tools to improve pricing precision in response to highly competitive commercial lines markets. These tools better align individual insurance policy pricing to risk attributes, providing our underwriters with enhanced abilities to target profitability and to discuss pricing impacts with agency personnel. We also continue to leverage our local relationships with agents through the efforts of our teams that work closely with them. We believe our field focus is unique and has several advantages, including providing us with quality intelligence on local market conditions. We seek to maintain appropriate pricing discipline for both new and renewal business as management emphasizes the importance of our agencies and underwriters assessing account quality to make careful decisions on a case-by-case basis whether to write or renew a policy. Rate credits may be used to retain renewals of quality business and to earn new business, but we do so selectively in order to avoid commercial accounts that we believe have insufficient profit margins.
Our 11 percent increase in 2013 agency renewal written premiums largely reflected higher pricing and improving economic conditions. We measure average changes in commercial lines renewal pricing as the rate of change in renewal premium for the new policy period compared with the premium for the expiring policy period, assuming no change in the level of insured exposures or policy coverage between those periods for respective policies. In 2013, our standard commercial lines policies averaged an estimated pricing change that increased in a mid-single-digit range, somewhat higher in that range than in 2012. The average pricing change for policies renewed during 2011 was slightly positive, near the low end of the low-single-digit range. For policies renewed during both 2010 and 2009, the typical pricing change was a decline, on average in the low-single-digit range. Our average commercial lines pricing change includes the flat pricing effect of certain coverages within package policies written for a three-year term that were in force but did not expire during the period being measured. Therefore, the average commercial lines pricing change we report reflects a blend of policies that did not expire and other policies that did expire during the measurement period.
New business premium volume in recent years has been significantly influenced by new agency appointments. All agencies appointed since the beginning of 2012 produced commercial lines new business written premiums of $40 million during 2013, up $25 million from what they produced during 2012, while all other agencies contributed the remaining $351 million, up $14 million from the $337 million they produced in 2012.
Other written premiums, primarily premiums that are ceded to reinsurers and that lower our net written premiums, had a slightly more favorable effect in 2013 than in 2012. The $30 million change for 2012, compared with 2011, was largely due to $24 million of additional ceded premiums in 2011 for our property catastrophe reinsurance treaty, a result of reinstatement premiums following two large catastrophe events during 2011.
Loss and loss expenses include both net paid losses and reserve changes for unpaid losses as well as the associated loss expenses. Most of the incurred losses and loss expenses shown in the commercial lines segment three-year highlights table are for the respective current accident years, and reserve development on prior accident years is shown separately. Since less than half of our commercial lines insurance segment current accident year incurred losses and loss expenses represents net paid amounts, the majority represents reserves for our estimate of ultimate losses and loss expenses. These reserves develop over time, and we re-estimate previously reported reserves as we learn more about the development of the related claims. The table below illustrates that development. For example, the 71.8 percent accident year 2012 loss and loss expense ratio reported as of December 31, 2012, developed favorably by 2.7 percentage points to 69.1 percent due to claims settling for less than previously estimated, or due to updated reserve estimates for unpaid claims, as of December 31, 2013. Accident years 2012 and 2011 for the commercial lines segment have both developed favorably, as indicated by the progression over time for the ratios in the table.
Commercial lines reserve development on prior accident years continued to net to a favorable amount in 2013, as $95 million was recognized, a lower benefit than the $292 million recognized in 2012. Of the $197 million decrease in 2013 compared with 2012, $144 million was attributable to re-estimates of IBNR. More than 85 percent of our commercial lines reserve development on prior accident years recognized during 2013 occurred in our commercial casualty and workers’ compensation lines of business, with approximately 70 percent occurring in commercial casualty. Development recognized during 2012 and 2011 was also mostly from our commercial casualty and workers’ compensation lines of business. Development by line of business and other trends for commercial lines loss and loss expenses and the related ratios are further analyzed in Commercial Lines of Business Analysis and in Liquidity and Capital Resources, Consolidated Property Casualty Insurance Development of Estimated Reserves by Accident Year.
In 2013, total large losses incurred increased by $52 million or 9 percent, net of reinsurance. The corresponding ratio decreased 0.3 percentage points, as earned premium growth outpaced the rate of growth in total large losses. The 2013 increase in large losses was primarily due to more commercial fire losses. In 2012, the total large losses incurred ratio was lower than it was in 2011, primarily due to an incurred losses increase for commercial auto and general liability claims. Our analysis indicated no unexpected concentration of these losses and reserve increases by geographic region, policy inception, agency or field marketing territory. We believe the inherent volatility of aggregate loss experience for our portfolio of larger policies is greater than that of our portfolio of smaller policies, and we continue to monitor the volatility in addition to general inflationary trends in loss costs.
Commercial lines commission expenses as a percent of earned premiums were essentially unchanged in 2013, compared with 2012. The ratio decreased slightly during 2012, compared with 2011, largely due to higher earned premiums that offset the effect of higher agency profit-sharing commissions.
Approximately 95 percent of our commercial lines premiums relate to accounts with coverages from more than one of our business lines. As a result, we believe that the commercial lines segment is best measured and evaluated on a segment basis. However, we provide line-of-business data to analyze growth and profitability trends separately for each line. The accident year loss data provides current estimates of incurred loss and loss expenses and corresponding ratios over the most recent three accident years. Accident year data classifies losses according to the year in which the corresponding loss events occur, regardless of when the losses are actually reported, recorded or paid.
Commercial casualty is our largest line of business and has in recent years maintained a very satisfactory total loss and loss expense ratio. Premium growth was strong in 2013, exceeding 2012 growth rates. Growth in both years included the effects of higher pricing and premium growth initiatives that helped new business written premiums increase more than 15 percent in 2013 and nearly 20 percent in 2012. During 2011, our underwriters began making full use of predictive modeling tools for general liability coverages in our commercial package accounts, and we believe such tools are improving our pricing precision.
Improving economic conditions also contributed to growth through higher premiums from audits that confirmed or adjusted initial premium estimates. As discussed in the commercial lines insurance premiums section of Commercial Lines Insurance Results of Operations, economic trends cause corresponding changes in underlying insured exposures, including general liability coverage where the premium amount is heavily influenced by economically-driven measures of risk exposure such as sales volume.
The 2013 total loss and loss expense ratio rose 6.8 percentage points, as a lower ratio for current accident year losses and loss expenses was offset by less benefit from favorable development on prior accident year reserves. That favorable reserve development occurred at a satisfactory level in 2013, but was less than in 2012. Moderation in loss cost trends, particularly for umbrella liability coverage included in many commercial package accounts, had a larger than usual effect in 2012. Development trends are further discussed in Liquidity and Capital Resources, Consolidated Property Casualty Insurance Development of Estimated Reserves by Accident Year.
The total loss and loss expense ratio improved 10.9 percentage points in 2013, compared with 2012, driven by lower catastrophe losses. Higher pricing and profit improvement initiatives described below contributed to the ratio improvement.
The 2012 total loss and loss expense ratio improved, compared with 2011, largely due to lower current accident year losses and loss expenses before catastrophes, reflecting higher earned premiums and more precise pricing. In 2011, we began full use of predictive modeling tools for property coverages in our commercial package accounts to improve our pricing precision.
In 2012, we formed a multi-department, multi-disciplinary taskforce that reviewed our property book of business and continues to seek ways to improve profitability, similar to the approach we used to improve workers’ compensation results. Several profit improvement initiatives have been completed and some, such as increasing the number of properties inspected, are in progress. Some of the more important initiatives include increasing specialization among selected claims and loss control associates, increasing the number of commercial property inspections for both new and renewal business, applying wind and hail deductibles in areas prone to convective storm losses, and implementing new guidelines for underwriting and pricing hail risk.
Commercial auto net written premiums and earned premiums rose in 2013 and 2012, primarily due to higher pricing in both years. Our increased focus on our commercial auto line of business contributed to it experiencing significant price increases in both years. New business written premiums rose nearly 15 percent in 2013 and nearly 10 percent in 2012, also contributing $8 million and $4 million, respectively, to growth in net written premiums.
The 2012 total loss and loss expense ratio increased, compared with 2011, primarily due to less benefit from favorable development on prior accident year reserves that was partially offset by an improved ratio for current accident year losses and loss expenses.
Workers’ compensation net written premiums and earned premiums rose in both 2013 and 2012, reflecting higher pricing and premium growth initiatives. New business written premiums contributed nearly half of the $33 million increase in net written premiums in 2013 and nearly one-quarter in 2012.
Improving economic conditions also contributed to growth through higher premiums from audits that confirmed or adjusted initial premium estimates. As discussed in the commercial lines insurance premiums section of Commercial Lines Insurance Results of Operations, economic trends cause corresponding changes in underlying insured exposures, including workers’ compensation coverage where the premium amount is heavily influenced by economically-driven measures of risk exposure such as payroll volume.
The 2013 total loss and loss expense ratio rose 12.6 percentage points compared with 2012, reflecting less benefit from favorable development on prior accident year reserves that offset an improved ratio for current accident year losses and loss expenses. Current accident year ratios continued to improve, compared with the previous year, in part reflecting profit improvement initiatives summarized below. Reserves were added during 2013 for older, pre-2009 accident years, reflecting paid loss data indicating it is taking longer to pay out older claims. Because some open workers’ compensation claims extend beyond 30 years, a small assumption change for the average life of a claim can add up to a considerable reserve amount recognized in any given period. Development trends are further discussed in Liquidity and Capital Resources, Consolidated Property Casualty Insurance Development of Estimated Reserves by Accident Year.
The 2012 total loss and loss expense ratio improved 4.6 percentage points compared with 2011, as lower current accident year losses and loss expenses were partially offset by less benefit from favorable development on prior accident year reserves.
section above, should also benefit our specialty packages line of business. We believe these initiatives will improve profitability over time.
The 2012 total loss and loss expense ratio improved 49.3 percentage points primarily due to a 33.7 point decrease in catastrophe losses. The 2012 current accident year loss and loss expense ratio before catastrophe losses also improved, compared with accident year 2011, largely due to higher earned premiums that included higher pricing.
We continue to address the potential risk inherent in the financial institutions portion of our management liability business as we work with our agents to identify the strongest financial institutions, in addition to using credit rating and other metrics to carefully re-underwrite in-force policies when they are considered for renewal.
We have actively managed the potentially high risk of writing director and officer liability by:
Closely monitoring our for-profit policyholders - At year-end 2013, our director and officer liability policies in force provided coverage to 13 nonfinancial publicly traded companies. Policies in force at year end included two Fortune 1000 companies. We also provided this coverage to approximately 400 banks, savings and loans and other financial institutions. The majority of these financial institution policyholders are smaller community banks, and we believe they have less exposure to credit-market concerns such as subprime mortgages. Based on new policy data or information from the most recent policy renewal, only nine of the banks we insure have assets greater than $2 billion; only 18 have assets from $1 billion to $2 billion; and 63 have assets from $500 million to $1 billion. The remaining 257 banks have assets below $500 million.
We intend to keep marketing our products to a broad range of business classes with a package approach, while also continuing to improve our pricing precision. We intend to maintain our underwriting selectivity and carefully manage our rate levels as well as our programs that seek to accurately match exposures with appropriate premiums. We will continue to evaluate each risk individually and to make decisions about rates, the use of three-year commercial policies and other policy conditions on a case-by-case basis, even in lines and classes of business that are under competitive pressure. We believe that our initiatives to improve pricing precision and lower loss costs will continue to benefit commercial lines profitability during 2014, and that recent-year premium growth initiatives will continue to increase commercial lines premiums.
Premiums - Earned premiums and net written premiums continued to climb in 2013, primarily due to higher renewal written premiums that included price increases. Renewal written premiums rose 11 percent for both 2013 and 2012.
In recent years, we have increased our use of pricing precision and implemented numerous rate increases to improve our personal lines segment results. To improve results, we also made more use of higher minimum loss deductibles and nonrenewed more policies in selected areas more prone to natural catastrophes. We have worked to improve our geographic diversification by expanding our personal lines operation to several states less prone to catastrophes.
Our personal lines statutory combined ratio was 96.3 percent in 2013, improved from 104.0 percent in 2012 and 124.2 percent in 2011. By comparison, the estimated industry personal lines combined ratio was 98.2 percent in 2013, 101.3 percent in 2012 and 106.1 percent in 2011. Our concentration of business in areas affected by catastrophe events contributed to recent-year results that differed from the overall industry, an issue we are addressing in part through gradual geographic expansion. The contribution of catastrophe losses to our personal lines statutory combined ratio was 7.7 percentage points in 2013, 15.9 percentage points in 2012 and
Personal lines insurance is a strategic component of our overall relationship with most of our agencies and is an important component of our agencies’ relationships with their clients. We believe agents recommend our personal insurance products for their clients who seek to balance quality and price and who are attracted by our superior claims service and the benefits of our package approach. We also believe our efforts to continue improving pricing precision are helping us attract and retain more of our agencies’ preferred business, while also obtaining higher rates for more thinly-priced business. Our progress toward improved geographic diversification is reflected in part through premium growth trends. Personal lines earned premiums in our four highest volume states increased in aggregate by 6 percent in 2013, while premiums for the remaining states that include our newer areas of operation increased 17 percent in aggregate.
Personal lines new business written premiums were down slightly in 2013, compared with 2012. Growth slowed as expected due to underwriting actions such as expanded use of actual cash value loss settlement for older roofs. For the majority of states where we market personal lines policies, those underwriting actions were effective beginning April 1, 2013. In 2012, our personal lines new business premiums written by our agencies grew 17 percent, reflecting the contribution from new agency appointments in addition to the effect of higher pricing from rate increases.
Other written premiums primarily consist of premiums that are ceded to reinsurers and that lower our net written premiums. Other written premiums reduced 2013 net written premium growth by $4 million more than in 2012, primarily due to higher premium volume subject to reinsurance. The change in 2012 other written premiums, compared with 2011, was driven by additional ceded premiums in 2011 for our property catastrophe reinsurance treaty.
Loss and loss expenses include both net paid losses and reserve changes for unpaid losses as well as the associated loss expenses. Most of the incurred losses and loss expenses shown in the personal lines segment three-year highlights table are for the respective current accident years, and reserve development on prior accident years is shown separately. Since approximately two-thirds of our personal lines current accident year incurred losses and loss expenses represent net paid amounts, the remaining one-third represents reserves for our estimate
Personal lines reserve development on prior accident years continued to net to a favorable amount in 2013, as $39 million was recognized. This total provided less benefit than the $99 million in 2012 and a benefit similar to $42 million in 2011. The homeowner line of business represented more than half of the 2013 decrease. Our personal lines net favorable reserve development on prior accident years recognized during 2013 primarily occurred in our homeowner line of business and in our other personal line of business, each slightly less than half of the total. Development recognized during 2012 and 2011 was mostly from those same lines of business. Development by line of business and other trends for personal lines loss and loss expenses and the related ratios are further analyzed in Personal Lines of Business Analysis, and in Liquidity and Capital Resources, Consolidated Property Casualty Insurance Development of Estimated Reserves by Accident Year.
In 2013, personal lines total large losses incurred increased by $4 million or 4 percent, net of reinsurance. The corresponding ratio decreased 0.9 percentage points, as earned premium growth more than doubled the rate of growth in total large losses. The majority of the 2013 increase was due to higher personal auto losses. In 2012, total large losses increased over 2011, primarily due to higher homeowner fire claims. Our analysis indicated no unexpected concentration of these losses and reserve increases by risk category, geographic region, policy inception, agency or field marketing territory. We believe the inherent volatility of aggregate loss experience for our portfolio of larger policies is greater than that of our portfolio of smaller policies, and we continue to monitor the volatility in addition to general inflationary trends in loss costs.
Net written premiums for personal auto increased in 2013 and 2012, with both years reflecting rate increases in recent years, ongoing high levels of policy retention, premium growth initiatives and a higher level of insured exposures.
The 2013 total loss and loss expense ratio rose 4.1 percentage points, largely due to a 4.3 point reduction in the ratio for favorable reserve development on prior accident years. That reduction related to both case and IBNR reserves. For accident year 2013, a lower catastrophe loss and loss expenses ratio offset a modest increase in the
Net written premiums for homeowner rose $50 million or 13 percent in 2013, primarily due to higher renewal premiums. Higher renewal premiums also drove the 2012 increase, with lower ceded premiums for reinsurance contributing approximately one-third of the increase in net written premiums.
The 27.7 percentage-point improvement in the 2013 total loss and loss expense ratio included a decrease of 17.1 points for catastrophe losses, compared with 2012. Noncatastrophe weather losses were approximately
$16 million lower during 2013, improving the 2013 loss ratio by approximately 6 percentage points compared with 2012. Better pricing and risk selection also contributed to the improvement for both 2013 and 2012.
Other personal premiums grew in 2013, although at a slower pace than in 2012. Premium trends for this line of business have generally tracked with the growth in our personal auto and homeowner lines before the effects of reinsurance. Most of our other personal coverages are endorsed to homeowner or auto policies. In addition to umbrella liability coverage, our other personal lines policies provide property-oriented coverages such as dwelling fire and inland marine.
Loss and loss expense ratios in 2013 continued at a profitable level, in part due to lower catastrophe losses and noncatastrophe weather. Reserve development on prior accident years provided less benefit in 2013 than in 2012, although development can fluctuate significantly for this business line because personal umbrella liability coverage is a major component of other personal losses.
A.M. Best projects industrywide personal lines written premiums may grow approximately 4 percent in 2014, with an industry statutory combined ratio estimated at approximately 99 percent. Due to rate increases and a stable policy retention rate, plus the effect of an accelerated pace for recent-year new agency appointments, we believe our growth rate will likely be higher than the industry projection for 2014. In Item 1, Strategic Initiatives, and Personal Lines Results of Operations, we discuss various actions we are taking to improve performance of our personal lines segment. Our personal lines pricing trends need to exceed loss trends to improve personal lines profitability, thereby helping to achieve our corporate financial targets. We discuss our overall outlook for our property casualty insurance operations in the Executive Summary.
Combined ratio - The combined ratio improved 13.2 percentage points in 2013, a reflection of better experience for loss and loss expenses before catastrophe losses largely due to higher pricing, careful underwriting and typical variability from new losses incurred of $250,000 or more.
Other written premiums are primarily premiums that are ceded to reinsurers and that lower our net written premiums. Ceded premium volume for 2013 increased relative to 2012, reflecting higher written premiums subject to reinsurance.
Catastrophe losses, as discussed in Consolidated Property Casualty Insurance Results of Operations, explain some of the movement in current accident year loss and loss expense ratios for accident years 2011 through 2013.
We believe the loss and loss expenses reserves for our excess and surplus lines business are adequate. We establish case reserves in a manner consistent with standard lines coverages, despite the more restrictive terms and conditions for excess and surplus lines policies. Our first excess and surplus lines policies were written in 2008. After two years of operation, reserves for estimated unpaid losses and loss expenses were $18 million as of December 31, 2009, for losses that occurred in 2008 and 2009. As of December 31, 2013, only an estimated $2 million remained unpaid for loss events that occurred in 2008 and 2009. The inherent uncertainty in estimating reserves is discussed in Liquidity and Capital Resources, Property Casualty Insurance Loss and Loss Expense Reserves. Development trends are further analyzed in Consolidated Property Casualty Insurance Development of Estimated Reserves by Accident Year.
In 2013, total large losses incurred decreased by $4 million or 17 percent, net of reinsurance, helping to lower the corresponding ratio by 7.2 percentage points, compared with 2012. The ratio for the year 2012 trended in the opposite direction, as earned premium growth lagged the rate of growth in total large losses. Our analysis indicated no unexpected concentration of these losses and reserve increases by risk category, geographic region, policy inception, agency or field marketing territory. We believe the inherent volatility of aggregate loss experience for our portfolio of larger policies is greater than that of our portfolio of smaller policies, and we continue to monitor the volatility in addition to general inflationary trends in loss costs.
Excess and surplus lines commission expense as a percent of earned premiums rose in 2013 and 2012, primarily due to higher agency profit-sharing commissions.
The excess and surplus lines market is expected to see the magnitude of rate increases begin to decline on several classes of business due to increased capacity in the market. Competition is expected to remain strong, especially on large accounts, due primarily to standard market insurance companies insuring businesses that previously were written by excess and surplus lines insurers. Firming is expected to continue for specific classes of business where loss costs are exceeding rates, such as habitational and lessors-risk classes for property coverages and also lawyers professional in errors and omissions coverages. The slowly recovering U.S. economy, another major factor in demand for insurance products, is also expected to contribute to premiums during 2014 for the excess and surplus lines industry.
Revenues - Earned premiums rose 6 percent for the year 2013. The largest life insurance product line, term life insurance, also rose 6 percent. Net in-force policy face amounts rose 7 percent to $48.063 billion at year-end 2013 from $45.126 billion at year-end 2012 and $42.001 billion at year-end 2011.
Earned premiums rose by $11 million in 2013, primarily due to growth in our term life insurance business. Earned premiums from term life insurance grew $7 million, or 6 percent.
Although we exclude most of our life insurance company investment income from investment segment results, we recognize that assets under management, capital appreciation and investment income are integral to evaluation of the success of the life insurance segment because of the long duration of life products. On a basis that includes investment income and realized gains or losses from life insurance-related invested assets, the life insurance company reported a net profit of $48 million in 2013, compared with a net profit of $38 million in 2012 and a net profit of $20 million in 2011. The life insurance company portfolio had after-tax net realized investment gains of $4 million in 2013, even with 2012. Net realized investment losses after taxes were $12 million in 2011, which included $20 million in OTTI charges. Realized investment gains and losses are discussed under Investment Results of Operations.
Operating expenses incurred, net of deferred acquisition costs, accounted for 22.7 percent of 2013 total benefits and expenses compared with 29.9 percent in 2012 and 24.7 percent in 2011. Expenses in 2013 decreased, primarily due to the impact of unlocking of actuarial assumptions for our universal life insurance contracts.
We continue to improve our operational technology in an effort to make it easier for our agents to do business with us. We recently introduced an app for the iPad®, which we expect to increase agent use of our electronic application process. We also will continue to modernize our policy and claims administration system, which will allow us to more efficiently service our customers.
Total investment return rose in 2013, compared with 2012. The return contribution from the combination of investment income and net investment gains, both realized and the change in unrealized, was up 11 percent. The base component of the return calculation, estimated annual average invested assets, was up 7 percent.
Dividend income rose $7 million or 6 percent in 2013 after rising 11 percent in 2012. Increases in dividend payment rates for most of the holdings in our common stock portfolio during both 2013 and 2012, plus a net increase in funds invested in that portfolio for both years, drove the increases in dividend income. In addition, several of our common stock holdings, in total, issued an additional $5 million in 2012 dividends not typically paid in the fourth quarter, as a result of anticipated dividend tax rate changes effective for 2013.
In 2013, we continued to invest available cash flow in both fixed income and equity securities in a manner that we believe balances current income needs with longer-term invested asset growth goals. While our bond portfolio more than covers our insurance reserve liabilities, we believe our diversified common stock portfolio of mainly blue chip, dividend-paying companies represents one of our best investment opportunities for the long term. We position our portfolio with consideration to both the challenges presented by the current low interest rate environment and the risks presented by potential future inflation. As bonds in our generally laddered portfolio mature or are called over the near term, we will be challenged to replace their current yield. Approximately 22 percent of our fixed-maturity investments mature during 2014 through 2016 with an average pretax yield-to-amortized cost of 4.6 percent, including 6.1 percent of the portfolio maturing during 2014 and yielding 4.8 percent, 7.6 percent of the portfolio maturing during 2015 and yielding 4.5 percent and 7.9 percent of the portfolio maturing during 2016 and yielding 4.5 percent.
As appropriate, we buy, hold or sell both fixed-maturity and equity securities on an ongoing basis to help achieve our portfolio objectives. We generally purchase fixed-maturity securities with the intention to hold until maturity. If they that no longer meet our investment criteria, they are divested. Sales of fixed-maturity securities are usually due to a change in credit fundamentals. Pretax realized investment gains in the past three years largely were due to the sale of equity holdings.
Net realized investment gains and losses totaling $83 million for the year ended December 31, 2013, included:
$9 million in other net realized gains, including $3 million in gains from changes in the fair value of securities with embedded derivatives, described as hybrid securities in Item 8, Note 2, of the Consolidated Financial Statements.
$2 million in OTTI charges to write down seven holdings of equity and fixed-maturity securities.
In 2011, the $70 million net realized investment gains and losses were mostly due to $111 million in net realized gains from equity security sales, partially offset by $57 million of OTTI charges for 12 securities.
We continue to focus on portfolio strategies to balance near-term income generation and long-term book value growth. In 2014, we expect to continue to allocate a portion of cash available for investment to equity securities, taking into consideration corporate liquidity and income requirements, as well as insurance department regulations and rating agency comments. We discuss our portfolio strategies in Item 1, Investments Segment.
We had $197 million of income tax expense in 2013 compared with $145 million in 2012 and $9 million in 2011. Our corporate effective tax rate for 2013 was 27.6 percent compared with 25.6 percent in 2012 and 5.2 percent in 2011.
The parent company’s primary sources of cash inflows are dividends from our insurance subsidiary, investment income, maturity of fixed income securities and sale proceeds from investments. The parent company’s cash outflows are primarily interest and principal payments on long- and short-term debt, dividends to shareholders, common stock repurchases, pension contributions, investment purchases and general operating expenses. As of December 31, 2013, the parent company had $1.532 billion in cash and marketable securities, providing strong liquidity to fund cash outflows, as needed.
The payment of dividends to shareholders is largely based upon receiving subsidiary dividends. Otherwise, we could sell investments or use our line of credit to support the payment.
The table below shows a summary, by the direct method, of the major sources and uses of cash flow by the parent company. Dividends received from subsidiaries in 2013 were $65 million more than 2012, reflecting an increase in property casualty insurance subsidiary net cash flow from operating activities. We expect 2014 sources of cash flows to be similar to 2013, assuming similar catastrophe losses. The majority of expenditures for the parent company have been consistent during the last three years, and we expect future expenditures to remain fairly stable. Share repurchases are discretionary, depending on cash availability and capital management decisions.
Investment income is a primary source of liquidity for both the parent company and our insurance subsidiary operations. For both, cash in excess of operating requirements and shareholder dividends is invested in fixed-maturity and equity securities.
income taxes, were $2.335 billion. Liquidity sourced from our investment portfolio is not materially at risk from European-based securities, as our total exposure to such securities at the end of 2013 was $455 million on a fair value basis, or 3.4 percent of our total invested assets. We own no European sovereign debt. Our European-based securities are summarized by country in Item 7A, Qualitative and Quantitative Disclosures About Market Risk.
The company’s senior debt is rated investment grade by independent rating firms. None of the four rating agencies made changes to our debt ratings in 2013. Our debt ratings at February 25, 2014, were: a- from A.M. Best, BBB+ from Fitch Ratings, A3 from Moody’s Investors Service and BBB from Standard & Poor’s Ratings Services.
At December 31, 2013, we had a $225 million line of credit with commercial banks, with $104 million borrowed. There was no change in the amount of short-term debt during 2013. Access to this line of credit requires compliance with various covenants, including maintaining a minimum consolidated net worth and not exceeding a 30 percent ratio of debt to capital, as defined by the agreement. The minimum consolidated net worth requirement is $3 billion plus 50 percent of consolidated net income and net cash proceeds from issuance of equity securities after March 31, 2012. At December 31, 2013, we were well within compliance with all covenants under the credit agreements and believe we will remain in compliance.
That $225 million unsecured revolving line of credit is administered by PNC Bank, N.A., a subsidiary of The PNC Financial Services Group Inc. (NYSE:PNC). It was established in 2012 and will expire in May 2017. Our subsidiary CFC Investment Company also is a borrower under this line of credit. PNC Bank is the lead participant bookrunner with a $65 million share. Fifth Third Bancorp (Nasdaq:FITB) is the syndication agent with a $65 million share. U.S. Bancorp (NYSE:USB), BB&T Corp (NYSE:BBT) and Huntington Bancshares, Inc. (Nasdaq:HBAN) each provide $25 million of capacity, and Northern Trust Corporation (Nasdaq:NTRS), provides $20 million of capacity.
Capital resources consisting of shareholders’ equity and total debt represent our overall financial strength to support writing and growing our insurance businesses. At December 31, 2013, we had total capital of $6.964 billion. Shareholders’ equity was $6.070 billion, an increase of $617 million, or 11 percent, from the prior year. Our total debt was $894 million, unchanged from a year ago. We seek to maintain a solid financial position and provide capital flexibility by keeping our ratio of debt to total capital moderate. We target a ratio below 20 percent. At year-end 2013, the ratio was 12.8 percent compared with 14.1 percent at year-end 2012.
Dividends to shareholders -The ability of the company to continue paying cash dividends is subject to factors the board of directors deem relevant. While the board and management believe there is merit to sustaining the company’s long record of dividend increases, our first priority is the company’s financial strength. Over the past
10 years, the company has paid an average of 58 percent of net income as dividends. Through 2013, the board had increased our cash dividend for 53 consecutive years. The board decisions in August 2013 and in January 2014 to increase the dividend demonstrated confidence in the company’s strong capital, liquidity, financial flexibility and initiatives to grow earnings.
As of December 31, 2013, we estimate our future contractual obligations as follows:
Our two most significant contractual obligations are discussed in conjunction with related insurance reserves in Property Casualty Loss and Loss Expense Obligations and Reserves and Life Insurance Policyholder Obligations and Reserves in this report. Other future contractual obligations include:
At December 31, 2013, we believe our most significant other commitments are:
A long-term perspective governs our liquidity and capital resources decisions, with the goal of benefitting our policyholders, agents, shareholders and associates over time. Our 2013 insurance results were better than our combined ratio objective of being consistently within the range of 95 percent to 100 percent, resulting in strong underwriting profits.
In any year, we consider the most likely source of pressure on liquidity would be an unusually high level of catastrophe loss payments within a short period of time, such as what occurred in the second quarter of 2011. We responded with a reduced insurance subsidiary dividend to our parent company in 2011. There could also be additional obligations for our insurance operations due to increasing severity or frequency of noncatastrophe claims. To address the risk of unusually large insurance loss obligations including catastrophe events, we maintain property casualty reinsurance contracts with highly rated reinsurers, as discussed under 2014 Reinsurance Programs. We also monitor the financial condition of our reinsurers because their insolvency could jeopardize a portion of our $547 million in outstanding reinsurance recoverable at December 31, 2013.
For the business lines in the commercial and personal lines insurance segments, and in total for the excess and surplus lines segment, the following table details gross reserves among case, IBNR and loss expense reserves, net of salvage and subrogation. Reserving practices are discussed in Critical Accounting Estimates, Property Casualty Insurance Loss and Loss Expense Reserves.
Our estimate of future gross property casualty loss and loss expense payments of $4.241 billion is lower than loss and loss expense reserves of $4.311 billion reported on our balance sheet at December 31, 2013. The $70 million difference is due to certain life and health loss reserves.
We carried $77 million of net loss and loss expense reserves for asbestos and environmental claims and $51 million of reserves for mold claims at year-end 2013, compared with $67 million and $54 million, respectively, for such claims at year-end 2012. The asbestos and environmental claims amounts for each respective year constituted 1.9 percent and 1.8 percent of total net loss and loss expense reserves at these year-end dates.
We believe our exposure to asbestos and environmental claims is limited, largely because our reinsurance retention was $500,000 or below prior to 1987. We also were predominantly a personal lines company in the 1960s and
1970s, when asbestos and pollution exclusions were not widely used by commercial lines insurers. During the 1980s and early 1990s, commercial lines grew as a percentage of our overall business and our exposure to asbestos and environmental claims grew accordingly. Over that period, we endorsed to or included in most policies an asbestos and environmental exclusion.
Our estimates of gross property casualty loss and loss expense payments do not include reinsurance receivables or ceded losses. As discussed in 2014 Reinsurance Programs, we purchase reinsurance to mitigate our property casualty risk exposure. Ceded property casualty reinsurance unpaid receivables of $299 million at year-end 2013 are an offset to our gross property casualty loss and loss expense obligations. Our reinsurance program mitigates the liquidity risk of a single large loss or an unexpected rise in claim severity or frequency due to a catastrophic event. Reinsurance does not relieve us of our obligation to pay covered claims. The financial strength of our reinsurers is important because our ability to recover losses under our reinsurance agreements depends on the financial viability of the reinsurers.
We reconcile the beginning and ending balances of our reserves for loss and loss expenses at December 31, 2013, 2012 and 2011, in Item 8, Note 4 of the Consolidated Financial Statements. The reconciliation of our year-end 2012 reserve balance to net incurred losses one year later recognizes $147 million of favorable reserve development.
Section B shows the cumulative net amount paid with respect to the previously recorded reserve as of the end of each succeeding year. For example, as of December 31, 2013, we had paid $2.197 billion of loss and loss expenses in calendar years 2004 through 2013 for losses that occurred in accident years 2003 and prior. An estimated $306 million of losses remained unpaid as of year-end 2013 (net re-estimated reserves of $2.503 billion from Section C less cumulative net paid loss and loss expenses of $2.197 billion).
Section D, cumulative net reserve development, represents the aggregate change in the estimates for all years subsequent to the year the reserves were initially established. For example, reserves established at December 31, 2003, had developed favorably by $342 million over 10 years, net of reinsurance, which was reflected in income over the 10 years. The table shows favorable reserve development as a negative number. Favorable reserve development on prior accident years, which represents a negative expense, is favorable to income. The “One year later” line in the table shows the effects on income before income taxes in 2013, 2012 and 2011 of changes in estimates of the reserves for loss and loss expenses for all accident years. The effect was favorable to pretax income for those three years by $147 million, $396 million, and $285 million, respectively.
In evaluating the development of our estimated reserves for loss and loss expenses for the past 10 years, note that each amount includes the effects of all changes in amounts for prior periods. For example, payments or reserve adjustments related to losses settled in 2013 but incurred in 2007 are included in the cumulative deficiency or redundancy amount for 2007 and each subsequent year. In addition, this table presents calendar year data, not accident or policy year development data, which readers may be more accustomed to analyzing. Conditions and trends that affected development of reserves in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future reserve development based on this data.
Overall favorable development for consolidated property casualty reserves of $147 million in 2013 illustrated the potential for revisions inherent in estimating reserves, especially for long-tail lines such as commercial casualty and workers’ compensation. As noted in Critical Accounting Estimates, Key Assumptions Loss Reserving, our models predict that actual loss and loss expense emergence will differ from projections, and we do not attempt to monitor or identify such normal variations. The table in Property Casualty Loss and Loss Expense Obligations and Reserves shows reserves by segment and lines of business and the components of gross reserves among case, IBNR and loss expense reserves.
Commercial auto loss emergence - Commercial auto developed slightly unfavorably during calendar year 2013. This line has become troublesome for the industry as a whole, perhaps due to an improving economy. We continue to watch it closely. Initiatives to improve profitability of our commercial auto line of business are discussed in Commercial Lines Insurance Results of Operations, Commercial Lines of Business Analysis.
Workers’ compensation trends and initiatives - We continue to see favorable calendar year development for this line. Loss emergence during 2013 was less than expected for the more recent accident years, but older years developed adversely. The trend for payments to be made in future calendar years is down slightly. However, we are watching this line closely, as a sudden increase in trend for future payments has a highly leveraged effect. Initiatives to improve profitability of our workers’ compensation line of business are discussed in Commercial Lines Insurance Results of Operations, Commercial Lines of Business Analysis.
Our estimates of gross life, annuity and disability obligations do not reflect net recoveries from reinsurance agreements. Ceded life reinsurance receivables were $239 million at year-end 2013. As discussed in 2014 Reinsurance Programs, we purchase reinsurance to mitigate our life insurance risk exposure. At year-end 2013, ceded death benefits represented approximately 43.5 percent of our total gross policy face amounts in force.
These estimated cash outflows are undiscounted with respect to interest. As a result, the sum of the cash outflows for all years of $4.550 billion (total of life insurance obligations) exceeds the liabilities recorded in life policy and investment contract reserves and separate accounts for future policy benefits and claims of $3.065 billion (total of life insurance policy reserves and separate account policy reserves). Separate account policy reserves make up all but $9 million of separate accounts liabilities.
Gross life policy reserves were $2.390 billion at year-end 2013, compared with $2.295 billion at year-end 2012. The increase was primarily due to reserves for traditional life insurance contracts. We establish reserves for traditional life insurance policies based on expected expenses, mortality, morbidity, withdrawal rates and investment yields, including a provision for uncertainty. Once these assumptions are established, they generally are maintained throughout the lives of the contracts. We use both our own experience and industry experience adjusted for historical trends in arriving at our assumptions for expected mortality, morbidity and withdrawal rates. We use our own experience and historical trends for setting our assumptions for expected expenses. We base our assumptions for expected investment income on our own experience adjusted for current economic conditions.
To help determine appropriate reinsurance coverage for hurricane, earthquake and tornado/hail exposures, we use the RMS and AIR models to estimate the probable maximum loss from a single event or multiple events occurring in a one-year period. The models are proprietary in nature, and the vendors that provide them periodically update the models, sometimes resulting in significant changes to their estimate of probable maximum loss. As of the end of 2013, both models indicated that a hurricane event represents our largest amount of exposure to losses. The table below summarizes estimated probabilities and the corresponding probable maximum loss from a single hurricane event occurring in a one-year period, and indicates the effect of such losses on consolidated shareholders’ equity as of December 31, 2013. Net losses are net of reinsurance and income taxes, and assume our 2014 reinsurance programs apply.
The following table shows our five largest property casualty reinsurance receivable amounts by reinsurer at year-end 2013 and 2012. USAIG is a joint underwriting association of individual insurance companies that collectively functions as a worldwide aviation insurance market. We terminated our participation in the association after policy year 2002. The A.M. Best insurer financial strength ratings as of December 31, 2013, are also shown for each those reinsurers.
Property per risk treaty - The primary purpose of the property treaty is to provide capacity up to $25 million, adequate for the majority of the risks we write. It also includes protection for extra-contractual liability coverage losses. We retain the first $8 million of each loss. Losses between $8 million and $25 million are reinsured at 100 percent. The ceded premium is estimated at $29 million for 2014, compared with initial estimates of
$37 million for both 2013 and 2012. Lower 2014 rates and a $1 million increase in our retention per loss offset the effect of estimates of higher levels of property coverage direct written premiums that are subject to the treaty.
Casualty per occurrence treaty - The casualty treaty provides capacity up to $25 million. Similar to the property treaty, it provides sufficient capacity to cover the vast majority of casualty accounts we insure and also includes protection for extra-contractual liability coverage losses. We retain the first $8 million of each loss. Losses between $8 million and $25 million are reinsured at 100 percent. The ceded premium is estimated at $24 million for 2014, compared with initial estimates of approximately $29 million for 2013 and $37 million for 2012. Lower 2014 rates and a $1 million increase in our retention per loss offset the effect of estimates of higher levels of liability coverage direct written premiums that are subject to the treaty.
Casualty excess treaty - We purchase a casualty reinsurance treaty that provides an additional $45 million in protection for certain casualty losses. This treaty, along with the casualty per occurrence treaty, provides a total of $70 million of protection for workers’ compensation, extra-contractual liability coverage and clash coverage losses, which would apply when a single occurrence involves multiple policyholders of The Cincinnati Insurance Companies or multiple coverages for one insured. The ceded premium is estimated at approximately $3 million for 2014, similar to the premium estimated for both 2013 and 2012.
Property catastrophe treaty - To protect against catastrophic events such as wind and hail, hurricanes or earthquakes, we purchased property catastrophe reinsurance with a limit up to $600 million. The treaty contains one reinstatement provision. For the 2014 treaty, ceded premiums are estimated at $50 million, down from approximately $60 million for 2013, reflecting lower rates and minor changes in our share of losses described below. We retain the first $75 million of any loss, plus varying shares of losses up to $600 million:
After reinsurance, and before any applicable benefit from our catastrophe bond, our maximum exposure to a catastrophic event that causes $600 million in covered losses in 2014 would be $115 million compared with $117 million for 2013. The largest catastrophe loss event in our history occurred during 2011 from a May 20-27 storm system that included a tornado in Joplin, Missouri, and also significant losses from hail in the Dayton, Ohio, area. Our losses from that storm were estimated at December 31, 2013, to be $229 million before reinsurance.
Terrorism coverage at various levels has been secured in most of our reinsurance agreements. The broadest coverage for this peril is found in the property and casualty working treaties, the property per risk treaty and the casualty per occurrence treaty, which provide coverage for commercial and personal risks. Our property catastrophe treaty provides terrorism coverage for personal risks, and coverage for commercial risks with total insured values of $13 million or less. For insured values between $13 million and $25 million, there also may be coverage in the property working treaty.
The Cincinnati Insurance Company’s reinsurance program for 2014 includes participation in two assumed reinsurance treaties with R.J. Kiln & Company Limited, a reinsurer that spreads its losses to its property book of
Declines in overall stock market values negatively affecting the company’s equity portfolio and book value
Impose new obligations on us that increase our expenses or change the assumptions underlying our critical accounting estimates
Further, the company’s insurance businesses are subject to the effects of changing social, economic and regulatory environments. Public and regulatory initiatives have included efforts to adversely influence and restrict premium rates, restrict the ability to cancel policies, impose underwriting standards and expand overall regulation. The company also is subject to public and regulatory initiatives that can affect the market value for its common stock, such as measures affecting corporate financial reporting and governance. The ultimate changes and eventual effects, if any, of these initiatives are uncertain.
We have prepared the consolidated financial statements of Cincinnati Financial Corporation and our subsidiaries for the year ended December 31, 2013, in accordance with accounting principles generally accepted in the United States of America (GAAP).
The audit committee meets periodically with management, our independent registered public accounting firm and our internal auditors to discuss how each is handling its respective responsibilities. The audit committee reports its findings to the board of directors. The audit committee recommends to the board the annual appointment of the independent registered public accounting firm. The audit committee reviews with this firm the scope of the audit assignment and the adequacy of internal controls and procedures.
The company’s management assessed the effectiveness of the company’s internal control over financial reporting as of December 31, 2013, as required by Section 404 of the Sarbanes Oxley Act of 2002. Management’s assessment was based on the criteria established in the Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission and was designed to provide reasonable assurance that the company maintained effective internal control over financial reporting as of December 31, 2013. The assessment led management to conclude that, as of December 31, 2013, the company’s internal control over financial reporting was effective based on those criteria.
The company’s independent registered public accounting firm has issued an audit report on our internal control over financial reporting as of December 31, 2013.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
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, 2013 and 2012 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such 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. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on the criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Net income per common share is based on the weighted average number of common shares outstanding during each of the respective years. We calculate net income per common share (diluted) assuming the exercise of share-based awards.
A segment premium deficiency is recorded when the sum of expected loss and loss adjustment expenses, expected policyholder dividends and unamortized deferred acquisition expenses exceeds the total of unearned premiums and anticipated investment income. A premium deficiency is first recognized by charging any unamortized acquisition costs to expense to the extent required to eliminate the deficiency. If the premium deficiency is greater than unamortized acquisition costs, a liability is accrued for the excess deficiency. We did not record a premium deficiency for the three years ended 2013, 2012 and 2011.
The consolidated property casualty companies actively write property casualty insurance through independent agencies in 39 states. Our 10 largest states generated 63.8 percent and 65.4 percent of total earned premiums in 2013 and 2012, respectively. Ohio, our largest state, accounted for 18.5 percent and 19.1 percent of total earned premiums in 2013 and 2012, respectively. Illinois, Indiana, Pennsylvania, Georgia, North Carolina and Michigan each accounted for between 4 percent and 8 percent of total earned premiums in 2013. Our largest single agency relationship accounted for approximately 0.8 percent of our total property casualty earned premiums in 2013. No aggregate agency relationship locations under a single ownership structure accounted for more than 2.1 percent of our total property casualty earned premiums in 2013.
Certain workers’ compensation policies include the possibility of a policyholder earning a return of a portion of its premium in the form of a policyholder dividend. The dividend generally is calculated by determining the profitability of a policy year along with the associated premium. We reserve for all probable future policyholder dividend payments. We record policyholder dividends as underwriting, acquisition and insurance expenses.
Long-duration contracts are written to provide coverage for an extended period of time. Traditional long-duration contracts require policyholders to pay scheduled gross premiums, generally not less frequently than annually, over the term of the coverage. Premiums for these contracts are recognized as revenue when due. Whole life insurance and disability income insurance are examples. Some traditional long-duration contracts have premium payment
periods shorter than the period over which coverage is provided. For these contracts, the excess of premium over the amount required to pay expenses and benefits is recognized over the term of the coverage rather than over the premium payment period. Ten-pay whole life insurance is an example.
related to separate accounts consist of contractual fees and mortality, surrender and expense risk charges. Also, each separate account BOLI includes a negotiated capital gain and loss sharing arrangement between the company and the bank. A percentage of each separate account’s realized capital gain and loss representing contract fees and assessments accrues to us and is transferred from the separate account to our general account and is recognized as revenue or expense.
Our portfolio investments are primarily in publicly traded fixed-maturity, equity and short-term investments. Fixed-maturity investments (taxable bonds, tax-exempt bonds, redeemable preferred stocks and commercial mortgage backed securities) and equity investments (common and nonredeemable preferred stocks) are classified as available for sale and recorded at fair value in the consolidated financial statements. The number of fixed-maturity securities with fair value below 100 percent of amortized cost can be expected to fluctuate as interest rates rise or fall. Because of our strong surplus and long-term investment horizon, our general intent is to hold fixed-maturity investments until maturity, regardless of short-term fluctuations in fair values.
We account for our investment portfolio at fair value and apply fair value measurements as defined by ASC 820, Fair Value Measurements and Disclosures, to financial instruments. Fair value is applicable to ASC 320, Investments-Debt and Equity Securities, and ASC 825, Financial Instruments.
ASC 820 defines fair value as the exit price or the amount that would be (1) received to sell an asset or (2) paid to transfer a liability in an orderly transaction between marketplace participants at the measurement date. When determining an exit price, we rely upon observable market data whenever possible. We primarily base fair value for investments in equity and fixed-maturity securities (including redeemable preferred stock and assets held in separate accounts) on quoted market prices or on prices from a pricing vendor, an outside resource that supplies global securities pricing, dividend, corporate action and descriptive information to support fund pricing, securities operations, research and portfolio management. The company obtains and reviews the pricing service’s valuation methodologies and related inputs and validates these prices by replicating a sample across each asset class using a discounted cash flow model. When a price is not available from these sources, as in the case of securities that are not publicly traded, we determine the fair value using various inputs including quotes from independent brokers. The fair value of investments not priced by a pricing vendor is less than 1 percent of the fair value of our total investment portfolio.
We record land at cost, and record building and equipment at cost less accumulated depreciation. Equipment held under capital leases also is classified as property and equipment with the related lease obligations recorded as liabilities. We capitalize and amortize costs for internally developed computer software during the application development stage. These costs generally consist of external consulting, payroll and payroll-related costs. Our depreciation is based on estimated useful lives (ranging from three years to 39.5 years ) using straight-line and accelerated methods. Depreciation expense was $37 million in 2013, $37 million in 2012, and $46 million in 2011. We monitor land, building and equipment and software assets for potential impairments. Potential impairments may include a significant decrease in the fair values of the assets, considerable cost overruns on projects, a change in legal factors or business climate or other factors that indicate that the carrying amount may not be recoverable or useful. There were no recorded land, building and equipment impairments for 2013, 2012 or 2011.
numerous temporary differences between our taxable income and financial statement income and other changes in shareholders’ equity. Such temporary differences relate primarily to unrealized gains and losses on investments and differences in the recognition of deferred acquisition costs, unearned premium and insurance reserves. We charge deferred income taxes associated with balances that impact other comprehensive income, such as unrealized appreciation and depreciation of investments (except the amounts related to the effect of income tax rate changes), to shareholders’ equity in AOCI. We charge deferred taxes associated with other differences to income.
See Note 11, Income Taxes for further detail on our uncertain tax positions. Although no Internal Revenue Service (IRS) penalties currently are accrued, if incurred, they would be recognized as a component of income tax expense. Accrued IRS interest expense is recognized as other operating expense in the consolidated statements of income.
The following table provides cost or amortized cost, gross unrealized gains, gross unrealized losses and fair value for our invested assets:
The net unrealized investment gains in our fixed-maturity portfolio are primarily the result of the continued low interest rate environment that has increased the fair value of our fixed-maturity portfolio. The five largest net unrealized investment gains in our common stock portfolio are from Exxon Mobil Corporation (NYSE:XOM), The Procter & Gamble Company (NYSE:PG), Chevron Corporation (NYSE:CVX), Dover Corporation (NYSE:DOV), and Honeywell International Inc. (NYSE:HON), which had a combined net gain position of $452 million. We had
At December 31, 2013, fixed-maturity investments with amortized cost of $80 million and fair value of $84 million were on deposit with various states in compliance with regulatory requirements. At December 31, 2012, fixed-maturity investments with amortized cost of $85 million and fair value of $93 million were on deposit with various states in compliance with regulatory requirements.
During 2013, we other-than-temporarily impaired seven securities. At December 31, 2013, 40 fixed-maturity investments with a total unrealized loss of $5 million had been in an unrealized loss position for 12 months or more. Of that total, no fixed-maturity investments had fair values below 70 percent of amortized cost. There were no equity investments in an unrealized loss position for 12 months or more as of December 31, 2013.
During 2011, we other-than-temporarily impaired 12 securities. At December 31, 2011, 20 fixed-maturity investments with a total unrealized loss of $5 million had been in an unrealized loss position for 12 months or more. Of that total, no fixed-maturity investments had fair values below 70 percent of amortized cost. Two equity investments with a total unrealized loss of less than $1 million had been in an unrealized loss position for 12 months or more as of December 31, 2011. Of that total, no equity investments were trading below 70 percent of cost.
When determining OTTI charges for our fixed-maturity portfolio, management places significant emphasis on whether issuers of debt are current on contractual payments and whether future contractual amounts are likely to be paid. As required by ASC 320, our invested asset impairment policy for fixed-maturity securities states that OTTI is considered to have occurred (1) if we intend to sell the impaired fixed-maturity security or (2) if it is more likely than not we will be required to sell the impaired fixed-maturity security before recovery of its amortized cost basis. If we intend to sell or it is more likely than not we will be required to sell, the amortized cost of any such securities is reduced to fair value as the new cost basis, and a realized loss is recorded in the period in which it is recognized. When we believe that full collection of interest and/or principal is not likely, we determine the net present value of future cash flows by using the effective interest rate implicit in the security at the date of acquisition as the discount rate and compare that amount to the amortized cost and fair value of the security. The difference between the net present value of the expected future cash flows and amortized cost of the security is considered a credit loss and recognized as a realized loss in the period in which it occurred. The difference between the fair value and the net present value of the cash flows of the security, the noncredit loss, is recognized in other comprehensive income as an unrealized loss.
For each of our equity securities in an unrealized loss position at December 31, 2013, we applied the objective qualitative and quantitative criteria of our invested asset impairment policy for OTTI. Our long-term equity investment philosophy, emphasizing companies with strong indications of paying and growing dividends, combined with our strong surplus, liquidity and cash flow, supports our ability to hold these investments to recovery. Based on the individual qualitative and quantitative factors, as discussed above, we evaluate and determine an expected recovery period for each security. A change in the condition of a security can warrant an OTTI charge before the expected recovery period. If the security has not recovered cost within the expected recovery period, the security is other-than-temporarily impaired.
Quotes from brokers or other external sources where the inputs are not deemed observable.
The Level 2 nonredeemable preferred equities technique used is the application of matrix pricing. The inputs used, similar to those used by the pricing vendor for our fixed-maturity securities, include relevant market information, trade activity of like securities, yield to maturity, corporate action notices and economic events. All of the Level 2 nonredeemable preferred equities are priced by a nationally recognized pricing vendor.
We use actuarial methods, models and judgment to estimate, as of a financial statement date, the property casualty loss and loss expense reserves required to pay for and settle all outstanding insured claims, including incurred but not reported (IBNR) claims, as of that date. The actuarial estimate is subject to review and adjustment by an
During 2012, we experienced $396 million of favorable development on prior accident years including $292 million of favorable development in commercial lines. Favorable development in 2012 was $111 million more than in 2011, in part due to $39 million for catastrophe losses. Overall favorable development for commercial lines reserves illustrated the potential for revisions inherent in estimating reserves, especially for long-tail lines such as commercial casualty and workers’ compensation. We recognized favorable reserve development of $177 million for the commercial casualty line, $74 million for the workers’ compensation line and $52 million for the homeowner line due to reduced uncertainty of these lines one year later.
We carried $77 million of net loss and loss expense reserves for asbestos and environmental claims and
$51 million of reserves for mold claims at December 31, 2013, compared with $67 million and $54 million, respectively, at December 31, 2012. The asbestos and environmental claims amounts for each respective year constituted 1.9 percent and 1.8 percent of total net loss and loss expense reserves at these year-end dates.
The change in amortized shadow deferred policy acquisition costs in 2013 compared to 2012 was the result of rising interest rates. No premium deficiencies were recorded in the consolidated statements of income, as the sum of the anticipated loss and loss adjustment expenses, policyholder dividends and unamortized deferred acquisition expenses did not exceed the related unearned premiums and anticipated investment income.
retention are affected by various factors, including changes in our underwriting practices, capacity to retain risks and reinsurance market conditions.
Our consolidated statements of income include life insurance contract policyholders’ benefits incurred on ceded business:
The provision for federal income taxes is based upon filing a consolidated income tax return for the company and its subsidiaries. As of December 31, 2013, we had no operating or capital loss carry forwards. The change in our effective tax rate was primarily due to changes in pretax income from underwriting results and realized investment gains and losses, with unchanged levels of permanent book-tax differences.
The statute of limitations for federal and state income tax purposes have closed for tax years 2008 and earlier. In November, 2011, the IRS began its audit of tax years 2009 and 2010. In December 2012, the IRS Exam Team completed its phase of the audit with no material changes to the returns as filed. As is standard practice whenever large refunds are received, the Joint Committee on Taxation in Washington DC reviewed the 2009 and 2010 IRS audit and completed its review in September of 2013. Although the Joint Committee had no changes to the audit, our exam for tax year 2009 will remain open until the IRS completes its review of a limited partnership we hold as an investment. We expect no material changes as a result of this limited partnership audit. Federal statutes for tax year 2009 will expire in August 2014.
Income taxes paid in our Consolidated Statements of Cash Flows are shown net of refunds received of less than $1 million, $11 million and $2 million for 2013, 2012 and 2011, respectively.
We also sponsor a defined contribution plan (401(k) plan). Matching contributions totaled $10 million, $9 million and $8 million during the years 2013, 2012 and 2011, respectively. Associates who are not accruing benefits under the pension plan are eligible to receive the company match of up to 6 percent of cash compensation. We also pay all operating expenses for the 401(k) plan. Participants vest in the company match for the 401(k) plan after three years of eligible service.
We maintain a supplemental executive retirement plan (SERP) with a benefit obligation of $9 million at both
We evaluate our pension plan assumptions annually and update them as necessary. This is a summary of the weighted-average assumptions used to determine our benefit obligations at December 31 for the plans:
To determine the discount rate for each plan, a hypothetical diversified portfolio of actual domestic Aa rated bonds was chosen to provide payments approximately matching the plan’s expected benefit payments. A single interest rate for each plan was determined based on the anticipated yield of the constructed portfolio. Based on this analysis, we increased the rate from the prior year by 0.95 percentage points for the qualified pension plan and by 0.85 percentage points for the SERP due to market interest rate conditions at year-end 2013. Compensation increase assumptions reflect anticipated rates of inflation, real return on wage growth and merit and promotional increases.
The discount rate was decreased by 0.90 percentage points for the qualified pension plan and 0.80 percentage points for the SERP due to market interest rate conditions at the beginning of 2013. The discount rate assumptions for our benefit obligation generally track with high grade corporate bond yields chosen in our hypothetical portfolio, and yearly adjustments reflect any changes to those bond yields. We believe the expected return on plan assets is representative of the expected long-term rate of return on these assets which is consistent with 2013 expectations of interest rates and based partially on the fact that the plan’s common stock holdings pay dividends. We believe this rate is representative of the expected long-term rate of return on these plan assets. We review historical actual return on plan assets when determining our expected long-term rate of return. Total portfolio return for 2013 was 24.0 percent. Our compensation increase assumptions in 2013 reflect anticipated rates of inflation, real return on wage growth and merit and promotional increases.
Benefit obligation activity using an actuarial measurement date for our qualified plan and SERP at December 31 follows:
A reconciliation follows of the funded status for our qualified plan and SERP at the end of the measurement period to the amounts recognized in the consolidated balance sheets at December 31:
The change in the amount recognized in other comprehensive income is largely due to the increase in discount rate and corresponding increases in assumed lump sum rates.
The total recognized in net periodic benefit cost and other comprehensive income was a net benefit of $63 million for the year ended December 31, 2013. We recognized $31 million and $38 million in net periodic benefit cost and other comprehensive income for the years ended December 31, 2012 and 2011, respectively. The change in the amount recognized in other comprehensive income from 2012 is largely due to increases in discount and lump sum rates and a greater than anticipated return on plan assets. The estimated costs to be amortized from AOCI into net periodic benefit cost over the next year for our plans are a $2 million actuarial loss and less than $1 million in prior service cost.
at December 31, 2013 and 2012. Excluded from the table below is cash on hand of $19 million and $3 million at December 31, 2013 and 2012.
We contributed $5 million to our qualified plan during the first quarter of 2014 and expect to pay out $2 million of benefit payments from the SERP during 2014. We expect to make the following benefit payments for our qualified plan and SERP, reflecting expected future service:
Insurance companies’ financial statements are presented on the basis of accounting practices prescribed or permitted by applicable state insurance departments of domicile. Insurance companies use statutory accounting practices (SAP) as recognized by various states. We have adopted the National Association of Insurance Commissioners’ (NAIC) Accounting Practices and Procedures manual, version effective January 1, 2001, and updates through the current year as a component of prescribed or permitted practices by laws of the state of domicile. The primary differences between SAP and GAAP include the valuation of unrealized investment gains and losses, expensing of policy acquisition costs, actuarial assumptions for life insurance reserves and deferred income taxes based on differences in statutory and taxable income.
Share-based compensation cost after tax was $12 million, $11 million and $9 million for the years ended
Stock options are granted to associates at an exercise price that is equal to the fair value as determined by the average high and low sales price reported on the Nasdaq Global Select Market for the grant date and are exercisable over 10-year periods. The stock options generally vest ratably over a three-year period. In determining the share-based compensation amounts, we estimate the fair value of each option granted on the date of grant using a binomial option-pricing model. We make the following assumptions to develop the binomial option-pricing model as follows:
During 2013, we renamed the line of business surety and executive risk in the commercial segment to management liability and surety.
Our investment operations’ revenues consist of pretax net investment income and realized investment gains and losses.
Identifiable assets are used by each segment in its operations. We do not separately report the identifiable assets for the commercial, personal or excess and surplus lines segments because we do not use that measure to analyze the segments. We include all investment assets, regardless of ownership, in the investment operations segment.
Revenues including realized investment gains and losses, which are integral to our financial results over the long term, may cause this value to fluctuate substantially because we have substantial discretion in the timing of investment sales. Also, applicable accounting standards require us to recognize gains and losses from certain changes in fair values of securities and embedded derivatives without actual realization of those gains and losses. We discuss realized investment gains for the past three years in Item 7, Investments Results of Operations, Page 79.