1Refer to the Glossary of Terms attached to this Form 10-K as Exhibit 99.1 for definitions of terms used in these financial highlights.
2Effective January 1, 2018, changes in unrealized gains and losses on our equity portfolio are recognized in income through "Net unrealized losses on equity securities" on our Consolidated Statements of Income, as a result of our adoption of the Financial Accounting Standards Board issued Accounting Standards Update 2016-01, Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities.
Our Standard Commercial Lines and Standard Personal Lines products and services are written through our nine insurance subsidiaries, some of which write flood business through the federal government's National Flood Insurance Program's ("NFIP") Write Your Own Program ("WYO"). Our Excess and Surplus ("E&S") Lines products and services are written through one subsidiary, Mesa Underwriters Specialty Insurance Company ("MUSIC"). This subsidiary provides us with a nationally-authorized non-admitted platform to offer insurance products and services to customers who generally cannot obtain coverage in the standard marketplace.
We have identified the policies and estimates described below as critical to our business operations and the understanding of the results of our operations. Our preparation of the consolidated financial statements ("Financial Statements") requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our Financial Statements, and the reported amounts of revenue and expenses during the reporting period. We can offer no assurance that actual results will be the same as those estimates, and it is possible they will differ materially. Those estimates that were most critical to the preparation of the Financial Statements involved the following: (i) reserves for loss and loss expense; (ii) pension and post-retirement benefit plan actuarial assumptions; (iii) investment valuation and other-than-temporary-impairments (“OTTI”); and (iv) reinsurance.
Significant periods of time can elapse between the occurrence of an insured loss, the reporting of the loss to us, and our payment of that loss. To recognize liabilities for unpaid loss and loss expense, insurers establish reserves as balance sheet liabilities representing an estimate of amounts needed to pay reported and unreported net loss and loss expense. At December 31, 2019, we had recorded $4.1 billion of gross loss and loss expense reserves and $3.5 billion of net loss and loss expense reserves. At December 31, 2018, these gross and net reserves were $3.9 billion and $3.4 billion, respectively. The Insurance Subsidiaries' liability duration was approximately 3.6 years at both December 31, 2019 and December 31, 2018.
The following tables provide case and incurred but not reported (“IBNR”) reserves for loss and loss expenses, and reinsurance recoverable on unpaid loss and loss expense as of December 31, 2019 and 2018:
Reserves for loss and loss expense are comprised of both case reserves on individual claims and reserves for claims incurred but not reported ("IBNR"). Case reserves result from claims that have been reported to one or more of our Insurance Subsidiaries, and are estimated based on the facts and circumstances known at that time. IBNR reserves are established at more aggregated levels than case basis reserves, and include provisions for (i) claims not yet reported, (ii) claims that have been reported, but current case reserves are not sufficient, (iii) claims that will be reopened in the future, and (iv) anticipated salvage and subrogation received.
At its inception, the current accident year’s reserves are recorded based upon the actuarial expectation for the ultimate loss and loss expense ratios. This approach reflects that, at inception, there is no actual loss data from which to project estimates.
While these methods work effectively for prior accident years, they are less effective for the current accident year, which often has limited actual reported data from which to project. Therefore, the current accident year’s estimate is heavily dependent upon the loss and loss expense ratios that result from our detailed actuarial planning process. This process uses historical experience, adjusted for pricing changes, loss and loss expense trends, along with anticipated underwriting and claims improvements, to estimate ultimate loss and loss expense ratios for the current accident year. At the outset of the year, these estimates serve as the basis for establishing our reserves. As the year progresses, these projections are updated with actual price changes and updated loss trends to evaluate the original current accident year loss and loss expense ratios. Actual experience is also considered, including aggregate paid and incurred losses, and incurred claims counts and severities, when evaluating these loss and loss expense ratios. Where deemed appropriate, adjustments are made to the current accident year selected ultimate loss and loss expenses.
The result of the reserve review is a set of ultimate loss and loss expense estimates by line of business, including the current and prior accident years. While this serves as the primary basis for determining the recorded IBNR reserves, other internal and external factors are considered. Internal factors include (i) changes to our underwriting and claims practice, (ii) supplemental data regarding claims reporting and settlement trends, (iii) exposure estimates for reported claims, along with recent development on those estimates with respect to individual large claims and the aggregate of all claims, (iv) the rate at which new large or complex claims are being reported, and (v) additional trends observed by claims personnel or reported to them by defense counsel. External factors considered include (i) legislative enactments, (ii) judicial decisions, (iii) social inflation and heightened awareness of sources of liability, and (iv) trends in general economic conditions, including the effects of inflation.
After giving consideration to the items described above, management’s judgment is applied in determining any required IBNR adjustments, which are then established and recorded.
Our loss and loss expense reserves are estimates of future events, the outcomes of which are not yet known. It is possible that actual outcomes will differ materially from the provisions established. While this risk cannot be eliminated, we review our indicated reserves quarterly and make adjustments to IBNR based on information available at that time. These changes in our IBNR estimates are reflected in the Consolidated Statements of Income for the period in which such estimates are changed. Any changes in the liability estimate may be material to the results of operations in future periods.
We have estimated a range of reasonably possible reserve estimates for net loss and loss expense claims of $3,156 million to $3,737 million at December 31, 2019 . This range reflects low and high reasonable reserve estimates determined by judgmentally adjusting the methods, factors and assumptions selected within the internal reserve review. This approach produces a range of reasonable reserve estimates, as opposed to a distribution of all possible outcomes. Therefore, it is possible that the final outcomes may fall above or below these amounts. The range does not include a provision for potential increases or decreases associated with asbestos, environmental, certain other continuous exposure claims, and other latent exposures, as traditional actuarial techniques cannot be effectively applied.
The Insurance Subsidiaries are multi-state, multi-line property and casualty insurance companies and, as such, are subject to reserve uncertainty stemming from a variety of sources. These uncertainties are considered at each step in the process of establishing loss and loss expense reserves. As market conditions change, certain developments may occur that increase or decrease the amount of uncertainty. These developments include impacts within our own paid and reported loss and loss expense experience, as well as other internal and external factors that have not yet manifested within our data, but may do so in the future. All of these developments are considered when establishing loss and loss expense reserves, and in estimating the range of reasonable reserve estimates.
During 2018, this line experienced favorable development of $9.5 million, attributable to lower than expected loss expenses in accident years 2013 through 2017. The favorable loss expense emergence was partially offset by higher than expected loss emergence in accident years 2016 and 2017.
While we believe the underwriting and claims operational changes improved our underwriting experience, there is always risk associated with change. Most notably, changes in operations, as well as potentially significant medical inflation, may inherently change paid and reported development patterns. While our reserve analyses incorporate methods that adjust for these changes, there remains a greater risk of fluctuation in the estimated reserves.
In addition to the uncertainties associated with our actuarial assumptions and methodologies, the workers compensation line of business can be impacted by a variety of issues, such as the following:
Changes in utilization of the workers compensation system - These changes may be driven by economic, legislative, or other changes, such as increased use of pharmaceuticals, more complex medical procedures, changes in the life expectancy of permanently-injured workers, and availability of health insurance, among others. Also, lower levels of unemployment may cause the hiring of less skilled workers who may experience higher loss frequencies.
Audit premium and endorsement premium may also introduce uncertainty into our reserves, as earned premiums are used as a basis to set initial reserves. Over recent years, this activity has been fairly consistent. Audit and endorsement activity resulted in additional DPW of $15.9 million in 2019 and $12.1 million in 2018.
At December 31, 2019, our commercial automobile line of business had recorded reserves, net of reinsurance, of $610 million, which represented 17% of our total net reserves. In 2019, this line experienced no material prior year reserve development.
Taking meaningful rate and underwriting actions on our renewal portfolio. We will continue to leverage our predictive modeling and analytical capabilities to provide more granular insights as to where best to focus our actions.
Reducing premium leakage by improving the quality of our rating information. This includes validating application information using third-party data and obtaining more detailed driver information.
We also are investing in technologies that help us enhance the overall customer experience and improve our retention rates and hit ratios over time, such as our "Selective® Drive" program that was introduced to our commercial automobile policyholders in
Over the course of late 2015 and early 2016, our E&S casualty lines claims handling function was aligned with our standard operations claims function. E&S casualty lines claims were migrated from the business unit in Scottsdale, Arizona to the appropriate regional claims operation. Complex claims are referred to the corporate Complex Claims Unit ("CCU") for specialized handling.
We believe that the actions above are resulting in earlier identification of severe claims and earlier claims resolutions with improved outcomes. However, changes in claims operations can result in changes to claims reserving and settlement patterns. Once claims initiatives are implemented, it takes time for patterns to stabilize, and in the near term, these operational changes increase the uncertainty in reserve estimates.
Our internal reserve analyses incorporate certain actuarial projection methods that make adjustments for changes in case reserve adequacy and claims settlement rates. These methods adjust our historical loss experience to the current level of case adequacy or settlement rate, which provides a more consistent basis for projecting future development patterns. These methods have their own assumptions and judgments associated with them, therefore, as with any projection method, they are not definitive in and of themselves. Further, our various claims initiatives may prove more or less beneficial than currently reflected, which will affect development in future years. Our various projection methods provide an indication of these potential future impacts. These impacts would be greatest within our larger reserve lines of workers compensation, general liability, and commercial automobile liability, within the more recent accident years.
The sensitivities of loss and loss expense reserves to these key assumptions are illustrated below for the major casualty lines. The first table shows the estimated impacts from changes in expected reported loss and loss expense development patterns. It shows reserve impacts by line of business if the actual calendar year incurred amounts are greater or less than current expectations by the selected percentages. While the selected percentages by line are judgmental, they are based on the reserve range analysis and the actual historical reserve development for the line of business. The second table shows the estimated impacts from changes to the expected loss and loss expense ratios for the current accident year. It shows reserve impacts by line of business if the expected loss and loss expense ratios for the current accident year are greater or less than current expectations by the selected percentages.
Note that there is some overlap between the impacts in the two tables. For example, increases in the calendar year development would ultimately impact our view of the current accident year's loss and loss expense ratios. However, these tables provide perspective into the sensitivity of each of these key assumptions. While the changes above represent outcomes based on reasonably likely changes to our underlying reserving assumptions, they do not represent a full range of possible outcomes. It is possible that our reserves could increase or decrease significantly more than or less than what is reflected in the tables above.
The total recorded net loss and loss expense reserves for these claims were $21.6 million as of December 31, 2019 and $22.8 million as of December 31, 2018. The emergence of these claims occurs over an extended period and is highly unpredictable. For example, within our Standard Commercial Lines book, certain landfill sites are included on the National Priorities List (“NPL”) by the United States Environmental Protection Agency (“USEPA”). Once on the NPL, the USEPA determines an appropriate remediation plan for these sites. A landfill can remain on the NPL for many years until final approval for the removal of the site is granted from the USEPA. The USEPA has the authority to re-open previously-closed sites and return them to the NPL. We currently have reserves for six customers related to three sites on the NPL.
“Asbestos claims” are claims for bodily injury alleged to have occurred from exposure to asbestos-containing products. Our primary exposure arises from insuring various distributors of asbestos-containing products, such as electrical and plumbing materials. At December 31, 2019, asbestos claims constituted 23% of our $21.6 million net asbestos and environmental reserves, compared to 27% of our $22.8 million net asbestos and environmental reserves at December 31, 2018.
Estimating IBNR reserves for asbestos and environmental claims is difficult because of the delayed and inconsistent reporting patterns associated with these claims. In addition, there are significant uncertainties associated with estimating critical assumptions, such as average clean-up costs, third-party costs, potentially responsible party shares, allocation of damages, litigation and coverage costs, and potential state and federal legislative changes. Normal historically-based actuarial approaches cannot be applied to asbestos and environmental claims because past loss history is not indicative of future potential loss emergence. In addition, while certain alternative models can be applied, such models can produce significantly different results with small changes in assumptions. As a result, we do not calculate an asbestos and environmental loss range.
Historically, our asbestos and environmental claims have been significantly lower in volume, with less volatility and uncertainty than many of our competitors in the Standard Commercial Lines industry. Prior to the introduction of the absolute pollution exclusion endorsement in the mid-1980's, we primarily wrote Standard Personal Lines, and therefore, our exposure to asbestos and environmental claims has been limited.
In addition to asbestos and environmental reserves, we also have exposure to other latent and continuous trigger exposures in our ongoing portfolio. Examples include construction defect claims and abuse and molestation coverage for which states have expanded the statute of limitations. We manage our exposure to these liabilities through our underwriting and claims practices. Similar to asbestos and environmental claims, these claims are handled by a dedicated claims unit. The impact of social, political, and legal trends remains highly uncertain, and as a result, our loss and loss expense reserves on these claims remain highly uncertain.
Our pension and post-retirement benefit obligations and related costs are calculated using actuarial methods, within the framework of U.S. generally accepted accounting principles ("GAAP"). Two key assumptions, the discount rate and the expected return on plan assets, are important elements of expense and liability measurement. We evaluate these key assumptions annually. Other assumptions involve demographic factors, such as retirement age and mortality.
, Our pension and post-retirement benefit plan obligation was $408.5 million at December 31, 2019 and $350.0 million at December 31, 2018. Plan assets were $385.1 million at December 31, 2019 and $331.7 million at December 31, 2018. Volatility in the marketplace, coupled with changes in the discount rate assumption, could materially impact our pension and post-retirement life valuation in the future. For additional information regarding our pension and post-retirement benefit plan obligations, see Note 14. “Retirement Plans” in Item 8. “Financial Statements and Supplementary Data.” of this Form 10-K.
marketplace, typically using matrix pricing. The fair value of our Level 2 securities are determined by external pricing services. We have evaluated the pricing methodology used for these Level 2 prices and have determined that the inputs used are observable. For additional information regarding the valuation techniques used, refer to item (d) of Note 2. "Summary of Significant Accounting Policies" within Item 8. "Financial Statements and Supplementary Data." of this Annual Report.
Less than 1% of our investment portfolio is classified as Level 3 in the fair value hierarchy. Fair value measurements in Level 3 are based on unobservable market inputs because the related securities are not traded on a public market. For additional information regarding the valuation techniques used for our Level 3 securities, refer to item (d) of Note 2. "Summary of Significant Accounting Policies" within Item 8. "Financial Statements and Supplementary Data." of this Annual Report.
2Non-GAAP operating income is used as an important financial measure by us, analysts, and investors, because the realization of net investment gains and losses on sales of securities in any given period is largely discretionary as to timing. In addition, these net realized investment gains and losses, as well as OTTI that are charged to earnings, unrealized gains and losses on equity securities, the deferred tax asset charge that was recognized in 2017 in relation to the Tax Cuts and Jobs Act of 2017 ("Tax Reform"), and debt retirement costs could distort the analysis of trends.
Reconciliations of net income, net income per diluted share, and ROE to non-GAAP operating income, non-GAAP operating income per diluted share, and non-GAAP operating ROE, respectively, are provided in the tables below:
We generated 21% growth in book value per share in 2019 compared to 2018. In 2019, the strong growth in book value per share was driven by net income and the after-tax net unrealized gains on our fixed income securities portfolio, partially offset by dividends paid to shareholders.
Our insurance segments delivered profitable results in 2019, contributing to a combined ROE in the year of 6.5%. The 2019 ROE increased 1.0 point compared to 2018, reflecting a 1.3-point improvement in our combined ratio. The improvement was principally driven by (i) lower levels of non-catastrophe property loss and loss expenses and catastrophe property losses, and (ii) higher levels of favorable prior year casualty reserve development. These improvements were partially offset by a higher expense ratio of 0.6 points, which reflected a 0.5-point increase in profit-based expenses to our employees and compensation to our distribution partners.
Our 2019 results continued to reflect our efforts to: (i) achieve overall renewal pure price increases (3.6%) that were in line with expected loss trend; (ii) generate new business; and (iii) improve the underlying profitability of our business through various underwriting and claims initiatives. We continue to execute on our strategy for disciplined NPW growth, with 7% growth in 2019 compared to 2018. The growth in 2019 was primarily due to strong retention and new business growth, mainly in our Standard Commercial Lines. Our growth in 2019 was aided by the net appointment of about 80 retail agents, excluding agency consolidations.
The loss and loss expense ratio decreased 1.8 points in 2019, compared to the same prior year period, driven by the following:
For qualitative discussions regarding reserve development, refer to the insurance segment sections below in "Results of Operations and Related Information by Segment."
Net investment income, after tax, grew 13% in 2019 compared to 2018, principally driven by: (i) strong cash flow from operations that was 18% of NPW; (ii) $106 million in net proceeds from our 5.375% Senior Notes issuance on March 1, 2019; and (iii) active portfolio management. Net investment income, after tax, contributed 9.1 percentage points to ROE in 2019, compared to 9.2 points in 2018.
Net realized and unrealized gains and losses increased ROE by 0.5 points in 2019, compared to a reduction of 2.3 points in 2018. The improvement of 2.8 points was primarily driven by the sales of securities within our investment portfolio in 2019. In 2019, we sold a significant portion of our public equity securities, generating $24.8 million of realized gains, compared to sales of certain fixed income securities in 2018 that resulted in losses.
We ended 2019 with record levels of GAAP equity, holding company cash and invested assets, statutory surplus, and strong financial results, which reflects our capital management and disciplined execution within our underwriting and investment functions. In the first quarter of 2019, we executed our first institutional public debt offering with the issuance of $300 million aggregate principal amount of 5.375% Senior Notes.
For 2020, we have established a non-GAAP operating ROE target of 11% based on our current estimated weighted average cost of capital, the current interest rate environment, and property and casualty insurance market conditions. The reduction in our non-GAAP operating ROE target from 12% in 2019, to 11% in 2020, principally reflects a reduction in our weighted average cost of capital and the lower interest rate environment, which has put pressure on investment yields and increased our stockholders' equity.
Actively managing the investment portfolio to minimize the impact of lower interest rates on after-tax yields while managing credit, duration, and liquidity risk.
Continuing to achieve written renewal pure price increases that meet or exceed expected loss trend.
Overall, we remain extremely pleased with our financial and strategic position heading into 2020. We will maintain a steadfast focus on underwriting discipline as we execute on our various strategies to generate profitable growth. The investments we are making today in our franchise distribution model, sophisticated underwriting tools and technology, and overall customer experience in an omni-channel environment, will position us as a leader in the coming years.
After-tax net investment income of $185 million, which includes $14 million after-tax net investment income from our alternative investments;
An overall effective tax rate of approximately 19.5%, which also includes an effective tax rate of 18.5% for net investment income, reflecting a tax rate of 5.25% for tax-advantaged municipal bonds, and a tax rate of 21% for all other items; and
Weighted average shares outstanding of 60.5 million on a diluted basis.
NPW growth in this segment of our business has reflected: (i) renewal pure price increases; (ii) new business growth; and (iii) stable retention. Quantitative information on these drivers is as follows:
For quantitative information on the prior year development by line of business, see "Financial Highlights of Results for Years Ended December 2019, 2018, and 2017" above and for qualitative information about the significant drivers of this development, see the line of business discussions below.
Our underwriting expense ratio increased by 0.5 points in 2019 compared to 2018, primarily driven by an increase in profit-based expenses to our employees and compensation to our distribution partners.
NPW growth in 2019 compared to 2018 was primarily due to direct new business as outlined in the table above, coupled with strong retention and renewal pure price increases.
The combined ratio increased by 1.0 points in 2019, driven principally by lower favorable prior year casualty reserve development compared to 2018, as outlined in the table below.
The increases in NPW shown in the table above reflect renewal pure price increases on this line, coupled with an increase in
new business as we continue to write commercial automobile policies as part of our overall customer accounts. The growth in
While the prior year casualty reserve development in 2019 was relatively minor, in 2018 we had unfavorable prior year casualty reserve development of 7.6 points, which was driven primarily by increases in frequencies and severities in accident years 2015 through 2017.
NPW decreased slightly in 2019 compared to 2018, driven by renewal pure price decreases, partially offset by an increase in policy counts and stable retention as shown in the table above.
The 3.8-point increase in the combined ratio in 2019 compared to 2018 was primarily attributable to lower favorable prior year reserve development of 4.3 points. The favorable reserve development for both periods was due to continued favorable medical severity trends impacting accident years 2017 and prior. Due to the length of time that injured workers receive medical treatment, decreases in medical inflation can cause favorable loss development across an extended number of accident years.
margins do not support the continued negative pricing levels that are being set by the National Council on Compensation
the potential to significantly increase this line's combined ratio, which we are monitoring closely.
NPW declined in 2019 compared to 2018, reflecting the impact of a decrease in direct new business as a result of a competitive marketplace. Retention decreased in 2019 compared to 2018, as we continue to achieve renewal pure price increases on our personal automobile line of business in excess of loss trends, while the industry has seen softening in rate activity. Additionally, the deteriorating competitive position on our automobile business has led to lower new homeowners business, as we typically write policies at the account level, which include both automobile and homeowners coverage.
The underwriting expense ratio increased 0.8 points in 2019 compared to 2018, reflecting an increase in profit-based expenses to our employees and distribution partners, driven by our strong overall insurance segments' underwriting results.
The loss and loss expense ratio improvement in 2019 compared to 2018 was primarily attributable to a decrease in property losses and lower unfavorable prior year casualty reserve development. These were partially offset by an increase in current year loss costs of 2.3 points.
The primary purposes of the reinsurance pooling agreement among our Insurance Subsidiaries are the following:
We have reinsurance contracts that separately cover our property and casualty insurance business. Our reinsurance protection can be segregated into the following key categories:
We use the results of a third-party vendor model and proprietary analysis in our review of exposure to hurricane risk. The third-party vendor model provides a long-term view that closely relates modeled event frequency to historical hurricane activity and is adjusted to reflect assumptions for certain un-modeled costs, such as the impact of loss expenses, residual market assessments, and automobile-related losses. We believe that modeled estimates provide a range of potential outcomes and we review multiple estimates for purposes of understanding our catastrophic risk.
1Gross losses include secondary uncertainty, demand and storm surge, and assumptions for certain un-modeled costs, such as the impact of loss expenses, residual market assessments, and automobile-related losses, which collectively increase our gross losses by approximately 13%.
Our current catastrophe reinsurance program exhausts at approximately 1 in 217 year return period, or events with 0.5% probability, based on a multi-model view of hurricane risk. Our actual gross and net losses incurred from U.S. landfalling hurricanes will vary, perhaps materially, from our estimated modeled losses.
The property excess of loss treaty, which covers both our standard market and E&S business, was renewed on July 1, 2019 with the top layer renewed on January 1, 2020. The major terms of these treaties are consistent with the prior year.
In addition, our $35 million above $5 million retention treaty that responds on per occurrence basis covers 85% of losses outside of our standard lines original 22-state footprint and has an annual aggregate limit of $30 million, net of the Insurance Subsidiaries' co-participation. This layer was purchased primarily to protect the growth of our E&S property book but also provides coverage for our Standard Lines expansion states.
All NBCR losses are excluded regardless of whether or not they are certified under TRIPRA. For non-NBCR losses, the treaty distinguishes between acts committed on behalf of foreign persons or foreign interests ("Foreign Terrorism") and those that are not. The treaty provides annual aggregate limits for Foreign Terrorism (other than NBCR) acts of $24 million for the first layer and $60 million for the second layer and for the third layer $40 million. Non-foreign terrorism losses (other than NBCR) are covered to the same extent as non-terrorism losses.
The casualty excess of loss treaty, which covers both our standard market and E&S Lines business, was renewed on July 1, 2019 and is effective through June 30, 2020, with substantially the same terms as the expiring treaty.
All NBCR losses are excluded. All other losses stemming from the acts of terrorism are subject to the following:
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgment. The communication of critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Evaluating the Company’s actuarial techniques by comparing them to generally accepted actuarial techniques;
Developing an independent estimate of reserves for certain lines of business using generally accepted actuarial techniques;
For other lines of business, assessing the Company's internal actuarial analysis by inspecting the assumptions and actuarial techniques used;
•Assessing any movement of the Company’s recorded reserves within the independent consolidated range of reserves.
Corporate securities, which may include investment grade and below investment grade bonds, bank loan investments, redeemable preferred stock, and non-redeemable preferred stock with certain debt-like characteristics;
unrealized gains and losses on securities that were transferred into an HTM designation from an AFS designation, are also included in AOCI.
Short-term investments may include money market instruments, savings accounts, commercial paper, and fixed income securities purchased with a maturity of less than one year. We also enter into reverse repurchase agreements that are included in short-term investments. These repurchase agreements are fully collateralized by high-quality, readily-marketable instruments that support the principal amount. At maturity, we receive principal and interest income on these agreements. Short-term investments are generally recorded at cost, which approximates fair value.
Federal low income housing tax credits are accounted for under the proportional amortization method; and
Income related to federal tax credits (either low income housing tax credits or other federal credits) is recorded in our Consolidated Statements of Income as a component of “Federal income tax expense” proportionately over the life of the investment.
Realized gains and losses on the disposal of investment securities, which are determined on the basis of the cost of the specific investments sold;
The degree to which the issuer is current or in arrears in making principal and interest payments on the fixed income security;
To determine if an impairment is other than temporary, we perform assessments that may include, but are not limited to, a discounted cash flow analysis ("DCF") to determine the security's present value of future cash flows. This analysis is also performed on all previously-impaired debt securities that continue to be held by us and all RMBS, CMBS, CLOs and ABS that were not of high credit quality at the date of purchase. Any shortfall in the expected present value of the future cash flows, based on the DCF, from the amortized cost basis of a security is considered a “credit impairment,” with the remaining decline in fair value of a security considered a “non-credit impairment.” Credit impairments are charged to earnings as a component of realized losses, while non-credit impairments are recorded to other comprehensive income ("OCI") as a component of unrealized losses.
The discount rate used in a DCF is one of the following:
The current yield in effect at the reporting date to accrete the beneficial interest for RMBS, CMBS, CLO and other ABS that were not of high credit quality at acquisition;
The effective interest rate implicit in the security at the date of acquisition for all other securities.
A significant deterioration in the financial condition or liquidity of the Federal Home Loan Bank.
We estimate an allowance for uncollectible accounts on our premiums receivable. This allowance is based on historical write-off percentages adjusted for the effects of current trends. An account is charged off when we believe it is probable that we will not collect a receivable. In making this determination, we consider information obtained from our efforts to collect amounts due directly or through collection agencies.
Share-based compensation consists of all share-based payment transactions in which an entity acquires goods or services by issuing (or offering to issue) its shares, share units, share options, or other equity instruments. The cost resulting from all share-based payment transactions are recognized in the Financial Statements based on the fair value of both equity and liability awards. The fair value is measured at grant date for equity awards, whereas the fair value for liability awards are remeasured at each reporting period. The fair value of both equity and liability awards is recognized over the requisite service period. The requisite service period is typically the lesser of the vesting period or the period of time from the grant date to the date of retirement eligibility. The expense recognized for share-based awards, which, in some cases, contain performance criteria, is based on the number of shares or units expected to be issued at the end of the performance period. We repurchase the Parent’s stock from our employees in connection with tax withholding obligations, as permitted under our stock-based compensation plans. This activity is disclosed in our Consolidated Statements of Stockholders' Equity.
We recorded depreciation expense of $18.7 million, $19.5 million, and $17.8 million for 2019, 2018, and 2017, respectively.
Reserves for loss and loss expense are comprised of both case reserves on individual claims and reserves for claims incurred but not reported ("IBNR"). Case reserves result from claims that have been reported to one or more of our Insurance Subsidiaries, and are estimated at the amount of the expected ultimate payment. IBNR reserves are established at more aggregated levels than case basis reserves, and include: (i) reserves on IBNR claims; and (ii) provisions for future emergence
Certain types of exposures do not lend themselves to generally accepted actuarial techniques. Examples of these are:
Another example of exposures that do not lend themselves to generally accepted actuarial techniques relate to loss expenses that cannot be attributed to a specific claim (referred to as “unallocated loss expenses”). These expenses are first allocated to line of business, and alternative projection methods are then applied to estimate expenses by calendar year, which are then allocated back to the applicable accident years for reporting.
The selected ultimate loss and loss expenses are translated into indicated IBNR reserves, which are then compared to the recorded IBNR reserves, which are assessed in aggregate. Management's judgment is applied in determining any required adjustments to IBNR and the resulting adjustments are then recorded and assigned or allocated to accident year using the results of the actuarial analysis.
Loss reserves are estimates, and as such, we also consider a range of possible loss and loss expense reserve estimates. This range is determined at the beginning of each year, using prior year-end data, and reflects the fact that there is no single precise method for estimating the required reserves, due to the many factors that may influence the amounts ultimately paid. Considering the items described above, as well as current market conditions, IBNR estimates are then established and recorded.
We also write a small amount of assumed reinsurance. Currently, this business is limited to our share of certain involuntary pools. As the associated claims are not processed by us, they are not captured within our claims system. Therefore, the claim counts reported exclude this business.
We determine if an arrangement is a lease on the commencement date of the contract. Lease assets represent our right to use an underlying asset for the lease term, and lease liabilities represent our obligation to make lease payments arising from the lease. The lease asset and liability are measured by the present value of the future minimum lease payments over the lease term. Our fleet vehicle leases include a residual value guarantee; however, it is not probable of being owed. Therefore, there is no impact to the lease liability or lease asset. To measure the present value, the discount rate available in the contract is used. If the discount rate is not readily determinable, our incremental borrowing rate is used. The lease asset is then adjusted to exclude lease incentives. We recognize variable lease payments in the periods in which the obligations for those payments are incurred. Our lease terms may include options to extend or terminate the lease at which time it is reasonably certain that we will exercise that option. Lease expense is calculated using the straight-line method. In addition, we have adopted accounting policy
elections to: (i) aggregate lease and non-lease components into a single lease component; and (ii) expense short-term leases on a straight-line basis over the lease term.
Two key assumptions, the discount rate and the expected return on plan assets, are important elements of expense and/or liability measurement. We evaluate these key assumptions annually unless facts indicate that a more frequent review is required. The discount rate enables us to state expected future cash flows at their present value on the measurement date. The purpose of the discount rate is to determine the interest rates inherent in the price at which pension benefits could be effectively settled. Our discount rate selection is based on high-quality, long-term corporate bonds. To determine the expected long-term rate of return on the plan assets, we consider the current and expected asset allocation, as well as historical and expected returns on each plan asset class. Other assumptions involve demographic factors such as retirement age and mortality.
ASU 2016-02 allows for certain practical expedients, accounting policy elections, and a transition method election. We adopted practical expedients related to reassessing: (i) whether our existing contracts are, or contain, leases; (ii) lease classification for existing leases; and (iii) initial direct costs for existing leases. Additionally, we adopted accounting policy elections to: (i) aggregate lease and non-lease components of a contract into a single lease component; and (ii) expense short-term leases on a straight-line basis over the lease term. We adopted ASU 2016-02 effective January 1, 2019. See Note 17. "Leases" in this Form 10-K for additional information regarding our leases and the impact of this guidance on our financial condition and results of operations.
In June 2018, the FASB issued ASU 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting ("ASU 2018-07"). The amendments in ASU 2018-07 expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. We adopted ASU 2018-07 in the first quarter of 2019 and it did not have a material impact on our financial condition or results of operations.
Requirements for Fair Value Measurement (“ASU 2018-13”). ASU 2018-13 modifies the disclosure requirements for fair value measurements. The modifications removed the following disclosure requirements: (i) the amount of, and reasons for, transfers between Level 1 and Level 2 of the fair value hierarchy; (ii) the policy for timing of transfers between levels; and (iii) the valuation processes for Level 3 fair value measurements. This ASU added the following disclosure requirements: (i) the changes in unrealized gains and losses for the period included in other comprehensive income ("OCI") for recurring Level 3 fair value measurements held at the end of the reporting period; and (ii) the range and weighted average of significant observable inputs used to develop Level 3 fair value measurements. We elected to early adopt the provisions related to removed disclosures in the fourth quarter of 2019 and will adopt the remaining disclosure requirements in the first quarter of 2020 as permitted under ASU 2018-13. As the requirements of this literature are disclosure only, ASU 2018-13 has no impact our financial condition or results of operations.
software. We will adopt this guidance on January 1, 2020 and we do not expect that it will have a material impact to our financial condition or results of operations.
Supplemental cash flow information for the years ended December 31, 2019, 2018, and 2017 is as follows:
The following table provides a reconciliation of cash and restricted cash reported within the Consolidated Balance Sheets that equate to the amount reported in the Consolidated Statements of Cash Flows:
(b) Information regarding our HTM fixed income securities as of December 31, 2019 and December 31, 2018 was as follows:
Unrecognized holding gains and losses of HTM securities are not reflected in the Financial Statements, as they represent fair value fluctuations from the date a security is designated as HTM through the date of the balance sheet.
(d) The severity of impairment on the securities in an unrealized/unrecognized loss position averaged approximately 1% of amortized cost at December 31, 2019 and approximately 2% at December 31, 2018. Quantitative information regarding unrealized losses on our AFS portfolio is provided below. Our HTM portfolio had less than $0.1 million in unrealized/unrecognized losses at December 31, 2019 and $0.2 million in unrealized/unrecognized losses at December 31, 2018.
The $37.3 million decrease in the unrealized loss position reflected: (i) lower interest rates, with a 90-basis point decrease in the 2-year U.S. Treasury Note yields and a 77-basis point decrease in 10-year U.S. Treasury Note yields during 2019; and (ii) tightening option adjusted corporate credit spreads with a 60-basis point decrease in the Bloomberg Barclays U.S. Aggregate Corporate Bond Index during 2019. We do not currently intend to sell any of the securities in the tables above, nor will we be required to sell any of these securities. Considering these factors and our review of these securities under our OTTI policy as described in Note 2. “Summary of Significant Accounting Policies” of this Form 10-K, we have concluded that they are temporarily impaired as we believe: (i) they will mature at par value; (ii) they have not incurred a credit impairment; and (iii) future values of these securities will fluctuate with changes in interest rates. This conclusion reflects our current judgment as to the financial position and future prospects of the entity that issued the investment security and underlying collateral.
Listed below are the contractual maturities of fixed income securities at December 31, 2019:
on behalf of these investments; however, we are contractually committed to make additional investments up to the remaining commitment outlined above. We have not provided any non-contractual financial support at any time during 2019 or 2018.
Primary Private Equity: This strategy makes private equity investments, primarily in established large and middle market companies across diverse industries globally, with an emphasis on North America.
Mezzanine Financing: This strategy provides privately-negotiated fixed income securities, generally with an equity component, to LBO firms and private and publicly-traded large, mid, and small-cap companies to finance LBOs, recapitalizations, and acquisitions.
Opportunistic and Distressed Debt: This strategy makes investments in debt and equity securities of companies that are experiencing financial distress, operational issues, or dislocated pricing of publicly-traded securities. Investments include buying indebtedness of bankrupt or financially-troubled companies, small balance loan portfolios, special situations and capital structure arbitrage trades, commercial real estate mortgages, and similar non-U.S. securities and debt obligations.
Infrastructure: This strategy invests in the equity or debt of cash flow generating assets, diversified across a variety of industries, including transportation, energy infrastructure, renewable power, such as wind and solar, social infrastructure, power generation, water, telecom, and other regulated entities principally located in North America and Western Europe.
Our alternative investment strategies may employ leverage and may use hedging to reduce foreign exchange or interest rate volatility. At this time, our alternative investment strategies do not include hedge funds. We typically cannot redeem our investments with the general partners of these investments; however, occasionally these partnerships can be traded on the secondary market. Once liquidation is triggered by clauses within the limited partnership agreements or at the funds’ stated end date, we will receive our final allocation of capital and any earned appreciation of the underlying investments, assuming we have not divested ourselves of our partnership interests prior to that time. We currently receive distributions from these alternative investments through the realization of the underlying investments or income generated in the limited partnerships.
The following tables set forth summarized financial information for our other investments portfolio, including the portion not owned by us. The investments are recorded under the equity method of accounting. The last line in the income statement information table below reflects our share of the aggregate income, which is the portion included in our Financial Statements. As the majority of these investments report results to us on a one quarter lag, the summarized financial statement information is as of, and for the 12-month period ended, September 30:
(g) We did not have exposure to any credit concentration risk of a single issuer greater than 10% of our stockholders' equity, other than certain U.S. government agencies, as of December 31, 2019 or December 31, 2018.
The following table summarizes the market value of these securities at December 31, 2019:
Unrealized (losses) recognized in income on equity securities, as reflected in the table above, include the following:
The components of net realized gains (losses) on disposals were as follows:
Net realized gains (losses) in the table above were driven by the following:
(a) The components of comprehensive income, both gross and net of tax, for 2019, 2018, and 2017 were as follows:
The following tables provide quantitative disclosures of our financial assets that were measured and recorded at fair value at December 31, 2019 and 2018:
The Insurance Subsidiaries remain liable to policyholders to the extent that any reinsurer becomes unable to meet their contractual obligations. In addition to this direct counterparty credit risk, we have indirect counterparty credit risk as our reinsurers often enter into their own reinsurance programs, or retrocessions, as part of managing their exposure to large losses. We evaluate and monitor the financial condition of our reinsurers under voluntary reinsurance arrangements to minimize our exposure to significant losses from reinsurer insolvencies. The allowance for uncollectible reinsurance recoverables was $4.4 million at December 31, 2019 and $4.5 million at December 31, 2018.
The ceded premiums and losses related to our participation in the NFIP, under which 100% of our flood premiums, and loss and loss expense are ceded to the NFIP, are as follows:
Our net loss and loss expense reserves increased by $166.5 million in 2019, $171.1 million in 2018, and $104.9 million in 2017. The loss and loss expense reserves are net of anticipated recoveries for salvage and subrogation claims, which amounted to $76.7 million for 2019, $67.7 million for 2018, and $64.8 million for 2017. The increase in net loss and loss expense reserves in 2019 was primarily driven by increases in exposure due to premium growth. This increase was partially offset by favorable prior year loss development, largely driven by the workers compensation line of business.
The Insurance Subsidiaries had $50.3 million of favorable prior accident year reserve development during 2019, which included $61.0 million of net favorable casualty reserve development and $10.7 million of unfavorable property reserve development. The net favorable casualty reserve development was largely driven by the workers compensation line of business, which was impacted by continued favorable medical trends in accident years 2017 and prior.
The Insurance Subsidiaries had $29.9 million of favorable prior accident year reserve development during 2018, which included $41.5 million of net favorable casualty reserve development and $11.6 million of unfavorable property reserve development. The net favorable casualty reserve development was largely driven by the workers compensation line of business, reflecting continued
(c) Reserves established for liability insurance include exposure to asbestos and environmental claims. These claims have arisen primarily from insured exposures in municipal government, small non-manufacturing commercial risk, and homeowners policies. The emergence of these claims is slow and highly unpredictable. There are significant uncertainties in estimating our exposure to asbestos and environmental claims (for both case and IBNR reserves) resulting from lack of relevant historical data, the delayed and inconsistent reporting patterns associated with these claims, and uncertainty as to the number and identity of claimants and complex legal and coverage issues. Legal issues that arise in asbestos and environmental cases include federal or state venue, choice of law, causation, admissibility of evidence, allocation of damages and contribution among joint defendants, successor and predecessor liability, and whether direct action against insurers can be maintained. Coverage issues that arise in asbestos and environmental cases include the interpretation and application of policy exclusions, the determination and calculation of policy limits, the determination of the ultimate amount of a loss, the extent to which a loss is covered by a policy, if at all, the obligation of an insurer to defend a claim, and the extent to which a party can prove the existence of coverage. Courts have reached different and sometimes inconsistent conclusions on these legal and coverage issues. We do not discount to present value that portion of our loss and loss expense reserves expected to be paid in future periods.
Wells Fargo on December 20, 2019. The effective date of the termination of the Prior Credit Agreement was December 30, 2019.
(1) In the first quarter of 2019, we issued $300 million of 5.375% Senior Notes due 2049 at a discount of $5.9 million which, when coupled with debt issuance costs of approximately $3.3 million, resulted in net proceeds from the offering of $290.8 million. The 5.375% Senior Notes will pay interest on March 1 and September 1 of each year. The first payment was made on September 1, 2019. A portion of the proceeds from this debt issuance was used to fully redeem the $185 million aggregate principal amount of our 5.875% Senior Notes due 2043, with the remaining $106 million being used for general corporate purposes. The 5.875% Senior Notes had pre-tax debt retirement costs of $4.2 million, or $3.3 million after tax, which was recorded in Interest expense on the Consolidated Statements of Income in the first quarter of 2019. There are no financial debt covenants to which we are required to comply in regards to the 5.375% Senior Notes.
(3) In the fourth quarter of 2015, SICA and Selective Insurance Company of New York ("SICNY") joined, and invested in, the FHLBNY, which provides them with access to additional liquidity. The aggregate investment for both subsidiaries was $3.1 million at December 31, 2019 and $2.7 million at December 31, 2018. Our investment provides us the ability to borrow approximately 20 times the total amount of the FHLBNY common stock purchased with additional collateral, at comparatively low borrowing rates. In 2016, SICA borrowed the following amounts from the FHLBNY: (i) $25 million in August 2016 at an interest rate of 1.56%, which is due on August 16, 2021; and (ii) $25 million in July 2016 at an interest rate of 1.61%, which is due on July 21, 2021. All borrowings from the FHLBNY require security. There are no financial debt covenants to which we are required to comply with in regards to these borrowings. For information on investments that are pledged as collateral for these borrowings, see Note 5. "Investments" above.
any event or condition that results in an acceleration of principal of any other debt instrument in excess of $10 million that we have outstanding concurrently with the 6.70% Senior Notes. There are no financial debt covenants to which we are required to comply in regards to these notes.
Our Investments segment is evaluated based on after-tax net investment income and its ROE contribution. Also included in our Investment segment results are after-tax net realized and unrealized gains and losses, which are not included in non-GAAP operating income.
(a) On December 22, 2017, Tax Reform was signed into law, which among other implications, reduced our statutory corporate tax rate from 35% to 21% beginning with our 2018 tax year. We revalued our deferred tax inventory at December 31, 2017 to reflect this reduction, which resulted in a $20.2 million charge to income as illustrated in the rate table below.
As of December 31, 2017, our accounting for the impact of Tax Reform on our deferred tax assets and liabilities was complete, with the exception of amounts related to loss reserve discounting. Prior to Tax Reform, we had elected to use our own loss reserve payment patterns for determining the factors to be used for calculating our discounted loss reserves for federal income tax purposes. Under Tax Reform, this election was eliminated and we are now required to use discount factors based on industry experience and a corporate bond yield curve, which the Internal Revenue Service ("IRS") had not finalized as of December 31, 2017. Considering this, at December 31, 2017, we calculated a pre-tax decrease to our discounted loss reserves of $35 million by using the industry experience approach under the tax law that existed prior to Tax Reform. This increased the deferred tax asset related to loss reserves by $7.5 million. A Tax Reform transition rule allows this change in accounting method to be amortized into expense over an eight-year period beginning in 2018. As a result, we established an offsetting deferred tax liability of $7.5 million as of December 31, 2017.
In June 2019, the IRS published the final loss reserve discount factors to be used for calculating the beginning and ending 2018 discounted loss reserves under the industry experience approach. Based on these factors, we calculated a revised pre-tax decrease to our discounted loss reserves of $109.5 million, which resulted in a deferred tax asset of $23.0 million, a decrease from the $26.3 million estimate described above. The $23.0 million will be taken into income over eight years, beginning with the 2018 tax year, at approximately $2.9 million per year.
We have analyzed our tax positions in all open tax years, which as of December 31, 2019 were 2016 through 2018. The 2018 tax year is currently under audit. We do not expect any material adjustments to arise out of the 2018 audit.
We believe our tax positions will more likely than not be sustained upon examination, including related appeals or litigation. In the event we had a tax position that did not meet the more likely than not criteria, any tax, interest, and penalties incurred related to such a position would be reflected in "Total federal income tax expense" on our Consolidated Statements of Income.
In addition to the Pension Plan, SICA also sponsors the Supplemental Excess Retirement Plan (the "Excess Plan") and a life insurance benefit plan (the "Retirement Life Plan"). Both of these plans are closed to new entrants and participants in the Excess Plan ceased accruing benefits after March 31, 2016. The Retirement Life Plan does not accrue benefits and this plan applies only to retirees who terminated employment with SICA on or before March 31, 2009. These are both unfunded plans with benefit obligations as of December 31, 2019 and December 31, 2018 of $10.9 million and $9.5 million, respectively, for the Excess Plan and $6.6 million and $5.8 million, respectively, for the Retirement Life Plan. Expense recorded for the Excess Plan was $0.4 million in each of 2019, 2018, and 2017. Expense recorded for the Retirement Life Plan was $0.3 million in each of 2019, 2018, and 2017.
When determining the most appropriate discount rate to be used in the valuation, we consider, among other factors, our expected payout patterns of the Pension Plan's obligations as well as our investment strategy, and we ultimately select the rate that we believe best represents our estimate of the inherent interest rate at which our pension and post-retirement life benefits can be effectively settled. The approach we utilize discounts the individual expected cash flows using the applicable spot rates derived from the yield curve over the projected cash flow period. Our discount rate decreased 113 basis points, to 3.33%, as of December 31, 2019, compared to 4.46% as of December 31, 2018, which resulted in a significant increase in the actuarial loss driving the increase in the benefit obligation for the period. The weighted average discount rate used to determine 2020 interest cost is 2.95%.
Assets of the Pension Plan are invested to adequately support the liability associated with the Pension Plan's defined benefit obligation. Our return objective is to exceed the returns of the plan's policy benchmark, which is the return the plan would have earned if the assets were invested according to the target asset class weightings and earned index returns shown below. In 2020, we will continue to phase in adjustments to the asset allocation to steadily close the gap between the duration of the assets and the duration of the liabilities, provided certain improved funding targets are achieved. Over time, the target and actual asset allocations may change based on the funded status of the Pension Plan and market return expectations.
The investments in the equities and liability hedging funds include collective investment funds and fund of funds that utilize a market approach wherein the published prices in the active market for identical assets are used. These investments are traded at their net asset value per share. These investments are classified as Level 1 in the fair value hierarchy.
The deposit administration contract is recorded at cost, which approximates fair value. Given the liquid nature of the underlying investments in overnight cash deposits and other short-term duration products, we have determined that a correlation exists between the deposit administration contract and other short-term investments, such as money market funds. As such, this investment is classified as Level 2 in the fair value hierarchy.
In addition, refer to Note 5. "Investments" for discussion regarding the limited partnership investment strategies, excluding the secondary private equity and direct lending strategies as these investments are currently not part of the Pension Plan's investment portfolio.
As of December 31, 2019, the following four plans were available for the issuance of share-based payment awards:
Shares authorized and available for issuance as of December 31, 2019 are as follows:
As of December 31, 2019, total unrecognized compensation expense related to unvested RSU awards granted under our Stock Plan was $8.9 million. That expense is expected to be recognized over a weighted-average period of 1.7 years. The total intrinsic value of RSUs vested was $22.0 million for 2019, $18.0 million for 2018, and $16.0 million for 2017. In connection with vested RSUs, the total value of the DEUs that vested was $0.8 million in 2019 and 2018, and $0.9 million in 2017.
The total intrinsic value of options exercised was $5.2 million in 2019, $4.5 million in 2018, and $4.0 million in 2017.
The grant date fair value of each option award is estimated using the Black Scholes option valuation model ("Black Scholes"). The following are the significant assumptions used in applying Black Scholes: (i) the risk-free interest rate, which is the implied yield currently available on U.S. Treasury zero-coupon issues with an equal remaining term; (ii) the expected term, which is based on historical experience of similar awards; (iii) the dividend yield, which is determined by dividing the expected per share dividend during the coming year by the grant date stock price; and (iv) the expected volatility, which is based on the
The weighted-average fair value of options and stock per share, including RSUs granted under the Parent's stock plans, during 2019, 2018, and 2017 was as follows:
In 2005, we established a private foundation, now named The Selective Insurance Group Foundation (the "Foundation"), under Section 501(c)(3) of the Internal Revenue Code. The Board of Directors of the Foundation is comprised of some of the Parent's officers. We made $1.3 million of contributions to the Foundation in 2019, $0.5 million in 2018, and no contributions in 2017.
BlackRock, Inc., a leading publicly-traded investment management firm (“BlackRock”), has purchased our common shares in the ordinary course of its investment business and has previously filed Schedules 13G/A with the SEC. On February 4, 2020, BlackRock filed a Schedule 13G/A reporting beneficial ownership as of December 31, 2019, of 11.7% of our common stock.
In connection with purchasing our common shares, BlackRock filed the necessary filings with insurance regulatory authorities. On the basis of those filings, BlackRock is deemed not to be a controlling person for the purposes of applicable insurance law.
Our Pension Plan's investment portfolio contained investments in BlackRock funds of $144.2 million at December 31, 2019 and $131.9 million at December 31, 2018. During 2019, with regard to BlackRock funds, the Pension Plan (i) purchased $19.7 million, (ii) sold $44.1 million, and (iii) recorded net investment income of $36.7 million. In 2018, with regard to BlackRock funds, the Pension Plan (i) purchased $132.5 million, (ii) sold $125.6 million, and (iii) recorded net investment income of $9.3 million. In 2017, with regard to BlackRock funds, the Pension Plan (i) purchased $10.0 million, (ii) sold $4.1 million, and (iii) recorded net investment income of $25.2 million. In addition, our Deferred Compensation Plan and Retirement Savings Plan may offer our employees the option to invest in various BlackRock funds. All contracts and transactions with BlackRock were consummated in the ordinary course of business on an arm's-length basis.
As of December 31, 2019, the Vanguard Group ("Vanguard") held 9.4% of our common stock. Vanguard is one of the world's largest investment management companies, offering low cost mutual funds, exchange-trade funds ("ETFs"), and other investment related services. On January 10, 2019, Vanguard filed a Schedule 13G/A reporting beneficial ownership as of December 31, 2018, of 10.1% of our common stock. In connection with purchasing our common shares in the prior year, Vanguard filed the necessary filings with insurance regulatory authorities to disclaim control and we do not expect Vanguard to be deemed a controlling person by any insurance regulator.
Our Pension Plan's investment portfolio contained no investments in Vanguard funds at December 31, 2019 and December 31, 2018. Our Pension Plan's investment portfolio contained investments in Vanguard funds of $86.3 million in 2017. The Pension Plan had no transactions with Vanguard in 2019. During 2018 and 2017, the Pension Plan purchased $8.4 million and $5.2 million of Vanguard funds, respectively. In 2018, the Pension Plan sold $85.4 million of Vanguard funds. The Pension Plan recorded a net investment loss on Vanguard funds of $5.5 million in 2018, and net investment income of $9.1 million in 2017. In addition, our Deferred Compensation Plan and Retirement Savings Plan may offer our employees the option to invest in various Vanguard funds. All transactions with Vanguard are consummated in the ordinary course of business on an arm's-length basis.
1Prior to adoption of ASU 2016-02, our historical capital lease liabilities and assets were measured using an un-discounted cash flow stream due to immateriality of the capital lease population.
(b) As of December 31, 2019, we have made commitments that may require us to invest additional amounts into our investment portfolio, which are as follows:
In the ordinary course of conducting business, we are parties in various legal actions. Most are claims litigation involving our Insurance Subsidiaries as either: (i) liability insurers defending or providing indemnity for third-party claims brought against our customers; (ii) insurers defending first-party coverage claims brought against them; or (iii) liability insurers seeking declaratory judgment on our insurance coverage obligations. We account for such activity through the establishment of unpaid loss and loss expense reserves. In ordinary course claims litigation, we expect that any potential ultimate liability, after consideration of provisions made for potential losses and costs of defense, will not be material to our consolidated financial condition, results of operations, or cash flows.
The Insurance Subsidiaries prepare their statutory financial statements in accordance with accounting principles prescribed or permitted by the various state insurance departments of domicile. Prescribed statutory accounting principles include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (“NAIC"). Permitted statutory accounting principles encompass all accounting principles that are not prescribed; such principles differ from state to state, may differ from company to company within a state and may change in the future. The Insurance Subsidiaries do not utilize any permitted statutory accounting principles that affect the determination of statutory surplus, statutory net income, or risk-based capital (“RBC”). As of December 31, 2019, the various state insurance departments of domicile have adopted the March 2019 version of the NAIC Accounting Practices and Procedures manual in its entirety, as a component of prescribed or permitted practices.
As of December 31, 2019, the Parent had an aggregate of $278.0 million in investments and cash available to fund future dividends and interest payments. These amounts are not subject to any regulatory restrictions other than the standard state insolvency restrictions noted above, whereas our consolidated retained earnings of $2.1 billion is predominately restricted due to the regulation associated with our Insurance Subsidiaries. In 2020, the Insurance Subsidiaries have the ability to provide for $266.7 million in annual dividends to the Parent; however, as regulated entities, these dividends are subject to certain restrictions, which are further discussed below. The Parent also has available to it other potential sources of liquidity, such as:
(i) borrowings from our Indiana Subsidiaries; (ii) debt issuances; (iii) common stock issuances; and (iv) borrowings under our Line of Credit. Borrowings from our Indiana Subsidiaries are governed by approved intercompany lending agreements with the Parent that provide for additional capacity of $89.4 million as of December 31, 2019, based on restrictions in these agreements that limit borrowings to 10% of the admitted assets of the Indiana Subsidiaries. For additional restrictions on the Parent's debt, see Note 10. "Indebtedness" in this Form 10-K.