The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes to those statements which accompany this report. Throughout the discussion we use certain terms and abbreviations, which can be found in the Glossary of Terms and Acronyms at the beginning of this report. In addition, a glossary of insurance terms and phrases is available on the investor section of our website. Throughout the discussion, references to "ProAssurance," "PRA," "Company," "we," "us" and "our" refer to ProAssurance Corporation and its consolidated subsidiaries. The discussion contains certain forward-looking information that involves significant risks, assumptions and uncertainties. As discussed under the heading "Forward-Looking Statements," our actual financial condition and operating results could differ significantly from these forward-looking statements.
We report our results in four distinct segments, based on the operational focus of the segment. Our Specialty P&C segment includes our professional liability business and our medical technology liability business. Our Workers' Compensation segment includes workers' compensation insurance for employers, groups and associations. Our Lloyd's Syndicate segment reflects operating results from our 58% participation in Syndicate 1729, which underwrites risks over a wide range of property and casualty insurance and reinsurance lines in both the U.S. and international markets. Information regarding Lloyd's operations derived from U.K. based entities is reported on a quarter delay, although investment results associated with our FAL investments are reported concurrently as those results are available on an earlier time frame. Our Corporate segment includes our investment operations, which are managed at the corporate level, except results associated with investment assets solely allocated to Syndicate 1729 operations, non-premium revenues generated outside of our insurance entities, corporate expenses, interest and U.S. income taxes. Additional information regarding our segments is included in Note 15 of the Notes to Consolidated Financial Statements and in Part I.
We expect our long-term growth to come primarily through controlled expansion of our existing operations. In addition, from time to time, we may identify opportunities for growth through the acquisition of other service providers and books of business. Growth through acquisition is often opportunistic and cannot be predicted.
We operate in very competitive markets and face strong competition from other insurance companies for all of our insurance products. HCPL insurance represents a majority portion of our gross premiums written (55% in 2016, excluding tail) and the healthcare market has been trending toward the formation of larger medical practice groups and the employment of physicians by hospitals. Large medical groups and facilities frequently manage their healthcare professional liability exposure outside of the traditional first dollar insurance marketplace using self-insured mechanisms and other risk sharing arrangements. In response to these trends, we offer products designed to provide greater risk sharing options to hospitals and large physician groups.
Considerable judgment is required in establishing our initial reserve for any current accident year period, as there is limited data available upon which to base our case reserves. Our process for setting an initial reserve considers the unique characteristics of each product, but in general we rely heavily on the loss assumptions that were used to price business, as our pricing reflects our analysis of loss costs that we expect to incur relative to the insurance product being priced.
situation of the claimant or the claimant's family, the outcome of jury trials, the legislative and judicial climate where any potential litigation may occur, general economic conditions and, for claims involving bodily injury, the trend of healthcare costs. Within our Specialty P&C segment, for our HCPL business (77% of our consolidated gross reserve for losses and loss adjustment expenses for the year ended December 31, 2016), we set an initial reserve using the average loss ratio used in our pricing, plus an additional provision in consideration of the historical loss volatility we and others in the industry have experienced. For our HCPL business our target loss ratio during recent accident years approximated 75% and the provision for loss volatility has ranged from 8 to 10 percentage points, producing an overall average initial loss ratio for our HCPL business of approximately 85%. Most recently, our target loss ratio has more closely ranged from 77% to 78% and with the provision for loss volatility previously discussed the average initial loss ratio for our HCPL business has approximated 87%. The reasons for the higher loss provisions vary from period to period and have included additional loss activity within our surplus lines business, provisions for losses in excess of policy limits, adjustments to unallocated loss adjustment expenses, adjustment to the reserve for the death, disability and retirement provisions in our policies and additional losses recorded for particular exposures, such as mass torts. These specific adjustments are made if we believe the results for a given accident year are likely to exceed those anticipated by our pricing. We believe use of a provision for volatility appropriately considers the inherent risks and limitations of our rate development process and the historic volatility of professional liability losses (the industry has experienced accident year loss ratios as high as 163% and as low as 53% over the past 30 years) and produces a reasonable best estimate of the reserve required to cover actual ultimate unpaid losses. A similar practice is followed for our legal professional liability business (4% of our consolidated gross reserve for losses and loss adjustment expenses for the year ended December 31, 2016).
the use of consulting actuaries provides an independent view of our loss data as well as a broader perspective on industry loss trends.
For our Lloyd's Syndicate segment we rely on actual loss experience on the book of business written by Syndicate 1729 to reflect loss development by accident year.
Even though the actuarial process is highly technical, it is also highly judgmental, both as to the selection of the data used in the various actuarial methodologies (e.g., initial expected loss ratios and loss development factors) and in the interpretation of the output of the various methods used. Each actuarial method generally returns a different value and for the more recent accident years the variations among the various methodologies can be significant. For each partition of our reserves, the results of the various methods, along with the supplementary statistical data regarding such factors as closed with and without indemnity ratios, claim severity trends, the expected duration of such trends and changes in the legal and legislative environment and the current economic environment are used to develop a point estimate based upon management's judgment and past experience. The series of selected point estimates is then combined to produce an overall point estimate for ultimate losses.
For the 2004 to 2009 accident years, both our internal and consulting actuaries observed an unprecedented reduction in the frequency of HCPL claims (or number of claims per exposure unit) that cannot be attributed to any single factor. Since
2009, claim frequency has been relatively constant, at a lower level than had historically existed. For a number of years, we believed that much of the reduction in claim frequency was the result of a decline in the filing of non-meritorious lawsuits that had historically been dismissed or otherwise resulted in no payment of indemnity on behalf of our insureds. With fewer non-meritorious claims being filed we expected that the claims that were filed had the potential for greater average losses, or greater severity. To date, however, this effect has not materialized to the extent we anticipated. The uncertainty as to the impact this decline in frequency might ultimately have on the average cost of claims complicated the selection of an appropriate severity trend for our pricing model for these lines. It also made it more challenging to factor severity into the various actuarial methodologies we use to evaluate our reserve. Based on the weighted average of payments, typically 91% of our HCPL claims are resolved after eight years for a given accident year.
Although we remain uncertain regarding the ultimate severity trend to project into the future due to the long-tailed nature of our business, we have given consideration to observed loss costs in setting our rates. For our HCPL business this practice has resulted in rate reductions in recent years. For example, on average, excluding our podiatry business acquired in 2009, we have gradually reduced the premium rates we charge on our standard physician renewal business (our largest HCPL line) by approximately 17% from the beginning of 2006 to December 31, 2016. Loss ratios for the current accident years have thus remained fairly constant because expected loss reductions have been reflected in our rates.
Workers' Compensation. The projection of changes in claim severity trend has not historically been an influential factor affecting our workers' compensation analysis of reserves, as claims are typically resolved more quickly than the industry norm. As previously mentioned, the determination and calculation of loss development factors, in particular, the selection of tail factors which are used to extend the projection of losses beyond historical data, requires considerable judgment. These factors are determined in the absence of direct loss development history and thus require reliance upon industry data which may not be representative of the Company’s data and experience.
The following table presents additional information about the loss development for our professional liability line of business:
At December 31, 2016, 2015 and 2014 management reserve estimates for the three most recent prior accident years (which have closed claim percentages at or below 85%) were influenced by the initial reserve estimate set for these years, moderated to reflect consideration of better than anticipated claims experience observed during the periods. Estimates for older accident years with higher percentages of closed claims were more heavily influenced by the more moderate severity trend, particularly with regard to claims closed during the periods.
Approximately $5.8 million of the $11.5 million total net favorable development recognized in 2016 related to the 2011 to 2013 accident years. The development for the 2011 to 2013 accident years represents a 14.3% reduction to the ultimates established for those reserves at December 31, 2015. Approximately $10.4 million of the $11.7 million total net favorable development recognized in 2015 related to the 2008 to 2012 accident years. The development for the 2008 to 2012 accident years represents a 7.9% reduction to the ultimates established for those reserves at December 31, 2014. Approximately $10.3 million of the $11.9 million total net favorable development recognized in 2014 related to the 2008 to 2011 accident years. The development for the 2008 to 2011 accident years represents an 8.0% reduction to the ultimates established for those reserves at December 31, 2013.
In 2016, 2015 and 2014 the development was largely attributable to favorable results from claims closed during the year. As time has elapsed we have recognized that actual loss experience has on average been better than estimated. We have been cautious in recognizing the improvement, but as claims have matured and claims are closed or have become more certain for the remaining open claims, we have revised reserve estimates. We believe the need for a cautious approach is required as outcomes are uncertain and results can be significantly affected by outcomes for a small number of cases, as evidenced by the unfavorable experience shown for specific accident years in the table above.
We recognized $6.1 million of net favorable development in 2016 which included $4.5 million of net favorable development at our SPCs and $1.6 million of net favorable development related to the amortization of the purchase accounting fair value adjustment for our traditional business. In 2015, we recognized $2.2 million of net favorable development which included $0.6 million of net unfavorable development at our SPCs primarily related to claims activity prior to the 2009 accident year and $1.6 million of net favorable development related to the amortization of the purchase accounting fair value adjustment for our traditional business. In 2014, we recognized $1.3 million of net favorable development which included $0.3 million of net unfavorable development at our SPCs primarily reflecting medical severity-related claims activity in the 2013 accident year, which was more than offset by $1.6 million of net favorable development related to the amortization of the purchase accounting fair value adjustment for our traditional business.
We use insurance and reinsurance (collectively, “reinsurance”) to provide capacity to write larger limits of liability, to provide reimbursement for losses incurred under the higher limit coverages we offer, to provide protection against losses in excess of policy limits, and, in the case of risk sharing arrangements, to align our objectives with those of our strategic business partners and to provide custom insurance solutions for large customer groups. The purchase of reinsurance does not relieve us from the ultimate risk on our policies, but it does provide reimbursement for certain losses we pay.
We make a determination of the amount of insurance risk we choose to retain based upon numerous factors, including our risk tolerance and the capital we have to support it, the price and availability of reinsurance, the volume of business, our level of experience with a particular set of claims and our analysis of the potential underwriting results. We purchase excess of loss reinsurance to limit the amount of risk we retain and we do so from a number of companies to mitigate concentrations of credit risk. We utilize reinsurance brokers to assist us in the placement of these reinsurance programs and in the analysis of the credit quality of our reinsurers. The determination of which reinsurers we choose to do business with is based upon an evaluation of their then current financial strength, rating and stability.
Because of the number of securities we own and the complexity of developing accurate fair values, we utilize multiple independent pricing services to assist us in establishing the fair value of individual securities. The pricing services provide fair values based on exchange traded prices, if available. If an exchange traded price is not available, the pricing services, if possible, provide a fair value that is based on multiple broker/dealer quotes or that has been developed using pricing models. Pricing models vary by asset class and utilize currently available market data for securities comparable to ours to estimate a fair value for our securities. The pricing services scrutinize market data for consistency with other relevant market information before including the data in the pricing models. The pricing services disclose the types of pricing models used and the inputs used for each asset class. Determining fair values using these pricing models requires the use of judgment to identify appropriate comparable securities and to choose a valuation methodology that is appropriate for the asset class and available data.
Most fixed income securities do not trade daily, and thus exchange traded prices are generally not available for these securities. However, market information (often referred to as observable inputs or market data, including but not limited to, last reported trade, non-binding broker quotes, bids, benchmark yield curves, issuer spreads, two sided markets, benchmark securities, offers and recent data regarding assumed prepayment speeds, cash flow and loan performance data) is available for most of our fixed income securities. We determine fair value for a large portion of our fixed income securities using available market information. In accordance with GAAP, for disclosure purposes we classify securities valued based on multiple market observable inputs as Level 2 securities.
We hold interests in certain LPs/LLCs that are investment funds which measure fund assets at fair value on a recurring basis and provide us with a NAV for our interest. As a practical expedient, we consider the NAV provided to approximate the fair value of the interest. In accordance with GAAP, we do not categorize these investments within the fair value hierarchy.
Certain of our investments, in accordance with GAAP for the type of investment, are measured using methodologies other than fair value. At December 31, 2016, these investments represented approximately 6% of total investments, and are detailed in the following table. Additional information about these investments is provided in Notes 3 and 4 of the Notes to Consolidated Financial Statements.
if it is more likely than not that the security will be required to be sold before full recovery of its amortized cost basis
For non-structured fixed maturities (obligations of states, municipalities and political subdivisions, and corporate debt) the estimate of expected cash flows is determined by projecting a recovery value and a recovery time frame and assessing whether further principal and interest will be received. We consider various factors in projecting recovery values and recovery time frames, including the following:
collateral (loans) underlying the securitization or, if historical data is not available, sector based assumptions, to estimate expected future cash flows of these securities.
Investments in tax credit partnerships are evaluated for OTTI by considering both qualitative and quantitative factors which include: whether the current expected cash flows from the investment, primarily tax benefits, are less than those expected at the time the investment was acquired and ProAssurance's ability and intent to hold the investment until the recovery of its carrying value.
Policy acquisition costs (primarily commissions, premium taxes and underwriting salaries) which are directly related to the successful acquisition of new and renewal premiums are capitalized as DPAC and charged to expense, net of ceding commissions earned, as the related premium revenue is recognized. We evaluate the recoverability of our DPAC at the segment level each reporting period, and any amounts estimated to be unrecoverable are charged to expense in the current period. As of December 31, 2016 we have not determined that any amounts are unrecoverable.
We evaluate tax positions taken on tax returns and recognize positions in our financial statements when it is more likely than not that we will sustain the position upon resolution with a taxing authority. If recognized, the benefit is measured as the largest amount of benefit that has a greater than 50% probability of being realized. We review uncertain tax positions each period, considering changes in facts and circumstances, such as changes in tax law, interactions with taxing authorities and developments in case law, and make adjustments as we consider necessary. Adjustments to our unrecognized tax benefits may affect our income tax expense, and settlement of uncertain tax positions may require the use of cash. Other than differences related to timing, no significant adjustments were considered necessary during 2016 or 2015. During 2014, we reversed a previously held tax position of $4.8 million due to the favorable resolution of an IRS exam. At December 31, 2016, our liability for unrecognized tax benefits approximated $8.4 million.
We review goodwill for impairment annually on October 1 and whenever events or changes in circumstances indicate the carrying amount of goodwill may not be recoverable. Goodwill is tested for impairment at the reporting unit level. Our reporting units are consistent with the reportable segments identified in Note 15 of the Notes to Consolidated Financial Statements. Of the four reporting units, two have goodwill - Specialty P&C and Workers' Compensation. As of the most recent valuation date on October 1, 2016, we performed a qualitative goodwill impairment assessment for our Specialty P&C segment and a quantitative goodwill impairment test for our Workers' Compensation segment.
Under the income approach, we estimated the fair value of a reporting unit based on the present value of estimated future cash flows. Cash flow projections were based on management's estimates of revenue growth rates and operating margins, taking into consideration industry and market conditions. The discount rate used was based on the weighted average cost of capital adjusted for relevant risks associated with business specific characteristics and the uncertainty related to the reporting unit's ability to meet projected cash flows.
If the fair value of a reporting unit exceeded the carrying amount of the net assets assigned to that reporting unit, goodwill would not be impaired and no further testing would be required. Upon completion of step one of the assessment, it was determined that goodwill was not impaired for our Workers' Compensation segment; and therefore, the second step of the quantitative assessment was not deemed necessary. If the fair value of the reporting unit was less than its carrying amount, the second step of the goodwill impairment test is performed which measures the amount of impairment loss, if any.
At the valuation date, management concluded that the fair values of both the Specialty P&C and Workers’ Compensation reporting units exceeded their respective carrying values. No goodwill impairment was recorded in 2016 or 2015.
We did not adopt any accounting changes during 2016 that had a material effect on our results of operations nor are we aware of any accounting changes not yet adopted as of December 31, 2016 that would have a material effect on our results of operations or financial position. Note 1 of the Notes to Consolidated Financial Statements provides additional detail regarding accounting changes.
The increase in operating cash flows in 2015 as compared to 2014 was primarily due to an increase in cash contributed by our Lloyd's Syndicate operations of $18.3 million and a decrease in loss payments of $34.5 million, partially offset by a decrease in cash received from investment income of $24.3 million and an increase in tax payments of $18.9 million. The increase in tax payments during 2015 primarily reflected the effect of a $30.5 million tax refund received in 2014, slightly offset by a $13.0 million decrease in 2015 estimated tax payments.
In each year reflected in the table, we have estimated our reserve for losses utilizing the management and actuarial processes discussed in Critical Accounting Estimates. Factors that have contributed to the variation in loss development are primarily related to the extended period of time required to resolve professional liability claims and include the following:
Within our Specialty P&C segment, we use insurance and reinsurance (collectively, “reinsurance”) to provide capacity to write larger limits of liability, to provide reimbursement for losses incurred under the higher limit coverages we offer and to provide protection against losses in excess of policy limits. We also have a quota share arrangement with Syndicate 1729 established to provide an initial premium base for Syndicate 1729. Within our Workers' Compensation segment, we use reinsurance to reduce our net liability on individual risks, to mitigate the effect of significant loss occurrences (including catastrophic events), to stabilize underwriting results, and to increase underwriting capacity by decreasing leverage. In both the Specialty P&C and Workers' Compensation segments, we use reinsurance in risk sharing arrangements, to align our objectives with those of our strategic business partners and to provide custom insurance solutions for large customer groups. The purchase of reinsurance does not relieve us from the ultimate risk on our policies, but it does provide reimbursement for certain losses we pay. We pay our reinsurers a premium in exchange for reinsurance of the risk. For our excess of loss arrangements, the premium due to the reinsurer is determined by the loss experience of the business reinsured, subject to certain minimum and maximum amounts. Until all loss amounts are known, we estimate the premium due to the reinsurer. Changes to the estimate of premium owed under reinsurance agreements related to prior periods are recorded in the period in which the change in estimate occurs and can have a significant effect on net premiums earned.
Property umbrella excess of loss reinsurance is utilized for peak catastrophe and frequency of catastrophe exposures.
Our investments at December 31, 2016 and December 31, 2015 are comprised as follows:
A detailed listing of our investment holdings as of December 31, 2016 is located under the Financial Information header on the Investor Relations page of our website which can be reached directly at www.proassurance.com/investmentholdings, or through links from the Investor Relations section of our website, Investor.Proassurance.com.
We manage our investments to ensure that we will have sufficient liquidity to meet our obligations, taking into consideration the timing of cash flows from our investments, including interest payments, dividends and principal payments, as well as the expected cash flows to be generated by our operations. In addition to the interest and dividends we will receive, we anticipate that between $70 million and $90 million of our investments will mature (or be paid down) each quarter of the next
year and become available, if needed, to meet our cash flow requirements. The primary outflow of cash at our insurance subsidiaries is related to paid losses and operating costs, including income taxes. The payment of individual claims cannot be predicted with certainty; therefore, we rely upon the history of paid claims in estimating the timing of future claims payments. To the extent that we may have an unanticipated shortfall in cash, we may either liquidate securities or borrow funds under existing borrowing arrangements through our Revolving Credit Agreement and the FHLB system. Currently, $50 million could be made available for use through an accordion feature under our Revolving Credit Agreement, as discussed in this section under the heading "Debt." Given the duration of our investments, we do not foresee a shortfall that would require us to meet operating cash needs through additional borrowings. Additional information regarding the Revolving Credit Agreement is detailed in Note 10 of the Notes to Consolidated Financial Statements.
As discussed under the heading "Business Combinations and Ventures" and in Note 4 of the Notes to Consolidated Financial Statements, our fixed maturity and short-term investments include securities deposited with Lloyd's in order to meet our FAL requirement. At December 31, 2016, securities on deposit with Lloyd's included fixed maturities having a fair value of $95.6 million and short term investments with a fair value of $1.5 million.
Investment fund LPs/LLCs are by nature less liquid and may involve more risk than other investments. We manage our risk through diversification of asset class and geographic location. At December 31, 2016, we had investments in 23 separate investment funds with a total carrying value of $274.0 million (7% of our total investments). We review and monitor the performance of these investments on a quarterly basis.
Our total energy-related exposures approximated $195.4 million (approximately 5% of invested assets) at December 31, 2016. Our energy-related debt securities at December 31, 2016 included investments of $130.6 million (of which approximately $24.5 million is below investment grade). We believe investments in the energy sector could have the most volatility and potential for future impairments based upon petroleum and petroleum product prices. At December 31, 2016, approximately 99% of our energy-related debt securities were rated; the average rating was BBB+. In addition, we held a $23.7 million investment in a mid-stream focused energy infrastructure limited partnership, which was impaired by $3.1 million during 2016, $40.8 million of energy related, dividend-paying blue chip stocks and MLPs and $0.4 million of other energy related investments. We will continue to monitor developments within the energy sector and the credit risk associated with energy companies within our investment portfolio using publicly available financial and rating agency data.
On January 1, 2014 we acquired Eastern for approximately $205 million in cash.
December 31, 2013. The cash was returned to us during 2014 when we began satisfying the FAL requirement by placing securities on deposit with Lloyd's (see "Investment Exposures").
We did not repurchase any common shares subsequent to December 31, 2016 and as of February 17, 2017 our remaining Board authorization was approximately $109.6 million.
The anticipated payout of Losses and loss adjustment expenses is based upon our historical payout patterns. Both the timing and amount of these payments may vary from the payments indicated. Our operating lease obligations are primarily for the rental of office space and office equipment.
Results of Operations-Year Ended December 31, 2016 Compared to Year Ended December 31, 2015
Consolidated Net premiums earned increased in 2016 as compared to 2015 driven by increases in net premiums earned from both our Lloyd's Syndicate segment and our Specialty P&C segment. The increase from our Specialty P&C segment was primarily due to $11.8 million in premium earned from a novation entered into during the fourth quarter of 2016 (see further discussion in our Segment Operating Results - Specialty Property & Casualty section that follows).
We had Net realized investment gains of $34.9 million in 2016 as compared to Net realized investment losses of $41.6 million in 2015. OTTI recognized in earnings were $9.8 million in 2016 and $15.3 million in 2015.
The primary components of the consolidated increase in Underwriting, policy acquisition and operating expenses for 2016 were:
Increase in operating expenses in our Workers' Compensation segment of $3.5 million primarily due to an increase in compensation and related benefit costs, state assessments and pension settlement charges.
Our effective tax rate was 14.3% for the year ended December 31, 2016, as compared to our 2015 effective tax rate of 9.8%. The increase in the rate for the year ended December 31, 2016 was primarily due to Net realized investment gains as compared to Net realized investment losses during 2015.
Our operating ratio (calculated as our combined ratio, less our investment income ratio) increased by 3.0 percentage points in the year ended December 31, 2016, which reflected a higher net loss ratio driven by a lower amount of prior year favorable development in our Specialty P&C segment and a lower investment ratio due to a decline in income from our fixed maturity securities.
ROE was 8.0% for the year ended December 31, 2016 and was 5.6% for the year ended December 31, 2015. The increase in 2016 was primarily due to Net realized investment gains as compared to Net realized investment losses during 2015.
We believe our commitment to share repurchases and the declaration of dividends are currently our most effective uses of capital even though, in the short-term, dividends and significant share repurchases above book value dampen growth in book value per share. Our book value per share at December 31, 2016 as compared to December 31, 2015 is shown in the following table.
Our legal professionals policies are primarily individual and small group policies in select areas of practice. The decline in 2016 was primarily due to retention losses, partially offset by new business written. Retention losses were primarily driven by an increase in renewal pricing in certain jurisdictions as well as stricter underwriting standards.
During 2016, we expanded our alternative market solutions by writing new healthcare premium in certain SPCs. We added approximately $4.1 million in healthcare professional liability premium during the year ended 2016 which included $1.2 million written in our physicians line of business, $2.9 million in our healthcare facilities line of business and a nominal amount written in our other healthcare providers line of business. All or a portion of the premium written was ceded to the SPCs at our wholly owned Cayman Islands reinsurance subsidiary, Eastern Re. Under the SPC structure, the net operating results of each cell, net of any participation we have taken in the SPCs, are due to the external owners of that cell. Our Specialty P&C segment does not currently participate in the cells that write HCPL premium, and therefore retains no underwriting profit or loss. However, we receive ceding commissions on the
Ceded premiums represent the amounts owed to our reinsurers for their assumption of a portion of our losses. Through our current excess of loss reinsurance arrangements we retain the first $1 million in risk insured by us and cede coverages in excess of this amount. For our medical technology liability coverages, we also retain 20% of the next $9.0 million of risk for coverages in excess of $1.0 million. We pay our reinsurers a ceding premium in exchange for their accepting the risk, the ultimate amount of which is determined by the loss experience of the business ceded, subject to certain minimum and maximum amounts.
We generally reinsure risks under our excess of loss reinsurance arrangements pursuant to which the reinsurers agree to assume all or a portion of all risks that we insure above our individual risk retention levels, up to the maximum individual limits offered. The decrease in ceded premiums written under our excess of loss reinsurance arrangements during 2016 was primarily due to more favorable contract terms on our 2015 core treaty which renewed in October 2016 with similar terms.
As shown in the table below, our ceded premiums ratio was affected in both 2016 and 2015 by revisions to our estimate of premiums owed to reinsurers related to coverages provided in prior accident years.
The following table summarizes calendar year net loss ratios by separating losses between the current accident year and all prior accident years. Additionally, the table shows our current accident year net loss ratio was affected by revisions to our estimate of premiums owed to reinsurers related to coverages provided in prior accident years. Net loss ratios for 2016 and 2015 compare as follows:
Reductions to premiums owed under reinsurance agreements for prior accident years increased net premiums earned (the denominator of the current accident year ratio) in both 2016 and 2015. See the discussion in the Premiums section for our Specialty P&C segment under the heading "Ceded Premiums Written" for additional information.
The decrease in the current accident year net loss ratio primarily reflected changes in expected loss costs related to mass tort litigation and, to a lesser extent, changes in the mix of business. While we increased our reserves related to mass tort litigation in both 2016 and 2015 the increase was substantially less in 2016, resulting in approximately 1.9 percentage points of the decrease. Slightly offsetting the decrease by approximately 0.4 percentage points was the effect of a novation (net premiums earned at a high loss ratio) entered into during the fourth quarter 2016. Additional information regarding the novation is included in the Premiums section for our Specialty P&C segment under the heading "Gross Premiums Written."
Our Workers' Compensation segment provides traditional workers' compensation insurance products to employers with 1,000 or fewer employees and alternative market solutions, as discussed in Note 15 to the Notes to Consolidated Financial Statements. Segment operating results reflect pre-tax underwriting profit or loss, which includes SPC dividend expense (income) and excludes investment results which are included in our Corporate segment. Segment operating results were net earnings of $2.7 million and $8.4 million for the years ended December 31, 2016 and 2015, respectively. SPC dividend expense (income) for this segment reflects both the underwriting and investment results of our alternative market business ceded to the SPCs at Eastern Re, net of our participation in the SPCs. The SPC investment results, which include Net investment income and Net realized gains and losses, reflected income of $3.2 million in 2016 compared to losses of $1.0 million in 2015. The SPC investment results should be considered in the calculation of the segment operating results as they are included in SPC dividend expense (income). Segment operating results, inclusive of the SPC investment results, were net earnings of $5.9 million and $7.4 million for the years ended December 31, 2016 and 2015, respectively.
Ceded premiums written reflected our external reinsurance programs and alternative market business ceded to unaffiliated captive insurance companies.
We retain the first $0.5 million in risk insured by us on our traditional business and cede losses in excess of this amount on each loss occurrence under our primary external reinsurance contract. The traditional external reinsurance contract contains a return premium provision under which we estimate return premium based on the underlying loss experience of policies covered under the contract. Changes in the return premium estimate reflect the loss experience under the reinsurance contract for the years ended December 31, 2016 and 2015. In our alternative market business, the risk retention for each loss occurrence ranges from $0.3 million to $0.35 million based on the alternative market program. We cede 100% of premiums written under four alternative market programs to unaffiliated captive insurers.
Premiums ceded to external reinsurers in our traditional business increased during the year ended December 31, 2016, which primarily reflected an increase in reinsurance rates for the contract year effective May 1, 2016.
Per our reinsurance agreements, we cede premiums related to our traditional business on an earned premium basis, whereas alternative market premiums are ceded on a written premium basis. The increase in the traditional ceded premiums ratio, less the effect of return premiums, in 2016 as compared to 2015 reflected the increase in reinsurance rates previously discussed. The decrease in the alternative markets ceded premiums ratio in 2016 as compared to 2015 primarily reflected the impact of the premiums ceded to and assumed by the traditional business.
The following table summarizes calendar year net loss ratios by separating losses between the current accident year and all prior accident years. Calendar year net loss ratios by component were as follows:
Non-recurring expenses for the year ended December 31, 2016 in the above table reflected a pension settlement charge of $1.0 million related to the termination of a legacy Eastern pension plan which was finalized during the fourth quarter of 2016.
The remaining increase in the traditional expense ratio in 2016, exclusive of the items noted in the table, primarily reflected increases in compensation and related benefits and state assessments, as well as the effect of the decrease in net premiums earned. The alternative markets expense ratio primarily reflected ceding commissions, which vary by program.
Syndicate 1729 covers a range of property and casualty insurance and reinsurance lines, and had a maximum underwriting capacity of £90.0 million for the 2016 underwriting year, of which £51.8 million ($63.9 million based on December 31, 2016 exchange rates) is our allocated underwriting capacity. We are required to provide capital (also referred to as FAL) to support our underwriting capacity and are meeting our FAL requirement with investment securities held at Lloyd's. Our FAL securities had a fair value of $97.1 million at December 31, 2016, as discussed in Note 4 of the Notes to Consolidated Financial Statements.
Gross premiums written in 2016 consisted of casualty coverages (53% of total gross written premium), property insurance coverages (28%), catastrophe reinsurance coverages (15%), and property reinsurance coverages (4%). The increase in net premiums written during 2016 was attributable to new business.
Net premiums earned consist of gross premiums earned less the portion of earned premiums that we cede to our reinsurers for their assumption of a portion of our losses. Policies written to date primarily carry a term of one year. Because premiums are generally earned pro rata over the entire policy period, fluctuations in premiums earned tend to lag those of premiums written. Additionally, premiums for certain policies and assumed reinsurance contracts are reported subsequent to the coverage period and/or may be subject to adjustment based on loss experience. These premium adjustments are earned when reported, which can result in further fluctuation in earned premium. Net premiums earned reported included premium assumed from our Specialty P&C segment of approximately $14.0 million for 2016 and $14.4 million for 2015.
Losses for the year were primarily recorded using the loss assumptions by risk category incorporated into the business plan submitted to Lloyd's for Syndicate 1729 with consideration given to loss experience incurred to date. The assumptions used in the business plan were consistent with loss results reflected in Lloyd's historical data for similar risks. We expect loss
Underwriting expenses increased $4.3 million during 2016 when compared to 2015 primarily related to a $5.9 million increase in DPAC amortization. As operations have matured, the total amount of underwriting salaries has increased along with the number of policies successfully written. Underwriting compensation is capitalized as DPAC only when efforts are successful and amounts capitalized in 2016 were greater than in 2015. During 2014, the initial year of operations, no underwriting salaries were capitalized as DPAC, as there was no established success rate. The first quarter 2015 reflected results from 2014 due to the delay in reporting. Consequently, DPAC amortization was greater in 2016 than in 2015 but underwriting compensation charged directly to expense was lower in 2016 than in 2015. Also, certain startup expenses were incurred in 2015. The improvement in the 2016 expense ratio primarily reflected the increase in net premiums earned and we anticipate a continued reduction to the ratio as the level of net premiums earned is expected to continue to grow.
Net investment income for the years ended December 31, 2016 and 2015 was primarily attributable to interest earned on the FAL investments. Our FAL investments are primarily short-term investments and investment-grade corporate debt securities.
Operating results of this segment are subject to U.K. income tax law. During the fourth quarter of 2016, we recognized a $3.0 million tax benefit, which reversed taxes accrued in previous quarters of 2016. The benefit is a result of a current period change in the calculation of the currency exchange gains and losses on our Syndicate 1729’s investments for U.K. tax purposes, which are primarily denominated in U.S. dollars.
Net investment income is primarily derived from the income earned by our fixed maturity securities and also includes dividend income from equity securities, income from our short-term and cash equivalent investments, earnings from other investments and increases in the cash surrender value of BOLI contracts. Investment fees and expenses are deducted from investment income.
The following table provides detailed information regarding our Net realized investment gains (losses).
We recognized a $3.1 million and an $8.1 million OTTI in earnings during 2016 and 2015 related to our interest in an investment fund that is accounted for using the cost method (classified as part of Other investments). The fund is focused on the energy sector and securities held by the fund declined in value during both 2016 and 2015. OTTI was recognized to reduce our carrying value of the investment to the NAV reported by the fund.
Corporate segment operating expenses for the years ended December 31, 2016 and 2015, respectively, were comprised as follows:
Our effective tax rates for both 2016 and 2015 were different from the statutory federal income tax rate primarily due to the following:
We did not recognize U.S. or U.K. tax expense relative to our pro rata portion of the operating profits of Syndicate 1729 in 2016 as we were able to utilize Syndicate 1729 operating losses from prior years as an offset. We did not recognize a tax benefit for our U.K.operating losses in 2015 as no tax benefit was currently available and it was not more likely than not that a future benefit would be realized.
Our net investment result, which includes both net investment income and earnings from unconsolidated subsidiaries, decreased $17.2 million or 13.3% for the year ended December 31, 2015. The decrease was primarily attributable to reduced earnings from our fixed income portfolio, and reflected both a smaller portfolio, due to our sustained capital management activities, and lower yields.
We had net realized investment losses of $41.6 million for the year ended December 31, 2015 as compared to net realized investment gains of $14.7 million for the same respective period in 2014. Approximately $36.4 million of the 2015 decline was attributable to the performance of our equity trading securities. OTTI recognized in earnings were $15.3 million for the year ended December 31, 2015 and $1.2 million for the year ended December 31, 2014.
The increase in our 2015 consolidated expense ratio is primarily attributable to certain costs being allocated to operating expense in 2015 and allocated to ULAE in 2014. Cost shifts between segments and between operating expense and ULAE were the primary reason that our Corporate segment expense ratio increased and our Specialty P&C segment expense ratio decreased in 2015. The Lloyd's Syndicate segment expense ratio decreased in 2015 as compared to 2014 reflecting growth in earned premium during 2015, as Syndicate 1729 did not begin operations until January 1, 2014. The 2015 decrease in the Workers' Compensation segment expense ratio reflects prudent expense management as well as a higher ratio during 2014 due to transaction-related expenses.
Our effective tax rate was 9.8% for the year ended December 31, 2015, as compared to our 2014 effective tax rate of 25.0%. The reduction to the ratio for the year ended December 31, 2015, was primarily due to the combined effect of higher tax credits and lower pre-tax income.
We believe our commitment to share repurchases and the declaration of dividends are currently our most effective uses of capital even though, in the short-term, dividends and significant share repurchases above book value dampen growth in book value per share. Our book value per share at December 31, 2015 as compared to December 31, 2014 is shown in the following table.
term policies was primarily due to the loss of a few large policies in 2015 and the shifting of certain policies from a twelve month term to a twenty-four month term during 2015, partially offset by new business written. We offer twenty-four month term policies to our physician insureds in one selected jurisdiction. The increase in twenty-four month premium as compared to 2014, was primarily due to the normal cycle of renewals (policies subject to renewal in 2015 were previously written in 2013 rather than in 2014) and to the renewal of certain twelve month term policies as twenty-four month term as mentioned above.
We offer extended reporting endorsement or "tail" coverage to insureds who discontinue their claims-made coverage with us, and we also periodically offer tail coverage through custom policies. The amount of tail coverage premium written can vary widely from period to period.
As previously discussed, we are a 58% participant in Syndicate 1729 and record our pro rata share of its operating results in our Lloyd's Syndicate segment on a quarter delay. We also record this agreement within the Specialty P&C segment on a quarter delay as the amounts are not material and this permits the cession to be reported by both the Lloyd's Syndicate segment and the Specialty P&C segment in the same reporting period. Premium ceded to Syndicate 1729 reported for the 2015 period in the table above reflects cessions that occurred during the first three quarters of 2015 and the fourth quarter of 2014. Premiums ceded to Syndicate 1729 reported for the 2014 period in the table above reflected cessions that occurred during the first three quarters of 2014. As our premiums are earned, we recognize the related ceding commission income which reduces underwriting expense by offsetting DPAC amortization. The related ceding commission income was $6.7 million for the year ended 2015 and $5.6 million for the year ended 2014. For our consolidated results, eliminations of the inter-segment portion (58% of the Specialty P&C cession) of the transactions are also recorded on a quarter delay.
We recognized net favorable loss development related to our previously established reserve of $159.0 million and $180.8 million for the years ended December 31, 2015 and 2014, respectively. We re-evaluate our previously established reserve each quarter based on our most recently available claims data and currently available industry trend information. Development recognized during 2015 principally related to accident years 2008 through 2012. Development recognized during 2014 principally related to accident years 2007 through 2011.
A detailed discussion of factors influencing our recognition of loss development recognized is included in our Critical Accounting Estimates section under the heading "Reserve for Losses and Loss Adjustment Expenses." Assumptions used in establishing our reserve are regularly reviewed and updated by management as new data becomes available. Any adjustments necessary are reflected in the current operations. Due to the size of our reserve, even a small percentage adjustment to the assumptions can have a material effect on our results of operations for the period in which the change is made, as was the case in both 2015 and 2014.
DPAC amortization decreased $9.6 million during 2015 primarily due to increased ceding commission income of $5.1 million, almost all of which resulted from a quota share reinsurance arrangement with Syndicate 1729, as previously discussed. The remaining decrease is attributable to both lower capitalization of underwriting and sales salaries in 2015 due to corporate restructuring initiatives (see discussion below) and a reduction in gross earned premium in 2015 as compared to 2014.
The reduction to the ratio in 2015 was primarily due to the implementation of the new management agreement and the shifting of certain expenses to the Corporate segment, as previously discussed. Net earned premium declined in 2015 but the effect of the decline was substantially offset by the effect of the previously discussed reduction to DPAC amortization during 2015.
We retain the first $0.5 million in risk insured by us on our traditional business and cede losses in excess of this amount on each loss occurrence under our primary external reinsurance contract. The traditional external reinsurance contract contains a return premium provision under which we estimate return premium based on the underlying loss experience of policies covered under the contract. Changes in the return premium estimate reflect the loss experience under the reinsurance contract for the years ended December 31, 2015 and 2014. In our alternative market business, the risk retention for each loss occurrence ranges from $0.3 million to $0.35 million based on the alternative market program. We cede 100% of premiums written under three alternative market programs to an unaffiliated captive insurer.
Premiums ceded to external reinsurers in our traditional business decreased during the year ended December 31, 2015, which primarily reflected a reduction in reinsurance rates. The $0.4 million decrease in the return premium estimate for the year ended December 31, 2015 primarily reflected 2015 traditional ceded incurred losses of $7.9 million (including $4.9 million related to the 2015 accident year), partially offset by favorable loss experience on contract years prior to 2014. The increase in premiums ceded to the unaffiliated captive insurer during the year ended December 31, 2015 reflected premium growth in the programs.
We recognized net favorable prior year development related to our previously established reserve of $2.2 million for the year ended December 31, 2015 and $1.3 million for the same respective period of 2014. The net favorable prior year development included $1.6 million related to amortization of the purchase accounting fair value adjustment for our traditional business for both 2015 and 2014. It also included $0.6 million in net favorable prior year development for our alternative market business for 2015 and $0.3 million in net unfavorable prior year development for 2014.
Within our alternative market business, audit premium from insureds results in a decrease in the net loss ratio, whereas audit premium returned to insureds results in an increase in the net loss ratio. We recognized audit premium in our alternative market business during both 2015 and 2014 and the effect of that premium on the current accident year net loss ratio is reflected in the table above.
The decrease in the traditional business expense ratio for 2015 primarily reflected the growth in net premiums earned and prudent expense management. The alternative markets expense ratio primarily reflected ceding commissions charged to each program.
Our Workers' Compensation segment provides turn-key workers' compensation alternative market solutions that include program design, fronting, claims administration, risk management, SPC rental, asset management and SPC management services. The asset management and SPC management services are outsourced to a third-party. Alternative market customers include individual companies, groups and associations. SPC dividend expense (income) for each period represents the profit or loss attributable to the alternative market business ceded to the SPCs of Eastern Re, net of any participation we have taken in the SPCs.
SPC dividend expense (income) for 2015 primarily reflected an increase in the SPC loss ratio and a decrease in net realized gains when compared to the same 2014 period. The increase in the SPC loss ratio primarily reflected severity related claim activity in the fourth quarter of 2015. Net realized losses totaled $1.5 million in 2015, compared to net realized gains of $0.5 million in 2014, primarily reflecting a decline in the fair value of the SPC’s equity securities in 2015. The SPC investment results, which are reported in our Corporate segment as discussed at the beginning of the Segment Operating Results - Workers' Compensation section, reflected losses of $1.0 million in 2015, compared to income of $0.9 million in 2014.
Through a wholly owned and consolidated subsidiary, we are a corporate member of Lloyd's of London and have provided the majority (58%) of the capital for Syndicate 1729, which began writing and reinsuring property and casualty business as of January 1, 2014. The remaining capital for Syndicate 1729 is provided by unrelated third parties, including private names and other corporate members.
Our Lloyd's Syndicate segment operating results for 2015 was a loss of $5.6 million and for 2014 was a loss of $5.0 million, composed as follows:
Net investment income for the years ended December 31, 2015 and 2014 was primarily attributable to interest earned on the FAL investments. Our FAL investments are primarily short-term investments and investment-grade corporate debt securities.
Income from our equity portfolio increased approximately 23.1% for the year ended December 31, 2015, as compared to 2014. The 2015 increase in income reflects an increase to our allocation to this asset category during 2015 as well as a different mix of equities owned.
Investment fees and expenses decreased $2.0 million for the year ended December 31, 2015. The decrease reflected lower portfolio management fees, due to various factors including a smaller portfolio and a more favorable fee structure obtained in 2015.
We believe that to fully understand our investment returns it is important to consider the current tax benefits associated with certain investments as the tax benefit received represents a portion of the return provided by our tax-exempt bonds, BOLI, common and preferred stocks, and tax credit partnership investments (our tax-preferred investments). We impute a pro forma tax-equivalent result by estimating the amount of fully-taxable income needed to achieve the same after-tax result as is currently provided by our tax-preferred investments. We believe this better reflects the economics behind our decision to invest in certain asset classes that are either taxed at lower rates and/or result in reductions to our current federal income tax expense. Our pro forma tax-equivalent investment result is shown in the table that follows as is a reconciliation of our tax equivalent result to our GAAP net investment result.
not allocated to the subsidiaries within the Workers' Compensation segment during 2014 as these subsidiaries were newly acquired.
On a combined basis, exclusive of any effect from DPAC amortization, management fees or allocations, there was a $2.8 million decrease in expenses in 2015 as compared to 2014. The net decrease was attributable to acquisition-related expenses incurred in 2014 but not in 2015, partially offset by higher expenses during 2015. Expenses incurred in 2014 but not in 2015 included expenses associated with discontinued operations of an acquired entity, certain retention and severance expenses, and amortization of intangible assets that became fully amortized early in 2015. Expense increases during 2015 primarily resulted from the following: higher costs for technology enhancements, corporate restructuring which shifted expense, primarily compensation expense, from ULAE cost centers to operating expense cost centers, and a corporate litigation recovery received in 2014.
We calculate our effective tax rate on a consolidated basis, dividing consolidated tax expense by consolidated pre-tax income. Consolidated tax expense reflects both U.S. tax expense, all of which is allocated to our Corporate segment, and U.K. tax expense, all of which is allocated to our Lloyd's Syndicate segment, as detailed in the table that follows: