On December 3, 2017, Hartford Holdings, Inc., a wholly owned subsidiary of the Company, entered into a definitive agreement to sell all of the issued and outstanding equity of Hartford Life, Inc. (“HLI”), a holding company, and its life and annuity operating subsidiaries. For discussion of this transaction, see Note 20 - Business Dispositions and Discontinued Operations of Notes to Consolidated Financial Statements.
On July 29, 2016, the Company completed the acquisition of Maxum Specialty Insurance Group and Lattice Strategies LLC. Maxum's revenue and earnings since the acquisition date are included in the operating results of the Company's Commercial Lines reporting segment. Lattice's revenue and earnings since the acquisition date are included in the operating results of the Company's Mutual Funds reporting segment. For discussion of
these transactions, see Note 2 - Business Acquisitions of Notes to Consolidated Financial Statements.
Unpaid losses and loss adjustment expenses and reinsurance recoverables for structured settlements reserves and recoverables due from the Company's life and annuity run-off business now classified as held for sale have been reclassified into the Company's P&C commercial lines business. Annuities purchased from third-party life insurers under structured settlements, including from life and annuity run-off obligations held for sale, are recognized as reinsurance recoverables in cases where the Company has not obtained a release from the claimant. These amounts were previously eliminated in consolidation.
Policy loans have been reclassified to Other investments on the Consolidated Balance Sheets.
Other intangible assets have been reclassified out of Other assets on the Consolidated Balance Sheets into their own line item.
Likewise, amortization of intangible assets has been reclassified out of Insurance operating costs and other expenses on the Consolidated Statements of Operations into their own line item.
Assets Under Management (“AUM”)- include mutual fund and ETP assets. AUM is a measure used by the Company because a significant portion of the Company’s mutual fund revenues are based upon asset values. These revenues increase or decrease with a rise or fall in AUM whether caused by changes in the market or through net flows.
because it eliminates the effect of items that can fluctuate significantly from period to period, primarily based on changes in interest rates.
Core Earnings Margin- a non-GAAP financial measure that the Company uses to evaluate, and believes is an important measure of, the Group Benefits segment’s operating performance. Core earnings margin is calculated by dividing core earnings by revenues excluding buyouts and realized gains (losses). Net income margin is the most directly comparable U.S. GAAP measure. The Company believes that core earnings margin provides investors with a valuable measure of the performance of Group Benefits because it reveals trends in the business that may be obscured by the effect of buyouts and realized gains (losses). Core earnings margin should not be considered as a substitute for net income margin and does not reflect the overall profitability of Group Benefits. Therefore, the Company believes it is important for investors to evaluate both core earnings margin and net income margin when reviewing performance. A reconciliation of net income margin to core earnings margin for the years ended December 31, 2017, 2016 and 2015 is set forth in the Results of Operations section within MD&A - Group Benefits.
Expense Ratio- for the underwriting segments of Commercial Lines and Personal Lines is the ratio of underwriting expenses less fee income, to earned premiums. Underwriting expenses include the amortization of deferred policy acquisition costs and insurance operating costs and expenses, including certain centralized services and bad debt expense. Deferred policy acquisition costs include commissions, taxes, licenses and fees and other underwriting expenses and are amortized over the policy term.
Fee Income- largely driven from amounts earned as a result of contractually defined percentages of assets under management. These fees are generally earned on a daily basis. Therefore, the growth in assets under management either through positive net flows or favorable market performance will have a favorable impact on fee income. Conversely, either
negative net flows or unfavorable market performance will reduce fee income.
Loss and Loss Adjustment Expense Ratio before Catastrophes and Prior Accident Year Development- a measure of the cost of non-catastrophe claims incurred in the current accident year divided by earned premiums. Management believes that the current accident year loss and loss adjustment expense ratio before catastrophes is a performance measure that is useful to investors as it removes the impact of volatile and unpredictable catastrophe losses and prior accident year development.
Loss Ratio, excluding Buyouts- utilized for the Group Benefits segment and is expressed as a ratio of benefits, losses and loss adjustment expenses to premiums and other
considerations, excluding buyout premiums. Since Group Benefits occasionally buys a block of claims for a stated premium amount, the Company excludes this buyout from the loss ratio used for evaluating the underwriting results of the business as buyouts may distort the loss ratio. Buyout premiums represent takeover of open claim liabilities and other non-recurring premium amounts.
Mutual Fund and Exchange-Traded Product Assets- are owned by the shareholders of those products and not by the Company and therefore are not reflected in the Company’s consolidated financial statements. Mutual fund and ETP assets are a measure used by the Company primarily because a significant portion of the Company’s revenues are based upon asset values. These revenues increase or decrease with a rise or fall in AUM whether caused by changes in the market or through net flows.
Reinstatement Premiums- represents additional ceded premium paid for the reinstatement of the amount of reinsurance coverage that was reduced as a result of a reinsurance loss payment.
Renewal Earned Price Increase (Decrease)- Written premiums are earned over the policy term, which is six months for certain Personal Lines automobile business and twelve months for substantially all of the remainder of the Company’s Property and Casualty business. Since the Company earns premiums over the six to twelve month term of the policies,
Renewal Written Price Increase (Decrease)-for Commercial Lines, represents the combined effect of rate changes, amount of insurance and individual risk pricing decisions per unit of exposure on policies that renewed. For Personal Lines, renewal written price increases represent the total change in premium per policy on those policies that renewed and includes the combined effect of rate changes, amount of insurance and other changes in exposure. For Personal Lines, other changes in exposure include, but are not limited to, the effect of changes in number of drivers, vehicles and incidents, as well as changes in customer policy elections, such as deductibles and limits. The rate component represents the change in rate filed with and approved by state regulators during the period and the amount of insurance represents the change in the value of the rating base, such as model year/vehicle symbol for automobiles, building replacement costs for property and wage inflation for workers’ compensation. A number of factors affect renewal written price increases (decreases) including expected loss costs as projected by the Company’s pricing actuaries, rate filings approved by state regulators, risk selection decisions made by the Company’s underwriters and marketplace competition. Renewal written price changes reflect the property and casualty insurance market cycle. Prices tend to increase for a particular line of business when insurance carriers have incurred significant losses in that line of business in the recent past or the industry as a whole commits less of its capital to writing exposures in that line of business. Prices tend to decrease when recent loss experience has been favorable or when competition among insurance carriers increases. Renewal written price statistics are subject to change from period to period, based on a number of factors, including changes in actuarial estimates and the effect of subsequent cancellations and non-renewals, and modifications made to better reflect ultimate pricing achieved.
combined ratio to underlying combined ratio for the years ended December 31, 2017, 2016 and 2015 is set forth in the Results of Operations section within MD&A - Commercial Lines and Personal Lines.
The Company derives its revenues principally from: (a) premiums earned for insurance coverage provided to insureds; (b) asset management fees on mutual fund and ETP assets; (c) net investment income; (d) fees earned for services provided to third parties; and (e) net realized capital gains and losses. Premiums charged for insurance coverage are earned principally on a pro rata basis over the terms of the related policies in-force.
business. In addition to appropriately evaluating and pricing risks, the profitability of the Group Benefits business depends on other factors, including the Company’s response to pricing decisions and other actions taken by competitors, its ability to offer voluntary products and self-service capabilities, the persistency of its sold business and its ability to manage its expenses which it seeks to achieve through economies of scale and operating efficiencies.
The financial results in the Company’s mutual fund and ETP businesses depend largely on the amount of assets under management on which it earns fees and the level of fees charged. Changes in assets under management are driven by two main factors: net flows, and the market return of the funds, which is heavily influenced by the return realized in the equity markets. Net flows are comprised of new sales less redemptions by mutual fund and ETP shareholders. Financial results are highly correlated to the growth in assets under management since these products generally earn fee income on a daily basis.
The investment return, or yield, on invested assets is an important element of the Company’s earnings since insurance products are
priced with the assumption that premiums received can be invested for a period of time before benefits, loss and loss adjustment expenses are paid. Due to the need to maintain sufficient liquidity to satisfy claim obligations, the majority of the Company’s invested assets have been held in available-for-sale securities, including, among other asset classes, equities, corporate bonds, municipal bonds, government debt, short-term debt, mortgage-backed securities and asset-backed securities and collateralized debt obligations.
Net Loss of $3,131, or $8.61 per basic and diluted share, compared with prior year net income of $896, or $2.31 per basic share and $2.27 per diluted share. The change from net income in 2016 to a net loss in 2017 was mostly due to a loss on discontinued operations of $2.9 billion related to the pending sale of the life and annuity run-off business, a charge to income tax expense of $877 arising primarily from the reduction of net deferred tax assets due to the enactment of lower Federal income tax rates and a pension settlement charge of $488 after-tax.
Combined ratio of 100.0 compared with 100.1 in the prior year for Property & Casualty, as a higher combined ratio in Commercial Lines was largely offset by the effect of asbestos and environmental reserve strengthening in P&C Other Operations in 2016 and modest improvement in the Personal Lines combined ratio.
Commercial Lines includes installment fees of $37, $39 and $40, for 2017, 2016 and 2015, respectively. Personal Lines includes installment fees of $44, $39, and $37, for 2017, 2016 and 2015, respectively.
Net income (loss) decreased from net income in 2016 to a net loss in 2017 primarily due to a loss on discontinued operations of $2.9 billion related to the pending sale of the life and annuity run-off business, a charge to income tax expense of $877 arising primarily from the reduction of net deferred tax assets due to the enactment of lower Federal income tax rates and a pension settlement charge of $488 after-tax. Partially offsetting the decline were the effects of a $179 after-tax change from net realized capital losses in 2016 to net realized capital gains in 2017, the effect of a $423 after-tax charge in 2016 related to a loss on reinsurance covering the Company’s asbestos and environmental exposures and a reduction in the valuation allowance on capital loss carryovers in 2016. In addition, a $324 after-tax improvement in P&C prior accident year development and higher earnings in Group Benefits and Mutual Funds were largely offset by a $273 after-tax increase in current accident year catastrophes and higher variable incentive compensation.
Earned premiums increased by $444, before tax, reflecting growth of 3% in Commercial Lines, including the effect of the Maxum acquisition, and 14% in Group Benefits, including the effect of acquiring the Aetna U.S. group life and disability business, partially offset by a 5% decrease in Personal Lines. For a discussion of the Company's operating results by segment, see MD&A - Results of Operations by segment.
Net investment income increased 2%, primarily due to higher income from limited partnerships and other alternative investments, partially offset by lower make-whole payment income on fixed maturities and increased investment expenses. For further discussion of investment results, see MD&A - Investment Results, Net Investment Income (Loss).
Net realized capital gains of $165 before-tax compared to net realized capital losses of $110 before-tax in 2016, primarily due to higher net gains on sales, lower impairments and the effect of losses in 2016 related to the sale of the Company's U.K. property and casualty run-off subsidiaries and the write-down of investments in solar energy partnerships in 2016 that generated tax benefits. For further discussion of investment results, see MD&A - Investment Results, Net Realized Capital Gains (Losses).
Current accident year losses and loss adjustment expenses before catastrophes in Property & Casualty were relatively flat, primarily resulting from improved loss ratios and lower
Current accident year catastrophe losses of $836, before tax, compared to $416, before tax, for the prior year period. Catastrophe losses in 2017 were primarily due to hurricanes Harvey and Irma, California wildfires and multiple wind and hail events across various U.S. geographic regions, primarily in the Midwest, Colorado, Texas and the Southeast. Catastrophe losses in 2016 were primarily due to multiple wind and hail and winter storm events across various U.S. geographic regions, concentrated in Texas and the central and southern plains and, to a lesser extent, winter storms and hurricane Matthew. For additional information, see MD&A - Critical Accounting Estimates, Property & Casualty Insurance Product Reserves, Net of Reinsurance.
Income tax expense increased primarily due to a charge of $877 as a result of the Tax Cuts and Jobs Act ("Tax Reform") enacted in December, 2017. Among other changes, Tax Reform reduced the Federal corporate income tax rate from 35% to 21% effective January 1, 2018 which resulted in a reduction of the
Company's net deferred tax assets, including its net operating loss carryovers. Also contributing to the increase in income tax expense were federal income tax benefits of $113 in 2016 arising from investments in solar energy partnerships that generated tax benefits and the effect of a federal income tax benefit of $65 in 2016 related to the sale of the Company's U.K. property and casualty run-off subsidiaries.
Income (loss) from discontinued operations, net of tax decreased from income of $283 in 2016 to a net loss of $2.9 billion in 2017 with the net loss in 2017 due to a loss on sale of the Company’s life and annuity run-off business of $3.3 billion, partially offset by operating income from discontinued operations of $388. Operating income from discontinued operations increased from $283 in 2016 primarily due to lower net realized capital losses in 2017. Apart from the reduction in net realized capital losses, earnings were relatively flat as an increase in the unlock benefit and lower interest credited were largely offset by lower net investment income and lower fee income due to the continued run-off of the variable annuity block.
Net realized capital losses were $110 in 2016 an increase from net realized capital losses of $12 in 2015 primarily due to losses associated with the sale of the Company's U.K. property and casualty run-off subsidiaries and a change from net
gains to net losses on non-qualifying derivatives, partially offset by lower impairments and an increase in net realized gains on sale of corporate securities, U.S. Treasury securities, municipal bonds and equity securities. Also contributing to the increase in net realized capital losses was a $96 write-down of an investment in solar energy partnerships that generated tax credits and other tax benefits of $113 in 2016. For further discussion of investment results, see the Net Realized Capital Gains (Losses) section within MD&A - Investment Results,
Current accident year catastrophe losses of $416, before tax, in 2016, compared to $332, before tax, in 2015. Catastrophe losses in 2016 were primarily due to multiple wind and hail events across various U.S. geographic regions, concentrated in Texas and the central and southern plains and, to a lesser extent, winter storms and Hurricane Matthew. Catastrophe losses in 2015 were primarily due to multiple winter storms and wind and hail events across various U.S. geographic regions as well as tornadoes and wildfires. For additional information, see MD&A - Critical Accounting Estimates, Property & Casualty Insurance Product Reserves.
Fixed maturities, AFS increased primarily due the transfer in of fixed maturities, AFS related to the acquisition of Aetna's U.S. group life and disability business as well as an increase in valuations due to tighter credit spreads.
Mortgage Loans increased largely due to originations of multifamily commercial whole loans.
Primarily includes income from derivatives that qualify for hedge accounting and hedge fixed maturities.
below the average yield of sales and maturities of 3.7% for the same period. For the year ended December 31, 2017, the average reinvestment rate of 3.5% remained consistent with that of the same period in 2016.
Gross gains and losses on sales were primarily the result of duration, liquidity and credit management within corporate securities, U.S. treasury securities, equity securities, and tax-exempt municipal bonds.
Other, net gain included gains of $21 related to credit derivatives due to credit spread tightening, partially offset by losses of $7 related to equity derivatives hedging against the impact of a decline in the equity market on the investment portfolio.
Other, net losses were primarily related to losses of $7 on credit derivatives driven by widening credit spreads.
It typically takes many months or years to pay claims incurred under a property and casualty insurance product; accordingly, the Company must establish reserves at the time the loss is incurred. Most of the Company’s policies provide for occurrence-based
Factors that Change Reserve Estimates- Reserve estimates can change over time because of unexpected changes in the external environment. Inflation in medical care, hospital care, automobile parts, wages and home and building repair would cause claims to settle for more than they are initially reserved. Changes in the economy can cause an increase or decrease in the number of reported claims (claim frequency). For example, an improving economy could result in more automobile miles driven and a higher number of automobile reported claims while a contracting economy can sometimes lead to an increase in workers’ compensation reported claims. An increase in the number or percentage of claims litigated can increase the average settlement amount per claim (claim severity). Changes in the judicial environment can affect interpretations of damages and how policy coverage applies which could increase or decrease claim severity. Over time, judges or juries in certain jurisdictions may be more inclined to determine liability and award damages. New legislation can also change how damages are defined resulting in greater frequency or severity. In addition, new types of injuries may arise from exposures not contemplated when the policies were written. Past examples include pharmaceutical products, silica, lead paint, molestation or abuse and construction defects.
present estimates of direct and assumed reserves, particularly when those settlements may not occur until well into the future.
For a discussion of how A&E reserves are set, see MD&A - P&C Insurance Product Reserves, Reserving for Asbestos and Environmental Claims within Property & Casualty Other Operations. The following is a discussion of the reserving methods used for the Company's property and casualty lines of business other than asbestos and environmental.
How Reserves Are Set- Reserves are set by line of business within the operating segments. A single line of business
may be written in more than one segment. Case reserves are established by a claims handler on each individual claim and are adjusted as new information becomes known during the course of handling the claim. Lines of business for which reported losses emerge over a long period of time are referred to as long-tail lines of business. Lines of business for which reported losses emerge more quickly are referred to as short-tail lines of business. The Company’s shortest-tail lines of business are homeowners, commercial property and automobile physical damage. The longest tail lines of business include workers’ compensation, general liability, professional liability and assumed reinsurance. For short-tail lines of business, emergence of paid loss and case reserves is credible and likely indicative of ultimate losses. For long-tail lines of business, emergence of paid losses and case reserves is less credible in the early periods after a given accident year and, accordingly, may not be indicative of ultimate losses.
Reserve Discounting- Most of the Company’s property and casualty insurance product reserves are not discounted. However, the Company has discounted liabilities funded through structured settlements and has discounted certain reserves for indemnity payments due to permanently disabled claimants under workers’ compensation policies. For further discussion of these discounted liabilities, see Note 1 - Basis of Presentation and Significant Accounting Policies of Notes to Consolidated Financial Statements.
Differences Between GAAP and Statutory Basis Reserves- As of December 31, 2017 and 2016, U.S. property and casualty insurance product reserves for losses and loss adjustment expenses, net of reinsurance recoverables, reported under U.S. GAAP were approximately equal to net reserves reported on a statutory basis. The primary difference between the statutory and GAAP reserve amounts is due to a ceded asbestos and environmental ADC which is a retroactive reinsurance agreement between the Company and NICO that is not included in insurance liabilities for statutory accounting. This difference is largely offset by liabilities for unpaid losses for permanently disabled workers’ compensation claimants discounted under U.S. GAAP at rates that are no higher than risk-free interest rates in effect at the time the claims are incurred which can vary from the statutory discount rates set by regulators. In addition, a portion of the U.S. GAAP provision for uncollectible reinsurance is not recognized under statutory accounting.
Reserving Methods by Line of Business- Apart from A&E which is discussed in the following section on Property & Casualty Other Operations, below is a general discussion of which reserving methods are preferred by line of business. Because the actuarial estimates are generated at a much finer level of detail than line of business (e.g., by distribution channel, coverage, accident period), other methods than those described for the line of business may also be employed for a coverage and accident year within a line of business. Also, as circumstances change, the methods that are given more influence will change.
In the final step of the reserve review process, senior reserving actuaries and senior management apply their judgment to determine the appropriate level of reserves considering the actuarial indications and other factors not contemplated in the actuarial indications. Those factors include, but are not limited to, the assessed reliability of key loss trends and assumptions used in the current actuarial indications, the maturity of the accident year, pertinent trends observed over the recent past, the level of volatility within a particular line of business, and the improvement or deterioration of actuarial indications in the current period as compared to the prior periods. The Company also considers the magnitude of the difference between the actuarial indication and the recorded reserves.
Based on the results of the quarterly reserve review process, the Company determines the appropriate reserve adjustments, if any,
Difficult to Estimate Tort Exposures- Within Commercial Lines and Property & Casualty Other Operations, the Company has exposure to bodily injury claims as a result of long-term or continuous exposure to harmful products or substances. Examples include, but are not limited to, pharmaceutical products, silica, talcum powder, head injuries and lead paint. The Company also has exposure to claims from construction defects, where property damage or bodily injury from negligent construction is alleged. In addition, the Company has exposure to claims asserted against religious institutions and other organizations relating to molestation or abuse. Such exposures may involve potentially long latency periods and may implicate coverage in multiple policy periods. These factors make reserves for such claims more uncertain than other bodily injury or property damage claims. With regard to these exposures, the Company monitors trends in litigation, the external environment, the similarities to other mass torts and the potential impact on the Company’s reserves.
Specialty Lines- In specialty lines, many lines of insurance are “long-tail”, including large deductible workers’ compensation insurance; as such, reserve estimates for these lines are more difficult to determine than reserve estimates for shorter-tail lines of insurance. Reserves for large deductible workers’ compensation insurance require estimating losses attributable to the deductible amount that will be paid by the insured; if such losses are not paid by the insured due to financial difficulties, the Company is contractually liable. Uncertainty in estimated claim severity causes reserve variability for commercial automobile losses including reserve variability due to changes in internal claim handling and case reserving practices as well as due to changes in the external environment. Another example of reserve variability is with directors’ and officers’ insurance where uncertainty regarding the number and severity of class action
suits can result in reserve volatility. Additionally, the Company’s exposure to losses under directors’ and officers’ insurance policies is primarily in excess layers, making estimates of loss more complex.
The following discussion discloses possible variation from current estimates of loss reserves due to a change in certain key indicators of potential losses. For automobile liability lines in both Personal Lines and Commercial Lines, the key indicator is the annual loss cost trend, particularly the severity trend component of loss costs. For workers’ compensation and general liability, loss development patterns are a key indicator, particularly for more mature accident years. For workers’ compensation, paid loss development patterns have been impacted by medical cost inflation and other changes in loss cost trends. For general liability, loss development patterns have been impacted by, among other things, emergence of new types of claims (e.g., construction defect claims) and a shift in the mixture between smaller, more routine claims and larger, more complex claims.
Each of the impacts described below is estimated individually, without consideration for any correlation among key indicators or among lines of business. Therefore, it would be inappropriate to take each of the amounts described below and add them together in an attempt to estimate volatility for the Company’s reserves in total. For any one reserving line of business, the estimated variation in reserves due to changes in key indicators is a reasonable estimate of possible variation that may occur in the future, likely over a period of several calendar years. The variation discussed is not meant to be a worst-case scenario, and,
In the opinion of management, based upon the known facts and current law, the reserves recorded for the Company’s property and casualty insurance products at December 31, 2017 represent the Company’s best estimate of its ultimate liability for losses and loss adjustment expenses related to losses covered by policies written by the Company. However, because of the significant
(Favorable) Unfavorable Prior Accident Year Development for the Year Ended December 31, 2017
Automobile liability reserves within Commercial Lines were increased in Small Commercial and large national accounts for the 2013 to 2016 accident years, driven by higher frequency of more severe accidents, including litigated claims.
Catastrophes reserves were reduced primarily due to lower estimates of 2016 wind and hail event losses and a decrease in losses on a 2015 wildfire.
Represents liabilities classified as held-for-sale as of December 31, 2016 and subsequently transferred to the buyer in connection with the sale of the Company's U.K. property and casualty run-off subsidiaries in May 2017. For discussion of the sale transaction, see Note 20 - Business Dispositions and Discontinued Operations of Notes to Consolidated Financial Statements.
Professional liability reserves decreased for claims made years 2008 - 2013, primarily for large accounts, including on non-securities class action cases. Claim costs have emerged favorably as these years have matured and management has placed more weight on the emerged experience.
Automobile liability reserves increased due to increases in both commercial lines automobile and personal lines automobile. Commercial automobile liability reserves increased, predominately for the 2015 accident year, primarily due to increased frequency of large claims. Personal automobile liability reserves increased, primarily related to increased bodily injury frequency and severity for the 2015 accident year, including for uninsured and under-insured motorist claims, and increased bodily injury severity for the 2014 accident year. Increases in automobile liability loss costs were across both the direct and agency distribution channels.
(Favorable) Unfavorable Prior Accident Year Development for the Year Ended December 31, 2015
Workers' compensation reserves decreased due to an improvement in claim closure rates resulting in a decrease in outstanding claims for permanently disabled claimants. In addition, accident years 2013 and 2014 continue to exhibit favorable frequency and medical severity trends; management has been placing additional weight on this favorable experience as it becomes more credible.
Automobile liability reserves within Commercial Lines were increased due to increased severity of large claims predominantly for accident years 2010 to 2013.
surety reserves related to accident years 2007 and prior, as the number of new claims reported has outpaced expectations.
Included $289 related to the settlement in 2016 of PPG Industries ("PPG") asbestos liabilities, net of reinsurance billed to third-party reinsurers.
The survival ratios shown below are calculated for the one and three year periods ended December 31, 2017. The net basis survival ratio has been materially affected by the adverse development cover entered into between the Company and NICO. The Company cedes adverse asbestos and environmental development in excess of its December 31, 2016 net carried reserves of $1.7 billion to NICO up to a limit of $1.5 billion. Since December 31, 2016, net reserves for asbestos and environmental have been declining as the Company has had no net incurred losses but continues to pay down net loss reserves. As a result, this has the effect of reducing the one- and three-year net survival ratios shown in the table below. For asbestos, the table also presents the net survival ratios excluding the effect of the PPG settlement in 2016. See section that follows entitled Major Categories of Asbestos Accounts for discussion of the PPG settlement.
Beginning in 2017, the Company performs its regular comprehensive annual review of asbestos reserves in the fourth quarter. As part of this evaluation in the fourth quarter of 2017, the Company reviewed all of its open direct domestic insurance accounts exposed to asbestos liability, as well as assumed reinsurance accounts.
As a result of the 2017 fourth quarter review, the Company increased estimated reserves before NICO reinsurance by $183, primarily due to mesothelioma claim filings not declining as expected, unfavorable developments in coverage law in some jurisdictions and continued filings in specific, adverse jurisdictions. An increased share of adverse development from the fourth quarter review is from umbrella and excess policies in the 1981-1985 policy years. This increase in reserves was offset by a $183 reinsurance recoverable under the NICO treaty.
During the 2016 second quarter review, a substantial majority of the Company’s direct accounts trended as expected, and the Company observed no material changes in the underlying legal environment. However, mesothelioma claims filings have not declined as expected for a small subset of peripheral defendants with a high concentration of asbestos filings in specific, adverse jurisdictions. As a result, aggregate indemnity and defense costs did not decline as expected. While the mesothelioma and adverse jurisdiction claim trends observed in the 2016 comprehensive annual review were similar to the 2015 comprehensive annual review, most of the defendants that had reserve increases in the
During the 2015 comprehensive annual review, the Company found a substantial majority of direct accounts trended as expected, and the Company saw no material changes in the underlying legal environment during the past year. However, a small percentage of the Company’s direct accounts experienced greater than expected claim filings, including mesothelioma claims. This was driven by a subset of peripheral defendants with a high concentration of filings in specific, adverse jurisdictions. As a result, the aggregate indemnity and defense costs did not decline as expected. To a lesser degree, the Company also saw unfavorable development on certain assumed reinsurance accounts, driven by various account-specific factors, including filing activity experienced by the direct accounts. Based on this evaluation, the Company increased its net asbestos reserves for prior year development by $146 in second quarter 2015.
Beginning in 2017, the Company performs its regular comprehensive annual review of environmental reserves in the fourth quarter. As part of its evaluation in the fourth quarter of 2017, the Company reviewed all of its open direct domestic insurance accounts exposed to environmental liability, as well as assumed reinsurance accounts.
During the 2015 comprehensive annual review, a substantial majority of the Company's environmental exposures trended as expected, however the Company found loss and expense estimates for certain individual account exposures increased based upon an increase in clean-up costs, including at a handful of Superfund sites. In addition, new claim severity deteriorated, although frequency continued to decline as expected. The net effect of these account-specific changes as well as quarterly actuarial evaluations of new account emergence and historical loss and expense paid experience resulted in an increase of $57 in net environmental reserves for prior years development.
Unallocated Direct Accounts- includes an estimate of the reserves necessary for asbestos claims related to direct insureds that have not previously tendered asbestos claims to the Company and exposures related to liability claims that may not be subject to an aggregate limit under the applicable policies. These exposures represent approximately 37% of the Company's Direct gross asbestos reserves as of December 31, 2017 compared to approximately 39% as of June 30, 2016.
The Company provides an allowance for uncollectible reinsurance, reflecting management’s best estimate of reinsurance cessions that may be uncollectible in the future due to reinsurers’ unwillingness or inability to pay. During the fourth quarter of 2017, and second quarters of 2016 and 2015, the Company completed its annual evaluations of the collectibility of the reinsurance recoverables and the adequacy of the allowance for uncollectible reinsurance associated with older, long-term casualty liabilities reported in Property & Casualty Other Operations. In conducting these evaluations, the Company used its most recent detailed evaluations of ceded liabilities reported in the segment. The Company analyzed the overall credit quality of the Company’s reinsurers, recent trends in arbitration and litigation outcomes in disputes between cedants and reinsurers and recent developments in commutation activity between reinsurers and cedants. The evaluations in the fourth quarter of 2017, and second quarters of 2016 and 2015, resulted in no material adjustments to the Property & Casualty Other Operations' overall ceded reinsurance reserves, including the
allowance for uncollectible reinsurance. As of December 31, 2017, 2016, and 2015 the allowance for uncollectible reinsurance for Property & Casualty Other Operations totaled $86, $136, and $220 respectively. Reductions in the allowance since 2015 are primarily the result of actuarial reserve evaluations that have given greater weight to favorable collectibility experience in recent calendar year periods in estimating future collections, and to a lesser extent impacts from the sale of the Company's UK P&C run-off subsidiaries in 2017. Due to the inherent uncertainties as to collection and the length of time before reinsurance recoverables become due, particularly for older, long-term casualty liabilities, it is possible that future adjustments to the Company's reinsurance recoverables, net of the allowance, could be required.
Ultimate losses may vary materially from the current estimates. Many factors can contribute to these variations and the need to change the previous estimate of required reserve levels. Prior accident year reserve development is generally due to the emergence of additional facts that were not known or anticipated at the time of the prior reserve estimate and/or due to changes in interpretations of information and trends.
Range of Prior Accident Year Unfavorable (Favorable) Development for the Ten Years Ended December 31, 2017
Estimates of ultimate losses have emerged favorably for accident years 2008 and 2009 mainly related to personal automobile liability.
Unfavorable reserve re-estimates on accident years 2010 and 2011 were primarily related to workers' compensation and commercial automobile liability. Workers' compensation loss cost trends were higher than initially expected as an increase in frequency outpaced a moderation of severity trends. Unfavorable commercial automobile liability reserve re-estimates were driven by higher frequency of large loss bodily injury claims.
Reserve changes for accident years 2014 and 2015 were largely driven by unfavorable frequency and severity trends for personal and commercial automobile liability and increased severity of liability claims on package business, offset by favorable frequency and medical severity trends for workers' compensation.
Reserves were decreased for the 2016 accident year largely due to reserve decreases on short-tail lines of business, where results emerge more quickly.
How Reserves are Set - A Disabled Life Reserve (DLR) is calculated for each LTD claim. The DLR for each claim is the expected present value of all future benefit payments starting with the known monthly gross benefit which is reduced for estimates of the expected claim recovery due to return to work or claimant death, offsets from other income including offsets from Social Security benefits, and discounting where the discount rate is tied to expected investment yield at the time the claim is incurred. Estimated future benefit payments represent the monthly income benefit that is paid until recovery, death or expiration of benefits. Claim recoveries are estimated based on claim characteristics such as age and diagnosis and represent an estimate of benefits that will terminate, generally as a result of the claimant returning to work or being deemed able to return to work. For claims recently closed due to recovery, a portion of the DLR is retained for the possibility that the claim reopens upon further evidence of disability. In addition, a reserve for estimated unpaid claim expenses is included in the DLR.
In group insurance, Long-Term Disability (LTD) has the longest pattern of loss emergence and the highest reserve amount. One significant risk to the reserve would be a slowdown in recoveries. In particular, the economic environment can affect the ability of a disabled employee to return-to-work and the length of time an employee receives disability benefits. Another significant risk is a change in benefit offsets. Often the Company pays a reduced benefit due to offsets from other income sources such as pensions or Social Security Disability Insurance (SSDI). Possible changes to the frequency, timing, or amount of offsets, such as a change in SSDI approval standards or benefit offerings, create a risk that the amount to settle open claims will exceed initial
estimates. Since the monthly income benefit for a claimant is established based on the individual’s salary at the time of disability and the level of coverages and benefits provided, inflation is not considered a significant risk to the reserve estimate. Few of the Company’s LTD policies provide for cost of living adjustments to the monthly income benefit.
Discount Rate - The discount rate is the interest rate at which expected future claim cash flows are discounted to determine the present value. A higher selected discount rate results in a lower reserve. If the discount rate is higher than our future investment returns, our invested assets will not earn enough investment income to cover the discount accretion on our claim reserves which would negatively affect our profit. For each incurral year, the discount rates are estimated based on investment yields expected to be earned net of investment expenses. The incurral year is the year in which the claim is incurred and the estimated settlement pattern is determined. Once established, discount rates for each incurral year are unchanged except that LTD reserves assumed from the acquisition of Aetna's U.S. group life and disability business are all discounted using current rates as of the November 1, 2017 acquisition date. The weighted average discount rate on LTD reserves was 3.5% and 4.3% in 2017 and 2016, respectively, with the decrease from 2016 to 2017 largely due to Aetna U.S. group life and disability business LTD reserves being discounted at current rates as of the acquisition date. Had the discount rate for each incurral year been 10 basis points lower at the time they were established, our Group Benefits unpaid loss and loss adjustment expense reserves would be higher by $34, pretax, as of December 31, 2017.
Goodwill balances are reviewed for impairment at least annually or more frequently if events occur or circumstances change that would indicate that a triggering event for a potential impairment has occurred. The goodwill impairment test follows a two-step process. In the first step, the fair value of a reporting unit is compared to its carrying value. If the carrying value of a reporting unit exceeds its fair value, the second step of the impairment test is performed for purposes of measuring the impairment. In the second step, the fair value of the reporting unit is allocated to all of the assets and liabilities of the reporting unit to determine an implied goodwill value. If the carrying amount of the reporting unit’s goodwill exceeds the implied goodwill value, an impairment loss is recognized in an amount equal to that excess, not to exceed the goodwill carrying value.
A reporting unit is defined as an operating segment or one level below an operating segment. The Company’s reporting units, for which goodwill has been allocated include Small Commercial within the Commercial Lines segment, Group Benefits, Personal Lines and Mutual Funds.
The carrying value of goodwill is $1,290 as of December 31, 2017 and is comprised of $38 for Small Commercial, $272 for Mutual Funds, $861 for Group Benefits and $119 for Personal Lines.
priority order: quoted prices, prices from third-party pricing services, internal matrix pricing, and independent broker quotes. The fair value of free-standing derivative instruments are determined primarily using a discounted cash flow model or option model technique and incorporate counterparty credit risk. In some cases, quoted market prices for exchange-traded transactions and transactions cleared through central clearing houses ("OTC-cleared") may be used and in other cases independent broker quotes may be used. For further discussion, see the Fixed Maturities, Equity Securities, Short-term Investments and Free-standing Derivatives section in Note 5 of Notes to Consolidated Financial Statements.
Deferred tax assets represent the tax benefit of future deductible temporary differences and certain tax carryforwards. Deferred tax assets are measured using the enacted tax rates expected to be in effect when such benefits are realized if there is no change in tax law. Under U.S. GAAP, we test the value of deferred tax assets for impairment on a quarterly basis at the entity level within each tax jurisdiction, consistent with our filed tax returns. Deferred tax assets are reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion, or all, of the deferred tax assets will not be realized. The determination of the valuation allowance for our deferred tax assets requires management to make certain judgments and assumptions. In evaluating the ability to recover deferred tax assets, we have considered all available evidence as of December 31, 2017, including past operating results, forecasted earnings, future taxable income, and prudent and feasible tax planning strategies. In the event we determine it is more likely than not that we will not be able to realize all or part of our deferred tax assets in the future, an increase to the valuation allowance would be charged to earnings in the period such determination is made. Likewise, if it is later determined that it is more likely than not that those deferred tax assets would be realized, the previously provided valuation allowance would be reversed. Our judgments and assumptions are subject to change given the inherent uncertainty in predicting future performance and specific industry and investment market conditions.
establishes reserves for these contingencies at its “best estimate,” or, if no one number within the range of possible losses is more probable than any other, the Company records an estimated reserve at the low end of the range of losses.
Earned premiums increased in 2017 reflecting written premium growth over the preceding twelve months.
Small Commercial written premium growth for 2017 was primarily due to higher renewal premium driven by renewal written price increases and growth from the acquisition of Maxum, partially offset by lower new business premium, excluding Maxum, and the effect of lower policy retention.
Middle Market written premiums in 2017 were up modestly as higher new and renewal premium was partially offset by modestly higher property reinsurance costs.
Specialty Commercial written premiums in 2017 were up slightly as growth in Bond was largely offset by new business declines in National Accounts.
Prior accident year development was favorable in 2017 compared to unfavorable prior accident year development in 2016. Net reserve decreases for 2017 were primarily related to reduced loss reserve estimates for workers' compensation and small commercial package business, partially offset by reserves increases for bond.
Prior accident year development of $28, before tax, was unfavorable in 2016, compared to unfavorable prior accident year development of $53, before tax, in 2015. Net reserve increases in 2016 were primarily related to package business, general liability and commercial automobile liability, largely offset by a decrease in reserves for workers’ compensation, professional liability and uncollectible reinsurance.
Includes servicing revenues of $85, $86, and $86 for 2017, 2016, and 2015, respectively and includes servicing expenses of $69, $66, and $64 for 2017, 2016, and 2015, respectively.
profitability improvement initiatives in personal automobile in 2018, the Company also plans to drive new business growth in select states, particularly in the direct channel. Due to those actions, the Company expects a low-single digit decline in Personal Lines written premiums in 2018, with AARP direct premiums expected to be flat to slightly higher and AARP agency and other agency premium expected to decline.
The Company expects the combined ratio for Personal Lines will be between approximately 96.0 and 98.0 for 2018 compared to 104.2 in 2017, primarily due to lower current accident year catastrophes and continued improvement in the underlying automobile loss ratio. Current accident year catastrophes are
assumed to be 5.6 points of the combined ratio in 2018 compared to 12.3 points in 2017. For automobile, we expect that management actions, including the effect of earned pricing, will exceed an expected increase in loss cost severity and higher direct marketing expenses, resulting in a lower underlying combined ratio. The underlying combined ratio for homeowners is expected to remain relatively flat in 2018, driven by earned pricing increases, offset by increased average claim severity and higher expenses.
Year ended December 31, 2016 compared to the year ended December 31, 2015
Policies in-force decreased in 2017 in both automobile and homeowners, driven by low new business and low policy count retention.
Renewal written pricing increased in both automobile and home as the Company increased rates to improve profitability.
Loss and loss adjustment expense ratio before catastrophes and prior accident year development increased primarily as a result of higher automobile liability frequency and severity, partially offset by the effect of increases in earned pricing.
Current accident year catastrophe losses for 2017 were primarily due to hurricanes Harvey and Irma and wildfires in California as well as multiple wind and hail events across various U.S. geographic regions, concentrated in Texas, Colorado, the Midwest and the Southeast. Catastrophe losses for 2016 were primarily due to multiple wind and hail events across various U.S. geographic regions, concentrated in the Midwest and central plains.
Prior accident year development was favorable for 2017 compared to unfavorable prior accident year development for 2016. Net reserves decreased in 2017 primarily due to decreases in reserves for prior accident year catastrophes and homeowners.
Net income (loss) improved from a net loss of $529 to net income of $69 primarily due to losses in 2016, including a loss on reinsurance transaction for premium paid to NICO covering adverse reserve development of asbestos and environmental reserves after 2016, as well adverse development in 2016 due to the second quarter study of asbestos and environmental reserves.
Net loss increased in 2016 primarily due to a $423 after-tax loss on the reinsurance transaction that cedes adverse development on asbestos and environmental reserves and higher unfavorable net asbestos and environmental prior accident year development associated with the Company's comprehensive annual review. Net realized capital losses before tax in 2016 included an $81 estimated capital loss on the pending sale of the Company's U.K. property and casualty run-off subsidiaries. Net of tax benefits, the pending sale resulted in an estimated after-tax loss of $5.
Environmental Reserves increased by $71 in 2016 primarily due to deterioration associated with the tendering of new sites for policy coverage, increased defense costs stemming from individual bodily injury liability suits, and increased clean-up costs associated with waterways.
The Company expects Group Benefits fully insured ongoing premiums to increase significantly in 2018 due to the acquisition of Aetna's U.S. group life and disability business in November
to decline slightly in 2018 as additional earnings from the acquired business will be offset by the fact that 2017 included a $52 million tax benefit associated with Tax Reform. Expected net income for 2018 is in the range of $275 to $295 million. Management expects that the 2018 core earnings margin, which does not include the effect of net realized capital gains (losses) or integration and transaction costs associated with the acquired business, will be down slightly from 5.8% in 2017 as strong returns from limited partnerships and strong long term disability recoveries in 2017 are not expected to repeat in 2018.
Net income decreased in 2016, compared to the prior year period, primarily due to lower investment management fees as a result of lower daily average AUM combined with transaction
Total Mutual Funds segment AUM increased in 2016 primarily due to market appreciation and the adoption of 10 Schroders' funds partially offset by net outflows and the continued run off of AUM related to the life and annuity run-off business held for sale.
Insurance operating costs and other expenses decreased in 2017 largely due to lower centralized services costs and lower estimated state income tax expense. Upon reporting the life and annuity run-off business as discontinued operations, centralized services costs were reallocated to Corporate for all periods presented and those reallocated costs declined from 2016 to 2017 principally due to a lower allocation of IT costs.
The Company manages and monitors risk through risk policies, controls and limits. At the senior management level, an Enterprise Risk and Capital Committee (“ERCC”) oversees the risk profile and risk management practices of the Company. As illustrated below, a number of functional committees sit underneath the ERCC, providing oversight of specific risk areas and recommending risk mitigation strategies to the ERCC.
The Company categorizes its main risks as insurance risk, operational risk and financial risk, each of which is described in more detail below.
Sources of Insurance Risk Non-catastrophe insurance risks exist within each of the Company's divisions except Mutual Funds and include:
Disability- Risk of loss incurred from personal or commercial automobile related losses, accidents arising outside of the workplace, injuries or accidents incurred during the course of employment, or from equipment, with each loss resulting in short term or long-term disability payments.
Longevity- Risk of loss from increased life expectancy trends among policyholders receiving long-term benefit payments.
effects on the Company's earnings and may result in losses that could constrain its liquidity.
including aggregate exposure limits by geographic zone and peril. The Company uses both internal and third-party models to estimate the potential loss resulting from various catastrophe events and the potential financial impact those events would have on the Company's financial position and results of operations across its businesses.
In addition to the policies and procedures outlined above, the Company uses reinsurance to transfer certain risks to reinsurance companies based on specific geographic or risk concentrations. A variety of traditional reinsurance products are used as part of the Company's risk management strategy, including excess of loss occurrence-based products that reinsure property and workers' compensation exposures, and individual risk or quota share arrangements, that reinsure losses from specific classes or lines of business. The Company has no significant finite risk contracts in place and the statutory surplus benefit from all such prior year contracts is immaterial.
$100 of the property occurrence treaty can alternatively be used as part of the Property Aggregate treaty referenced below.
In addition to the limit shown, the workers compensation reinsurance includes a non-catastrophe, industrial accident layer, providing coverage for 80% of a $30 per event limit in excess of a $20 retention.
TRIPRA provides a backstop for insurance-related losses resulting from any “act of terrorism”, which is certified by the Secretary of the Treasury, in consultation with the Secretary of Homeland Security and the Attorney General, for losses that exceed a threshold of industry losses of $160 in 2018, with the threshold increasing to $200 by 2020. Under the program, in any one calendar year, the federal government would pay a percentage of losses incurred from a certified act of terrorism after an insurer's losses exceed 20% of the Company's eligible direct commercial earned premiums of the prior calendar year up to a combined annual aggregate limit for the federal government and all insurers of $100 billion. The percentage of losses paid by the federal government is 82% in 2018, decreasing by 1 point annually to 80% in the year 2020. The Company's estimated deductible under the program is $1.3 billion for 2018. If an act of terrorism or acts of terrorism result in covered losses exceeding the $100 billion annual industry aggregate limit, Congress would be responsible for determining how additional losses in excess of $100 billion will be paid.
Property and casualty insurance product reinsurance recoverables represent loss and loss adjustment expense recoverables from a number of entities, including reinsurers and pools.
Includes Property & Casualty Commercial Lines reinsurance recoverables of $688 and $712 as of December 31, 2017 and 2016, respectively, for structured settlements recoverables due from the Company's life and annuity run-off business now classified as held for sale. These amounts were previously eliminated in consolidation.
No allowance for uncollectible reinsurance was required as of December 31, 2017 and 2016.
Sources of Operational Risk Operational risk is inherent in the Company's business and functional areas. Operational risks include legal; cyber and information security; models; third party vendors; technology; operations; business continuity; disaster recovery; internal and external fraud; and compliance.
From a governance perspective, senior members of our Enterprise Risk Management, Information Protection and Internal Audit functions provide detailed, regular reports on cybersecurity matters to the Board, including the Finance, Investment, and Risk Management Committee (FIRMCo), which has principal responsibility for oversight of cybersecurity risk, and/or the Audit Committee, which oversees controls for the Company's major risk exposures. The topics covered by these updates include the company's activities, policies and procedures to prevent, detect and respond to cybersecurity incidents, as well as lessons learned from cybersecurity incidents and internal and external testing of our protection measures. FIRMCo meets at each regular Board meeting and is briefed on cyber risks at least annually.
Financial risks include direct and indirect risks to the Company's financial objectives coming from events that impact market conditions or prices. Some events may cause correlated movement in multiple risk factors. The primary sources of financial risks are the Company's invested assets. Consistent with its risk appetite, the Company establishes financial risk limits to control potential loss on a U.S. GAAP, statutory, and economic basis. Exposures are actively monitored, and mitigated where appropriate. The Company uses various risk management strategies, including reinsurance and over-the-counter ("OTC") and exchange traded derivatives with counterparties meeting the appropriate regulatory and due diligence requirements. Derivatives are utilized to achieve one of four Company-approved objectives: hedging risk arising from interest rate, equity market, commodity market, credit spread and issuer default, price or currency exchange rate risk or volatility; managing liquidity; controlling transaction costs; or entering into synthetic replication transactions. Derivative activities are monitored and evaluated by the Company’s compliance and risk management teams and reviewed by senior management.
Liquidity risk is the risk to current or prospective earnings or capital arising from the Company's inability or perceived inability to meet its contractual funding obligations as they come due.
Credit risk is the risk to earnings or capital due to uncertainty of an obligor’s or counterparty’s ability or willingness to meet its obligations in accordance with contractually agreed upon terms. Credit risk is comprised of three major factors: the risk of change in credit quality, or credit migration risk; the risk of default; and the risk of a change in value due to changes in credit spreads.
Impact A decline in creditworthiness is typically associated with an increase in an investment’s credit spread, and potentially result in an increase in other-than-temporary impairments and an increased probability of a realized loss upon sale. Premiums receivable and reinsurance recoverables are also subject to credit risk based on the counterparty’s unwillingness or inability to pay.
portfolios. Potential losses are also limited within portfolios by diversifying across geographic regions, asset types, and sectors.
As of December 31, 2017, the Company had no investment exposure to any credit concentration risk of a single issuer or counterparty greater than 10% of the Company's stockholders' equity, other than the U.S. government and certain U.S. government securities. For further discussion of concentration of credit risk in the investment portfolio, see the Concentration of Credit Risk section in Note 6 - Investments of Notes to Consolidated Financial Statements.
Reinsurance recoverables Reinsurance recoverables, net of an allowance for uncollectible reinsurance, were $4,061 and $3,659, as of December 31, 2017 and 2016, respectively. (See the Enterprise Risk Management section of the MD&A under “Reinsurance as a Risk Management Strategy.”)
Downgrades to the credit ratings of the Company’s insurance operating companies may have adverse implications for its use of derivatives. In some cases, downgrades may give derivative counterparties for over-the-counter derivatives and clearing brokers for OTC-cleared derivatives the right to cancel and settle outstanding derivative trades or require additional collateral to be posted. In addition, downgrades may result in counterparties and clearing brokers becoming unwilling to engage in or clear additional derivatives or may require collateralization before entering into any new trades.
The Company minimizes the credit risk of derivative instruments by entering into transactions with high quality counterparties primarily rated A or better. The Company also generally requires that OTC derivative contracts be governed by an International Swaps and Derivatives Association ("ISDA") Master Agreement,
The Company has developed credit exposure thresholds which are based upon counterparty ratings. Credit exposures are measured using the market value of the derivatives, resulting in amounts owed to the Company by its counterparties or potential payment obligations from the Company to its counterparties. The notional amounts of derivative contracts represent the basis upon which pay or receive amounts are calculated and are not reflective of credit risk. For purposes of daily derivative collateral maintenance, credit exposures are generally quantified based on the prior business day’s market value and collateral is pledged to and held by, or on behalf of, the Company to the extent the current value of the derivatives exceed the contractual thresholds. In accordance with industry standards and the contractual agreements, collateral is typically settled on the same business day. The Company has exposure to credit risk for amounts below the exposure thresholds which are uncollateralized, as well as for market fluctuations that may occur between contractual settlement periods of collateral movements.
The Company uses credit derivatives to purchase credit protection with respect to a single entity or referenced index. The Company purchases credit protection through credit default swaps to economically hedge and manage credit risk of certain fixed maturity investments across multiple sectors of the investment portfolio. As of December 31, 2017 and 2016, the notional amount related to credit derivatives that purchase credit protection was $61 and $78, respectively, while the fair value was $1 and $(1), respectively. These amounts do not include positions that are in offsetting relationships.
Group life and disability product liabilities The cash outflows associated with contracts issued by the Company's Group Benefits segment, primarily group life and short and long-term disability policy liabilities, are not interest rate sensitive but vary based on timing. Though the aggregate cash flow payment streams are relatively predictable, these products may rely upon actuarial pricing assumptions (including mortality and morbidity) and have an element of cash flow uncertainty. As of December 31, 2017 and 2016, the Company had $8,512 and $5,772, respectively of reserves for group life and disability contracts with the increase since December 31, 2016 largely due to the acquisition of Aetna's U.S. group life and disability business.
Pension and other post-retirement benefit obligations The Company’s pension and other post-retirement benefit obligations are exposed to interest rate risk based upon the sensitivity of present value obligations to changes in liability discount rates. The discount rate assumption is based upon an interest rate yield curve that reflects high-quality fixed income investments consistent with the maturity profile of the expected liability cash flows. The Company is exposed to the risk of having to make additional plan contributions if the plans’ investment returns are lower than expected. (For further discussion of discounting pension and other postretirement benefit obligations, refer to Note 18 - Employee Benefit Plans of Notes to Consolidated Financial Statements.) As of December 31, 2017 and 2016, the Company had $926 and $1,106, respectively, of unfunded liabilities for pension and post-retirement benefit obligations recorded within Other Liabilities in the accompanying Balance Sheets.
Included in the following table is the before-tax change in the net economic value of contracts issued by the Company’s Group Benefits segment, primarily group life and disability, for which fixed valuation discount rate assumptions are established based upon investment returns assumed in pricing, along with the corresponding invested assets. Also included in this analysis are the interest rate sensitive derivatives used by the Company to hedge its exposure to interest rate risk in the investment portfolios supporting these contracts. This analysis does not include the assets and corresponding liabilities of other insurance products such as automobile, property, workers' compensation and general liability insurance. Certain financial instruments, such as limited partnerships and other alternative investments, have been omitted from the analysis as the interest rate sensitivity of these investments is generally lower and less predictable than fixed income investments. The calculation of the estimated hypothetical change in net economic value below assumes a 100 basis point upward and downward parallel shift in the yield curve.
The following table provides an analysis showing the estimated before-tax change in the fair value of the Company’s investments and related derivatives, excluding assets supporting group life and disability reserves which are included in the table above, assuming 100 basis point upward and downward parallel shifts in the yield curve as of December 31, 2017 and 2016. Certain financial instruments, such as limited partnerships and other alternative investments, have been omitted from the analysis as the interest rate sensitivity of these investments is generally lower and less predictable than fixed income investments.
The investment portfolio is exposed to losses from market declines affecting equity securities, alternative assets, and limited partnerships.
differ materially due to the nature of the estimates and assumptions used in the analysis.
Non-U.S. dollar denominated fixed maturities, equities, and cash The fair values of the non-U.S. dollar denominated fixed maturities , equities and cash, excluding assets held for sale, at December 31, 2017 and 2016 were approximately $298 and $213, respectively. Included in these amounts are $128 and $116 at December 31, 2017 and 2016, respectively, related to non-U.S. dollar denominated fixed maturities, equities and cash that directly support liabilities denominated in the same currencies. The currency risk of the remaining non-U.S. dollar denominated fixed maturities and equities are hedged with foreign currency swaps. In addition, the Company holds $55 of euro-denominated cash which is hedged with foreign currency forwards.
Investment in a P&C run-off entity in the United Kingdom During 2015, the Company entered into certain foreign currency forwards to hedge the currency impacts on changes in equity of a P&C run-off entity in the United Kingdom that was sold during 2017. At December 31, 2016, the derivatives used to hedge the currency impacts had a total notional amount of $200, and a total fair value of $(2), respectively. The Company no longer held these hedges as of December 31, 2017.
The following table presents the Company’s fixed maturities, AFS, by credit quality. The credit ratings referenced throughout this section are based on availability and are generally the midpoint of the available ratings among Moody’s, S&P, Fitch and Morningstar. If no rating is available from a rating agency, then an internally developed rating is used.
economic conditions have improved, sluggish wage growth points towards continued accommodative monetary policy throughout Europe in 2018. The Company manages the credit risk associated with the European securities within the investment portfolio on an on-going basis using several processes which are supported by macroeconomic analysis and issuer credit analysis. For additional details regarding the Company’s management of credit risk, see the Credit Risk section of this MD&A.
quality of European investments was A-. Entities domiciled in the United Kingdom comprise the Company's largest exposure; as of December 31, 2017 and 2016, the U.K. exposure totals less than 2% of total invested assets and largely relates to industrial and financial services corporate securities and has an average credit rating of BBB+. The majority of the European investments are U.S. dollar-denominated, and those securities that are British pound or euro-denominated are hedged to U.S. dollars. For a discussion of foreign currency risks, see the Foreign Currency Exchange Risk section of this MD&A.
Through December 31, 2017, commercial real estate market conditions, including property prices, occupancies, financial conditions, transaction volume, and delinquencies, remained mostly favorable and delinquencies remained very low. In
addition, the availability of credit has has been adequate to refinance loans that have come due.
The following table presents the Company’s exposure to municipal bonds by type and weighted average credit quality included in the preceding Securities by Type table.
Pre-Refunded bonds are bonds for which an irrevocable trust containing sufficient U.S. treasury, agency, or other securities has been established to fund the remaining payments of principal and interest.
Consists of an insurer-owned life insurance policy which is invested in hedge funds and other investments. This amount was previously included in hedge funds.
The total gross unrealized losses were $130 as of December 31, 2017, and have improved $189, or 59%, from December 31, 2016, due to tighter credit spreads. As of December 31, 2017, (117) of the gross unrealized losses were associated with securities depressed less than 20% of cost or amortized cost. The remaining (13) of gross unrealized losses were associated with securities depressed greater than 20%. The securities depressed more than 20% are primarily equity securities depressed due to issuer specific deterioration, as well as securities with exposure to commercial real estate which are depressed primarily due to higher rates since the securities were purchased.
For the year ended December 31, 2017, impairments recognized in earnings were comprised of credit impairments of $2 and impairments on equity securities of $6. There were no securities that the Company intends to sell ("intent-to-sell impairments").
Non-credit impairments recognized in other comprehensive income were $7 for the year ended December 31, 2017.
For the year ended December 31, 2015, impairments recognized in earnings were comprised of intent-to-sell impairments of $30 and credit impairments of $6, both of which were primarily concentrated in corporate securities. Also, impairments recognized in earnings included impairments on equity securities of $2 that were in an unrealized loss position and the Company no longer believed the securities would recover in the foreseeable future, as well as $3 of other impairments.
Capital available at the holding company as of December 31, 2017:
$1.1 billion in fixed maturities, short-term investments and cash at HFSG Holding Company
Expected liquidity requirements for the next twelve months as of December 31, 2017:
$295 interest on debt, of which $7 is related to debt included in liabilities held for sale
Effective October 13, 2017, the Company suspended 2017 equity repurchases. The Company does not currently expect to authorize an equity repurchase plan in 2018.
The Company has dividend capacity of $1.4 billion from its property and casualty subsidiaries with $350 net dividends expected in 2018.
Hartford Life and Accident Insurance Company ("HLA") has no dividend capacity for 2018 and does not anticipate paying dividends to the HFSG Holding Company.
operations, as well as the issuance of common stock, debt or other capital securities and borrowings from its credit facilities, as needed.
On March 15, 2017, the Company repaid its $416, 5.375% senior notes at maturity.
During the year ended December 31, 2017, the Company repurchased 20.2 million common shares for $1,028. Effective October 13, 2017, the Company suspended 2017 equity repurchases. The Company does not currently expect to authorize an equity repurchase plan in 2018.
On February 22, 2018, The Hartford’s Board of Directors declared a quarterly dividend of $0.25 per common share payable on April 2, 2018 to common shareholders of record as of March 5, 2018. There are no current restrictions on the HFSG Holding Company's ability to pay dividends to its shareholders. For a discussion of restrictions on dividends to the HFSG Holding Company from its insurance subsidiaries, see "Dividends from Insurance Subsidiaries" below. For a discussion of potential limitations on the HFSG Holding Company's ability to pay dividends, see Part I, Item 1A, - Risk Factors for the risk factor "Our ability to declare and pay dividends is subject to limitations" .
In connection with this transaction, the Company made a contribution of $280 in September 2017 to the U.S. qualified pension plan in order to maintain the plan’s pre-transaction funded status.
Dividends to the HFSG Holding Company from its insurance subsidiaries are restricted by insurance regulation. The payment of dividends by Connecticut-domiciled insurers is limited under the insurance holding company laws of Connecticut. These laws require notice to and approval by the state insurance commissioner for the declaration or payment of any dividend, which, together with other dividends or distributions made within the preceding twelve months, exceeds the greater of (i) 10% of the insurer’s policyholder surplus as of December 31 of the preceding year or (ii) net income (or net gain from operations, if such company is a life insurance company) for the twelve-month period ending on the thirty-first day of December last preceding, in each case determined under statutory insurance accounting principles. The insurance holding company laws of the other jurisdictions in which The Hartford’s insurance subsidiaries are domiciled or deemed commercially domiciled under applicable state insurance laws contain similar or in certain state(s) more restrictive limitations on the payment of dividends. In addition, if any dividend of a domiciled insurer exceeds the insurer's earned surplus or certain other thresholds as calculated under applicable state insurance law, the dividend requires the prior approval of the domestic regulator. Dividends paid to HFSG Holding Company by its life insurance subsidiaries are further dependent on cash requirements of Hartford Life, Inc. ("HLI"), the holding company of its life and annuity run-off business held for sale, and Hartford Life and Accident Insurance Company ("HLA") and other factors. Dividends paid to HFSG from HLI are subject to provisions of the Stock and Asset Purchase agreement related to the sale of HLI and its run-off life and annuity insurance business and provides for expected dividends from HLI of $300 prior to closing of the sale, subject to regulatory approval. In addition to statutory limitations on paying dividends, the Company also takes other items into consideration when determining dividends from subsidiaries. These considerations include, but are not limited to, expected earnings and capitalization of the subsidiary, regulatory
The $800 of extraordinary dividends from HLIC were funded in part by $550 of extraordinary dividends from HLIC's indirect wholly-owned subsidiary, Hartford Life and Annuity Insurance Company ("HLAI").
Total net dividends received by HFSG from subsidiaries in 2017 were $3.1 billion, including the $1.5 billion of net dividends from P&C subsidiaries, $1.4 billion from HLIC, $188 from HLA and $75 from Mutual Funds.
Group Benefits - Hartford Life and Accident Insurance Company ("HLA") has no dividend capacity for 2018 and does not anticipate paying dividends to the HSFG Holding Company.
Life and annuity run-off business - On December 4, 2017, The Hartford announced it had entered into a definitive agreement to sell its life and annuity run-off businesses to a group of investors led by Cornell Capital LLC, Atlas Merchant Capital LLC, TRB Advisors LP, Global Atlantic Financial Group, Pine Brook and J. Safra Group. Up until the anticipated close of the sale, HLIC does not have any additional dividend capacity. Prior to the expected close in 2018, HSFG Holding company anticipates receiving $300 of dividends from HLIC through HLI, subject to approval by the Connecticut Insurance Commissioner. Other intercompany transactions with HLI will be net settled prior to closing.
The Hartford endeavors to maintain a capital structure that provides financial and operational flexibility to its insurance subsidiaries, ratings that support its competitive position in the financial services marketplace (see the “Ratings” section below
Upon receipt of the proceeds, the Company entered into a replacement capital covenant (the "RCC"). Under the terms of the RCC, if the Company redeems the debentures at any time prior to February 12, 2047 (or such earlier date on which the RCC terminates by its terms) it can only do so with the proceeds from the sale of certain qualifying replacement securities. The RCC also prohibits the Company from redeeming all or any portion of the notes on or prior to February 15, 2022.
The Company has a senior unsecured five-year revolving credit facility (the “Credit Facility”) that provides for borrowing capacity up to $1 billion of unsecured credit through October 31, 2019 available in U.S. dollars, Euro, Sterling, Canadian dollars and Japanese Yen. As of December 31, 2017, no borrowings were outstanding under the Credit Facility. As of December 31, 2017, the Company was in compliance with all financial covenants within the Credit Facility.
Certain of the Company’s derivative agreements contain provisions that are tied to the financial strength ratings, as set by nationally recognized statistical agencies, of the individual legal entity that entered into the derivative agreement. If the legal entity’s financial strength were to fall below certain ratings, the counterparties to the derivative agreements could demand immediate and ongoing full collateralization and in certain instances enable the counterparties to terminate the agreements and demand immediate settlement of all outstanding derivative positions traded under each impacted bilateral agreement. The settlement amount is determined by netting the derivative positions transacted under each agreement. If the termination rights were to be exercised by the counterparties, it could impact the legal entity’s ability to conduct hedging activities by increasing the associated costs and decreasing the willingness of counterparties to transact with the legal entity. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that are in a net liability position as of December 31, 2017 was $534. For this $534, the legal entities have posted collateral of $609, which is inclusive of initial margin requirements, in the normal course of business. Based on derivative market values as of December 31, 2017, a downgrade of one level below the current financial strength ratings by either Moody’s or S&P would not require additional assets to be posted as collateral. Based on derivative market values as of December 31, 2017, a downgrade of two levels below the current financial strength ratings by either Moody’s or S&P would require an additional $10 of assets to be posted as collateral. These collateral amounts could change as derivative market values change, as a result of changes in our hedging activities or to the extent changes in contractual terms are negotiated. The nature of the collateral that we would post, if required, would be primarily in the form of U.S. Treasury bills, U.S. Treasury notes and government agency securities.
As of December 31, 2017, the Company did not participate in any derivative relationships that would be subject to an immediate termination in the event of a downgrade of one level below the current financial strength ratings. This could change as a result of changes in our hedging activities or to the extent changes in contractual terms are negotiated.
While subject to variability period to period, claim frequency and severity patterns continue to be within historical norms and, therefore, the Company’s insurance operations’ current liquidity position is considered to be sufficient to meet anticipated demands over the next twelve months. For a discussion and tabular presentation of the Company’s current contractual obligations by period, refer to Off-Balance Sheet Arrangements and Aggregate Contractual Obligations within the Capital Resources and Liquidity section of the MD&A.
Liquidity requirements that are unable to be funded by Property & Casualty Operation’s short-term investments would be satisfied with current operating funds, including premiums or proceeds received through the sale of invested assets. A sale of invested assets could result in significant realized capital losses.
investments in limited partnerships and other alternative investments, private placements, and mortgage loans as disclosed in Note 14 - Commitments and Contingencies of Notes to Consolidated Financial Statements.
Estimated group life and disability obligations are based on assumptions comparable with the Company’s historical experience, modified for recent observed trends. Due to the significance of the assumptions used, the amounts presented could materially differ from actual results. As of December 31, 2017, the total group life and disability obligations in the above table are gross of a reserve discount of $1.5 billion.
Total stockholders' equity decreased in 2017 primarily due to the net loss in 2017, share repurchases and common stockholder dividends. Total capitalization decreased $3,320, or 15%, as of December 31, 2017 compared with December 31, 2016 primarily due to the decrease in stockholders' equity.
For additional information regarding AOCI, net of tax, see Note 17 - Changes in and Reclassifications From Accumulated Other Comprehensive Income (Loss) of Notes to Consolidated Financial Statements.
Cash provided by operating activities decreased in 2016 as compared to the prior year period primarily due to an increase in claims paid, including the Company's payment of $315 related to the settlement of PPG asbestos liabilities. In addition, the Company contributed $300 to its U.S. qualified pension plan in 2016 versus a contribution of $100 in 2015.
Cash provided by investing activities in 2016 primarily related to net proceeds from available-for-sale securities of $2.7 billion, partially offset by net payments for short-term investments of $1.4 billion. Cash provided by investing activities in 2015 primarily relates to net proceeds from
For a discussion of the potential impact of the equity markets on capital and liquidity, see the Financial Risk on Statutory Capital and Liquidity Risk section in this MD&A.
On October 23, 2017, Moody's Investor Service affirmed the A2 insurance financial strength rating of HLA and downgraded the insurance financial strength rating of HLIC and HLAI to Baa3 from Baa2. The ratings outlook on these companies remains stable. The debt ratings of The Hartford Financial Services Group and the insurance financial strength rating of Hartford Fire Insurance Company were not affected.
On December 4, 2017, Moody's Investors Service placed the long-term debt ratings of The Hartford Financial Services Group, Inc. (senior debt Baa2) on review for upgrade following the Company's announcement of a definitive agreement to sell its life and annuity run-off business. In the same action, Moody's has affirmed the A1 insurance financial strength ratings of Hartford's P&C's active insurance subsidiaries and the A2 insurance financial strength rating of HLA, both with stable outlooks. Moody's also placed its ratings for the life and annuity run-off business held for sale, under review for further downgrade, including HLIC and HLAI, both rated Baa3 for insurance financial strength ratings, and downgraded the senior debt rating of HLI to Ba3 from Baa2 with a continuing review for downgrade.
On December 4, 2017, S&P Global Ratings lowered its issuer credit rating on HLI to BB/B from BBB/A-2. At the same time, they lowered the issuer and financial strength ratings on HLIC and HLAI to BBB from BBB+. The above ratings were placed on CreditWatch with Negative implications. The BBB+/A-2 issuer credit rating on Hartford Financial Services Group, A+ long-term issuer and financial strength ratings on Hartford's core property and casualty operating companies, and the A long-term issuer and financial strength ratings on Hartford Life and Accident Insurance Company were unaffected by this announcement.
On December 5, 2017, A.M. Best downgraded the Financial Strength Rating to B++ (Good) from A- (Excellent) and the Long-Term Issuer Credit Ratings (Long-Term ICR) to bbb+ from a- of Hartford Life Insurance Company and Hartford Life and Annuity Insurance Company. Additionally, A.M. Best downgraded the Long-Term ICR to bbb- from bbb of HLI. Concurrently, A.M. Best has placed all credit ratings for these entities under review with developing implications. In addition, A.M. Best has indicated that the ratings of The Hartford Financial Services Group, Inc., its P&C subsidiaries, and HLA are unchanged by these rating actions.
The assumptions used in the determination of Life benefit reserves (i.e. for Group Benefits contracts) are prescribed under U.S. STAT, while the assumptions used under U.S. GAAP are generally the Company’s best estimates.
Goodwill arising from the acquisition of a business is tested for recoverability on an annual basis (or more frequently, as necessary) for U.S. GAAP, while under U.S. STAT goodwill is amortized over a period not to exceed 10 years and the amount of goodwill admitted as an asset is limited.
For a discussion regarding contingencies related to The Hartford’s legal proceedings, please see the information contained under “Litigation” and “Asbestos and Environmental Claims,” in Note 14 - Commitments and Contingencies of the Notes to Consolidated Financial Statements and Part II, Item 1 Legal Proceedings, which are incorporated herein by reference.
Patient Protection and Affordable Care Act of 2010 (the "Affordable Care Act") It is unclear whether the Administration and Congress will seek to amend or alter the ongoing operation of the Affordable Care Act ("ACA"). If such actions were to occur, they may have an impact on various aspects of our business, including our insurance businesses. It is unclear what an amended ACA would entail, and to what extent there may be a transition period for the phase out of the ACA. The impact to The Hartford as an employer would be consistent with other large employers. The Hartford’s core business does not involve the issuance of health insurance, and we have not observed any material impacts on the Company’s workers’
compensation business or group benefits business from the enactment of the ACA. We will continue to monitor the impact of the ACA and any reforms on consumer, broker and medical provider behavior for leading indicators of changes in medical costs or loss payments primarily on the Company's workers' compensation and disability liabilities.
The impact of the new regulation on our mutual fund business is difficult to assess because the regulation is new and is still being studied. While we continue to analyze the regulation, we believe the regulation may impact the compensation paid to the financial intermediaries who sell our mutual funds to their retirement clients and could negatively impact our mutual funds business.
In 2016, several plaintiffs, including insurers and industry groups such as the U.S. Chamber of Commerce and the Securities Industry and Financial Markets Association (SIFMA), filed a lawsuit against the DOL challenging the constitutionality of the fiduciary rule, and the DOL's rulemaking authority. In most cases, the district courts have entered a summary judgment in favor of the DOL. Certain cases were appealed to the Fifth Circuit and on July 5, 2017, the DOL filed a brief in support of upholding the rule. We continue to monitor potential effects of case law and the regulatory landscape on our mutual funds business.
For a discussion of accounting standards, see Note 1 - Basis of Presentation and Significant Accounting Policies of Notes to Consolidated Financial Statements.