Certain statements in this report, including information incorporated by reference, are “forward-looking statements” as that term is defined in the Private Securities Litigation Reform Act of 1995 (“PSLRA”). The PSLRA provides a safe harbor under the Securities Act of 1933, as amended, and the Exchange Act for forward-looking statements. These statements relate to our intentions, beliefs, projections, estimations or forecasts of future events or future financial performance and involve known and unknown risks, uncertainties and other factors that may cause us or the industry’s actual results, levels of activity, or performance to be materially different from those expressed or implied by the forward-looking statements. In some cases, forward-looking statements may be identified by use of the words such as “may,” “will,” “could,” “would,” “should,” “expect,” “plan,” “anticipate,” “target,” “project,” “intend,” “believe,” “estimate,” “predict,” “potential,” “pro forma,” “seek,” “likely,” or “continue” or other comparable terminology. These statements are only predictions, and we can give no assurance that such expectations will prove to be correct. We undertake no obligation, other than as may be required under the federal securities laws, to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
The following is Management’s Discussion and Analysis (“MD&A”) of the consolidated results of operations and financial condition, as well as known trends and uncertainties, that may have a material impact in future periods.
Financial Highlights of Results for Years Ended December 31, 2016, 2015, and 2014;
legal developments in the imposition of damages, and changes in political attitudes; and (iv) trends in general economic conditions, including the effects of inflation. Based on the consideration of the range of possible IBNR reserves, recent loss and loss expense trends, uncertainty associated with actuarial assumptions, and other factors, IBNR is established and the ultimate net liability for losses and loss expenses is determined. Such an assessment requires considerable judgment given that it is frequently not possible to determine whether a change in the data is an anomaly until sometime after the event. Even if a change is determined to be permanent, it is not always possible to reliably determine the extent of the change until sometime later. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of reserves because the eventual deficiency or redundancy is affected by many factors. The changes in these estimates, resulting from the continuous review process and the differences between estimates and ultimate payments, are reflected in the Consolidated Statements of Income for the period in which such estimates are changed. Any changes in the liability estimate may be material to the results of operations in future periods. In addition to our internal review, statutory regulation requires us to have a Statement of Actuarial Opinion issued annually on our statutory reserve adequacy. We engage an independent actuary to issue this opinion based on their independent review.
We have estimated a range of reasonably possible reserves for net loss and loss expense claims to be $2,780 million to $3,237 million at December 31, 2016, which compares to $2,694 million to $3,136 million at December 31, 2015. These ranges reflect low and high reasonable reserve estimates, which were selected primarily by considering the range of indications calculated using generally accepted actuarial techniques. Such techniques assume that past experience, adjusted for the effects of current developments and anticipated trends, are an appropriate basis for predicting future events. Although these ranges reflect likely scenarios, it is possible that the final outcomes may fall above or below these amounts. The ranges do not include a provision for potential increases or decreases associated with asbestos, environmental, and other continuous exposure claims, as traditional actuarial techniques cannot be effectively applied to these exposures.
In 2016, we experienced overall net favorable loss development of $65.8 million, compared to $69.0 million in 2015, and $59.3 million in 2014. The following table summarizes prior year development by line of business:
The Insurance Subsidiaries are multi-state, multi-line property and casualty insurance companies and, as such, are subject to reserve uncertainty stemming from a variety of sources. These uncertainties are considered at each step in the process of establishing loss and loss expense reserves. As market conditions change, certain developments may occur that increase or decrease the amount of uncertainty. These developments include impacts within our own paid and reported loss and loss expense experience, as well as other internal and external factors that have not yet manifested within our data, but may do so in the future. All of these developments are considered when establishing loss and loss expense reserves, and in estimating the range of reasonable reserves.
For the past eleven years, the Insurance Subsidiaries have experienced net favorable prior accident year loss and loss expense development, although there can be no assurance that this will continue, or that we may experience adverse prior accident year loss and loss expense development in future periods. Over the past three years, contributions to the favorable emergence have come from different lines of business at different points in time. The greater contributions have generally come from the longer tailed casualty lines, primarily due to their associated volume of reserves and the inherent uncertainty of the longer claims settlement process, although this has been offset in part by adverse prior accident year loss and loss expense development within certain lines such as commercial and personal auto liability and E&S.
At December 31, 2016, our workers compensation line of business recorded reserves, net of reinsurance, of $1.0 billion, which represented 32% of our total net reserves. During 2016, this line experienced favorable development of $56.0 million driven by accident years 2014 and prior. During 2015, this line experienced favorable development of $37.0 million driven by virtually all prior accident years. The results over the past two years represent a change compared to 2014, during which this line experienced no development on prior accident years. During 2016, this line showed continued reductions in paid and reported loss amounts, due, in part, to: (i) lower medical inflation than originally anticipated; (ii) our proactive underwriting actions in recent years; and (iii) various significant claims initiatives that we implemented, including the centralization of our workers compensation claims handling in Charlotte, North Carolina, more favorable Preferred Provider Organizations ("PPO") contracts, greater PPO penetration, and more proactive case management in the areas of medical, pharmaceutical, and physical therapy treatments. Jurisdictionally trained and aligned medical only and lost-time adjusters manage non-complex workers compensation claims within our footprint. Claims with high exposure and/or significant escalation risk are referred to the workers compensation strategic case management unit.
While we believe these changes are significant drivers of our improved loss experience, there is always risk associated with change. Most notably, these changes in operations may inherently change paid and reported development patterns. While our reserve analyses incorporate methods that adjust for these changes, there nevertheless remains a greater risk in the estimated reserves.
Changes in statutory workers compensation benefits - Benefit changes may be enacted that affect all outstanding claims, regardless of having occurred in the past. Depending upon the social and political climate, these changes may either increase or decrease associated claim costs;
Changes in utilization of the workers compensation system - These changes may be driven by economic, legislative, or other changes. For example, higher levels of unemployment could ultimately impact both the severity and frequency of workers compensation claims. In particular, during more difficult economic times, workers may be more likely to use the system, and less likely to return to work. Another example is the potential changes to federal healthcare laws, which, depending on the nature of the changes, may have either positive or negative impacts on workers compensation costs.
Changes in the economy could impact reserves in other ways. For example, in 2016, audit and endorsement activity resulted in additional premium of $22.6 million, and in 2015, audit and endorsement activity resulted in additional premium of $22.5 million. As premiums earned are used as a basis for setting initial reserves on the current accident year, our reserves could be impacted. While audit and endorsement premiums are modeled within our annual budgeting process, they remain uncertain, and therefore provide additional variability to the resulting loss and loss expense ratio estimates.
For the industry, the commercial automobile line has experienced unfavorable trends in recent years, in both its casualty and property coverages. While no direct causal relationships can be drawn, increased frequencies may be due to increased miles driven, which may be the result of the economic recovery and lower gasoline prices, as well as distracted driving. Rising severities may be the result of the increasing complexity of vehicles and the technology they incorporate, which results in increased repair costs.
Reducing premium leakage by improving the quality of our rating information. This includes validating application information using third party data and using more detailed driver information.
Co-underwriting selected higher hazard classes by the field and home office, providing better recognition of risk drivers and improved pricing. This includes increasing rate targets on these exposures.
At December 31, 2016, our personal automobile line of business had recorded reserves, net of reinsurance, of $96 million, which represented 3% of our total net reserves. In 2016, this line experienced unfavorable development of $1.0 million. While this development is relatively neutral overall, it results from an increase in accident year 2015, largely offset by a decrease in accident year 2014. This line experienced unfavorable prior year development of $0.4 million in 2015. We continue to recalibrate our predictive models, as well as refine our underwriting and pricing approaches. While we believe these changes will ultimately lead to improved profitability and greater stability, they may impact paid and reported development patterns, thereby increasing the uncertainty in the reserves in the near-term.
Complex claims were integrated into our standard lines CCU in August 2015.
Potential complex liability claims are now systematically identified and referred to our CCU.
Effective January 1, 2016, the E&S Claims operation in Scottsdale, Arizona was closed and all open and new claims are now handled out of our standard lines regional claims offices by dedicated E&S claims personnel.
Claims have been segregated into “litigated” versus “non-litigated.” Separate claim handling teams have been created, with the required skill sets, to appropriately handle these two types of claims.
Implemented the following expense improvement initiatives regarding outside adjusters and legal counsel:
In addition to the expense improvement initiatives above, we anticipate implementing the following in 2017 to further improve benefits:
Expanding the use of staff counsel in high volume, high cost locations; and
For property claims, similar corporate oversight and referrals have been implemented. In addition, large losses are now adjusted by or overseen by Standard Lines property personnel.
A more comprehensive approach for handling workers compensation claims, with an emphasis towards improving recovery times, allowing for earlier “return-to-work.” This involves elevated and proactive case management in the areas of medical, pharmaceutical, and physical therapy treatments.
Sensitivity analysis: Potential impact on reserve uncertainty due to changes in key assumptions
While the sources of variability discussed above are generated by different underlying trends and operational changes, they ultimately manifest themselves as changes in the expected loss and loss expense development patterns. These patterns are a key assumption in the reserving process. In addition to the expected development patterns, the expected loss and loss expense ratios are another key assumption in the reserving process. These expected ratios are developed through a rigorous process of projecting recent accident years' experience to an ultimate settlement basis, and then adjusting it to the current accident year's pricing and loss cost levels. Impact from changes in the underwriting portfolio and changes in claims handling practices are also quantified and reflected, where appropriate. As is the case with all estimates, the ultimate loss and loss expense ratios may differ from those currently estimated.
The total carried net losses and loss expense reserves for these claims were $22.7 million as of December 31, 2016 and $23.2 million as of December 31, 2015. The emergence of these claims occurs over an extended period and is highly unpredictable. For example, within our Standard Commercial Lines book, certain landfill sites are included on the National Priorities List (“NPL”) by the United States Environmental Protection Agency (“USEPA”). Once on the NPL, the USEPA determines an appropriate remediation plan for these sites. A landfill can remain on the NPL for many years until final approval for the removal of the site is granted from the USEPA. The USEPA has the authority to re-open previously closed sites and return them to the NPL. We currently have reserves for nine customers related to six sites on the NPL.
“Asbestos claims” are claims for bodily injury alleged to have occurred from exposure to asbestos-containing products. Our primary exposure arises from insuring various distributors of asbestos-containing products, such as electrical and plumbing materials. At December 31, 2016, asbestos claims constituted 29% of our $22.7 million net asbestos and environmental reserves, compared to 29% of our $23.2 million net asbestos and environmental reserves at December 31, 2015.
The discount rate enables us to state expected future cash flows at their present value on the measurement date. The purpose of the discount rate is to determine the interest rates inherent in the price at which pension benefits could be effectively settled. Our discount rate selection is based on high-quality, long-term corporate bonds. A higher discount rate reduces the present value of benefit obligations and generally reduces pension expense. Conversely, a lower discount rate increases the present
Fair value of our investment portfolio is defined under accounting guidance as the exit price or the amount that would be: (i) received to sell an asset; or (ii) paid to transfer a liability in an orderly transaction between market participants. When determining an exit price we must, when available, rely upon observable market data. Our AFS portfolio is carried at fair value and the related unrealized gains or losses are reflected in stockholders' equity, net of tax. For both our AFS and HTM portfolios, fair value is a key factor in the evaluation of a security for OTTI.
Less than 1% of our investment portfolio is classified as Level 3 in the fair value hierarchy. Fair value measurements in Level 3 are based on unobservable market inputs because the related securities are not traded on a public market. For additional information regarding the valuation techniques used for our Level 3 securities, refer to item (e) of Note 2. "Summary of Significant Accounting Policies" within Item 8. "Financial Statements and Supplementary Data." of this Annual Report.
Our investment portfolio is subject to market declines below amortized cost that may be other than temporary and therefore may result in the recognition of OTTI losses. Factors considered in the determination of whether or not a decline is other than temporary require significant judgment and include, but are not limited to, the financial condition of the issuer, the expected near-term and long-term prospects of the issuer, and our evaluation of the projected cash flow stream from the security. For additional information regarding our OTTI process and OTTI charges recorded, see item (d) of Note 2. "Summary of Significant Accounting Policies" and item (j) of Note 5. "Investments" within Item 8. "Financial Statements and Supplementary Data." of this Annual Report, respectively.
Reinsurance recoverables on paid and unpaid losses and loss expenses represent estimates of the portion of such liabilities that will be recovered from reinsurers. Each reinsurance contract is analyzed to ensure that the transfer of risk exists to properly record the transactions in the Financial Statements. Amounts recovered from reinsurers are recognized as assets at the same time and in a manner consistent with the paid and unpaid losses associated with the reinsured policies. An allowance for estimated uncollectible reinsurance is recorded based on an evaluation of balances due from reinsurers and other available information. This allowance totaled $5.5 million at December 31, 2016 and $5.7 million at December 31, 2015. We continually monitor developments that may impact recoverability from our reinsurers and have available to us contractually provided remedies if necessary. For further information regarding reinsurance, see the “Reinsurance” section below and Note 8. “Reinsurance” in Item 8. “Financial Statements and Supplementary Data.” of this Form 10-K.
We generated excellent financial results in 2016, continuing the trend of excellent financial performance we achieved in 2015 and 2014, which reflects our hard work to drive renewal pure price increases within our Standard Commercial and Personal Lines segments as well as our E&S segment, generate new business, improve the underlying profitability of our book of business through various underwriting and claims initiatives. In 2016, we also moved to more actively manage our investment portfolio to generate higher after-tax net investment income in an investment environment of declining interest rates. Our NPW growth of 8% in 2016 and 10% in 2015 was driven by our strong franchise value with our ivy league distribution partners. Over the past 28 quarters, our Standard Commercial Lines renewal pure price increases have cumulatively outperformed the Willis Towers Watson Commercial Lines Pricing (or CLIPs) survey by approximately 1700 basis points, while maintaining high retention rates. In addition, NPW growth was aided by the appointment of 110 retail agents in 2016 and some new business opportunities in our E&S segment as we increased our appetite for new business through our brokerage channel.
Pre-tax net investment income grew 8% in 2016 compared to 2015 after decreasing 13% compared to 2014. The improvement in 2016 was driven by a higher fixed income asset base and improved returns on our alternative investments, while the decrease in 2015 compared to 2014 was due to lower returns on these alternative investments. During 2016, we determined that a more active management approach to our investment portfolio was necessary to maximize the risk-adjusted after-tax income and total return of the portfolio, while maintaining a similar level of credit quality and duration risk. We evaluated our previous buy-and-hold low turnover approach in the context of the current market environment, and concluded that a change was necessary to more effectively diversify, navigate, and manage the portfolio in response to the persistently low and volatile interest rate environment, the potential for rising inflation, and an uncertain political and tax landscape. To execute on this approach, we hired four new fixed income investment managers in 2016, increased our long-term target risk asset allocation, and modestly increased our exposure to non-investment grade fixed income securities, private equity investments, and private credit strategies to further diversity our allocation within risk assets. Our risk assets, which include public equities, non-investment grade fixed income securities, private equity investments, and other limited partnership private investments, represented 7% of our total invested assets at December 31, 2016 and may increase to approximately 10% over time.
Net favorable prior year casualty reserve development, the details of which are below:
The 1.5-point increase in the 2015 underwriting expense ratio compared to 2014 was driven by the following:
Improved underwriting profitability that also resulted in higher annual incentive compensation expense to
declining interest rates in 2014 that increased the ratio by 0.3 points; and
In 2016, we delivered on an aggressive plan built on a profitable foundation that outperformed the estimated industry statutory combined ratio by approximately nine points. According to A.M. Best's Review and Preview dated January 26, 2017, the industry's 2016 overall statutory combined ratio is expected to be 100.7%, with commercial lines and personal lines expected to deliver a combined ratio of about 98.2% and 102.6%, respectively. We were able to achieve our results in a weakening commercial lines pricing market. Our renewal pure price increases averaged 2.6% during 2016 reflecting our strong agency relationships and pricing sophistication. As reported by the Willis Towers Watson Commercial Lines Insurance Pricing (or CLIPs) Survey, renewal rates for the industry in commercial lines were only up an average of 0.4% in the first nine months of 2016.
Our results for the year reflect the various initiatives we have implemented to maintain strong profitability while executing our strategic initiatives around growing the business. We continue to invest in technology to enhance the ease of doing business for our agents, the overall customer experience, and our data and analytics platforms. We believe these will be key strategic imperatives as we look to the future.
Our plans are well on track to expand into Arizona and New Hampshire by the latter half of 2017. We have identified most of the agents that we will look to designate in those new markets. Our approach to entering new states is consistent with our agent franchise business model, which is predicated around our field based underwriting, claims, and customer service.
For 2017, based on our current view of the marketplace and assuming no tax law changes, we currently expect the following:
Our continued ability to obtain renewal pure price increases while balancing retention in this segment of our business has driven the NPW growth from 2014 through 2016 in the table above. Additionally, new business growth, especially in 2015 when compared to 2014, has also contributed to the NPW increases. Quantitative information on these drivers is as follows:
The GAAP loss and loss expense ratio increased 1.2 points in 2016 compared to 2015 due to net favorable prior year casualty reserve development of 4.7 points in 2016 compared to 5.3 points in 2015. Additionally, higher non-catastrophe property losses contributed to the increase in the loss and loss expense ratio. For quantitative information on this development by line of business, see "Financial Highlights of Results for Years Ended December 2016, 2015, and 2014" above and for qualitative information about the significant drivers of this development, see the line of business discussions below.
The GAAP loss and loss expense ratio decreased 7.9 points in 2015 compared to 2014 primarily due to the following: (i) earned rate above our expected claim inflation, which improved profitability by approximately 0.5 points for 2015; (ii) a 3.1-point decrease in property losses; (iii) net favorable prior year casualty reserve development of 5.3 points in 2015 compared to 3.2 points in 2014; and (iv) a decrease in the current year loss reserve estimate of 1.8 points in 2015 compared to 2014.
In addition to the increase in GAAP loss and loss expense ratio in 2016, there was an increase of 1.0 point in the GAAP underwriting expense ratio in 2016 compared to 2015. This increase was primarily attributable to higher supplemental commission expense to our distribution partners of 0.9 points.
The fluctuations in the statutory combined ratios were driven by changes in prior year development. Prior year development can be volatile year to year, requiring a longer period of time before true trends are fully recognized. The impact of the prior year casualty reserve development on this line was as follows:
The 5.7-point increase in the statutory combined ratio in 2015 compared to 2014 was driven by: (i) higher current year loss costs of 3.2 points driven by an increase in casualty claim frequency; (ii) prior year casualty reserve development that increased the combined ratio by 2.0 points compared to 2014; and (iii) higher property losses of 1.2 points.
In all three years, the combined ratio was positively impacted by earned rate that exceeded our expected claim inflation.
NPE increases in 2016 and 2015 were consistent with the fluctuations in NPW for their respective twelve-month periods ended December 31.
The implementation of a strategic case management unit for the handling of workers compensation claims with high exposure and/or significant escalation risk;
NPW and NPE increased in 2016 compared to 2015, as well as in 2015 compared to 2014, primarily due to: (i) growth in direct new business; (ii) renewal pure price increases; and (iii) strong retention.
The GAAP loss and loss expense ratio decreased 6.2 points in 2016 compared to 2015, primarily driven by: (i) property losses that were lower than 2015 by 5.9 points; (ii) earned rate above our expected claim inflation, which improved profitability by approximately 1.3 points for 2016; and (iii) increased flood claims handling fees of 1.0 point, mainly due to Louisiana flooding and Hurricane Matthew during the second half of 2016. These decreases were partially offset by unfavorable prior year casualty reserve development that was higher than 2015 by 1.6 points.
The GAAP loss and loss expense ratio increased 10.3 points in 2015 compared to 2014, primarily due to the following: (i) unfavorable prior year casualty reserve development that increased by 5.2 points compared to 2014; (ii) a 2.9-point increase in the current year loss costs; and (iii) a 1.5-point increase in property losses.
Unfavorable prior year casualty reserve development for 2016 was $6 million, driven by accident year 2014. Unfavorable prior year casualty reserve development for 2015 was $16 million. In 2015, we integrated the E&S claims operation with our Corporate Claims operation. As part of that effort, we completed a review of all complex claims. As a result, we recorded adverse prior year casualty reserve development of $10 million in the fourth quarter of 2015, bringing the full year adverse prior year development to $16 million. We also recorded a $5 million adjustment to the 2015 current accident year.
Our E&S business is comprised of risks that are similar in nature to our Standard Commercial Lines, with smaller-sized insureds and lower policy limits. Approximately 98% of the policies in this segment have limits of less than $1 million. We will continue to deploy our Corporate Claims practices into the E&S operation in 2017, including the use of more robust monitoring tools. We believe these actions will allow us to better assess the associated liability for these claims and will ultimately result in improved outcomes. For more information, refer to the E&S Lines discussion within the Reserves for Losses and Loss Expenses section of "Critical Accounting Policies and Estimates" in this MD&A.
We use reinsurance to protect our capital resources and insure us against losses on property and casualty risks that we underwrite. We use two main reinsurance vehicles: (i) a reinsurance pooling agreement among our Insurance Subsidiaries in which each company agrees to share in premiums and losses based on certain specified percentages; and (ii) reinsurance contracts and arrangements with third parties that cover various policies that we issue to our customers.
The following illustrates the pooling percentages by Insurance Subsidiary as of December 31, 2016:
The property catastrophe treaty, which covers both our standard market and E&S business, was renewed effective January 1, 2017. The current treaty structure remains the same, providing total coverage of $685 million in excess of $40 million. The annual aggregate limit net of our co-participation is approximately $1.0 billion for 2017. We also renewed the separate catastrophe treaty of $35 million in excess of $5 million that covers events outside of our standard lines footprint, in support of our growing E&S property book. We expect the overall catastrophe ceded premium for 2017 to be similar to 2016, although down modestly on a risk-adjusted basis. As our need for catastrophe reinsurance increases, we seek ways to minimize credit risk inherent in a reinsurance transaction by dealing with highly-rated reinsurance partners and purchasing collateralized reinsurance products, particularly for high severity, low-probability events. The current reinsurance program includes $201 million in collateralized limit, primarily in the top layer of the catastrophe program.
1 This amount represents reported and unreported gross losses estimated as of December 31, 2016.
The casualty excess of loss treaty, which covers both our standard market and E&S business, was renewed on July 1, 2016 and is effective through June 30, 2017, with substantially the same terms as the expiring treaty. The details of the current year treaty are included in the table below.
As part of the acquisition of MUSIC we entered into several reinsurance agreements that together provide protection for losses on policies written prior to the acquisition and any development on reserves established by MUSIC as of the date of acquisition. The reinsurance recoverables under these treaties are 100% collateralized. Montpelier Re was acquired by Endurance Specialty on December 29, 2015.
We have other reinsurance treaties that we do not consider core to our reinsurance program, such as our Surety and Fidelity Excess of Loss Reinsurance Treaty, National Workers Compensation Reinsurance Pool Quota Share, which covers business assumed from the involuntary workers compensation pool, a property catastrophe excess of loss treaty covering losses outside of our standard lines footprint states, and our Equipment Breakdown Coverage Reinsurance Treaty.
The primary objective of the investment portfolio is to maximize after-tax investment income while balancing risk and generating long-term growth in shareholder value. Our investment philosophy includes certain return and risk objectives for the fixed income, equity, and other investment portfolios. After-tax yield and income generation are key drivers to our investment strategy, which has historically been balanced with a long-term “buy-and-hold,” low turnover approach.
To execute on this revised approach, we hired several new investment managers who were on-boarded in the fourth quarter of 2016. We modestly increased our exposure to below investment grade fixed income securities, private equity, and private credit strategies to further diversity our allocation within risk assets, which principally includes public equities, high-yield fixed income securities, and private equity, in conjunction with repositioning the portfolio to a long-term target risk asset allocation of approximately 10% of total invested assets. While our approach to managing the investment portfolio has changed, our core investment philosophy has not changed. We remain focused on diversification, capital preservation, investment quality, and liquidity to meet our needs and obligations.
The increase in our investment portfolio at December 31, 2016 compared with year-end 2015 was primarily driven by operating cash flow of $301.8 million, partially offset by a decrease in unrealized gains of $4.4 million. The $4.4 million change in unrealized gains was comprised of a $12.6 million increase in unrealized gains in our equity portfolio offset by a decrease in unrealized gains in our fixed income securities portfolio of $17 million, which was driven by general interest rate movements as seen in the 10-year U.S. Treasury Note, which rose by 17 basis points in 2016.
1Included $68.2 million of preferred stock within corporate securities and $16.1 million of preferred stock within equity securities. In aggregate, these account for approximately 2% of invested assets at December 31, 2016.
Our fixed income securities portfolio maintained a weighted average credit rating of AA- as of December 31, 2016 with 97% and 99% of the securities within the portfolio being investment grade quality at December 31, 2016 and December 31, 2015, respectively. For further details on how we manage overall credit quality and the various risks to which our portfolio is subject, see
Selective Insurance Group, Inc. also has authorized, but not issued, 5,000,000 shares of preferred stock, without par value, of which 300,000 shares have been designated Series A junior preferred stock, without par value.
E&S Lines - comprised of insurance products and services provided to customers who have not obtained coverage in the standard marketplace.
The preparation of our Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported financial statement balances, as well as the disclosure of contingent assets and liabilities. Actual results could differ from those estimates.
Fixed income securities may include investment grade and below investment grade rated bonds, redeemable preferred stocks, non-redeemable preferred stocks with certain debt-like characteristics, mortgage-backed securities (“MBS”), collateralized loan obligations ("CLO") and other asset-backed securities (“ABS”). MBS, CLO, and other ABS are jointly referred to as structured securities. Fixed income securities classified as available-for-sale (“AFS”) are reported at fair value. Those fixed income securities that we have the ability and positive intent to hold to maturity are classified as held-to-maturity (“HTM”) and are carried at either: (i) amortized cost; or (ii) market value at the date of transfer into the HTM category, adjusted for subsequent amortization. The amortized cost of fixed income securities is adjusted for the amortization of premiums and the accretion of discounts over the expected life of the security using the effective yield method. Premiums and discounts arising from the purchase of structured securities are amortized over the expected life of the security based on future principal payments, and considering prepayments. These prepayments are estimated based on historical and projected cash flows. Prepayment assumptions are reviewed quarterly and adjusted to reflect actual prepayments and changes in expectations. Future amortization of any premium and/or discount is adjusted to reflect the revised assumptions. Interest income, as well as amortization and accretion, is included in "Net investment income earned" on our Consolidated Statements of Income. The amortized cost of a fixed income security is written down to fair value when a decline in value is considered to be other than temporary. See the discussion below on realized investment gains and losses for a description of the accounting for impairments. After-tax unrealized gains and losses on: (i) fixed income securities classified as AFS; and (ii) fixed income securities that were transferred into an HTM designation from an AFS designation, are included in accumulated other comprehensive income (loss) ("AOCI").
On a quarterly basis, we review our investment portfolio for impairments that are other than temporary. The following provides information on this analysis for our fixed income securities and short-term investments, our equity securities, and our other investments.
We review securities that are in an unrealized loss position to determine: (i) if we have the intent to sell the security; (ii) if it is more likely than not that we will be required to sell the debt security before its anticipated recovery; and (iii) if the decline is other than temporary. Broad changes in the overall market or interest rate environment generally will not lead to a write down. If we determine that we have either the intent or requirement to sell the security, we write down its amortized cost to its fair value through a charge to earnings as a component of realized losses. If we do not have either the intent or requirement to sell the security, our evaluation for OTTI may include, but is not limited to, evaluation of the following factors:
Non-redeemable preferred stocks that are classified as fixed income securities are evaluated under this OTTI method unless the security is below investment grade, at which time they are evaluated under the equity securities OTTI model discussed below.
To determine if an impairment is other than temporary, we perform assessments that may include, but are not limited to, discounted cash flow analyses ("DCFs") to determine the security's present value of future cash flows. In addition, this analysis is performed on all previously-impaired debt securities that continue to be held by us and all structured securities that were not of high-credit quality at the date of purchase. Any shortfall in the expected present value of the future cash flows, based on the DCF, from the amortized cost basis of a security is considered a “credit impairment,” with the remaining decline in fair value of
We review securities that are in an unrealized loss position to determine: (i) if we do not intend to hold the security to its forecasted recovery; or (ii) if the decline is other than temporary, which includes declines driven by market volatility for which we cannot assert will recover in the near term. If we determine either that we do not intend to hold a security, or the decline is other than temporary, we write down the security's cost to its fair value through a charge to earnings as a component of realized losses. If we intend to hold the security, our evaluation for OTTI may include, but is not limited to, an evaluation of the following factors:
If there is a decline in the fair value of an other investment that we do not intend to hold, or if we determine the decline is other than temporary, we write down the carry value of the investment and record the charge through earnings as a component of realized losses.
See Note 7. “Fair Value Measurements” for a summary table of the fair value and related carrying amounts of financial instruments.
Reinsurance recoverables represent estimates of amounts that will be recovered from reinsurers under our various treaties. Generally, amounts recoverable from reinsurers are recognized as assets at the same time and in a manner consistent with the paid and unpaid losses associated with the reinsured policies. We require collateral to secure reinsurance recoverables primarily from our reinsurance carriers that are not authorized, otherwise approved, or certified to do business in one or more of our ten insurance subsidiaries' domiciliary states. Our ten insurance subsidiaries are collectively referred to as the "Insurance Subsidiaries". This collateral is typically in the form of a letter of credit or cash. An allowance for estimated uncollectible reinsurance is recorded based on an evaluation of balances due from reinsurers and other available information, such as each reinsurers' credit rating from A.M. Best Company ("A.M. Best") or Standard & Poor's Rating Services ("S&P"). We charge off reinsurance recoverables on paid losses when it becomes probable that we will not collect the balance.
There were no premium deficiencies for any of the reported years, as the sum of the anticipated losses and loss expenses, unamortized acquisition costs, policyholder dividends, and other expenses for each segment did not exceed that segment’s related unearned premium and anticipated investment income. The investment yields assumed in the premium deficiency assessment for each reporting period, which are based on our actual average investment yield before tax as of the September 30 calculation date, were 2.4% for 2016, 2.5% for 2015, and 3.0% for 2014. Deferred policy acquisition costs amortized to expense were $450.3 million for 2016, $399.4 million for 2015, and $364.3 million for 2014.
Reserves for losses and loss expenses are comprised of both case reserves on individual claims, and reserves for claims incurred but not reported ("IBNR"). Case reserves result from claims that have been reported to one or more of our Insurance Subsidiaries, and are estimated at the amount of the expected ultimate payment. IBNR reserves are established at more aggregated levels than case basis reserves, and in addition to reserves on claims that have been incurred but not reported, they include provisions for future emergence on known claims, as well as reopened claims. IBNR reserves are established based on the results of the Insurance Subsidiaries’ internal reserve analysis, supplemented with other internal and external information.
The internal reserve analysis is performed quarterly, and relies upon generally accepted actuarial techniques. Such techniques assume that past experience, adjusted for the effects of current developments and anticipated trends, are an appropriate basis for predicting future events. Our analyses rely upon historical paid and case losses and loss adjustment expense experience organized by line of business, accident year and maturity (i.e., “triangles”). Standard actuarial projection methods are applied to this history, producing a set of estimated ultimate losses and loss adjustment expenses. Ultimate losses and loss adjustment expenses are selected from the various methods, considering the strengths and weaknesses of the methods as they apply to the specific line and accident year.
In some limited cases, an insured event may span multiple years and multiple policies, as in the case of asbestos and environmental claims, where the injury is deemed to occur over an extended period of time. These claims are analyzed without accident year detail, using alternative methods and metrics. The associated selected ultimate loss and loss adjustment expenses are then allocated to accident year for reporting.
Another example of non-standard methods relate to loss adjustment expenses that cannot be attributed to a specific claim (referred to as “unallocated loss adjustment expenses”). These expenses are first allocated to accident year and alternative projection methods are then applied to these expenses. The resulting ultimate expenses by accident year are then used for reporting purposes.
The combination of the IBNR estimates along with the case reserve estimates on individual claims results in our total reserves for losses and loss expenses. These reserves are expected to be sufficient for settling losses and loss reserve obligations under our policies on unpaid claims, including changes in the volume of business written, claims frequency and severity, the mix of business, claims processing, and other items that management expects to affect our ultimate settlement of losses and loss expenses. However, the ultimate claim settlements may be higher or lower than reserves established. As our experience emerges and other information develops, we revise our reserve estimates accordingly. The changes in these estimates, resulting from the continuous review process and the differences between estimates and ultimate payments, are reflected in the Consolidated Statements of Income for the period in which such estimates are changed. The associated impacts may be material to the results of operations in future periods.
We do not discount to present value that portion of our losses and loss expense reserves expected to be paid in future periods.
We use the asset and liability method of accounting for income taxes. Current federal income taxes are recognized for the estimated taxes payable or refundable on tax returns for the current year. Deferred federal income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax basis of assets and liabilities. We consider all evidence, both positive and negative, with respect to our federal tax loss carryback availability, expected levels of pre-tax financial statement income, and federal taxable income, when evaluating whether the temporary differences will be realized. In projecting future taxable income, we begin with budgeted pre-tax income adjusted for estimated non-taxable items. The assumptions about future taxable income require significant judgment and are consistent with the plans and estimates we use to manage our businesses. A valuation allowance is established when it is more likely than not that some portion of the deferred tax asset will not be realized. A liability for uncertain tax positions is recorded when it is more likely than not that a tax position will not be sustained upon examination by taxing authorities. The effect of a change in tax rates is recognized in the period of enactment. If we were to be levied interest and penalties by the Internal Revenue Service (“IRS”), the interest would be recognized as “Interest expense” and the penalties would be recognized as “Other expenses” on the Consolidated Statements of Income.
We have various operating leases for office space, equipment, and fleet vehicles. Rental expense for such leases is recorded on a straight-line basis over the lease term. If a lease has a fixed and determinable escalation clause, or periods of rent holidays, the difference between rental expense and rent paid is included in "Other liabilities" as deferred rent in the Consolidated Balance Sheets.
In June 2014, the FASB issued ASU 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (“ASU 2014-12”). ASU 2014-12 requires that performance targets that affect vesting and could be achieved after the requisite service period be treated as performance conditions. The adoption of ASU 2014-12 in the first quarter of 2016 did not affect us, as we have historically recorded expense consistent with the requirements of this accounting update.
In February 2015, the FASB issued ASU 2015-02, Amendments to the Consolidation Analysis (“ASU 2015-02”). ASU 2015-02 affects the following areas: (i) limited partnerships and similar legal entities; (ii) the evaluation of fees paid to a decision maker
in the first quarter of 2016. Under the new guidance, our limited partnership and tax credit investments are variable interest
entities ("VIEs"); however, we are not the primary beneficiary of any of these investments. As such, the adoption had no
impact on our financial condition or results of operations. The required disclosures related to our VIEs are included in Note 5.
In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”). ASU 2015-03 requires debt issuance costs to be netted against the related debt liability in the balance sheet rather than presented as a separate asset. However, ASU 2015-03 does not address the presentation or subsequent measurement of debt issuance costs related to line-of-credit arrangements. Therefore, in August 2015, the FASB issued ASU 2015-15, Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements - Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting (“ASU 2015-15”). ASU 2015-15 clarifies that, in the absence of authoritative guidance on line-of-credit arrangements within ASU 2015-03, the SEC would not object to the deferral and presentation of debt issuance costs as an asset and the subsequent amortization of the deferred costs over the term of the line-of-credit arrangement. We adopted this guidance retrospectively, effective in the fourth quarter of 2015. As such, 2014 balances in this Form 10-K have been restated to reflect the revised guidance, as follows:
In May 2015, the FASB issued ASU 2015-07, Disclosures for Investments in Certain Entities That Calculate Net Asset Value
consistent with the amount on the balance sheet. ASU 2015-07 also includes disclosure requirements for investments for which
the NAV practical expedient was used to determine fair value. We adopted this guidance in the first quarter of 2016 and have included the related disclosures in Note 14. "Retirement Plans" below.
certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Specifically the guidance:
fair value that is required to be disclosed for financial instruments measured at amortized cost; (iv) requires the use of the exit
price notion when measuring the fair value of financial instruments for disclosure purposes; and (v) clarifies that the need for a
periods. Early application to financial statements of annual or interim periods that have not yet been issued are permitted as of
the impact of this guidance on our financial condition and results of operations.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 requires all lessees to
lease commencement date. ASU 2016-02 is effective for annual periods beginning after December 15, 2018, including interim
In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee
Share-based Payment Accounting (“ASU 2016-09”). ASU 2016-09 simplifies several aspects of the accounting for share-based
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (“ASU 2016-13”). ASU 2016-13 will
expected to occur over the remaining life of many financial assets, including, among others, HTM debt securities,
assets and that they be presented on the financial statements net of the valuation allowance. The valuation allowance is a
conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This methodology is
referred to as the current expected credit loss model. ASU 2016-13 is effective for annual periods beginning after December 15, 2019, including interim periods within those annual periods. Early adoption is permitted, but no earlier than annual periods
guidance on the classification of certain cash receipts and payments in the statements of cash flows including, but not limited to: (i) debt prepayment or debt extinguishment costs; (ii) proceeds from the settlement of corporate-owned life insurance policies including bank-owned life insurance policies; (iii) distributions received from equity method investees; and (iv) separately identifiable cash flows and application of the predominance principle. ASU 2016-15 is effective for annual periods beginning after December 15, 2017, and interim periods within those annual periods. Early adoption is permitted. We are currently evaluating the impact of this guidance on our statements of cash flows.
In October 2016, the FASB issued ASU 2016-17, Consolidation: Interests Held through Related Parties That Are Under Common Control ("ASU 2016-17"). ASU 2016-17 changes how a decision maker considers indirect interests in a VIE held under common control in making the primary beneficiary determination. ASU 2016-17 will be effective for annual periods beginning after December 15, 2016, including interim periods within those annual periods. We do not expect this ASU to impact us as we are not the decision maker in any of the VIEs in which we are invested.
Included in "Other assets" on the Consolidated Balance Sheet was $36.9 million at December 31, 2016 and $11.9 million at December 31, 2015 of cash received from the National Flood Insurance Program ("NFIP"), which is restricted to pay flood claims under the Write Your Own ("WYO") Program.
(a) Net unrealized gains on investments included in OCI by asset class were as follows for the years ended December 31, 2016, 2015, and 2014:
(d) The table below provides our net unrealized/unrecognized loss positions by impairment severity for both AFS and HTM securities as of December 31, 2016 compared to the prior year:
We do not intend to sell any of the securities in the tables above, nor do we believe we will be required to sell any of these securities. Additionally, we have reviewed these securities in accordance with our OTTI policy, as described in Note 2. “Summary of Significant Accounting Policies” of this Form 10-K and have concluded that they are temporarily impaired. This conclusion reflects our current judgment as to the financial position and future prospects of the entity that issued the security and underlying collateral. If our judgment about an individual security changes in the future, we may ultimately record a credit loss after having originally concluded that one did not exist, which could have a material impact on our net income and financial position in future periods.
(e) Fixed income securities at December 31, 2016, by contractual maturity are shown below. MBS are included in the maturity tables using the estimated average life of each security. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
1The maximum exposure to loss includes both the carry value of these investments and the related unfunded commitments. In addition, tax credits that have been previously recognized in Other securities are subject to the risk of recapture, which we do not consider significant.
Primary Private Equity: This strategy makes private equity investments, primarily in established large and middle market companies across diverse industries globally.
Secondary Private Equity: This strategy purchases seasoned private equity funds from investors desiring liquidity prior to normal fund termination. Investments are made across all sectors of the private equity market, including leveraged buyouts ("LBO"), venture capital, distressed securities, mezzanine financing, real estate, and infrastructure.
Venture Capital: In general, these investments are made principally by investing in equity securities of privately-held corporations, for long-term capital appreciation. This strategy makes private equity investments in growth equity and buyout partnerships.
Mezzanine Financing: This strategy provides privately negotiated fixed income securities, generally with an equity component, to LBO firms and private and publicly traded large, mid, and small-cap companies to finance LBOs, recapitalizations, and acquisitions.
Our alternative investment strategies generally employ low or moderate levels of leverage and use hedging only to reduce foreign exchange or interest rate volatility. At this time, our alternative investment strategies do not include hedge funds. We cannot redeem our investments with the general partners of these investments; however, occasionally these partnerships can be traded on the secondary market. Once liquidation is triggered by clauses within the limited partnership agreements or at the funds’ stated end date, we will receive our final allocation of capital and any earned appreciation of the underlying investments, assuming we have not divested ourselves of our partnership interests prior to that time. We currently receive distributions from these alternative investments through the realization of the underlying investments in the limited partnerships. We anticipate that the general partners of these alternative investments will liquidate their underlying investment portfolios through 2030.
(g) We did not have exposure to any credit concentration risk of a single issuer greater than 10% of our stockholders' equity, other than certain U.S. government agencies, as of December 31, 2016 or December 31, 2015.
2016: A repositioning of our equity portfolio partially offset by net losses in our AFS fixed income portfolio related to the change in our strategy to more actively manage this portfolio.
2015: A change in our dividend strategy from a quantitative, model-driven stock selection strategy to a fundamentally-based stock selection approach that incorporates an assessment of the sustainability and growth rate of a company's dividends and future cash flow.
The following tables provide quantitative disclosures of our financial assets that were measured at fair value at December 31, 2016 and 2015:
As a Standard Commercial Lines and E&S Lines writer, we are required to participate in Terrorism Risk Insurance Program Reauthorization Act ("TRIPRA"), which was extended by Congress to December 31, 2020. TRIPRA requires private insurers and the United States government to share the risk of loss on future acts of terrorism certified by the U.S. Secretary of the Treasury. Under TRIPRA, each participating insurer is responsible for paying a deductible of specified losses before federal assistance is available. This deductible is based on a percentage of the prior year’s applicable Standard Commercial Lines and E&S Lines premiums. In 2017, our deductible is approximately $304 million. For losses above the deductible, the federal government will pay 83% of losses to an industry limit of $100 billion, and the insurer retains 17%. The federal share of losses will be reduced by 1% each year to 80% by 2020.
The following table represents our total reinsurance balances segregated by reinsurer to depict our concentration of risk throughout our reinsurance portfolio:
(a) The table below provides a roll forward of reserves for losses and loss expenses for beginning and ending reserve balances:
Our net losses and loss expense reserves increased by $113.8 million in 2016, $60.8 million in 2015, and $97.0 million in 2014. The losses and loss expense reserves are net of anticipated recoveries for salvage and subrogation claims, which amounted to $64.9 million for 2016, $62.1 million for 2015, and $65.1 million for 2014. The changes in the net losses and loss expense reserves were the result of growth in exposures, particularly associated with our E&S Lines of business, anticipated loss trends, and normal reserve changes inherent in the uncertainty in establishing reserves for losses and loss expenses. As additional information is collected in the loss settlement process, reserves are adjusted accordingly. These adjustments are reflected in the Consolidated Statements of Income in the period in which such adjustments are identified. These changes could have a material impact on the results of operations of future periods when the adjustments are made.
The prior accident year development during 2015 was favorable by $69.0 million, which included $67.0 million of net favorable casualty development and $2.0 million of favorable property development. The net favorable casualty reserve development was largely driven by the general liability and workers compensation lines of business. For workers compensation, this was a significant change from 2014, during which period this line experienced no development. Our E&S Lines experienced unfavorable casualty development of $15.5 million in 2015.
The majority of the 2015 net favorable development was attributable to accident years 2009 through 2013, driven by general liability and workers compensation lines of business. This net favorable development was partially offset by unfavorable development in accident years 2012 through 2014, which was attributable to our E&S Lines.
The prior accident year development during 2014 was favorable by $59.3 million, which included $48.2 million of net favorable casualty development and $11.1 million of property development. The property development was primarily related to a prior year reinsurance recoverable. The net favorable casualty reserve development was largely driven by the general liability and personal automobile lines of business. Conversely, businessowners' policies and our E&S Lines experienced unfavorable emergence in 2014.
environmental losses. In addition, while certain alternative models can be applied, such models can produce significantly different results with small changes in assumptions. As a result, we do not calculate an asbestos and environmental loss range. Historically, our asbestos and environmental claims have been significantly lower in volume as, prior to the introduction of the absolute pollution exclusion endorsement in the mid-1980’s, we were primarily a personal lines carrier and therefore do not have broad exposure to asbestos and environmental claims. Additionally, we are the primary insurance carrier on the majority of these exposures, which provides more certainty in our reserve position compared to other insurance carriers.
(c) The following is information about incurred and paid claims development as of December 31, 2016, net of reinsurance, as well as cumulative claim frequency and the total of IBNR liabilities. During the experience period, we implemented a series of claims-related initiatives and claims management changes. These initiatives focused on claims handling and reserving, medical claims costs, and loss adjustment expenses. As a result of these initiatives, several historical patterns have changed and may no longer be appropriate to use as the sole basis for projections.
In 2011, the Parent purchased MUSIC, a wholly-owned E&S Lines subsidiary of Montpelier Re Holdings, Ltd. Under the terms of the purchase agreement, the Parent acquired loss and loss adjustment reserves amounting to approximately $15 million. All development on this acquired business was fully reinsured as of the acquisition date.
(d) The reconciliation of the net incurred and paid claims development tables to the liability for loss and loss adjustment expenses in the consolidated statement of financial position is as follows:
The table below provides a summary of our outstanding debt at December 31, 2016 and 2015:
(2) In December 2011, the Indiana Subsidiaries borrowed $45 million in the aggregate from the FHLBI with an interest rate of 1.25%. The funds were loaned to the Parent for use in the acquisition of Mesa Underwriters Specialty Insurance Company ("MUSIC") on December 31, 2011. We repaid this borrowing in December 2016.
In addition to the above borrowings, the Parent's line of credit with Wells Fargo Bank, National Association, as administrative agent, and Branch Banking and Trust Company (BB&T) (referred to as our "Line of Credit"), was renewed effective December 1, 2015, with a borrowing capacity of $30 million, which can be increased to $50 million with the approval of both lending partners. Our Line of Credit expires on December 1, 2020, and has an interest rate, which varies and is based on, among other factors, the Parent’s debt ratings. There were no balances outstanding under our Line of Credit at December 31, 2016 or at any time during 2016.
In addition to the above requirements, the Line of Credit agreement contains a cross-default provision that provides that the Line of Credit will be in default if we fail to comply with any condition, covenant, or agreement (including payment of principal and interest when due on any debt with an aggregate principal amount of at least $20 million), which causes or permits the acceleration of principal.
(5) In July 2016, SICA borrowed $25 million from the FHLBNY. The unpaid principal amount accrues interest of 1.61%. The principal amount is due on July 21, 2021.
(6) In February 2013, we issued $185 million of 5.875% Senior Notes due 2043. The notes are callable by us on or after February 8, 2018, at a price equal to 100% of their principal outstanding amount, plus accrued and unpaid interest to, but excluding, the date of redemption. A portion of the proceeds from this debt issuance was used to fully redeem the $100 million aggregate principal amount of our 7.5% Junior Subordinated Notes due 2066. Of the remaining net proceeds, $57.1 million was used to make capital contributions to the Insurance Subsidiaries, while the balance was used for general corporate purposes. There are no financial debt covenants to which we are required to comply in regards to these Senior Notes.
(8) In November 2004, we issued $50 million of 7.25% Senior Notes due 2034. These notes were issued at a discount of $0.1 million, resulting in an effective yield of 7.27%. We contributed $25 million of the bond proceeds to the Insurance Subsidiaries as capital. The remainder of the proceeds was used for general corporate purposes. The agreements covering these notes contain a standard default cross-acceleration provision that provides the 7.25% Senior Notes will enter a state of default upon the failure to pay principal when due or upon any event or condition that results in an acceleration of principal of any other debt instrument in excess of $10 million that we have outstanding concurrently with the 7.25% Senior Notes. There are no financial debt covenants to which we are required to comply in regards to these notes.
In computing the results of each segment, we do not make adjustments for interest expense or net general corporate expenses. While we do not fully allocate taxes to all segments, we do allocate taxes to our investments segment as we manage that segment on after-tax results. We do not maintain separate investment portfolios for the segments and therefore, do not allocate assets to the segments.
Our combined insurance segments are subject to certain geographic concentrations, particularly in the Northeast and Mid-Atlantic regions of the country. In 2016, approximately 20% of NPW were related to insurance policies written in New Jersey.
(b) The tax effects of the significant temporary differences that give rise to deferred tax assets and liabilities are as follows:
After considering all evidence, both positive and negative, with respect to our federal tax loss carryback availability, expected levels of pre-tax financial statement income, and federal taxable income, we believe it is more likely than not that the existing deductible temporary differences will reverse during periods in which we generate net federal taxable income or have adequate
As of December 31, 2016, we had federal tax net operating loss ("NOL") carryforwards of $2.2 million. These NOLs, which are subject to an annual limitation of $1.9 million, will expire between 2030 and 2031 as follows:
Stockholders' equity reflects tax benefits related to compensation expense deductions for share-based compensation awards of $23.8 million at December 31, 2016, $22.0 million at December 31, 2015, and $20.2 million at December 31, 2014.
SICA offers a nonqualified deferred compensation plan ("Deferred Compensation Plan") to a group of management or highly compensated employees as a method of recognizing and retaining such employees. The Deferred Compensation Plan provides these employees the opportunity to elect to defer receipt of specified portions of compensation and to have such deferred amounts deemed to be invested in specified investment options. In addition to the employee deferrals, SICA may choose to make matching contributions to some or all of the participants in this plan to the extent the participant did not receive the maximum matching or non-elective contributions permissible under the Retirement Savings Plan due to limitations under the Internal Revenue Code or the Retirement Savings Plan. Expense recorded for these contributions was $0.3 million in 2016 and $0.2 million in both 2015 and 2014.
SICA's primary pension plan is the Retirement Income Plan for Selective Insurance Company of America (the "Pension Plan"). This qualified, noncontributory defined benefit plan is closed to new entrants and existing participants ceased accruing benefits after March 31, 2016.
The estimated net actuarial loss for the Pension Plan that will be amortized from AOCI into net periodic benefit cost during the 2017 fiscal year is $1.9 million. This is lower than the $6.3 million amortized in 2016 due to a change in the amortization period for the net actuarial loss. Historically, the amortization period was the average remaining service life of the active participants. However, as the Pension Plan is no longer accruing service benefits, the amortization period has changed to the average remaining life expectancy of plan participants.
Our latest measurement date was December 31, 2016 and we decreased our expected return on plan assets to 6.24%, reflecting the current interest rate environment.
At December 31, 2016, the Pension Plan's allocation to cash and short-term investments was slightly above the targeted range, as we were analyzing the most effective deployment of these balances considering current market conditions.
The Pension Plan had no investments in the Parent’s common stock as of December 31, 2016 or 2015.
The techniques used to determine the fair value of the Pension Plan's invested assets are as follows:
As of December 31, 2016, the following four plans were available for the issuance of share-based payment awards:
As of December 31, 2016, total unrecognized compensation expense related to unvested RSU awards granted under our stock plans was $5.3 million. That expense is expected to be recognized over a weighted-average period of 1.8 years. The total intrinsic value of RSUs vested was $12.6 million for 2016, $10.3 million for 2015, and $8.5 million for 2014. In connection with vested RSUs, the total value of the DEU shares that vested was $0.7 million during each of 2016, 2015, and 2014.
The total intrinsic value of options exercised was $2.3 million during 2016, $2.2 million in 2015, and $0.8 million in 2014.
The weighted-average fair value of options and stock per share, including RSUs granted for the Parent's stock plans, during 2016, 2015, and 2014 was as follows:
The following table provides share-based compensation expense in 2016, 2015, and 2014:
William M. Rue, a Director of the Parent, is Chairman of, and owns more than 10% of the equity of, Chas. E. Rue & Son, Inc., t/a Rue Insurance, a general independent retail insurance agency ("Rue Insurance"). Rue Insurance is an appointed distribution partner of the Insurance Subsidiaries on terms and conditions similar to those of our other distribution partners and includes the right to participate in the Agent Plan. Mr. Rue’s son is President, and an employee, of Rue Insurance and Mr. Rue’s daughter is an employee of Rue Insurance. Our relationship with Rue Insurance has existed since 1928.
Rue Insurance placed insurance policies with the Insurance Subsidiaries for its customers and itself. Direct premiums written associated with these policies were $10.4 million in 2016, $9.6 million in 2015, and $9.0 million in 2014. In return, the Insurance Subsidiaries paid standard market commissions to Rue Insurance of $2.1 million in 2016, $1.7 million in 2015, and $1.6 million in 2014 including supplemental commissions. Amounts due to Rue Insurance at December 31, 2016 and December 31, 2015 were $0.7 million and $0.6 million, respectively.
(a) We purchase annuities from life insurance companies to fulfill obligations under claim settlements that provide for periodic future payments to claimants. As of December 31, 2016, we had purchased such annuities with a present value of $17.9 million for settlement of claims on a structured basis for which we are contingently liable. To our knowledge, there are no material defaults from any of the issuers of such annuities.
In addition, certain of these leases are non-cancelable, and liability for payment will continue even though the leased asset may no longer be in use. At December 31, 2016, the total future minimum rental commitments under non-cancelable leases were as follows:
(c) At December 31, 2016, we have contractual obligations that expire at various dates through 2030 to invest up to an additional $143.7 million in alternative and other investments. There is no certainty that any such additional investment will be required. For additional information regarding these investments, see item (f) of Note 5. "Investments" in this Form 10-K.
From time to time, our Insurance Subsidiaries also are named as defendants in other legal actions, some of which assert claims for substantial amounts. These actions include, among others, putative class actions seeking certification of a state or national class. Such putative class actions have alleged, for example, improper reimbursement of medical providers paid under workers compensation and personal and commercial automobile insurance policies. Similarly, our Insurance Subsidiaries are also named from time-to-time in individual actions seeking extra-contractual damages, punitive damages, or penalties, some of which allege bad faith in the handling of insurance claims. We believe that we have valid defenses to these cases. We expect that any potential ultimate liability in any such lawsuit will not be material to our consolidated financial condition, after consideration of provisions made for estimated losses. Nonetheless, given the inherent unpredictability of litigation and the large or indeterminate amounts sought in certain of these actions, an adverse outcome in certain matters could possibly have a material adverse effect on our consolidated results of operations or cash flows in particular quarterly or annual periods.
As of December 31, 2016, we do not believe the Company was involved in any legal action that could have a material adverse effect on our consolidated financial condition, results of operations, or cash flows.
The Insurance Subsidiaries prepare their statutory financial statements in accordance with accounting principles prescribed or permitted by the various state insurance departments of domicile. Prescribed statutory accounting principles include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (“NAIC"). Permitted statutory accounting principles encompass all accounting principles that are not prescribed; such principles differ from state to state, may differ from company to company within a state and may change in the future. The Insurance Subsidiaries do not utilize any permitted statutory accounting principles that materially affect the determination of statutory surplus, statutory net income, or risk-based capital (“RBC”). As of December 31, 2016, the various state insurance departments of domicile have adopted the March 2016 version of the NAIC Accounting Practices and Procedures manual in its entirety, as a component of prescribed or permitted practices.
The Insurance Subsidiaries are required to maintain certain minimum amounts of statutory surplus to satisfy the requirements of their various state insurance departments of domicile. RBC requirements for property and casualty insurance companies are designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policyholders. The Insurance Subsidiaries' combined total adjusted capital exceeded the authorized control level RBC, as defined by the NAIC based on their 2016 statutory financial statements. In addition to statutory capital requirements, we are impacted by various rating agency requirements related to certain rating levels. These required capital levels may be more than statutory requirements.
In general, New York defines an ordinary dividend as a dividend whose fair market value, together with other dividends made within the preceding 12 months, is less than the lesser of 10% of the insurer's statutory surplus, or 100% of adjusted net investment income. New Jersey and Indiana require notice of the declaration of any ordinary dividend distribution. During the notice period, the relevant state regulatory authority may disallow all or part of the proposed dividend if it determines that the dividend is not appropriate given the above considerations. New York does not require notice of ordinary dividends. Dividend payments exceeding ordinary dividends are referred to as extraordinary dividends and require review and approval by the applicable domiciliary insurance regulatory authority prior to payment.
The following table provides quantitative data regarding all Insurance Subsidiaries' dividends paid to the Parent in 2016 for debt service, shareholder dividends, and general operating purposes:
Based on the 2016 statutory financial statements, the maximum ordinary dividends that can be paid to the Parent by the Insurance Subsidiaries in 2017 are as follows: