Workers' Compensation Insurance - This segment includes our workers' compensation insurance business which is provided primarily to employers with 1,000 or fewer employees. Our workers' compensation products include guaranteed cost, policyholder dividend policies, retrospectively-rated policies, deductible policies and alternative market solutions. The underwriting results of SPCs that assume workers’ compensation business were previously reported in this segment and are now reported in our Segregated Portfolio Cell Reinsurance segment.
All prior period segment information has been recast to conform to the current period presentation and the segment reorganization had no impact on previously reported consolidated financial results. Additional information regarding our segments is included in Note 16 of the Notes to Consolidated Financial Statements, Part I and the Segment Operating Results sections that follow.
Over the long-term we expect our growth to come primarily through controlled expansion of our existing operations. In addition, from time to time, we may identify opportunities for growth through the acquisition of other insurers, service providers or books of business. Growth through acquisition is often opportunistic and cannot be predicted.
Late in 2013, we completed the process of establishing a corporate member of Lloyd's of London, an internationally recognized specialist insurance market, by providing the majority of the capital to Syndicate 1729. Syndicate 1729 covers a range of property and casualty insurance and reinsurance lines and began active operations effective January 1, 2014. For the 2019 underwriting year, we slightly decreased our participation in the operating results of Syndicate 1729 from 62% to 61%. Syndicate 1729 has a maximum underwriting capacity of £128 million (approximately $163.3 million at December 31, 2018) for the 2019 underwriting year, of which £78 million (approximately $99.5 million at December 31, 2018) is our allocated underwriting capacity as a corporate member.
Late in 2017, we began providing 100% of the capital for the newly formed SPA, Syndicate 6131. Syndicate 6131, which began writing business effective January 1, 2018, serves as a quota share reinsurer to Syndicate 1729 and focuses on contingency and specialty property business. For the 2019 underwriting year, Syndicate 6131 has a maximum underwriting capacity of £12 million (approximately $15.3 million at December 31, 2018). We have a total capital commitment to support our Lloyd's Syndicate operations through 2019 of up to $200 million, referred to as FAL. The Board, through a non-binding resolution, extended this commitment through 2022. See further discussion in our Segment Operating Results - Lloyd's Syndicates section that follows.
The net loss ratio which is calculated as net losses incurred divided by net premiums earned and is a component of underwriting profitability.
ROE which is calculated as net income divided by the average of beginning and ending shareholders’ equity. This ratio measures our overall after-tax profitability and shows how efficiently capital is being used.
Our Consolidated Financial Statements are prepared in conformity with GAAP. Preparation of these financial statements requires us to make estimates and assumptions that affect the amounts we report on those statements. We evaluate these estimates and assumptions on an ongoing basis based on current and historical developments, market conditions, industry trends and other information that we believe to be reasonable under the circumstances. There can be no assurance that actual results will conform to our estimates and assumptions; reported results of operations may be materially affected by changes in these estimates and assumptions.
The largest component of our liabilities is our reserve for losses and loss adjustment expenses ("reserve for losses" or "reserve"), and the largest component of expense for our operations is incurred losses and loss adjustment expenses (also referred to as “losses and loss adjustment expenses,” “incurred losses,” “losses incurred” and “losses”). Incurred losses reported in any period reflect our estimate of losses incurred related to the premiums earned in that period as well as any changes to our previous estimate of the reserve required for prior periods.
Our reserving process can be broadly grouped into three areas: the establishment of the reserve for the current accident year (the initial reserve), the re-estimation of the reserve for prior accident years (development of prior accident years) and the establishment of the initial reserve for risks assumed in business combinations, applicable only in periods in which acquisitions occur (the acquired reserve). A summary of the activity in our net reserve for losses during 2018, 2017 and 2016 is provided under the heading "Losses" in the Liquidity and Capital Resources and Financial Condition section that follows.
Considerable judgment is required in establishing our initial reserve for any current accident year period, as there is limited data available upon which to base our estimate. Our process for setting an initial reserve considers the unique characteristics of each product, but in general we rely heavily on the loss assumptions that were used to price business, as our pricing reflects our analysis of loss costs that we expect to incur relative to the insurance product being priced.
may occur, general economic conditions and, for claims involving bodily injury, the trend of healthcare costs. Within our Specialty P&C segment, for our HCPL business (75% of our consolidated gross reserve for losses and loss adjustment expenses as of December 31, 2018), we set an initial reserve using the average loss ratio used in our pricing, plus an additional provision in consideration of the historical loss volatility we and others in the industry have experienced. The current accident year reserve also includes provisions for any loss portfolio transfers we enter into during the current period. For our HCPL business our target loss ratio during recent accident years has ranged from 77% to 80% and the provision for loss volatility has ranged from 8 to 10 percentage points, producing an overall average initial loss ratio for our HCPL business of approximately 90%. Changes in observed claim frequency and/or severity can result in variations from these levels. The reasons for the variability in loss provisions from period to period have included additional loss activity within our excess and surplus lines business, provisions for losses in excess of policy limits, adjustments to ULAE, adjustment to the reserve for the DDR provisions in our policies and additional losses recorded for particular exposures, such as mass torts. These specific adjustments are made if we believe the results for a given accident year are likely to vary from those anticipated by our pricing. We believe use of a provision for volatility appropriately considers the inherent risks and limitations of our rate development process and the historic volatility of professional liability losses (the industry has experienced accident year loss ratios as high as 138% and as low as 54% over the past 30 years) and produces a reasonable best estimate of the reserve required to cover actual ultimate unpaid losses. A similar practice is followed for our legal professional liability business (3% of our consolidated gross reserve for losses and loss adjustment expenses as of December 31, 2018).
Workers' Compensation Insurance Segment. Many factors affect the ultimate losses incurred for our workers' compensation coverages (11% of our consolidated gross reserve for losses and loss adjustment expenses as of December 31, 2018) including but not limited to the type and severity of the injury, the age and occupation of the injured worker, the estimated length of disability, medical treatment and related costs, and the jurisdiction and workers' compensation laws of the state of the injury occurrence. We use various actuarial methodologies in developing our workers’ compensation reserve, combined with a review of the exposure base generally based upon payroll of the insured. For the current accident year, given the lack of seasoned information, the different actuarial methodologies produce results with significant variability; therefore, more emphasis is placed on supplementing results from the actuarial methodologies with trends in exposure base, medical expense inflation, general inflation, severity, and claim counts, among other things, to select an expected loss ratio.
The foundation of our reserve re-estimation process is an actuarial analysis that is performed by both our internal and consulting actuaries. This very detailed analysis projects ultimate losses based on partitions which include line of business, geography, coverage layer and accident year. The procedure uses the most representative data for each partition, capturing its unique patterns of development and trends. In all there are over 200 different partitions of our business for purposes of this analysis. We believe that the use of consulting actuaries provides an independent view of our loss data as well as a broader perspective on industry loss trends.
Average Paid Value and Average Reported Value Methods. In these methods, average claim cost data (paid claim cost for the Average Paid Value Method and reported claim cost for the Reported Value Method) is developed to an ultimate average cost level by report year based on historical data. Claim counts are similarly developed to an ultimate count level. The average claim cost (after rounding and adjustment, if necessary, to accommodate report year data that is not considered to be predictive) is then multiplied by the ultimate claim counts by report year to derive ultimate loss and ALAE.
points. In the Adjusted Reported Method reported loss estimates are adjusted to reflect a common case reserve adequacy basis. In the Adjusted Paid Method, the historical paid loss experience is adjusted to reflect a common claim settlement rate basis. We principally use these methods to evaluate reserves for our legal liability coverages.
Even though the actuarial process is highly technical, it is also highly judgmental, both as to the selection of the data used in the various actuarial methodologies (e.g., initial expected loss ratios and loss development factors) and in the interpretation of the output of the various methods used. Each actuarial method generally returns a different value and for the more recent accident years the variations among the various methodologies can be significant. For each partition of our reserves, we evaluate the results of the various methods, along with the supplementary statistical data regarding such factors as closed with and without indemnity ratios, claim severity trends, the expected duration of such trends, changes in the legal and legislative environment and the current economic environment to develop a point estimate based upon management's judgment and past experience. The series of selected point estimates is then combined to produce an overall point estimate for ultimate losses.
Given the potential for unanticipated volatility for long-tailed lines of business, we are cautious in giving full credibility to emerging trends that, when more fully mature, may lead to the recognition of either favorable or adverse development of our
Net favorable development recognized within our Specialty P&C segment was primarily attributable to the favorable resolution of HCPL claims during the period and an evaluation of established case reserves and paid claims data that indicated that the average severity trend associated with the remaining HCPL claims is less than we had previously estimated, principally related to accident years 2011 through 2014. The favorable development in our Specialty P&C segment for the year ended December 31, 2018 included $13.3 million attributable to our medical technology liability line of business and $10.9 million attributable to our legal professionals liability line of business.
Net favorable development recognized within the Workers' Compensation Insurance segment reflected overall favorable trends in claim closing patterns primarily in the 2015 and 2016 accident years.
Net favorable development recognized within our Segregated Portfolio Cell Reinsurance segment primarily reflected better than expected claim trends in the 2015, 2016 and 2017 accident years. The improved claim trends reflected lower frequency and severity than anticipated at the time the reserves were established.
Net unfavorable development recognized within our Lloyd's Syndicates segment was driven by higher than expected losses and development on certain large claims which resulted in unfavorable development with respect to a previous year of account. See further discussion in our Segment Operating Results - Lloyd's Syndicates section that follows.
Our professional liability line of business includes both our HCPL and legal professional lines, with our HCPL line representing the largest component of our reserve. In support of our concern that the decline in frequency will result in a higher severity trend for our HCPL claims, we saw our closed-with-indemnity-payment ratio (i.e., the number of claims closed with an indemnity or loss payment as compared to the total number of closed claims) for our claims increase from 10% in 2005 to 15% in 2018.
At December 31, 2018, 2017 and 2016 management reserve estimates for the three most recent prior accident years (which have closed claim percentages at or below 85%) were influenced by the initial reserve estimate set for these years, moderated to reflect consideration of better than anticipated claims experience observed during the periods. Estimates for older accident years with higher percentages of closed claims were more heavily influenced by the more moderate severity trend, particularly with regard to claims closed during the periods.
In 2018, 2017 and 2016 the development was largely attributable to favorable results from claims closed during the year. As time has elapsed we have recognized that actual loss experience has on average been better than estimated. We have been cautious in recognizing the improvement, but as claims have matured and claims are closed or have become more certain for the remaining open claims, we have revised reserve estimates. We believe the need for a cautious approach is required as outcomes are uncertain and results can be significantly affected by outcomes for a small number of cases.
Fair values for a majority of our equity securities and portions of our corporate debt, short-term and convertible securities are determined using exchange-traded prices. There is little judgment involved when fair value is determined using an exchange-traded price. In accordance with GAAP, for disclosure purposes we classify securities valued using an exchange-traded price as Level 1 securities.
Most fixed income securities do not trade daily; and thus, exchange-traded prices are generally not available for these securities. However, market information (often referred to as observable inputs or market data, including but not limited to, last reported trade, non-binding broker quotes, bids, benchmark yield curves, issuer spreads, two-sided markets, benchmark securities, offers and recent data regarding assumed prepayment speeds, cash flow and loan performance data) is available for most of our fixed income securities. We determine fair value for a large portion of our fixed income securities using available market information. In accordance with GAAP, for disclosure purposes we classify securities valued based on multiple market observable inputs as Level 2 securities.
When a pricing service does not provide a value for one of our fixed maturity securities, management estimates fair value using either a single non-binding broker quote or pricing models that utilize market based assumptions which have limited observable inputs. The process involves significant judgment in selecting the appropriate data and modeling techniques to use in the valuation process. For disclosure purposes, we classify securities valued using limited observable inputs as Level 3 securities.
our ability and intent to hold the investment until the recovery of its carrying value; and
Investments which are accounted for under the equity method are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value of the investment might not be recoverable. These circumstances include, but are not limited to, evidence of the inability to recover the carrying value of the investment, the inability of the investee to sustain an earnings capacity that would justify the carrying value of the investment or the current fair value of the investment that is less than the carrying value.
Asset-backed debt securities that have been impaired due to credit reasons or are below investment grade quality are accounted for under the effective yield method. Under the effective yield method, estimates of cash flows expected over the life of asset-backed securities are used to recognize income on the investment balance for subsequent accounting periods.
Policy acquisition costs (primarily commissions, premium taxes and underwriting salaries) which are directly related to the successful acquisition of new and renewal premiums are capitalized as DPAC and charged to expense, net of ceding commissions earned, as the related premium revenue is recognized. We evaluate the recoverability of our DPAC at the segment level each reporting period, and any amounts estimated to be unrecoverable are charged to expense in the current period. As of December 31, 2018 we have not determined that any amounts are unrecoverable.
A valuation allowance has been established against the full value of the deferred tax asset related to the NOL carryforwards for the U.K. operations as management concluded that it was more likely than not that the deferred tax asset will not be realized. In 2018, we also established a valuation allowance of $0.3 million against the deferred tax assets of certain SPCs at our newly formed wholly owned Cayman Islands reinsurance subsidiary, Inova Re. Due to the limited operations of these newly formed SPCs as of December 31, 2018, management concluded that a valuation allowance was required. See further discussion in Note 6 of the Notes to Consolidated Financial Statements.
compensation that could qualify as a tax deduction, a change in how property and casualty taxpayers discount loss reserves, a minimum tax on payments made to related foreign entities and a new tax on certain income of controlled foreign corporations. See Note 6 of the Notes to Consolidated Financial Statements for discussion of the current status of our accounting for certain provisions of the TCJA.
The TCJA placed limitations on the future deductibility of certain executive compensation. At December 31, 2017, the IRS had not yet issued guidance in this area, and thus we made a reasonable estimate of the effects on our existing deferred tax balances related to executive compensation at that time. During the third quarter of 2018, the IRS issued guidance addressing the effects of the TCJA on executive compensation; therefore, we were able to complete our accounting for the impact of the TCJA on our December 31, 2017 deferred tax asset balances related to executive compensation. As a result, we did not record any measurement-period adjustments to the previously recorded provisional amount.
At December 31, 2017, the IRS had not yet released the information necessary for us to determine a reasonable estimate for the tax effects of the TCJA on our deferred tax balances related to loss reserve discounting; therefore, no provisional amount was recorded at that time. We were able to complete our analysis during the measurement period following the release of new discount factors by the IRS on December 19, 2018. We used the new discount factors to determine the impact of the TCJA on our deferred tax balances related to loss reserve discounting. The adjustment, which is referred to as the transition rule adjustment, will be reflected as a component of taxable income evenly over eight years beginning in 2018. The transition rule adjustment is a taxable temporary difference and has no impact on total tax expense for the current year. The ultimate impact of the TCJA on our deferred tax balances for loss reserve discounting could be materially impacted if the IRS publishes any future revisions to the loss discount factors used in our analysis.
Effective January 1, 2018, the TCJA introduced a minimum tax on payments made to related foreign entities referred to as the BEAT. The BEAT is imposed by adding back into the U.S. tax base any base erosion payment made by the U.S. taxpayer to a related foreign entity and applying a minimum tax rate to this newly calculated modified taxable income. Base erosion payments represent any amount paid or accrued by the U.S. taxpayer to a related foreign entity for which a deduction is allowed. Premiums we cede to the SPCs at our newly formed wholly owned Cayman Islands reinsurance subsidiary, Inova Re, do not fall within the scope of base erosion payments as the SPCs at Inova Re intend to elect to be taxed as U.S. taxpayers. However, premiums that we cede to any active SPC at our other wholly owned Cayman Islands reinsurance subsidiary, Eastern Re, fall within the scope of base erosion payments and therefore could be significantly impacted by the BEAT. We have evaluated our exposure to the BEAT and have concluded that our expected outbound deductible payments to related foreign entities are below the threshold for application of the BEAT; therefore, we have not recognized any incremental tax expense for the BEAT provision of the TCJA as of December 31, 2018. See further discussion on our new subsidiary, Inova Re, and our Cayman Islands SPC operations in the Segment Operating Results - Segregated Portfolio Cell Reinsurance section that follows.
The TCJA also requires a U.S. shareholder of a controlled foreign corporation to include its GILTI in U.S. taxable income. The GILTI amount is based on the U.S. shareholder’s aggregate share of the gross income of the controlled foreign corporation reduced by certain exceptions and a net deemed tangible income return. The net deemed tangible income return is based on the controlled foreign corporation’s basis in the tangible depreciable business property. Cell rental fee income earned by Inova Re and Eastern Re fall within the scope of the GILTI provisions of the TCJA. We have evaluated the new GILTI provisions of the TCJA and we have made an accounting policy election to treat the taxes due on inclusions of GILTI in U.S. taxable income as a current period expense when incurred.
We estimated the fair value of the Workers' Compensation Insurance and Segregated Portfolio Cell Reinsurance reporting units using both an income approach and market approach using the same valuation methodologies and process for developing assumptions that we use in our annual impairment assessment, as discussed above. To corroborate the reporting units’ valuation, we performed a reconciliation of the estimate of the aggregate fair value of the reporting units to ProAssurance's market capitalization, including consideration of a control premium. Because we were not required to estimate the fair value of
The Specialty P&C reporting unit's net operating results were not impacted by the segment reorganization and there was no change to the amount of goodwill allocated to that reporting unit. Consequently, a quantitative goodwill impairment assessment was not required for this reporting unit due to the segment reorganization.
Intangible assets with definite lives are amortized over the estimated useful life of the asset. Amortizable intangible assets primarily consist of agency and policyholder relationships, renewal rights and trade names. Intangible assets with an indefinite life, primarily state licenses, are not amortized. Intangible assets are evaluated for impairment on an annual basis or upon the occurrence of certain triggering events or substantive changes in circumstances that indicate the fair value of the asset may be impaired. The third quarter 2018 segment reorganization had no impact on how we evaluate our intangible assets for impairment. Additional information regarding intangible assets is included in Note 1 of the Notes to Consolidated Financial Statements.
During 2018, our operating subsidiaries paid dividends to us of approximately $178 million, including extraordinary dividends from our insurance subsidiaries of approximately $48 million. Our insurance subsidiaries, in the aggregate, are permitted to pay dividends of approximately $128 million over the course of 2019 without prior approval of state insurance regulators. However, the payment of any dividend requires prior notice to the insurance regulator in the state of domicile, and the regulator may reduce or prevent the dividend if, in its judgment, payment of the dividend would have an adverse effect on the surplus of the insurance subsidiary. We make the decision to pay dividends from an insurance subsidiary based on the capital needs of that subsidiary, and may pay less than the permitted dividend or may also request permission to pay an additional amount (an extraordinary dividend).
The decrease in operating cash flows in 2017 as compared to 2016 of $5.6 million was primarily driven by an increase in tax payments of $25.1 million and an increase in cash paid for other underwriting and operating expenses of approximately $17.0 million. The increase in tax payments was due to the effect of a $15.0 million tax refund received in 2016 for the 2015 tax year and a $10.1 million increase in 2017 estimated tax payments. The increase in cash paid for other underwriting and operating expenses was primarily due to an increase in policy acquisition costs and an increase in cash paid for interest, primarily due to the increase in our weighted average outstanding debt in 2017. These decreases in operating cash flows were largely offset by an increase in premium receipts of $16.1 million, driven by our Workers' Compensation Insurance segment, a decrease in loss payments of $11.9 million, driven by our Specialty P&C segment and an increase in cash received from investment income of $10.8 million primarily due to distributions from unconsolidated subsidiaries.
The line entitled “Reserve for losses, undiscounted and net of reinsurance recoverables” reflects our reserve for losses and loss adjustment expense, less the receivables from reinsurers, each as reported in our consolidated financial statements at the end of each year (the Balance Sheet Reserves).
At December 31, 2018 our gross reserve for losses included case reserves of approximately $1.4 billion and IBNR reserves of approximately $0.7 billion. Our consolidated gross reserve for losses on a GAAP basis exceeds the combined gross reserves of our insurance subsidiaries on a statutory basis by approximately $0.2 billion, which is principally due to the portion of the GAAP reserve for losses that is reflected for statutory accounting purposes as unearned premiums. These unearned premiums are applicable to extended reporting endorsements (“tail” coverage) issued without a premium charge upon death, disability or retirement of an insured who meets certain qualifications.
alternative market professional liability policies are ceded from our Specialty P&C segment to the SPCs under either excess of loss or quota share reinsurance agreements, depending on the structure of the individual program, and the portion of the risk that is not ceded to an SPC may also be reinsured under our standard healthcare professional liability reinsurance program depending on the policy limits provided. The remaining premium written in our alternative market business of $4.5 million and $6.8 million in 2018 and 2017, respectively, is 100% ceded to unaffiliated captive insurers.
For all of our segments, we make a determination of the amount of insurance risk we choose to retain based upon numerous factors, including our risk tolerance and the capital we have to support it, the price and availability of reinsurance, the volume of business, our level of experience with a particular set of claims and our analysis of the potential underwriting results. We purchase excess of loss reinsurance to limit the amount of risk we retain and we do so from a number of companies to mitigate concentrations of credit risk. We utilize reinsurance brokers to assist us in the placement of these reinsurance programs and in the analysis of the credit quality of our reinsurers. The determination of which reinsurers we choose to do business with is based upon an evaluation of their then current financial strength, rating and stability. However, the financial strength of our reinsurers and their corresponding ability to pay us may change in the future due to forces or events we cannot control or anticipate. As of December 31, 2018, there is no reinsurer, on an individual basis, for which our recoverables for both paid and unpaid claims (net of amounts due to the reinsurer) and our prepaid balances are aggregately $36 million or more.
(1) Prior to May 1, 2018, ProAssurance assumed 100% of aggregate losses in excess of an aggregate attachment point with a maximum loss limit of $100K. Effective May 1, 2018, ProAssurance no longer participates in the aggregate reinsurance coverage.
Each SPC has participants and the profit or loss of each cell accrues fully to these cell participants. We participate in certain SPCs and as of December 31, 2018, our ownership interest in the SPCs in which we participate is as low as 25% and as high as 85%. Each SPC maintains a loss fund initially equal to the difference between premium assumed by the cell and the ceding commission. The external participants of each cell provide a letter of credit to us that is initially equal to the difference between the loss fund of the SPC (amount of funds available to pay losses after deduction of ceding commission) and the aggregate attachment point of the reinsurance. Over time, a SPC's retained profits are considered in the determination of the collateral amount required to be provided by the cell's external participants.
Within our Lloyd's Syndicates segment, Syndicate 1729 utilizes reinsurance to provide capacity to write larger limits of liability on individual risks, to provide protection against catastrophic loss and to provide protection against losses in excess of policy limits. The level of reinsurance that Syndicate 1729 purchases is dependent on a number of factors, including its underwriting risk appetite for catastrophic exposure, the specific risks inherent in each line or class of business written and the pricing, coverage and terms and conditions available from the reinsurance market. Reinsurance protection by line of business is as follows:
We manage our investments to ensure that we will have sufficient liquidity to meet our obligations, taking into consideration the timing of cash flows from our investments, including interest payments, dividends and principal payments, as well as the expected cash flows to be generated by our operations. In addition to the interest and dividends we will receive, we anticipate that between $30 million and $70 million of our investments will mature (or be paid down) each quarter over the next twelve months and become available, if needed, to meet our cash flow requirements. The primary outflow of cash at our insurance subsidiaries is related to paid losses and operating costs, including income taxes. The payment of individual claims cannot be predicted with certainty; therefore, we rely upon the history of paid claims in estimating the timing of future claims payments. To the extent that we may have an unanticipated shortfall in cash, we may either liquidate securities or borrow funds under existing borrowing arrangements through our Revolving Credit Agreement and the FHLB system. As of February 15, 2019, $250 million could be made available for use through our Revolving Credit Agreement, as discussed in this section under the heading "Debt." Given the duration of our investments, we do not foresee a shortfall that would require us to meet operating cash needs through additional borrowings. Additional information regarding our Revolving Credit Agreement is detailed in Note 10 of the Notes to Consolidated Financial Statements.
As discussed in Note 3 of the Notes to Consolidated Financial Statements, our fixed maturity and short-term investments include securities deposited with Lloyd's in order to meet our FAL requirement. At December 31, 2018, securities on deposit with Lloyd's included fixed maturities having a fair value of $123.4 million and short-term investments with a fair value of $19.3 million.
Our investment portfolio continues to be primarily composed of high quality fixed income securities with approximately 94% of our fixed maturities being investment grade securities as determined by national rating agencies. The weighted average effective duration of our fixed maturity securities at December 31, 2018 was 2.99 years; the weighted average effective duration of our fixed maturity securities combined with our short-term securities was 2.60 years.
We did not repurchase any common shares subsequent to December 31, 2018 and as of February 15, 2019 our remaining Board authorization was approximately $110 million.
We have a Revolving Credit Agreement which may be used for general corporate purposes, including, but not limited to, short-term working capital, share repurchases as authorized by the Board and support for other activities. Our Revolving Credit Agreement permits borrowings of up to $200 million, and has available a $50 million accordion feature, which, if successfully subscribed, would expand permitted borrowings up to $250 million. At December 31, 2018, there were no outstanding borrowings on our Revolving Credit Agreement and we are in compliance with the financial covenants of the Revolving Credit Agreement, which expires in June 2020.
A schedule of our non-cancellable contractual obligations at December 31, 2018 was as follows:
The anticipated payout of losses and loss adjustment expenses is based upon our historical payout patterns. Both the timing and amount of these payments may vary from the payments indicated.
At December 31, 2018, there were no outstanding borrowings on our Revolving Credit Agreement; however, the above table includes unused commitment fees associated with our Revolving Credit Agreement as we presume the full unused facility will remain available through expiration of the agreement in June 2020. Additionally, we presume the current interest rate on our Mortgage Loans at December 31, 2018 will remain constant until maturity of the Mortgage Loans. For more information regarding these agreements see Note 10 of the Notes to Consolidated Financial Statements.
The decrease in our consolidated net investment result in 2018 as compared to 2017 was primarily attributable to a decrease in net investment income primarily due to reduced earnings from our fixed income portfolio which reflected lower average investment balances. The decrease in equity in earnings (loss) of unconsolidated subsidiaries was primarily due to lower reported earnings from a few LP investments and increases in the amortization on our tax credit partnerships. In addition, equity in earnings (loss) of unconsolidated subsidiaries reflected the impact of the adoption of an accounting standard during the first quarter of 2018 around the recognition and measurement of financial assets and financial liabilities (see Note 1 of the Notes to Consolidated Financial Statements for additional detail regarding accounting changes adopted during the period).
In both 2018 and 2017, our consolidated calendar year net loss ratio was lower than our consolidated current accident year net loss ratio due to the recognition of net favorable loss development, as shown in the previous table.
Our effective tax rates for the years ended December 31, 2018 and 2017 were different from the statutory federal income tax rates in effect for each year primarily due to the utilization of tax credits transferred to us from our tax credit partnership investments and a portion of our investment income being tax-exempt. See further discussion, including notable items during 2018 and 2017 in the Segment Operating Results - Corporate section that follows under the heading "Taxes."
Our operating ratio is our combined ratio, less our investment income ratio. This ratio is the effect of underwriting profitability and investment income. Our operating ratio for the years ended December 31, 2018 and 2017 was as follows:
The increase in 2018 primarily reflected a higher consolidated net loss ratio driven by our Specialty P&C segment primarily due to a lower amount of prior year favorable development and a lower investment income ratio driven by a decline in income from our fixed maturity securities due to lower average investment balances. The lower investment income ratio also reflected the decrease to net investment income due to the adoption of an accounting standard during the first quarter of 2018 around the recognition and measurement of financial assets and financial liabilities (see previous discussion under the heading "Revenues"). The increase was partially offset by a lower expense ratio in our Corporate segment primarily driven by a decrease in share-based compensation expenses and other compensation related costs.
(2) The annual expected incremental tax rate for 2018 is 21% as compared to 35% for 2017, associated with the taxable or tax deductible items listed above. Excluding certain discrete items, which are tax effected at the annual expected incremental tax rate in the period they are included in net income, our effective tax rate for the respective years was applied to these items in calculating net income. See previous discussion in this section under the heading "Taxes."
(3) Due to tax reform enacted by the TCJA, we remeasured our deferred tax assets and liabilities based on the newly enacted tax rate of 21% and recognized a charge of $6.5 million, which is included as a component of income tax expense from continuing operations for the year ended December 31, 2017. In addition, we made a reasonable estimate of the effects on our deferred tax asset balances at December 31, 2017 as it related to the limitation on the future deductibility on certain executive compensation and recorded a provisional charge to income tax expense of $3.5 million for the year ended December 31, 2017. During 2018, we were able to complete our accounting for the impact of the TCJA on our December 31, 2017 deferred tax asset balances related to executive compensation; no measurement period adjustment was recorded in 2018 as a result (see further discussion in Note 6 of the Notes to Consolidated Financial Statements).
As previously discussed under the heading "ProAssurance Overview," we reorganized our segment reporting in the third quarter of 2018 which resulted in the creation of a new segment: Segregated Portfolio Cell Reinsurance. The underwriting results of the SPCs that assume healthcare professional liability business were previously reported in our Specialty P&C segment and are now reported in our Segregated Portfolio Cell Reinsurance segment. All prior period segment information has been recast to conform to the current period presentation. See further information regarding our segments in Note 16 of the Notes to Consolidated Financial Statements.
Our Specialty P&C segment focuses on professional liability insurance and medical technology liability insurance. Segment operating results reflected pre-tax underwriting profit or loss from these insurance lines, exclusive of investment results, which are included in our Corporate segment. Segment operating results included the following:
Changes in our premium volume within our Specialty P&C segment are driven by four primary factors: (1) the amount of new business, (2) our retention of existing business, (3) the premium charged for business that is renewed, which is affected by rates charged and by the amount and type of coverage an insured chooses to purchase and (4) the timing of premium written through multi-period policies. In addition, premium volume may periodically be affected by shifts in the timing of renewals between periods. The healthcare professional liability market, which accounts for a majority of the revenues in this segment, remains challenging as physicians continue joining hospitals or larger group practices and are thus no longer purchasing individual or group policies in the standard market. In addition, some competitors have chosen to compete primarily on price; both factors may impact our ability to write new business and retain existing business.
Our healthcare facilities premium (which includes hospitals, surgery centers and other similar facilities) increased in 2018 as compared to 2017 driven by new business written, primarily due to the addition of two large policies in 2018, and, to a lesser extent, an increase in coverage pertaining to one large entity which consolidated certain policies that were not previously insured by us. Additionally, given the loss environment and initial loss indications we are seeing in the healthcare facilities space, we are seeking rate increases where we believe appropriate. These increases were partially offset by retention losses during the period.
We offer custom alternative risk solutions including loss portfolio transfers for large healthcare entities who, most commonly, are exiting a line of business, changing an insurance approach, or simply preferring to transfer risk. In the second quarter of 2018, we entered into a loss portfolio transfer with a large healthcare organization. Per the agreement, we will cover a specific inventory of existing claims as well as provide tail coverage. The premiums received for the
Certain components of our gross premiums written include alternative market premiums. We cede either all or a portion of the alternative market premium, net of reinsurance, to certain SPCs of our wholly owned Cayman Islands reinsurance subsidiaries, Eastern Re and Inova Re, which are reported in our Segregated Portfolio Cell Reinsurance segment (see further discussion in the Ceded Premiums Written section that follows). The portion not ceded to the SPCs is retained within our Specialty P&C segment. Alternative market gross premiums written by component were as follows:
The increase in our alternative market healthcare facilities premium during 2018 was primarily due to new business written and, to a lesser extent, an increase in renewal pricing primarily due to increases in exposure related to a few policies, partially offset by retention losses.
For our Specialty P&C segment, we calculate our retention rate as annualized renewed premium divided by all annualized premium subject to renewal. Retention rates are affected by a number of factors. We may lose insureds to competitors or to alternative insurance mechanisms such as risk retention groups or self-insurance entities (often when physicians join hospitals or large group practices) or due to pricing or other issues. We may choose not to renew an insured as a result of our underwriting evaluation. Insureds may also terminate coverage because they have left the practice of medicine for various reasons, principally for retirement, death or disability, but also for personal reasons.
We are committed to a rate structure that will allow us to fulfill our obligations to our insureds, while generating competitive returns for our shareholders. Our pricing continues to be based on expected losses, as indicated by our historical loss data and available industry loss data. In recent years, this practice has resulted in gradual rate increases and we anticipate further rate increases due to indications of increasing loss severity. Additionally, the pricing of our business includes the effects of filed rates, surcharges and discounts. Renewal pricing also reflects changes in our exposure base, deductibles, self-insurance retention limits and other policy items.
due to the quarter delay. Additionally, the decrease in premiums ceded to Syndicate 1729 during 2018 reflected the revised contract terms on our previous quota share agreement effective January 1, 2017 which reduced the premiums ceded by essentially half. See the Segment Operating Results - Lloyd's Syndicates section for further discussion on the quota share agreement. As our premiums are earned, we recognize the related ceding commission income which reduces underwriting expense by offsetting DPAC amortization. For 2018 and 2017, the related ceding commission income was approximately 27% of ceded premiums written. For our consolidated results, eliminations of the inter-segment portion (58% of the Specialty P&C cession) of the transactions are also recorded on a quarter delay.
As previously discussed, as a part of our alternative market solutions, all or a portion of certain healthcare premium written is ceded to the SPCs in our Segregated Portfolio Cell Reinsurance segment under either excess of loss or quota share reinsurance agreements, depending on the structure of the individual program. See the Segment Operating Results - Segregated Portfolio Cell Reinsurance section for further discussion on the cession to the SPCs from our Specialty P&C segment. The increase in premiums ceded to the SPCs during 2018 was primarily driven by new business written (see discussion in footnote 8 under the heading "Gross Premiums Written").
Given the length of time that it takes to resolve our claims, many years may elapse before all losses recoverable under a reinsurance arrangement are known. As a part of the process of estimating our loss reserve we also make estimates regarding the amounts recoverable under our reinsurance arrangements. As previously discussed, the premiums ultimately ceded under certain of our excess of loss reinsurance arrangements are subject to the losses ceded under the arrangements. For 2018, we increased our estimate of expected losses and associated recoveries for prior year ceded losses, as well as our estimate of ceded premiums owed to reinsurers. The increase in our estimate of ceded premiums owed to reinsurers during 2018 as compared to 2017 was due to an increase in the number of claims that exceeded our individual risk retention levels under certain loss-sensitive treaties. We believe that this increase in claim severity is reflective of the evolving loss trends within the industry. For 2017, we reduced our estimate of expected losses and associated recoveries for prior year ceded losses, as well as our estimate of ceded premiums owed to reinsurers. Changes to estimates of premiums ceded related to prior accident years are fully earned in the period the changes in estimates occur.
During 2018, we increased the premiums owed under reinsurance agreements for prior accident years which decreased net premiums earned (the denominator of the current accident year ratio). During 2017, reductions to premiums owed under reinsurance agreements for prior accident years increased net premiums earned. See the discussion in the Premiums section for our Specialty P&C segment under the heading "Ceded Premiums Written" for additional information.
We recognized net favorable loss development related to our previously established reserve of $77.0 million and $119.4 million for the years ended December 31, 2018 and 2017, respectively. The net favorable loss development in 2018 and 2017 included $13.3 million and $10.1 million, respectively, attributable to our medical technology liability line of business and $10.9 million and $5.2 million, respectively, attributable to our legal professionals liability line of business. We re-evaluate our previously established reserve each quarter based on our most recently available claims data and currently available industry trend information. Development recognized during 2018 principally related to accident years 2011 through 2014. Development recognized during 2017 principally related to accident years 2010 through 2014.
Our Specialty P&C segment underwriting, policy acquisition and operating expenses for the years ended December 31, 2018 and 2017 were comprised as follows:
Our expense ratio for the Specialty P&C segment for the year ended December 31, 2018 as compared to 2017, was as follows:
The SPC dividend expense for the year ended December 31, 2017 represented a one-time $5.2 million pre-tax expense related to previously unrecognized SPC dividend expense for the cumulative earnings of unrelated parties that have owned SPCs at various times since 2003 within a Bermuda captive insurance operation. Historically, within our HCPL business, we have written a limited number of segregated cell captive programs through this Bermuda captive arrangement and the use of this facility declined as the HCPL insurance market has softened. The SPC dividend expense attributable to those cells was unrelated to our Cayman Islands captive operations.
As previously discussed under the heading "ProAssurance Overview," we reorganized our segment reporting in the third quarter of 2018 which resulted in the creation of a new segment: Segregated Portfolio Cell Reinsurance. The underwriting results of the SPCs at Eastern Re and Inova Re that assume workers' compensation business were previously reported in our Workers' Compensation segment and are now reported in our Segregated Portfolio Cell Reinsurance segment. The traditional workers' compensation business remains in the Workers' Compensation segment which has been renamed to "Workers' Compensation Insurance." All prior period segment information has been recast to conform to the current period presentation. See further information regarding our segments in Note 16 of the Notes to Consolidated Financial Statements.
The current accident year net loss ratio for the year ended December 31, 2018 was 68.0% as compared to 66.1% for 2017. The increase in the current accident year net loss ratio reflected an increase in claim trends in 2018, including the impact of severity-related claim activity related to economic growth trends and the increase in new and less experienced workers to the workforce.
Underwriting, policy acquisition and operating expenses includes the amortization of commissions, premium taxes and underwriting salaries, which are capitalized and deferred over the related workers’ compensation policy period, net of ceding commissions earned. The capitalization of underwriting salaries can vary as they are subject to the success rate of our contract acquisition efforts. These expenses also include a management fee charged by the Corporate segment, which represents intercompany charges pursuant to a management agreement, and the amortization of intangible assets, primarily related to the acquisition of Eastern by ProAssurance. The management fee is based on the extent to which services are provided to the subsidiary and the amount of gross premium written by the subsidiary.
As previously discussed under the heading "ProAssurance Overview," we reorganized our segment reporting during the third quarter of 2018 which resulted in the creation of the Segregated Portfolio Cell Reinsurance segment. See further information regarding our segments in Note 16 of the Notes to Consolidated Financial Statements.
The Segregated Portfolio Cell Reinsurance segment reflects the operating results (underwriting profit or loss, plus investment results) of SPCs at Eastern Re and Inova Re, our Cayman Islands SPC operations. As of December 31, 2018, there were 26 (22 active) SPCs. The SPCs assume workers' compensation insurance, healthcare professional liability insurance or a combination of the two from our Workers' Compensation Insurance and Specialty P&C segments. SPCs are segregated pools of assets and liabilities that provide an insurance facility for a defined set of risks. Assets of each SPC are solely for the benefit of that individual cell and each SPC is solely responsible for the liabilities of that individual cell. Assets of one SPC are statutorily protected from the creditors of the others. Each SPC is owned, fully or in part, by an agency, group or association and the operating results of the SPCs are due to the participants of that cell. We participate to a varying degree in the results of selected SPCs and, for the SPCs in which we participate, our participation interest is as low as 25% and as high as 85%. SPC operating results due to external cell participants are reflected as a SPC dividend expense in our Segregated Portfolio Cell Reinsurance segment. In addition, our Segregated Portfolio Cell Reinsurance segment includes the SPC investment results as the investments are solely for the benefit of the cell participants and investment results due to external cell participants are reflected in the SPC dividend expense.
Segment operating results reflects our share of the underwriting and investment results of the SPCs in which we participate, and included the following:
The above table reflects ceded premiums as a percent of gross premiums written for the workers' compensation business only; healthcare professional liability business is assumed net of reinsurance, as discussed above. The ceded premiums ratio remained unchanged for the year ended December 31, 2018 as compared to 2017.
The following table summarizes the calendar year net loss ratios by separating losses between the current accident year and all prior accident years. Calendar year and current accident year net loss ratios were as follows:
The current accident year net loss ratio reflected the aggregate loss ratio for all programs. Loss reserves are estimated for each program on a quarterly basis. Due to the size of some of the programs, quarterly claims activity can cause the current accident year net loss ratio to fluctuate significantly from period to period. The current accident year net loss ratio decreased as compared to 2017 primarily due to a decrease in severity-related claims activity.
Current accident year incurred losses (excluding IBNR) ceded to our external reinsurers totaled $2.0 million and $3.2 million for the years ended December 31, 2018 and 2017, respectively.
We recognized net favorable prior year development of $9.0 million and $8.5 million for the years ended December 31, 2018 and 2017, respectively, which primarily reflected better than expected claim trends in the 2015, 2016 and 2017 accident years. The improved claim trends reflected lower frequency and severity than anticipated at the time the reserves were established.
We normally report results from our involvement in Lloyd's Syndicates on a quarter delay, except when information is available that is material to the current period (see discussion that follows under the heading "Property and Natural Catastrophe Losses"). Furthermore, the investment results associated with our FAL investments and certain U.S. paid administrative expenses are reported concurrently as that information is available on an earlier time frame.
Lloyd's Syndicate 1729. We are the majority capital provider to Syndicate 1729, which covers a range of property and casualty insurance and reinsurance lines. For the 2018 underwriting year, we increased our participation in the operating results of Syndicate 1729 from 58% to 62% which, due to the quarter delay, was not reflected in our Lloyd's Syndicates segment results until the second quarter of 2018. The remaining capital for Syndicate 1729 is provided by unrelated third parties, including private names and other corporate members. Syndicate 1729 had a maximum underwriting capacity of £132.0 million for the 2018 underwriting year, of which £82.0 million ($104.6 million based on December 31, 2018 exchange rates) was our allocated underwriting capacity. For the 2019 underwriting year, we slightly decreased our participation in the operating results of Syndicate 1729 from 62% to 61% which, due to the quarter delay, will not be reflected in our Lloyd's Syndicates segment results until the second quarter of 2019. Syndicate 1729's maximum underwriting capacity for the 2019 underwriting year is £128 million (approximately $163.3 million at December 31, 2018), of which £78 million (approximately $99.5 million at December 31, 2018) is our allocated underwriting capacity.
Lloyd's Syndicate 6131. Beginning in the second quarter of 2018, our Lloyd's Syndicates segment includes the operating results of a SPA, Syndicate 6131, which began writing business effective January 1, 2018 and focuses on contingency and specialty property business. As a SPA, Syndicate 6131 is only allowed to underwrite one quota share reinsurance contract with Syndicate 1729. We are the sole (100%) capital provider to Syndicate 6131 and for the 2018 underwriting year Syndicate 6131 had a maximum underwriting capacity of £8.0 million ($10.2 million based on December 31, 2018 exchange rates). For the 2019 underwriting year, Syndicate 6131 has a maximum underwriting capacity of £12 million (approximately $15.3 million at December 31, 2018).
As previously mentioned, we normally report results from our involvement in Lloyd's Syndicates on a quarter delay; however, during the fourth quarter of 2018, Syndicate 1729 reported loss estimates in connection with Hurricane Michael, which affected the northwest portion of Florida during October 2018. We estimated our allocated share of the net pre-tax losses in connection with Hurricane Michael to be approximately $6.8 million, net of reinsurance and reinstatement premiums. These losses would normally be reported in the first quarter of 2019 due to the aforementioned quarter delay. However, due to the availability and significance of these estimates, we have accelerated our reporting of these storm-related losses into the fourth quarter of 2018, which is consistent with our policy of disclosing significant losses in the period in which they become known to us.
Gross premiums written in 2018 consisted of property insurance coverages (41% of total gross premiums written), casualty coverages (30%), catastrophe reinsurance coverages (21%), property reinsurance coverages (4%) and specialty property coverages (4%). The increase in gross premiums written during 2018 as compared to 2017 was primarily driven by our increased participation in the operating results of Syndicate 1729, our participation in the operating results of Syndicate 6131 and, to a lesser extent, the effect of reinstatement premiums received in 2018 of approximately $0.9 million as compared to $0.2 million in 2017. The reinstatement premiums represented the additional premium payable to Syndicate 1729 to restore coverage limits that were exhausted under certain excess of loss reinsurance treaties as a result of the previously discussed natural catastrophe-related losses.
As discussed in our Specialty P&C segment operating results, prior to January 1, 2018 Syndicate 1729 served as a reinsurer on a quota share basis for a wholly owned insurance subsidiary in our Specialty P&C segment. For premiums assumed, we include in gross premiums written an estimate of all premiums to be earned over the entire period covered by the
reinsurance agreement, generally one year, in the quarter in which the reinsurance agreement becomes effective. Results from this ceding arrangement are reported in our Specialty P&C segment on the same quarter delay in order to be consistent with our Lloyd's Syndicates segment as the effect of doing so is not material. The quota share agreement with our Specialty P&C segment effective January 1, 2017 reflected revised contract terms which reduced premiums assumed by Syndicate 1729 by essentially half. Syndicate 1729 did not renew the quota share agreement with our Specialty P&C segment on January 1, 2018; however, due to the previously discussed quarter delay, the impact began to be reflected in each segment's operating results in second quarter of 2018.
The following table summarizes calendar year net loss ratios by separating losses between the current accident year and all prior accident years. Net loss ratios for the period were as follows:
The slight increase in the underwriting expense ratio for the year ended December 31, 2018 was primarily due to the previously mentioned increase in operating expenses and broker commissions, partially offset by an increase in net premiums earned, as previously discussed.
As previously discussed under the heading "ProAssurance Overview," we reorganized our segment reporting in the third quarter of 2018 which resulted in the creation of a new segment: Segregated Portfolio Cell Reinsurance. The Segregated Portfolio Cell Reinsurance segment includes the results of investment assets solely allocated to SPC operations at our Cayman Islands reinsurance subsidiaries, Eastern Re and Inova Re, which were previously reported in our Corporate segment. All prior period segment information has been recast to conform to the current period presentation. See further information regarding our segments in Note 16 of the Notes to Consolidated Financial Statements.
the results of the LPs/LLCs become available. Our investment results from our portfolio of investments in LPs/LLCs decreased for the year ended December 31, 2018 primarily due to lower reported earnings from a few LP investments. In addition, our portfolio of investments in LPs/LLCs in 2018 were affected by the adoption of an accounting standard during the first quarter of 2018 around the recognition and measurement of financial assets and financial liabilities (see Note 1 of the Notes to Consolidated Financial Statements for additional detail regarding accounting changes adopted during the period). Under the new accounting standard, LPs/LLCs previously reported using the cost method are now reported at fair value with changes in fair value recognized in equity in earnings (loss) of unconsolidated subsidiaries.
Tax credits provided by the underlying projects of the historic tax credit partnerships are typically available in the tax year in which the project is put into active service, whereas the tax credits provided by qualified affordable housing project tax credit partnerships are provided over approximately a ten year period. The decrease in tax credits recognized in 2018 was primarily attributable to our qualified affordable housing project tax credit partnerships.
We believe that to fully understand our investment returns it is important to consider the current tax benefits associated with certain investments as the tax benefit received represents a portion of the return provided by our tax-exempt bonds, BOLI, common and preferred stocks, and tax credit partnership investments (collectively, our tax-preferred investments). We impute a pro forma tax-equivalent result by estimating the amount of fully-taxable income needed to achieve the same after-tax result as is currently provided by our tax-preferred investments. We believe this better reflects the economics behind our decision to invest in certain asset classes that are either taxed at lower rates and/or result in reductions to our current federal income tax expense. Our pro forma tax-equivalent investment result is shown in the table that follows as well as a reconciliation of our GAAP net investment result to our tax equivalent result.
During 2018, we recognized OTTI in earnings of $0.5 million related to debt instruments from two issuers in the energy sector. We recognized $39.9 million of net realized investment losses during 2018, primarily driven by unrealized holding losses on our equity trading portfolio of $49.4 million and, to a lesser extent, $3.8 million of unrealized holding losses on convertible securities. The primary driver of these unrealized holding losses was market volatility throughout 2018, which caused our equity securities to decline in value. The most significant sectors impacted were the financial and energy sectors, although all sectors were impacted. The net realized investment losses recognized in 2018 were partially offset by realized gains of $12.0 million on the sale of certain equity securities, primarily in the industrial sector.
The decrease in operating expenses during 2018 was primarily driven by a decrease in share-based compensation expenses and other compensation related costs and, to a lesser extent, a decrease in professional fees. The decrease in share-based compensation expense in 2018 was attributable to fewer awards outstanding and an adjustment of the projected award value based upon the decline of one of the performance metrics associated with a particular year's award.
The effective tax rate for 2017 also reflects the impact of the remeasurement of our deferred tax assets and liabilities at December 31, 2017 and the impact of a change in the limitation of future deductibility of certain executive compensation as a result of the enactment of the TCJA. As previously discussed, the TCJA was signed into law on December 22, 2017. Under
Our consolidated underwriting expense ratio increased 0.9 percentage points for the year ended December 31, 2017 as compared to 2016 primarily due to the increase in DPAC amortization relative to consolidated net premiums earned. Although consolidated net premiums earned increased in 2017, the increase was largely reduced by the effect of a prior year novation in
our Specialty P&C segment, as previously discussed, which resulted in a 0.5 percentage point increase in the consolidated underwriting expense ratio. After removing the impact of the prior year novation, the remaining increase in the consolidated underwriting expense ratio was driven by an increase in DPAC amortization, particularly in our Specialty P&C segment, as a result of an increase in commission expense and a decrease in ceding commission income, which is an offset to expense.
We offer extended reporting endorsement or "tail" coverage to insureds who discontinue their claims-made coverage with us, and we also periodically offer tail coverage through custom policies. The amount of tail coverage premium written can vary widely from period to period. The increase in 2017 as compared to 2016 was driven by the purchase of tail coverage for a few large claims-made policies in one jurisdiction that were rewritten to occurrence coverage in 2017. These policies are part of one of our shared risk arrangements and therefore, a large portion of the premium written was ceded during the current period (see further discussion in the Ceded Premiums Written section that follows).
by retention losses, including the loss of one large policy in the first quarter of 2017. Retention losses in 2017 are largely attributable to price competition and merger activity within the industry.
Certain components of our gross premiums written include alternative market premiums. We cede either all or a portion of the alternative market premium, net of reinsurance, to certain SPCs of our wholly owned Cayman Islands reinsurance subsidiary, Eastern Re, which are reported in our Segregated Portfolio Cell Reinsurance segment (see further discussion in the Ceded Premiums Written section that follows). The portion not ceded to the SPCs is retained within our Specialty P&C segment. Alternative market gross premiums written by component were as follows:
Ceded premiums written for the years ended December 31, 2017 and 2016 were as follows:
As previously discussed, as a part of our alternative market solutions, all or a portion of certain healthcare premium written is ceded to the SPCs in our Segregated Portfolio Cell Reinsurance segment under either excess of loss or quota share reinsurance agreements, depending on the structure of the individual program. See the Segment Operating Results - Segregated Portfolio Cell Reinsurance section for further discussion on the cession to the SPCs from our Specialty P&C segment. The slight decrease in premiums ceded to the SPCs during 2017 was primarily driven by retention losses (see discussion in footnote 7 under the heading "Gross Premiums Written").
The increase in gross premiums earned in 2017 primarily reflected the pro rata effect of the higher premiums written during the preceding twelve months, primarily in our healthcare facilities line of business, and a few large tail policies written and earned during 2017. This increase was largely offset by the effect of a large novation written and earned during the fourth quarter of 2016, as discussed above under the heading "Gross Premiums Written." In addition, prior accident year ceded premiums reductions were $5.9 million lower in 2017 than in 2016 (see discussion under the heading "Ceded Premiums Written").
The current accident year net loss ratio was unchanged as compared to 2016 primarily due to offsetting factors. Changes in the mix of business resulted in an 1.2 percentage point increase in the current accident year net loss ratio in 2017 as compared to 2016. However, the effect of a DDR reinsurance commutation during the fourth quarter of 2017 (reduction in current year net losses) partially offset the increase by 0.5 percentage points and the effect of a prior year novation (net premiums earned at a high loss ratio) partially offset the increase by 0.4 percentage points. Additional information regarding the prior year novation is included in the Premiums section for our Specialty P&C segment under the heading "Gross Premiums Written."
A detailed discussion of factors influencing our recognition of loss development is included in our Critical Accounting Estimates section under the heading "Reserve for Losses and Loss Adjustment Expenses." Assumptions used in establishing our reserve are regularly reviewed and updated by management as new data becomes available. Any adjustments necessary are reflected in the then current operations. Due to the size of our reserve, even a small percentage adjustment to the assumptions can have a material effect on our results of operations for the period in which the change is made, as was the case in both 2017 and 2016.
Management fees are charged pursuant to a management agreement by the Corporate segment to the operating subsidiaries within our Specialty P&C segment for services provided, based on the extent to which services are provided to the subsidiary and the amount of gross premium written by the subsidiary. While the terms of the management agreement were consistent between 2017 and 2016, fluctuations in the amount of gross premium written by each subsidiary can result in corresponding variations in the management fee charged to each subsidiary during a particular period.
In the third quarter of 2018, we reorganized our segment reporting which resulted in the creation of a new segment: Segregated Portfolio Cell Reinsurance. The Segregated Portfolio Cell Reinsurance segment provides the results of SPCs at our Eastern Re and Inova Re subsidiaries, including SPCs that assume healthcare professional liability business which were previously reported within our Specialty P&C segment. As such, there is no longer an SPC dividend expense reported in the Specialty P&C segment associated with these SPCs and prior period information has been recast to conform to the current period presentation. See more information on our Cayman Islands SPC operations in the Segment Operating Results - Segregated Portfolio Cell Reinsurance section that follows.
The SPC dividend expense for the year ended December 31, 2017 represented a one-time $5.2 million pre-tax expense related to previously unrecognized SPC dividend expense for the cumulative earnings of unrelated parties that have owned SPCs at various times since 2003 within a Bermuda captive insurance operation. Historically, within our HCPL business, we have written a limited number of segregated cell captive programs through this Bermuda captive arrangement and the use of this facility has declined as the HCPL insurance market has softened. The SPC dividend expense attributable to those cells was unrelated to the captive operations of our Eastern Re subsidiary.
As previously discussed, we reorganized our segment reporting in the third quarter of 2018 which resulted in the creation of a new segment: Segregated Portfolio Cell Reinsurance. The underwriting results of the SPCs that assume workers' compensation business were previously reported in our Workers' Compensation segment and are now reported in our Segregated Portfolio Cell Reinsurance segment. The traditional workers' compensation business remains in the Workers' Compensation segment which has been renamed to "Workers' Compensation Insurance." All prior period segment information has been recast to conform to the current period presentation. See further information regarding our segments in Note 16 of the Notes to Consolidated Financial Statements.
Gross premiums written in our traditional business business increased during the year ended December 31, 2017 as compared to 2016, which reflected new business written, partially offset by a decrease in renewal pricing and a decrease in audit premium. New business written included $4.6 million of premium related to our Eastern Specialty Risk unit and $3.4 million of premium related to the acquisition of Great Falls' book of business. The growth in our alternative market business was driven by new business written, partially offset by a decrease in renewal pricing. We retained the 23 alternative market programs up for renewal for the year ended December 31, 2017. During 2017, we added one new alternative market program at Eastern Re that was a designed consolidation of two unaffiliated captive programs.
Our Workers' Compensation Insurance segment cedes alternative market business under a 100% quota share reinsurance agreement, net of a ceding commission, to SPCs in our Segregated Portfolio Cell Reinsurance segment. The ceding commission consists of an amount for fronting fees, cell rental fees, commissions, premium taxes, claims administration fees and risk management fees. The fronting fees, commissions, premium taxes and risk management fees are recorded as an offset to underwriting, policy acquisition and operating expenses (see discussion that follows under the heading "Underwriting, Policy Acquisition and Operating Expenses"). Cell rental fees are recorded as a component of other income and claims administration fees are recorded as ceded ULAE. The increase in premiums ceded to SPCs primarily reflected growth in our alternative market business, as previously discussed.
The above table reflects ceded premiums earned as a percent of gross premiums earned. As discussed above, we cede premiums related to our traditional business to external reinsurers on an earned premium basis. The increase in the ceded premiums ratio for the year ended December 31, 2017 as compared to 2016 primarily reflected the increase in reinsurance rates.
Net premiums earned consist of gross premiums earned less the portion of earned premiums that we cede to SPCs in our Segregated Portfolio Cell Reinsurance segment, external reinsurers or unaffiliated captive insurers. Because premiums are generally earned pro rata over the entire policy period, fluctuations in premiums earned tend to lag those of premiums written. Our workers’ compensation policies are twelve-month policies and premiums are earned on a pro rata basis over the policy period. Net premiums earned also include premium adjustments related to the audit of our insureds' payrolls. Payroll audits are conducted subsequent to the end of the policy period and any related adjustments are recorded as fully earned in the current period. In addition, we record an estimate for EBUB and evaluate the estimate on a quarterly basis. We did not adjust the EBUB estimate for the year ended December 31, 2017. We increased the EBUB estimate by $0.4 million for the year ended December 31, 2016. The increase in net premiums earned primarily reflected the pro rata effect of higher net premiums written during the preceding twelve months.
The current accident year net loss ratio for the year ended December 31, 2017 was 66.1% as compared to 67.5% for 2016. The improvement in the current accident year net loss ratio primarily reflected more favorable trends in claims closing results in 2017 as compared to 2016, which reduced loss indications for the 2017 accident year.
Current accident year incurred losses (excluding IBNR) ceded to our external reinsurers totaled $9.8 million for the year ended December 31, 2017 as compared to ceded incurred losses of $6.9 million for 2016. The increase in ceded incurred losses in 2017 primarily reflected the aforementioned increase in severity-related claim activity.
We estimate our current accident year loss and loss adjustment expenses based on an expected loss ratio. Incurred losses and loss adjustment expenses are determined by applying the expected loss ratio to net premiums earned, which includes audit premium, for the respective period.
Underwriting, policy acquisition and operating expenses includes the amortization of commissions, premium taxes and underwriting salaries, which are capitalized and deferred over the related workers’ compensation policy period, net of ceding commissions earned. The capitalization of underwriting salaries can vary as they are subject to the success rate of our contract acquisition efforts. These expenses also include a management fee charged by our Corporate segment, which represents intercompany charges pursuant to a management agreement, and the amortization of intangible assets, primarily related to the acquisition of Eastern by ProAssurance. The management fee is based on the extent to which services are provided to the subsidiary and the amount of gross premium written by the subsidiary.
The expense ratio, exclusive of the items noted in the table above, was consistent from 2016 to 2017.
As previously discussed, we reorganized our segment reporting during the third quarter of 2018 which resulted in the creation of the Segregated Portfolio Cell Reinsurance segment. All prior period information has been recast to conform to the current period presentation. See further information regarding our segments in Note 16 of the Notes to Consolidated Financial Statements.
The Segregated Portfolio Cell Reinsurance segment for the years ended December 31, 2017 and 2016 reflects the operating results (underwriting profit or loss, plus investment results) of SPCs at Eastern Re, our Cayman Islands SPC operation. As of December 31, 2017, there were 24 (21 active) SPCs. The SPCs assume workers' compensation insurance, healthcare professional liability insurance or a combination of the two from our Workers' Compensation Insurance and Specialty P&C segments. SPCs are segregated pools of assets and liabilities that provide an insurance facility for a defined set of risks. Assets of each SPC are solely for the benefit of that individual cell and each SPC is solely responsible for the liabilities of that individual cell. Assets of one SPC are statutorily protected from the creditors of the others. Each SPC is owned, fully or in part, by an agency, group or association and the operating results of the SPCs are due to the participants of that cell. We participate to a varying degree in the results of selected SPCs and, for the SPCs in which we participate, our ownership interest is as low as 25% and as high as 85%. SPC operating results due to external cell participants are reflected as a SPC dividend expense in our Segregated Portfolio Cell Reinsurance segment. In addition, our Segregated Portfolio Cell Reinsurance segment includes the SPC investment results as the investments are solely for the benefit of the cell participants and investment results due to external cell participants are reflected in the SPC dividend expense. Segment operating results reflects our share of the underwriting and investment results of the SPCs in which we participate, and included the following:
Gross premiums written for the years ended December 31, 2017 and 2016 was primarily comprised of workers' compensation coverages assumed from our Workers' Compensation Insurance segment. Gross premiums written increased during 2017 as compared 2016, driven by new business written and an increase in the retention rate, partially offset by a decrease in renewal pricing. We retained the 23 alternative market programs up for renewal for the year ended December 31, 2017. During 2017, we added one new alternative market program at Eastern Re that was a designed consolidation of two unaffiliated captive insurers included our Workers' Compensation Insurance segment.
New business, audit premium, retention and renewal price changes for the assumed workers' compensation premium is shown in the table below:
occurrence ranges from $0.3 million to $0.35 million based on the program. Per the SPC external reinsurance agreements, premiums are ceded on a written premium basis and the increase in premiums ceded to external reinsurers for the year ended December 31, 2017 primarily reflected an increase in premiums written in certain programs. External reinsurance rates vary based on the alternative market program.
Net investment income for the years ended December 31, 2017 and 2016 was primarily attributable to interest earned on available-for-sale fixed maturity investments, which primarily includes investment-grade corporate debt securities. Net realized investment gains for the years ended December 31, 2017 and 2016 primarily reflected changes in the value of the SPCs' equity trading portfolio.
We recognized net favorable prior year development of $8.5 million and $4.6 million for the years ended December 31, 2017 and 2016, respectively. The 2017 favorable development primarily reflected better than expected claim trends related to accident years 2015 and 2016, and the 2016 favorable development primarily reflected favorable claim trends related to accident year 2015. The improved claim trends reflected lower frequency and severity than anticipated at the time the reserves were established.
Our Lloyd's Syndicate segment includes operating results from our participation in Lloyd's of London. We have a total capital commitment to support our Lloyd's Syndicate operations through 2019 of up to $200 million, referred to as FAL. The Board, through a non-binding resolution, extended this commitment through 2022. For the 2018 underwriting year, our FAL was comprised of investment securities deposited with Lloyd's which at December 31, 2017 had a fair value of approximately $123.9 million, as discussed in Note 3 of the Notes to Consolidated Financial Statements.
In addition to the results of our participation in Syndicate 1729, as discussed above, our Lloyd's Syndicate segment also includes 100% of the operating results of our wholly owned subsidiaries that support our operations at Lloyd's. For the years ended December 31, 2017 and 2016, the results of our Lloyd's Syndicate segment were as follows:
Losses for the year were primarily recorded using the loss assumptions by risk category incorporated into the business plan submitted to Lloyd's for Syndicate 1729 with consideration given to loss experience incurred to date. The assumptions used in the business plan were consistent with loss results reflected in Lloyd's historical data for similar risks. We expect loss ratios to fluctuate from quarter to quarter as Syndicate 1729 writes more business and the book begins to mature. The loss ratios
The net loss ratio increased 14.9 percentage points in 2017 as compared to 2016 driven by the storm-related losses and associated net reinsurance reinstatement premiums recognized during 2017, as previously discussed, which accounted for approximately 11.2 percentage points of the increase in the net loss ratio. Additionally, the net loss ratio for 2016 was lower than in prior periods and reflected reductions attributable to shifts in the mix of business.
Underwriting expenses increased by $4.1 million for the year ended December 31, 2017 as compared to 2016 and primarily reflected the anticipated growth in Syndicate 1729 operations. As operations have matured, the total amount of underwriting salaries has increased along with the number of policies successfully written. Underwriting compensation is capitalized as DPAC only when efforts are successful. The increase in the expense ratio for 2017 was primarily due to the timing of certain expenses relative to the increase in earned premiums.
Operating results of this segment are subject to U.K. income tax law. Tax expense incurred in 2016 reflected the use of prior year Syndicate 1729 operating losses to offset current period Syndicate 1729 operating results.
Our Corporate segment includes our investment operations, other than those reported in our Segregated Portfolio Cell Reinsurance and Lloyd's Syndicate segments, interest expense and U.S. income taxes. Our Corporate segment also includes non-premium revenues generated outside of our insurance entities and corporate expenses. Segment operating results for our Corporate segment were net earnings of $48.1 million and $54.9 million for the years ended December 31, 2017 and 2016, respectively, and included the following:
Investment fees and expenses increased for the year ended December 31, 2017 as compared to 2016 primarily due to an increase in subsequent interest expense on our LP subscriptions and incentive fees on our convertible bond portfolio. Subsequent interest expense on some of our LPs is paid on subscriptions that occur later in the fund-raising process and incentive fees for returns that exceed a high water mark on our convertible bond portfolio reflected an increase in the fair value of the portfolio.
Our tax credit investments are designed to generate returns in the form of tax credits and tax-deductible project operating losses and are comprised of qualified affordable housing project tax credit partnership interests and historic tax credit interests. We account for our tax credit investments under the equity method and record our allocable portion of the operating losses of the underlying properties based on estimates provided by the partnerships. For our qualified affordable housing project tax credit partnership interests we adjust our estimates of our allocable portion of operating losses periodically as actual operating results of the underlying properties become available. Our historic tax credit investments are short-term in nature and remaining operating losses are expected to be recognized primarily in 2018. Based on operating results received, we increased our estimate of partnership operating losses by $2.1 million for the year ended December 31, 2017, as compared to $10.2 million for the same respective period in 2016, predominantly related to our qualified affordable housing project tax credit partnership interests.
Interest expense increased during 2017 as compared to 2016 driven primarily by an increase in our weighted average outstanding debt, which was $421 million for the year ended December 31, 2017, as compared to $351 million for the same respective period of 2016, and, to a lesser extent, an increase in the average interest rate on the outstanding borrowings under our Revolving Credit Agreement. In addition, interest expense for the year ended December 31, 2017 included the change in fair value recognized on the interest rate cap entered into during the fourth quarter of 2017. The interest rate cap is designated as an economic hedge of interest rate risk associated with our variable rate Mortgage Loans. See further discussion of our outstanding debt in Note 10 and further discussion of our interest rate cap agreement in Note 11 of the Notes to Consolidated Financial Statements.
One additional item of note impacting our effective tax rate in 2017 was the excess tax benefit on share-based compensation that resulted from the application of revised accounting guidance, which was effective January 1, 2017 and resulted in a 2.1% reduction to our effective tax rate in 2017. Under the revised accounting guidance, the difference between
the income tax deduction, which is based upon the fair market value of share-based awards and the time of vesting, and the compensation cost recognized in the financial statements, which is based upon the fair market value of the share-based awards on the date of grant, is to be recognized as income tax expense (benefit) in the current period rather than an adjustment to OCI as was required under the previous guidance. See Note 1 of the Notes to Consolidated Financial Statements included in ProAssurance's December 31, 2017 Form 10-K for further discussion on the adoption of this guidance.
Consolidated Balance Sheets - December 31, 2018 and December 31, 2017
Consolidated Statements of Income and Comprehensive Income - Years Ended December 31, 2018, 2017 and 2016
Consolidated Statements of Cash Flows - Years Ended December 31, 2018, 2017 and 2016
The Supplementary Financial Information required by Item 302 of Regulation S-K is included in Note 19 of the Notes to Consolidated Financial Statements of ProAssurance and its subsidiaries.