We own seven buildings and related parking facilities in Cedar Rapids, Iowa. Our corporate headquarters includes: a five-story office building, a two-story office building and an eight-story office building in which a portion of the first floor is leased to commercial tenants. We also own three surrounding buildings as part of a commercial office complex. In September 2015, we acquired a two-story office building adjacent to our corporate headquarters, which is leased to commercial tenants.
The following table shows a brief description of our owned and leased office space as of December 31, 2015.
Originally founded in 1946 as United Fire & Casualty Company, United Fire Group, Inc. ("UFG", "United Fire", the "Registrant", the "Company", "we", "us", "our") and its consolidated insurance company subsidiaries provide insurance protection for individuals and businesses through several regional companies. Our property and casualty insurance company subsidiaries are licensed in 46 states plus the District of Columbia and are represented by approximately 1,200 independent agencies. Our life insurance subsidiary is licensed in 37 states and is represented by approximately 1,200 independent agencies.
For 2015, property and casualty business accounted for approximately 91.5 percent of our net premiums earned, with the majority of which, 91.9 percent, was generated from commercial insurance. Life insurance business made up approximately 8.5 percent of our net premiums earned, of which over 68.5 percent was generated from traditional life insurance products.
Catastrophe losses is a commonly used non-GAAP financial measure, which utilizes the designations of the Insurance Services Office ("ISO") and are reported with losses and loss settlement expense amounts net of reinsurance recoverables, unless specified otherwise. According to the ISO, a catastrophe loss is defined as a single unpredictable incident or series of closely related incidents that result in $25.0 million or more in U.S. industry-wide direct insured losses to property and that affect a significant number of insureds and insurers ("ISO catastrophe"). In addition to ISO catastrophes, we also include as catastrophes those events ("non-ISO catastrophes"), which may include U.S. or international losses, that we believe are, or will be, material to our operations, either in amount or in number of claims made. Management, at times, may determine for comparison purposes that it is more meaningful to exclude extraordinary catastrophe losses and resulting litigation. The frequency and severity of catastrophic losses we experience in any year affect our results of operations and financial position. In analyzing the underwriting performance of our property and casualty insurance segment, we evaluate performance both including and excluding catastrophe losses. Portions of our catastrophe losses may be recoverable under our catastrophe reinsurance agreements. We include a discussion of the impact of catastrophes because we believe it is meaningful for investors to understand the variability in our periodic earnings.
In 2014, the decrease in net income was driven by an increase in losses and loss settlement expenses offset by an increase in property and casualty premium revenue. The increase in losses and loss settlement expenses is primarily attributable to an increase in catastrophe losses from spring and summer convective storms in regions of the U.S. where we conduct much of our business and an increase in frequency and severity in fire-related losses in our commercial property line of business. Net premiums earned increased to $828.3 million compared to $754.8 million in 2013. The increase in property and casualty premium revenue represents organic growth and is the result of a combination of rate increases across most commercial and personal lines and, to a lesser extent, new business writings.
(2) The GAAP expense ratio is calculated by dividing nondeferred underwriting expenses and amortization of deferred policy acquisition costs by net premiums earned. The expense ratio measures a company's operational efficiency in producing, underwriting and administering its insurance business. The statutory expense ratio, presented here, is calculated in a similar fashion as GAAP but uses net premiums written instead of net premiums earned.
For the year ended December 31, 2014, our property and casualty insurance segment reported income before income taxes of $66.0 million compared to income before income taxes of $88.7 million in the same period in 2013. The
The following table shows our premiums written and earned for 2015, 2014 and 2013:
Net premiums written comprise direct and assumed premiums written, less ceded premiums written. Direct premiums written are the total policy premiums, net of cancellations, associated with policies issued and underwritten by our property and casualty insurance segment. Assumed premiums written are the total premiums associated with the insurance risk transferred to us by other insurance and reinsurance companies pursuant to reinsurance contracts. Ceded premiums written is the portion of direct premiums written that we cede to our reinsurers under our reinsurance contracts. Net premiums earned are recognized ratably over the life of a policy and differ from net premiums written, which are recognized on the effective date of the policy.
Direct premiums written increased $87.9 million in 2015 as compared to 2014 due to organic growth from a combination of new business and rate increases.
In 2015, our pre-tax catastrophe losses were $32.3 million, a decrease as compared to $49.7 million and an increase as compared to $30.2 million in 2014 and 2013, respectively. The decrease in catastrophe losses in 2015 is primarily due to elevated losses in the prior year. In 2014, there was an increase in catastrophes from spring and summer
convective storms in regions of the U.S. where we conduct much of our business. In 2015, our catastrophe losses included 37 catastrophes, where our largest single pre-tax catastrophe loss totaled $4.0 million. In 2014 our catastrophe losses included 26 catastrophes, where our largest single pre-tax catastrophe loss totaled $7.7 million and in 2013 our catastrophe losses included 29 catastrophes, where our largest single pre-tax catastrophe loss totaled $4.0 million.
In 2015, 2014 and 2013, we did not exceed our catastrophe reinsurance retention level of $20.0 million.
The following table represents the primary reinsurers we utilize and their financial strength ratings as of December 31, 2015:
In 2013, our losses and loss settlement expenses were affected by a reduction of $34.5 million in catastrophe losses in both our direct business and assumed reinsurance business as compared to 2012, and also, to a lesser extent, by an improvement in our non-catastrophe results.
The property and casualty insurance segment experienced $40.4 million of favorable development in our net reserves for prior accident years for the year ended December 31, 2015. Three lines in aggregate accounted for a majority of the favorable development. The largest single contributor was long-tail liability with $23.0 million of favorable development followed by workers' compensation with $22.1 million of favorable development and auto physical damage with $4.4 million of favorable development for the year ended December 31, 2015. The favorable development is attributable to reductions in reserves for reported claims as well as reductions in required reserves for incurred but not reported claims combined with continued successful management of litigation expenses. These
reserve decreases were more than sufficient to offset claim payments. The favorable development was partially offset by adverse development, the majority coming from three lines which included property with $5.6 million of adverse development from an increase in severity and frequency of losses, assumed reinsurance with $8.1 million of adverse development due to prior year development of catastrophe losses and commercial auto liability with $2.8 million of adverse development due to an increase in frequency of losses in the year ended December 31, 2015. No other single line of business contributed a significant portion of the total development.
The following table depicts our net loss ratios for 2015, 2014 and 2013:
The net loss ratio in our commercial lines of business, excluding assumed reinsurance, was 60.0 percent in 2015 compared to 64.7 percent in 2014 and 62.7 percent in 2013. The improvement in 2015 as compared to 2014 was primarily the result of a decrease in net losses and loss settlement expenses incurred in fire and allied lines and workers' compensation partially offset by an increase in losses in commercial automobile. The prior year results included an increase in catastrophe losses from spring and summer storms in regions of the U.S where we conduct much of our business and an increase in frequency and severity in fire-related losses in our commercial property line of business.
The deterioration in 2014 as compared to 2013 was primarily the result of an increase in catastrophe losses from spring and summer storms in regions of the U.S where we conduct much of our business and an increase in frequency and severity in fire-related losses in our commercial property line of business partially offset by an improvement in the loss ratio for workers' compensation and commercial automobile insurance.
Other liability is business insurance covering bodily injury and property damage arising from general business operations, accidents on the insured's premises and products manufactured or sold. Because of the long-tail nature of liability claims, significant periods of time, ranging up to several years, may elapse between the occurrence of the loss, the reporting of the loss to us and the settlement of the claim.
In recent years, we began to use our loss control department more extensively in an attempt to return this line of business to a higher level of profitability. For example, our loss control department has representatives who make multiple visits each year to businesses and job sites to ensure safety. We also non-renew accounts that no longer meet our underwriting or pricing guidelines. We avoid accounts that have become too underpriced for the risk.
Incurred losses from construction defect claims were $3.6 million in 2015 compared to $10.1 million and $13.7 million in 2014 and 2013, respectively. At December 31, 2015, we had $28.8 million in construction defect loss and loss settlement expense reserves (excluding IBNR reserves which is calculated at the overall other liability commercial line), which consisted of 1,721 claims. In comparison, at December 31, 2014, we had reserves of $33.6 million, excluding IBNR reserves, consisting of 1,597 claims. The decrease in the incurred losses and reserves is due to a decrease in loss severity.
Commercial fire and allied lines include fire, allied lines, commercial multiple peril and inland marine. The insurance covers losses to an insured's property, including its contents, from weather, fire, theft or other causes. We provide this coverage through a variety of business policies.
The improvement in the net loss ratio in 2015 as compared to 2014 was primarily attributable to elevated losses in the prior year. In 2014, there were elevated catastrophe losses from spring and summer storms in regions of the U.S. where we conduct much of our business and an increase in frequency and severity in fire-related losses in our commercial property line of business.
The deterioration in the net loss ratio in 2014 as compared to 2013, was due to an increase in catastrophe losses from spring and summer storms in regions of the U.S. where we conduct much of our business and an increase in frequency and severity in fire-related losses in our commercial property line of business.
We consider our workers' compensation business to be a companion product; we rarely write stand-alone workers' compensation policies. Our workers' compensation insurance covers primarily small- to mid-size accounts.
The improvement in our workers' compensation line of business in 2015 as compared to 2014 was due to a decrease in severity and frequency of claims and favorable development in reserves for reported claims. The improvement in our workers' compensation line of business in 2014 as compared to 2013 was due to the combined effects of lower claim frequency and favorable reserve development from previously reported claims.
The challenges faced by workers' compensation insurance providers to attain profitability include the regulatory climates in some states that make it difficult to obtain appropriate premium rate increases and inflationary medical costs. Despite these pricing issues, we continue to believe that we can improve the results of this line of business. Consequently, we have increased the utilization of our loss control unit in the analysis of current risks, with the
intention of increasing the quality of our workers' compensation book of business. We are currently using these modeling analytics to assist us in risk selection, and we will continue to evaluate the model results.
We will continue pursuing opportunities to grow our personal lines business in the future. We have added within our CATography™ Underwriter tool the ability to determine whether the premium we charge for an exposure is adequate in areas where hurricanes and earthquakes occur. We have also implemented predictive analytics and data prefill for our personal automobile line. Data prefill is a data accessing methodology that allows for a more complete profile of our customers at the agent's point of sale during the quotation process.
Our assumed reinsurance is the business we choose to write by participating in programs insuring insurance companies. The net loss ratio deterioration in 2015 was due to an increase in catastrophe losses assumed. The net loss ratio deterioration in 2014 was due to a combination of an increase in catastrophe losses, from development of losses on prior year catastrophes, and from an increase in frequency and severity in fire-related losses. The net loss ratio improvement in 2013 was driven by a decrease in catastrophe losses.
Net premiums earned increased 29.0 percent in 2015 as compared to 2014 primarily due to an increase in sales of SPWL policies. Net premiums earned increased 1.2 percent in 2014 as compared to 2013 due in part to an increase in the sale of single premium immediate annuities.
Underwriting expenses increased 22.5 percent in 2015 as compared to 2014 due to an increase in SPWL commissions related to the increase in premiums as previously mentioned and an increase in our postretirement benefit plan expenses.
We reported a federal income tax expense of $32.3 million, $17.3 million and $25.8 million in 2015, 2014, and 2013, respectively. Our effective federal tax rate varied from the statutory federal income tax expense rate of 35.0 percent in each year, due primarily to our portfolio of tax-exempt securities.
Due to our determination that we may not be able to fully realize the benefits of the NOLs acquired in the purchase of American Indemnity Financial Corporation, which are only available to offset the future taxable income of our property and casualty insurance operations and are further limited as to the amount that can be utilized in any given year, we have recorded a valuation allowance against these NOLs that totaled $1.3 million at December 31, 2015. Based on a yearly review, we determine whether the benefit of the NOLs can be realized, and, if so, the decrease in the valuation allowance is recorded as a reduction to current federal income tax expense. If NOLs expire during the year, the decrease in the valuation allowance is offset with a corresponding decrease to the deferred income tax asset. The valuation allowance was reduced by $0.6 million in 2015 due to the realization of $1.6 million in NOLs.
As of December 31, 2015, we had no alternative minimum tax ("AMT") credit carryforwards.
Our invested assets at December 31, 2015 totaled $3.1 billion, compared to $3.2 billion at December 31, 2014, a decrease of $28.2 million. At December 31, 2015, fixed maturity securities and equity securities comprised 90.4 percent and 7.6 percent of our investment portfolio, respectively. Because the primary purpose of the investment portfolio is to fund future claims payments, we utilize a conservative investment philosophy, investing in a diversified portfolio of high-quality, intermediate-term taxable corporate bonds, taxable U.S. government and government agency bonds and tax-exempt U.S. municipal bonds. Our overall investment strategy is to stay fully invested (i.e., minimize cash balances). If additional cash is needed we have an ability to borrow funds available under our revolving credit facility.
The following table shows the composition of fixed maturity securities held in our available-for-sale, held-to-maturity and trading security portfolios by credit rating at December 31, 2015 and 2014. Information contained in the table is generally based upon the issue credit ratings provided by Moody's, unless the rating is unavailable, in which case we obtain it from Standard & Poor's.
The weighted average effective duration of our portfolio of fixed maturity securities was 5.2 years at December 31, 2015 compared to 5.0 years at December 31, 2014.
In 2015, our investment income, net of investment expenses, decreased $3.8 million to $100.8 million as compared to 2014, primarily due the decline in invested assets and decline in reinvestment interest rates from the low interest rate environment.
In 2015, 86.0 percent of our gross investment income originated from interest on fixed maturities, compared to 88.3 percent and 86.3 percent in 2014 and 2013, respectively.
The following table details our annualized yield on average invested assets for 2015, 2014 and 2013, which is based on our invested assets (including money market accounts) at the beginning and end of the year divided by net investment income:
As of December 31, 2015, net unrealized investment gains, after tax, totaled $128.4 million compared to $149.6 million and $116.6 million as of December 31, 2014 and 2013, respectively. The decrease in unrealized gains in 2015 is the result of a decrease in the fair value of the fixed maturity portfolio due to an increase in interest rates and the decrease in the equity portfolio due to a decline in the financial markets. The increase in unrealized gains in 2014 resulted from an increase in the fair value of both the fixed maturity portfolio and the equity portfolio.
The amounts set forth in the following table detail the impact of hypothetical interest rate changes on the fair value of fixed maturity securities held at December 31, 2015. The sensitivity analysis measures the change in fair values arising from immediate changes in selected interest rate scenarios. We employed hypothetical parallel shifts in the yield curve of plus or minus 100 and 200 basis points in the simulations. Additionally, based upon the yield curve shifts, we employ estimates of prepayment speeds for mortgage-related products and the likelihood of call or put options being exercised within the simulations. According to this analysis, at current levels of interest rates, the duration of the investments supporting the deferred annuity liabilities is 2.15 years longer than the projected duration of the liabilities. If interest rates increase by 100 or 200 basis points, the duration of the investments supporting the deferred annuity liabilities would be 3.38 years and 4.07 years longer, respectively, than the projected duration of the liabilities.
The selection of a 100-basis-point and 200-basis-point increase or decrease in interest rates should not be construed as a prediction by our management of future market events, but rather as an illustration of the potential impact of an event.
To the extent actual results differ from the assumptions utilized, our duration and interest rate measures could be significantly affected. As a result, these calculations may not fully capture the impact of nonparallel changes in the relationship between short-term and long-term interest rates.
Credit risk is the willingness and ability of a borrower to repay on time and in full any principal and interest due to the lender. Losses related to credit risk are realized through the income statement and have a direct impact on the earnings of UFG. Given the vast majority of our holdings are fixed income maturity securities, we view credit risk as our primary investment risk. Our internal Investment Department has developed and maintains a rigorous underwriting process to analyze and measure the expected frequency and severity of loss (i.e., credit quality) for government, agency, municipal, structured security, and corporate bond issuers. The objective is to maintain the appropriate balance of risk in our portfolio, consistent with our Investment Policy Statement and conservative investment style, and ensure the portfolio is compensated appropriately for the credit risk it holds. We do have within our municipal bond holdings a small number of securities whose ratings were enhanced by third-party insurance for the payment of principal and interest in the event of an issuer default. A downgrade in the credit ratings of the insurers of these securities in 2015 and 2014 resulted in a corresponding downgrade in the ratings of the securities. Of the insured municipal securities in our investment portfolio, 99.3 percent and 98.9 percent were rated "A" or above, and 90.9 percent and 87.9 percent were rated "AA" or above at December 31, 2015 and 2014, respectively, without the benefit of insurance. Due to the underlying financial strength of the issuers of the securities, we believe that the loss of insurance would not have a material impact on our operations, financial position, or liquidity.
The following table displays a summary of cash sources and uses in 2015, 2014 and 2013:
Net cash flows provided by operating activities totaled $190.0 million, $151.3 million and $161.5 million in 2015, 2014 and 2013, respectively. Operating cash flows in 2015 reflect an increase in net income and the timing of the settlement of loss payments. Operating cash flows in 2014 reflect a higher level of property and casualty loss payments.
Net cash flows used in investing activities totaled $36.3 million, $58.9 million and $102.0 million in 2015, 2014 and 2013, respectively. In 2015, we had cash inflows from scheduled and unscheduled investment maturities, redemptions, prepayments, and sales of investments that totaled $674.9 million compared to $567.7 million and $508.3 million for the same period in 2014 and 2013, respectively. The cash inflows over the last three years primarily relate to redemptions of fixed maturity securities that are reinvested at lower interest rates as interest rates have been declining during this period.
Net cash flows used in financing activities totaled $137.8 million, $94.0 million and $74.8 million in 2015, 2014 and 2013, respectively. In 2015, 2014 and 2013 we had $118.4 million, $63.5 million and 58.6 million, respectively, of net annuity withdrawals.
Dividends paid to shareholders totaled $21.7 million, $19.7 million and $17.5 million in 2015, 2014 and 2013, respectively. Our practice has been to pay quarterly cash dividends, which we have paid every quarter since March 1968.
As a holding company with no independent operations of its own, United Fire Group, Inc. relies on dividends received from its insurance company subsidiaries in order to pay dividends to its common shareholders. Dividends payable by our insurance subsidiaries are governed by the laws in the states in which they are domiciled. In all cases, these state laws permit the payment of dividends only from earned surplus arising from business operations. For example, under Iowa law, the maximum dividend or distribution that may be paid within a 12-month period without prior approval of the Iowa Insurance Commissioner is generally restricted to the greater of 10 percent of statutory surplus as of the preceding December 31, or net income of the preceding calendar year on a statutory basis, not greater than earned statutory surplus. Other states in which our insurance company subsidiaries are domiciled may impose similar restrictions on dividends and distributions. Based on these restrictions, at December 31, 2015, our insurance company subsidiary, United Fire & Casualty, was able to make a maximum of $53.1 million in dividend payments without prior regulatory approval. These restrictions are not expected to have a material impact in meeting our cash obligations.
On February 2, 2016, the Company, as borrower, entered into a Credit Agreement (the "New Credit Agreement") by and among the Company, with the lenders from time to time party thereto and KeyBank National Association ("Key Bank"), as administrative agent, swingline lender and letter of credit issuer. The New Credit Agreement provides for a $50 million four-year unsecured revolving credit facility that includes a $20 million letter of credit subfacility and a swingline subfacility in the amount up to $5 million. The New Credit Agreement allows the Company to increase the aggregate amount of the commitments thereunder by up to $100 million, provided that no event of default has occurred and is continuing and certain other conditions are satisfied.
In December 2011, United Fire & Casualty Company entered into a credit agreement with a syndicate of financial institutions as lenders, which terminated by expiration on its stated termination date of December 22, 2015. KeyBank National Association was the administrative agent, lead arranger, sole book runner, swingline lender, and letter of credit issuer, and Bankers Trust Company was the syndication agent. The four-year credit agreement provided for a $100,000 unsecured revolving credit facility that included a $20,000 letter of credit subfacility and a swing line subfacility in the amount of up to $5,000.
The credit agreement contained customary representations, covenants and events of default, including certain covenants that limit or restrict our ability to engage in certain activities. Subject to certain exceptions, those activities included restricting our ability to sell or transfer assets or enter into a merger or consolidate with another company, grant certain types of security interests, incur certain types of liens, impose restrictions on subsidiary dividends, enter into leaseback transactions, or incur certain indebtedness. The credit agreement contained certain financial covenants including covenants that required us to maintain a minimum consolidated net worth, a debt to capitalization ratio and minimum stockholders' equity. We were in compliance with all covenants of the credit agreement until it terminated by expiration on its stated termination date of December 22, 2015.
Stockholders' equity increased 7.5 percent to $878.9 million at December 31, 2015, from $817.4 million at December 31, 2014. The increase was primarily attributable to net income of $89.1 million along with the change in valuation of our retirement benefit obligations of $10.5 million, partially offset by a decrease in net unrealized investment gains of $21.3 million, net of tax, stockholder dividends of $21.7 million and share repurchases of $2.4 million. As of December 31, 2015, the book value per share of our common stock was $34.94, compared to $32.67 at December 31, 2014.
presented above for future policy benefit reserves significantly exceeds the amount of future policy benefit reserves reported on our Consolidated Balance Sheets at December 31, 2015.
At December 31, 2015, pursuant to an agreement with our limited liability partnership investments, we are contractually committed to make capital contributions up to $10.3 million upon request of the partnerships through December 31, 2023.
of accounting. We record mortgage loans at their unpaid principal balance and policy loans at the outstanding loan amount due from policyholders.
We use a market-based approach for valuing all of our Level 2 securities except for our mortgage-backed securities, collateralized mortgage obligations and asset-backed securities, and submit them primarily to a third-party valuation service provider. Any of these securities not valued by this service provider are submitted to another third-party valuation service provider. Both service providers use a market approach to find pricing of similar financial instruments. The market inputs our service providers normally seek to value our securities include the following, listed in approximate order of priority: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including market research publications. The method and inputs for these securities classified as Level 2 are the same regardless of industry category, credit quality, duration, geographical concentration or economic characteristics. For our mortgage-backed securities, collateralized mortgage obligations and asset-backed securities, our service providers use additional market inputs to value these securities, including the following: new issue data, periodic payment information, monthly payment information, collateral performance and real estate analysis from third parties. Our service providers prioritize inputs based on market conditions, and not all inputs listed are available for use in the evaluation process for each security evaluation on any given day.
At least annually, we review the methodologies and assumptions used by our valuation service providers and verify that they are reasonable and representative of the fair value of the underlying securities held in the investment portfolio. We validate the prices obtained from independent pricing services and brokers prior to their use for reporting purposes by evaluating their reasonableness on a monthly basis. Our validation process includes a review for unusual fluctuations. In our opinion, the pricing obtained at December 31, 2015 was reasonable. Unusual fluctuations outside of our expectations are independently corroborated with an additional third party sources that use similar valuation techniques as discussed above. In addition, we also randomly select securities and independently corroborate the valuations obtained from our third party valuation service providers.
Securities categorized as Level 3 include holdings in certain private placement fixed maturity and equity securities for which an active market does not currently exist. The fair value of our Level 3 private placement securities is determined by management relying on pricing received from our independent pricing services and brokers consistent with the process to estimate fair value for Level 2 securities. However, securities are categorized as Level 3 if these quotes cannot be corroborated by other market observable data due to the unobservable nature of the brokers’ valuation processes. If pricing cannot be obtained from these sources, which occurs on a limited basis, management will perform a discounted cash flow analysis, using an appropriate risk-adjusted discount rate, on the underlying security to estimate fair value.
At December 31, 2015 and 2014, we had a number of securities with fair value less than the cost basis. The total unrealized loss on these securities was $28.1 million at December 31, 2015, compared with $13.9 million at December 31, 2014. At December 31, 2015, the largest pre-tax unrealized loss on an individual equity security was $0.2 million. Our rationale for not recording OTTI charges on these securities is discussed in Part II, Item 8, Note 2 "Summary of Investments."
Actual future results could differ materially from our assumptions used to calculate the recorded DAC asset. Changes in our assumed loss and loss settlement expense ratios in the future would impact the amount of deferred costs in the period such changes in assumptions are made. The premium deficiency charge calculated for the quarter ended December 31, 2015 was $0.0 million compared to the premium deficiency charge of $4.0 million calculated for the same period of 2014. The improvement in the premium deficiency charge for the quarter ended December 31, 2015 as compared to the same period of 2014 was due to a combination of an improvement in incurred losses and the previously mentioned enhancements to the DAC model.
Costs that vary with and relate to the successful acquisition of life insurance and annuity business are deferred. Such costs consist principally of commissions, premium taxes, and related variable underwriting, agency and policy issue expenses. The amount of underwriting compensation expense eligible for deferral is based on time studies and a ratio of success in policy placement. At December 31, 2015 and 2014, our DAC asset was $77.7 million and $66.9 million, respectively.
The DAC asset recorded in connection with our non-traditional business is also adjusted with respect to estimated expected gross profits as a result of changes in the net unrealized gains or losses on available-for-sale fixed maturity securities allocated to support the block of deferred annuities and universal life policies. That is, because we carry available-for-sale fixed maturity securities at fair value, we make an adjustment to the DAC asset equal to the change in amortization that would have been recorded if we had sold such securities at their stated fair value and reinvested the proceeds at current yields. We include this adjustment, which is called "shadow" DAC, net of tax, as a component of accumulated other comprehensive income. At December 31, 2015 and 2014, the "shadow" DAC adjustment decreased our DAC asset by $2.0 million and $13.4 million, respectively.
Our long-tail lines of business include workers' compensation and other liability. In addition, certain product lines such as personal and commercial auto, commercial multi-peril and surety include both long-tail coverages and short-tail coverages. For many long-tail liability claims, significant periods of time, ranging up to several years, may elapse between the occurrence of the loss, the reporting of the loss to us and the settlement of the claim. As a result, loss experience in the more recent accident years for the long-tail liability coverages has limited statistical credibility in our reserving process because a relatively small proportion of losses in these accident years are reported claims and an even smaller proportion are paid losses. In addition, long-tail liability claims are more susceptible to litigation and can be significantly affected by changing contract interpretations and the legal environment. Consequently, the estimation of loss reserves for long-tail coverages is more complex and subject to a higher degree of variability than for short-tail coverages.
Senior management meets with our internal actuary and controller quarterly to review the adequacy of carried IBNR reserves based on results from this actuarial analysis and makes adjustments for changes in business and other factors not completely captured by the data within the actuarial analysis. There are two fundamental types or sources of IBNR reserves. We record IBNR for "normal" types of claims and also specific IBNR reserves related to unique circumstances or events. A major hurricane is an example of an event that might necessitate specific IBNR reserves because an analysis of existing historical data would not provide an appropriate estimate. This method of establishing our IBNR reserves has consistently resulted in aggregate reserve levels that management believes are reasonable in comparison to the reserve estimates indicated by the actuarial analysis.
As an example, if our loss and loss settlement expense reserves of $1,003.9 million as of December 31, 2015, is 10.0 percent inadequate, we would experience a reduction in future pre-tax earnings of up to $100.4 million. This reduction could be recorded in one year or multiple years, depending on when we identify the deficiency. The deficiency would also affect our financial position in that our equity would be reduced by an amount equivalent to the reduction in net income. Any deficiency that would be recognized in our loss and loss settlement expense reserves usually does not have a material effect on our liquidity because the claims have not been paid. Conversely, if our estimates of ultimate unpaid loss and loss settlement expense reserves prove to be redundant, our future earnings and financial position would be improved. We believe our reserving philosophy, coupled with what we believe to be aggressive and successful claims management and loss settlement practices, has resulted in year-to-year redundancies in reserves. We believe our approach produces recorded reserves that are reasonable as to their relative position within a range of reasonable reserves from year-to-year.
We are unable to reasonably quantify the impact of changes in our key assumptions utilized to establish individual case-basis reserves on our total reported reserves because the impact of these changes would be unique to each specific case-basis reserve established. However, based on historical experience, we believe that aggregate case-basis reserve volatility levels of 5.0 percent and 10.0 percent can be attributed to the ultimate development of our net case-basis reserves. The impact to pre-tax earnings would be a decrease if the reserves were to be adjusted upwards and an increase if the reserves were to be adjusted downwards. The table below details the impact of this development volatility on our reported net case-basis reserves at December 31, 2015:
In 2015, we did not change the key method through which we develop our assumptions on which we based our reserving calculations. In estimating our 2015 loss and loss settlement expense reserves, we did not anticipate future events or conditions that were inconsistent with past development patterns.
Included in the other liability and assumed reinsurance lines of business are reserves for asbestos and other environmental losses and loss settlement expenses. At December 31, 2015 and 2014, we had $4.8 million and $5.0 million, respectively, in direct and assumed asbestos and environmental loss reserves. The estimation of loss reserves for environmental claims and claims related to long-term exposure to asbestos and other substances is one of the most difficult aspects of establishing reserves, especially given the inherent uncertainties surrounding such claims. Although we record our best estimate of loss and loss settlement expense reserves, the ultimate amounts paid upon settlement of such claims may be more or less than the amount of the reserves, because of the significant uncertainties involved and the likelihood that these uncertainties will not be resolved for many years.
In 2015, 2014 and 2013, we recognized a favorable development in our net reserves for prior accident years totaling $40.4 million, $56.7 million and $57.5 million, respectively.
The factors contributing to our year-to-year redundancy include: establishing reserves at their ultimate expected loss amount as soon as practicable after information becomes available, which produces, on average, prudently conservative case reserves; using claims negotiation to control the size of settlements; assuming that we have liability for all claims, even though the issue of liability may, in some cases, be resolved in our favor; promoting
We engage an independent actuarial firm to render an opinion as to the reasonableness of the statutory reserves internal management establishes. During 2015 and 2014, we engaged the services of Regnier Consulting Group, Inc. ("Regnier") as our independent actuarial firm for the property and casualty insurance segment. We anticipate that this engagement will continue in 2016.
Other reserves include claims that have been reported but not settled and IBNR reserves for claims on life and disability income insurance. We use our own historical experience and other assumptions such as any known or anticipated developments or trends to establish reserves for these unsettled or unreported claims. The effects of changes in our estimated reserves are included in our results of operations in the period in which the changes occur.
Our reserves for universal life and deferred annuity contracts are based upon the policyholders' current account value. Acquisition expenses are amortized in relation to expected gross profits forecasted based upon current best estimates of anticipated premium income, investment earnings, benefits and expenses. Annually, we review our estimates of reserves and the related DAC asset and compare them with actual experience. Differences between actual experience and the assumptions that we used in the pricing of these policies, guarantees and riders, and in the establishment of the related reserves will result in variances in profit for the underlying contract. The effects of the changes in such estimated reserves are included in our results of operations in the period in which the changes occur.
We engage an independent actuarial firm to assist us in establishing our future policy benefit reserves for statutory and GAAP reporting and our DAC asset and related amortization for GAAP reporting and to render an opinion as to the reasonableness of the statutory reserves we establish. Statutory reserves are established using prescribed assumptions which are considerably more conservative assumptions regarding future investment earnings and contractual benefit payments than are used for GAAP reserves. During 2015 and 2014, we engaged the services of Griffith, Ballard and Company as our independent actuarial firm for the life insurance segment. We anticipate that this engagement will continue in 2016.
A change in any one or more of these assumptions is likely to result in an ultimate liability different from the original actuarial estimate. Such changes in estimates may be material. For example, a 100 basis point decrease in our estimated discount rate would increase the pension and postretirement benefit obligation at December 31, 2015, by $28.0 million and $14.9 million, respectively, while a 100 basis point increase in the rate would decrease the benefit obligation at December 31, 2015, by $22.1 million and $11.6 million, respectively.
A 100 basis point decrease in our estimated long-term rate of return on pension plan assets would increase the benefit expense for the year ended December 31, 2015, by $1.1 million, while a 100 basis point increase in the rate would decrease benefit expense by $1.1 million, for the same period.
In December 2015, the FASB issued guidance on the balance sheet classification of deferred taxes. The new guidance eliminates the requirement to split deferred tax liabilities and assets between current and non-current in a classified balance sheet. The new guidance allows deferred tax liabilities and assets to be included in non-current accounts. The Company will adopt the new guidance on January 1, 2017 and is currently evaluating the impact on the Company's financial position and results of operations.
In April 2015, the FASB issued guidance which clarifies customers' accounting for fees paid for cloud computing arrangements. The new guidance provides guidance to customers about whether a cloud computing arrangement includes a software license or whether the arrangement is considered a service contract. The new guidance is effective for annual and interim periods beginning after December 15, 2015. The Company will adopt the new guidance on January 1, 2016. Management currently does not expect the adoption of the new guidance to have an
In April 2015, the FASB issued new guidance on the presentation of debt issuance costs. The new guidance requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the debt liability. The new guidance is effective for annual and interim periods beginning after December 15, 2015. The Company will adopt the new guidance on January 1, 2016. Management currently does not expect the adoption of the new guidance to have an impact on the Company's financial position or results of operations.
In August 2014, the FASB issued new guidance on the disclosure of uncertainties about an entity's ability to continue as a going concern. The new guidance requires management to evaluate whether there is substantial doubt about the entity's ability to continue as a going concern and, if so, to disclose the fact and what the entity's plans are to alleviate that doubt. The guidance is effective for annual periods ending after December 15, 2016 and interim periods within annual periods beginning after December 15, 2016. The Company will adopt the guidance on January 1, 2016. Management currently does not expect the adoption of the new guidance to have an impact on the Company's financial position or results of operations.
In June 2014, the FASB issued new guidance on the accounting for share based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. The new guidance requires a performance target that affects vesting and that could be achieved after the service period, be treated as a performance condition. The guidance is effective for interim and annual periods beginning after December 15, 2015. The amendments can be applied prospectively or retrospectively and early adoption is permitted. The Company will adopt the guidance on January 1, 2016. Management currently does not expect the adoption of the new guidance to have a material impact on the Company's financial position or results of operations.
In May 2014, the FASB issued comprehensive new guidance on revenue recognition which supersedes nearly all existing revenue recognition guidance under GAAP. The new guidance requires a company to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The standard creates a five-step model that requires companies to exercise judgment when considering the terms of the contract(s) and all relevant facts and circumstances. Insurance contracts are not within the scope of this new guidance. The new guidance is effective for annual and interim periods beginning after December 15, 2017. The Company will adopt the guidance on January 1, 2018 and is currently evaluating the impact on the Company's financial position and results of operations and considering which portions, of the guidance, if any, applies to the Company.
United Fire Group, Inc. ("UFG", "United Fire", the "Registrant", the "Company","we", "us", or "our") and its consolidated subsidiaries and affiliates are engaged in the business of writing property and casualty insurance and life insurance and selling annuities through a network of independent agencies. We report our operations in two business segments: property and casualty insurance and life insurance. Our insurance company subsidiaries are licensed as a property and casualty insurer in 45 states, plus the District of Columbia, and as a life insurer in 37 states.
The accompanying Consolidated Financial Statements include United Fire and its wholly owned subsidiaries: United Fire & Casualty Company, United Real Estate Holdings Company, LLC, United Life Insurance Company ("United Life"), Addison Insurance Company, Lafayette Insurance Company, United Fire & Indemnity Company, United Fire Lloyds, UFG Specialty Insurance Company (formerly known as Texas General Indemnity Company), Financial Pacific Insurance Company, Franklin Insurance Company, Mercer Insurance Company, and Mercer Insurance Company of New Jersey, Inc.
We record our best estimate of reserves for claim litigation that arises in the ordinary course of business. We consider all of our pending litigation as of December 31, 2015 to be ordinary, routine and incidental to our business.
Liabilities for future policy benefits for traditional products are computed by the net level premium method, using interest assumptions ranging from 4.2 percent to 6.0 percent and withdrawal, mortality and morbidity assumptions appropriate at the time the policies were issued. Liabilities for non-traditional business are stated at policyholder account values before surrender charges. Liabilities for traditional immediate annuities are based primarily upon future anticipated cash flows using assumptions for mortality and interest rates. Liabilities for deferred annuities are carried at the account value.
In 2015, 2014, and 2013, we made payments for income taxes of $39,497, $9,626 and $13,628, respectively. In addition, we received federal tax refunds of $919, $615 and $8,744 in 2015, 2014 and 2013, respectively, that resulted from the utilization of our 2011 net operating losses and net capital losses in the carryback period. We made no interest payments in 2015, 2014 and 2013. These payments exclude interest credited to policyholders' accounts.
Our other intangible assets, which consist primarily of agency relationships, trade names, licenses, and software, are being amortized by the straight-line method over periods ranging from 2 years to 15 years, with the exception of licenses, which are indefinite-lived and not amortized. We performed a qualitative assessment of our definite lived intangible assets and a quantitative assessment of our indefinite lived intangible assets. As a result of this assessment, we did not recognize an impairment charge on our intangible assets in 2015, 2014 and 2013. Amortization expense, which is allocated to the property and casualty insurance segment, totaled $769, $769 and $1,212 for 2015, 2014 and 2013, respectively.
On February 2, 2016, the Company, as borrower, entered into a Credit Agreement by and among the Company, with the lenders from time to time party thereto and KeyBank National Association, as administrative agent, swingline lender and letter of credit issuer. A more detailed discussion regarding this Credit Agreement is contained in Part II, Item 8, Note 14 "Credit Facility."
In May 2015, the FASB issued guidance on disclosure requirements for short-duration contracts. The new guidance requires additional disclosures about the liability for unpaid loss and loss adjustment expenses and requires disclosure of any information about significant changes in methodologies and assumptions used to calculate the liability. The new guidance is effective for annual periods beginning after December 15, 2015 and interim periods beginning the following year. The Company will include the new annual disclosures beginning with the December 31, 2016 annual financial statements. The adoption of the new guidance will change disclosures regarding short duration contracts, but management currently does not expect the adoption of the new guidance to have an impact on the Company's financial position or results of operations.
In April 2015, the FASB issued guidance which clarifies customers' accounting for fees paid for cloud computing arrangements. The new guidance provides guidance to customers about whether a cloud computing arrangement includes a software license or whether the arrangement is considered a service contract. The new guidance is effective for annual and interim periods beginning after December 15, 2015. The Company will adopt the new guidance on January 1, 2016. Management currently does not expect the adoption of the new guidance to have an impact on the Company's financial position or results of operations.
The table that follows is a reconciliation of the amortized cost (cost for equity securities) to fair value of investments in held-to-maturity and available-for-sale fixed maturity and available-for-sale equity securities as of December 31, 2015 and 2014.
Net realized gains (losses) on disposition of investments are computed using the specific identification method and are included in the computation of net income. A summary of net realized investment gains (losses) for 2015, 2014 and 2013, is as follows:
There were no sales of held-to-maturity securities in 2015, 2014 and 2013.
Our investment portfolio includes trading securities with embedded derivatives. These securities are primarily convertible securities which are recorded at fair value. Income or loss, including the change in the fair value of these trading securities, is recognized currently in earnings as a component of net realized investment gains and losses. Our portfolio of trading securities had a fair value of $16,975 and $20,928 at December 31, 2015 and 2014, respectively.
The tables on the following pages summarize our fixed maturity and equity securities that were in an unrealized loss position at December 31, 2015 and 2014. The securities are presented by the length of time they have been
In order to determine the proper classification in the fair value hierarchy for each security where the price is obtained from an independent pricing service, we obtain and evaluate the vendors' pricing procedures and inputs used to price the security, which include unadjusted quoted market prices for identical securities, such as a New York Stock Exchange closing price, and quoted prices for identical securities in markets that are not active. For fixed maturity securities, an evaluation of interest rates and yield curves observable at commonly quoted intervals, volatility, prepayment speeds, credit risks and default rates may also be performed. We have determined that these processes and inputs result in fair values and classifications consistent with the applicable accounting guidance on fair value measurements.
A summary of the carrying value and estimated fair value of our financial instruments at December 31, 2015 and 2014 is as follows:
The following tables present the categorization for our financial instruments measured at fair value on a recurring basis in our Consolidated Balance Sheets at December 31, 2015 and 2014:
We use a market-based approach for valuing all of our Level 2 securities except for our mortgage-backed securities, collateralized mortgage obligations and asset-backed securities, and submit them primarily to a third-party valuation service provider. Any of these securities not valued by this service provider are submitted to another third-party valuation service provider. Both service providers use a market approach to find pricing of similar financial instruments. The market inputs our service providers normally seek to value our securities include the following, listed in approximate order of priority: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including market research publications. The method and inputs for these securities classified as Level 2 are the same regardless of industry category, credit quality, duration, geographical concentration or economic characteristics. For our mortgage-backed securities, collateralized mortgage obligations and asset-backed securities, our service providers use additional market inputs to value these securities, including the following: new issue data, periodic payment information, monthly payment information, collateral performance and real estate analysis from third parties. Our service providers prioritize inputs based on market conditions, and not all inputs listed are available for use in the valuation process for each security on any given day.
For the year ended December 31, 2015, the change in our available-for-sale securities categorized as Level 1 and Level 2 was the result of investment purchases that were made using funds held in our money market accounts, disposals and the change in unrealized gains on both fixed maturities and equity securities. During the twelve month period ended December 31, 2015, there were no securities transferred between Level 1 and Level 2.
The Company formed a rabbi trust in 2014 to fund obligations under the United Fire & Casualty Company Non-qualified Deferred Compensation Plan and United Fire Group Supplemental Executive Retirement and Deferral Plan (collectively the "Executive Retirement Plans"). Within the rabbi trust, corporate-owned life insurance ("COLI") policies are utilized as an investment vehicle and source of funding for the Company's Executive Retirement Plans.
We also assume both property and casualty insurance from other insurance or reinsurance companies. Most of the business we have assumed is property insurance, with an emphasis on catastrophe coverage.
In 2013, we renewed our participation in all but one of our assumed programs and added two new programs to our portfolio. Loss and loss settlement expenses assumed decreased in 2013 as compared to 2012 primarily due to a decrease in catastrophe losses. We added two new programs to replace the lost premium from the program not renewed and to take advantage of areas where we had exposure capacity. One of the new programs has worldwide exposure and the other has exposure in the United Kingdom and Japan.
The ceding of insurance does not legally discharge United Life from primary liability under its policies. United Life must pay the loss if the reinsurer fails to meet its obligations. We periodically monitor the financial condition of our reinsurers to confirm that they are financially stable and have strong credit ratings. We believe that all of our reinsurers are in an acceptable financial condition. Approximately 99.0 percent of ceded life insurance in force as of December 31, 2015 was ceded to five reinsurers.
We paid dividends to our common shareholders of $21,658, $19,680 and $17,484 in 2015, 2014 and 2013, respectively. Payments of any future dividends and the amounts of such dividends, however, will depend upon factors such as net income, financial condition, capital requirements, and general business conditions. We will only pay dividends if declared by our Board of Directors, out of funds legally available, and subject to any other restrictions that may be applicable to us.
In 2015, 2014 and 2013, United Fire & Casualty Company received dividends from its wholly owned subsidiaries of $16,500, $13,500 and $26,335, respectively. In 2015, 2014 and 2013, United Fire & Casualty Company paid dividends to United Fire Group, Inc. totaling $22,500, $29,000 and $13,175, respectively. These intercompany dividend payments are eliminated for reporting in our Consolidated Financial Statements.
At December 31, 2015, United Life had net admitted assets, on a statutory basis, of $1,535,950, $195,380 in excess of its legal reserve requirement. Therefore, any restriction on funds deposited by United Life with the Iowa Insurance Commissioner would not materially affect its financial position or results of operations and its cash flows are sufficient to meet its operational requirements. Under the material transaction and dividend standards described above, United Life currently is not able to enter into an affiliate transaction and/or pay a dividend without approval from the Commissioner.
We are directed by the state insurance departments' solvency regulations to calculate a required minimum level of statutory capital and surplus based on insurance risk factors. The risk-based capital results are used by the NAIC and state insurance departments to identify companies that merit regulatory attention or the initiation of regulatory action. Both United Life and United Fire & Casualty Company and its property and casualty insurance subsidiaries and affiliates had statutory capital and surplus in regards to policyholders well in excess of their required levels at December 31, 2015.
A reconciliation of income tax expense computed at the applicable federal tax rate of 35.0 percent to the amount recorded in the accompanying Consolidated Statements of Income and Comprehensive Income is as follows:
We offer various benefits to our employees including a noncontributory defined benefit pension plan, an employee/retiree health and dental benefit plan, a profit-sharing plan and an employee stock ownership plan.
The investments held by the pension plan at December 31, 2015 include the following asset categories:
The fair value of the arbitrage fund and bond and mortgage pooled separate account fund are categorized as Level 2 since there are no restrictions as to the pension plan's ability to redeem its investment at the net asset value of the fund as of the reporting date.
The preparation of financial statements in conformity with GAAP requires us to make various estimates and assumptions that affect the reporting of net periodic benefit cost, plan assets and plan obligations for each plan at the date of the financial statements. Actual results could differ from these estimates. One significant estimate relates to the calculation of the benefit obligation for each plan. We annually establish the discount rate, which is an estimate of the interest rate at which these benefits could be effectively settled, that is used to determine the present value of the respective plan's benefit obligations as of December 31. In estimating the discount rate, we look to rates of return on high-quality, fixed-income investments currently available and expected to be available during the period to maturity of the respective plan's benefit obligations.
Increasing interest rates resulted in an increase in the discount rates we use to value our respective plan's benefit obligations at December 31, 2015 compared to December 31, 2014.
We anticipate amortization of the net actuarial losses for our pension plan in 2016 to be $3,967. We anticipate amortization of the net actuarial losses for our postretirement benefit plan in 2016 to be $1,518.
The components of the net periodic benefit cost for our pension and postretirement benefit plans are as follows:
All employees were eligible to participate in the ESOP upon completion of one year of service, meeting the hourly employment requirements and attaining 21 years of age. Contributions to the ESOP were made at our discretion. When made, these contributions were based upon a percentage of total payroll and are allocated to participants on the basis of compensation. We can make contributions in stock or cash, which the trustee uses to acquire shares of our stock to allocate to participants' accounts. Prior to merger of the plan into the United Fire Group, Inc. 401K Plan, the ESOP owned 214,614 shares of United Fire common stock. As of December 31, 2014, the ESOP owned 214,637 shares of United Fire common stock. Shares owned by the ESOP were included in shares issued and outstanding for purposes of calculating earnings per share, and dividends paid on the shares are charged to retained earnings. We made contributions to the ESOP of $150 and $250 in 2015 and 2014, respectively. We did not make any contributions to the ESOP in 2013.
The United Fire Group, Inc. 2008 Stock Plan (the "2008 Stock Plan") authorized the issuance of restricted and unrestricted stock awards, stock appreciation rights, incentive stock options, and non-qualified stock options for up to 1,900,000 shares of United Fire common stock to employees. In May 2014, the Registrant's shareholders approved an additional 1,500,000 shares of United Fire common stock issuable at any time and from time to time pursuant to the 2008 Stock Plan, among other amendments, and renamed such plan as the United Fire Group, Inc.
The United Fire Group, Inc. 2005 Non-Qualified Non-Employee Director Stock Option and Restricted Stock Plan (the "Director Plan") authorizes the issuance of restricted stock awards and non-qualified stock options to purchase shares of United Fire's common stock to non-employee directors. At December 31, 2015, we had 69,938 authorized shares available for future issuance.
In 2015, 2014 and 2013, we recognized stock-based compensation expense of $2,510, $1,944 and $1,777, respectively. Stock-based compensation expense is recognized over the vesting period of the stock options.
The analysis below details the award activity for 2015 and the awards outstanding at December 31, 2015, for both of our plans and ad hoc options, which were granted prior to the adoption of the other plans:
The following table summarizes information regarding the stock options outstanding and exercisable at December 31, 2015:
Life insurance in force, before ceded reinsurance, totaled $5,491,932 and $5,366,061 as of December 31, 2015 and 2014, respectively. Traditional life insurance products represented 68.5 percent and 67.7 percent of our insurance in-force at December 31, 2015 and 2014, respectively. Universal life insurance represented 26.3 percent and 27.3 percent of insurance in force at December 31, 2015 and 2014, respectively.
provided for a $100,000 unsecured revolving credit facility that included a $20,000 letter of credit subfacility and a swing line subfacility in the amount of up to $5,000.
We have audited the accompanying consolidated balance sheets of United Fire Group, Inc. as of December 31, 2015 and 2014, and the related consolidated statements of income and comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2015. Our audits also included the financial statement schedules listed in the Index at Item 15(a)(2). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of United Fire Group, Inc. at December 31, 2015 and 2014, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.