Cincinnati Financial Corporation owns our headquarters building located on 102 acres of land in Fairfield, Ohio. This building has 1,508,200 square feet of total space. The property, including land is recorded in our financial statements at $131 million at December 31, 2018, and is classified as land, building and equipment, net, for company use. John J. & Thomas R. Schiff & Co. Inc., a related party, occupies 6,750 square feet (less than 1 percent). This property is used for the operations described in the Consolidated Financial Statements and accompanying Notes.
Cincinnati Financial Corporation owns Gilmore Pointe, located on the northwest corner of our headquarters property. This four-story building contains approximately 103,000 square feet of usable space. The property is recorded in the financial statements at $6 million at December 31, 2018, and is classified as investment property in Other Invested Assets, net. At December 31, 2018, unaffiliated tenants occupied 88 percent, Cincinnati Financial affiliates occupy 12 percent.
The Cincinnati Insurance Company owns the CFC Winton Center used for multiple operations with approximately 48,000 square feet of total space, located approximately six miles from our headquarters. The property, including land, is recorded in our financial statements at $9 million at December 31, 2018, and is classified as land, building and equipment, net, for company use.
We begin with an executive summary of our results of operations, followed by other highlights, an overview of our strategy, an outlook for future performance and details about critical accounting estimates. In several instances, we refer to estimated industry data so that we can provide information on our performance within the context of the overall insurance industry. Unless otherwise noted, the industry data is prepared by A.M. Best, a leading insurance industry statistical, analytical and financial strength rating organization. Information from A.M. Best is presented on a statutory accounting basis. When we provide our results on a comparable statutory accounting basis, we label it as such; all other company data is presented in accordance with accounting principles generally accepted in the United States of America (GAAP).
Through The Cincinnati Insurance Company, Cincinnati Financial Corporation is one of the 25 largest property casualty insurers in the nation, based on net written premium volume for the first nine months of 2018, among approximately 2,000 U.S. stock and mutual insurer groups. We market our insurance products through a select group of independent insurance agencies in 42 states as discussed in Item 1, Our Business and Our Strategy.
We are targeting an annual value creation ratio averaging 10 percent to 13 percent over the next five-year period. At negative 0.1 percent for 2018, we were significantly below the low end of that range, but were within the range for the three-year and five-year periods that ended in December 2018.
The 2018 value creation ratio decreased by 23.0 percentage points, compared with 2017, and again included a significant contribution of operating results. VCR in 2018 included a 0.7 percent contribution from certain non-recurring items, including the impact of various tax accounting method changes. VCR in 2017 included a 7.0 percent contribution from a tax benefit due to net deferred income tax liability revaluation related to U.S. tax reform. The 2018 ratio decrease reflected a decline in market valuation, with reductions of 12.4 percentage-points from our equity securities investment portfolio and 4.3 points from our fixed-maturity securities investment portfolio. The 2017 value creation ratio was 8.4 percentage points higher than in 2016, reflecting the 7.0 percent tax benefit noted above and a 3.1 point increase in the contribution from realized gains plus the change in unrealized gains from our investment portfolios in aggregate.
Premium growth - We believe over any five-year period our agency relationships and initiatives can lead to a property casualty written premium growth rate that exceeds the industry average. The compound annual growth rate of our net written premiums was 5.3 percent over the five-year period 2014 through 2018, slightly exceeding the 5.1 percent estimated growth rate for the property casualty insurance industry, with 2018 representing industry data reported through the first nine months of 2018. The industry’s growth rate excludes its mortgage and financial guaranty lines of business.
The board of directors is committed to rewarding shareholders directly through cash dividends and share repurchase authorizations. Through 2018, the company has increased the annual cash dividend rate for 58 consecutive years, a record we believe is matched by only seven other publicly traded U.S. companies. In addition to regular dividends, strong capital and excellent company performance provided opportunities to further reward shareholders with special dividends paid in December 2017. The board regularly evaluates relevant factors in dividend-related decisions, and the 2018 increase to the regular dividend reflected confidence in our strong
capital, liquidity and financial flexibility, as well as progress through our initiatives to improve earnings performance while growing insurance premium revenues. We discuss our financial position in more detail in Liquidity and Capital Resources.
Net income in 2018 decreased $758 million or 73 percent compared with 2017, largely due to a $495 million benefit in 2017 from net deferred income tax liability revaluation due to U.S. tax reform and a $413 million decrease for 2018 in net investment gains after taxes. The 2018 decrease in net income was partially offset by an increase in property casualty underwriting income of $64 million after taxes, as discussed below, and a $57 million increase in investment income after taxes. Our investment operation’s performance is discussed further in Investments Results. Net income in 2018 also included a $56 million benefit from certain other non-recurring items, primarily the impact of various tax accounting method changes as disclosed in Item 8, Note 11 of the Consolidated Financial Statements.
As discussed in Investments Results, we reported a net investment loss in 2018, primarily due to unfavorable changes in fair values of equity securities even though we continued to hold the securities. For both 2017 and 2016 we reported investment gains, largely due to investment sales that were discretionary in timing and amount.
Property casualty net written premiums and earned premiums each grew 4 percent in 2018, reflecting average renewal price increases, a higher level of insured exposures and premium growth initiatives. Premium growth rates in 2018 were less than in 2017. Trends and related factors are discussed in Commercial Lines, Personal Lines and Excess and Surplus Lines Insurance Results, respectively.
Management has worked to identify a strategy that can lead to long-term success, with concurrence by the board of directors. Our strategy is intended to position us to compete successfully in the markets we have targeted while appropriately managing risk. We discuss our long-term, proven strategy in Item 1, Our Business and Our Strategy. We believe successful implementation of initiatives that support our strategy will help us better serve our agent customers and reduce volatility in our financial results while we also grow earnings and book value over the long term, successfully navigating challenging economic, market or industry pricing cycles.
For events designated as natural catastrophes resulting in losses incurred related to our reinsurance assumed operations, Cincinnati Re, we calculate IBNR reserves for losses incurred separately from losses related to direct premiums. That process begins with a review of our occurrence and aggregate in-force reinsurance limits for our portfolio of ceding companies likely to be affected by such events. Using third party catastrophe models combined with our own proprietary adjustments, we model a range of stochastic and scenario events for each ceding company to make an initial estimate of potential losses. Consideration of industry loss estimates promulgated by a variety of third parties provides a base to perform a market share loss analysis for each ceding company. We obtain loss estimates from ceding companies based on their view of losses, which includes their claim reports, actual claim payments and reserve estimates. Based on these data points, we estimate ultimate losses that we reinsure for each ceding company. We then benchmark individual ceding company reports against what we expected and use this information across our portfolio to refine our ultimate loss estimates. Once known payments and reserves are reported by individual ceding companies, we establish case reserves by reinsurance treaty. IBNR reserves are then calculated as the difference between the estimate of the ultimate loss and loss expenses incurred for each catastrophe event, reduced by the sum of total loss and loss expense payments and total case reserves. Incurred losses from catastrophe events for Cincinnati Re can include non-U.S. experience reported by the ceding companies, in addition to events designated as catastrophes by PCS.
Emergence of loss and defense and cost containment expenses, also referred to as DCCE, on an accident year basis. Historical paid loss, reported loss and paid DCCE data for the business lines we analyze contain patterns that reflect how unpaid losses, unreported losses and unpaid DCCE as of a financial statement date will emerge in the future. Unless our actuarial staff or management identifies reasons or factors that invalidate the extension of historical patterns into the future, these patterns can be used to make projections necessary for estimating IBNR reserves. Our actuaries significantly rely on this assumption in the application of all methods and models mentioned above.
The table below provides standard errors and reserve ranges by major property casualty lines of business and in total for net loss and loss expense reserves as well as the potential effects on our net income, assuming a 21 percent federal tax rate. Standard errors and reserve ranges for assorted groupings of these lines of business cannot be computed by simply adding the standard errors and reserve ranges of the component lines of business, since such an approach would ignore the effects of product diversification. See Liquidity and Capital Resources, Property Casualty Loss and Loss Expense Obligations and Reserves, Range of Reasonable Reserves, for more details on our total reserve range. While the table reflects our assessment of the most likely range within which each line’s actual unpaid loss and loss expenses may fall, one or more lines’ actual unpaid loss and loss expenses could nonetheless fall outside of the indicated ranges.
Impairment charges are recorded for other-than-temporary declines in value if fair value is below cost or amortized cost and, in the asset impairment committee’s judgment, the fair value is not expected to be recouped within a designated recovery period. When determining OTTI charges for our fixed-maturity portfolio, management places significant emphasis on whether issuers of debt are current on contractual payments and whether future contractual amounts are likely to be paid. Our invested asset impairment policy states that fixed maturities with fair values below their amortized cost that the company (1) intends to sell or (2) more likely than not will be required to sell before recovery of their amortized cost basis are deemed to be OTTI. The amortized cost of any such securities is reduced to fair value as the new cost basis, and a realized loss is recorded in the period in which it is recognized. When these two criteria are not met, and the company believes that full collection of interest and/or principal is not likely, we determine the net present value of future cash flows by using the effective interest rate implicit in the security at the date of acquisition as the discount rate and compare that amount with the amortized cost and fair value of the security. The difference between the net present value of the expected future cash flows and amortized cost of the security is considered a credit loss and recognized as a realized loss in the period in which it occurred. The difference between the fair value and the net present value of the cash flows of the security, the noncredit loss, is recognized in other comprehensive income as an unrealized loss.
Over 99 percent of the $16.609 billion of securities in our investment portfolio at year-end 2018, measured at fair value, are classified as Level 1 or Level 2. Financial assets that fall within Level 1 and Level 2 are priced according to observable data from identical or similar securities that have traded in the marketplace. Also within Level 2 are securities that are valued by outside services or brokers where we have evaluated and verified the pricing methodology and determined that the inputs are observable.
Holding all other assumptions constant, a 0.5 percentage-point decrease in the discount rate would increase our 2019 income before income taxes by less than $1 million. A 0.5 percentage-point decrease in the expected return on plan assets would decrease our 2019 income before income taxes by approximately $1 million.
For life insurance policies, acquisition costs are amortized into income in proportion to premium revenue, benefit base or in accordance with the recognition of gross profit from the contract, depending on the policy type. These costs are principally agent commissions and underwriting costs related to successful contract acquisition. We analyze our acquisition cost assumptions periodically to reflect actual experience; we evaluate our deferred acquisition cost for recoverability; and we regularly conduct reviews for potential premium deficiencies or loss recognition. Changes in the amounts or timing of estimated future profits could result in adjustments to the accumulated amortization of these costs.
For our consolidated property casualty insurance operations as well as the insurance segments, statutory accounting data and ratios are key performance indicators that we use to assess business trends and to make comparisons to industry results, since GAAP-based industry data generally is not as readily available.
Earned and net written premiums for our consolidated property casualty operations grew in 2018, reflecting average renewal price increases, a higher level of insured exposures and strategic initiatives for targeted growth. A key measure of property casualty profitability is underwriting profit or loss. Our 2018 underwriting profit of $186 million was $58 million more than in 2017, despite a $7 million unfavorable effect from a higher amount of natural catastrophe losses, mostly caused by severe weather. Prior accident year loss experience before catastrophes during 2018 was more favorable than in 2017, and was responsible for much of the 2018 underwriting profit increase. Improved profitability also included other factors, such as higher pricing, and our ongoing initiatives to improve pricing precision and loss experience related to claims and loss control practices. Underwriting profit trends are discussed further below.
New business written premiums produced through agencies increased $26 million in 2018, compared with 2017. Agents appointed during 2018 or 2017 produced a 2018 increase in standard lines new business of $44 million. Growth initiatives also favorably affect growth in subsequent years, particularly as newer agency relationships mature over time.
Net written premiums increased $33 million in 2018 from expansion of reinsurance assumed operations, known as Cincinnati ReSM. Cincinnati Re assumes risks through reinsurance treaties and in some cases cedes part of the risk and related premiums to one or more unaffiliated reinsurance companies through transactions known as retrocessions. In 2018, earned premiums for Cincinnati Re totaled $132 million.
Other written premiums consist primarily of premiums ceded to reinsurers as part of our ceded reinsurance program and in total contributed $29 million less in 2018 to net written premiums than in 2017. An increase in ceded premiums, other than Cincinnati Re premiums, reduced net written premium growth by $8 million in 2018, compared with 2017.
Our statutory combined ratio was 96.0 percent in 2018 compared with 97.2 percent in 2017 and 94.5 percent in 2016. The estimated statutory combined ratio for the property casualty industry, with the industry’s ratio excluding its mortgage and financial guaranty lines of business and based on industry data reported through the first nine months of 2018, was 97.6 percent in 2018, 105.1 percent in 2017 and 100.9 percent in 2016. The contribution of catastrophe losses to our statutory combined ratio was 7.1 percentage points in 2018, 7.2 percentage points in 2017 and 7.5 percentage points in 2016, compared with industry estimates of 5.1, 8.8 and 4.7 percentage points, respectively, with 2018 representing industry data reported through the first nine months of 2018. Components of the combined ratio are discussed below.
For our property catastrophe occurrence and aggregate excess of loss treaty that became effective in July 2018, we can recover catastrophe loss amounts up to $50 million in excess of net $125 million per occurrence for combined business written on a direct basis and by Cincinnati Re, $25 million in excess of $32 million for the aggregation of Cincinnati Re catastrophe occurrences subject to certain deductibles, $50 million in excess of $10 million for business written on a direct basis for the loss perils of earthquake, brushfire and wildfire in certain western states, or various combinations of occurrences with coverage up to the $50 million aggregate limit. The aggregate limit is $25 million if covered losses pertain only to Cincinnati Re. The aggregate recovery from reinsurers providing this coverage totaled $36 million for incurred losses in 2018, after considering all applicable deductibles. The Cincinnati Re portion of the aggregate recovery totaled $21 million. The aggregate recovery was from two events during 2018, both wildfires in California.
Loss and loss expenses include both net paid losses and reserve changes for unpaid losses as well as the associated loss expenses. For all property casualty lines of business in aggregate, net loss and loss expense reserves at December 31, 2018, were $376 million higher than at year-end 2017, including $233 million for incurred but not reported (IBNR) reserves. The $376 million reserve increase raised year-end 2017 net loss and loss expense reserves by 7 percent, compared with a 4 percent increase in 2018 earned premiums.
The 61.5 percent ratio for current accident year loss and loss expenses before catastrophe losses for 2018 increased 0.4 percentage points compared with the 61.1 percent accident year 2017 ratio measured as of December 31, 2017. Contributors to the increase included 0.3 points from our commercial casualty line of business, which experienced a 2018 increase of $41 million, compared with 2017, despite its earned premiums rising by only $3 million in 2018.
In 2018, total large losses incurred increased by $22 million, or 7 percent, net of reinsurance, primarily due to an increase for our commercial lines insurance segment. The corresponding ratio increased 0.2 percentage points. Our analysis of large losses incurred indicated no unexpected concentration of these losses and reserve increases by geographic region, policy inception, agency or field marketing territory. We believe the inherent volatility of aggregate loss experience for our portfolio of larger policies is greater than that of our portfolio of smaller policies, and we continue to monitor the volatility in addition to general inflationary trends in loss costs.
Premiums - Earned premiums and net written premiums rose in 2018, primarily due to a $45 million increase in renewal written premiums that continued to include higher average pricing. New business written premiums in 2018 increased $20 million, or 5 percent, compared with 2017. The increase was driven by production from agencies appointed since the beginning of 2017.
As discussed in Critical Accounting Estimates, Property Casualty Insurance Loss and Loss Expense Reserves, stable historical paid loss patterns are a key assumption used to make projections necessary for estimating IBNR reserves. During 2017, we observed paid losses or re-estimates of case reserves emerging at levels higher than expected for commercial casualty. Considering that new data at December 31, 2017, we estimated commercial casualty IBNR reserves for accident year 2017 at levels more likely to be adequate. During 2018, commercial casualty reserve development on prior accident years was favorable, as discussed below, but we estimated commercial casualty IBNR reserves for accident year 2018 at a prudent level, contributing an increase of 0.5 percentage points to the 2018 ratio for current accident year losses and loss expenses before catastrophes, compared with its contribution to accident year 2017 as of December 31, 2017.
Commercial auto, representing 21 percent of 2018 earned premiums for our commercial lines insurance segment, was the only major line of business in that segment with a 2018 total loss and loss expense ratio significantly higher than we desired. During 2018, our commercial auto policies experienced average renewal price percentage increases estimated in the high-single-digit range, which we believe will help improve future profitability. We also continued to improve premium rate classification and use of other rating variables in risk selection and pricing.
Pricing precision and other initiatives to improve commercial lines underwriting profitability complement our business practices that continue to leverage the local presence of our field associates. Field marketing representatives meet with local agencies to assess each risk, determine limits of insurance and establish appropriate terms and conditions. They underwrite new business while field loss control, machinery and equipment and claims representatives conduct on-site inspections. Field claims representatives also assist underwriters by preparing full reports on their first-hand observations of risk quality.
Our commercial lines statutory combined ratio was 95.1 percent in 2018, compared with 96.2 percent in 2017 and 93.9 percent in 2016. The contribution of catastrophe losses to our commercial lines statutory combined ratio was 5.8 percentage points in 2018, 5.0 percentage points in 2017 and 7.1 percentage points in 2016.
Our 2 percent increase in 2018 agency renewal written premiums included higher average pricing. We measure average changes in commercial lines renewal pricing as the rate of change in renewal premium for the new policy period compared with the premium for the expiring policy period, assuming no change in the level of insured exposures or policy coverage between those periods for respective policies. In 2018, our standard commercial lines policies averaged an estimated pricing change at a percentage in the low-single-digit range, slightly higher than in 2017. Our average commercial lines pricing change includes the flat pricing effect of certain coverages within package policies written for a three-year term that were in force but did not expire during the period being measured. Therefore, the average commercial lines pricing change we report reflects a blend of policies that did not expire and other policies that did expire during the measurement period.
Other written premiums primarily consist of premiums that are ceded to reinsurers and lower our net written premiums. An increase in ceded premiums reduced net written premium growth by $6 million for 2018, compared with 2017.
The 62.1 percent ratio for current accident year loss and loss expenses before catastrophe losses for 2018 increased 1.0 percentage point compared with the 61.1 percent accident year 2017 ratio measured as of December 31, 2017. Contributors to the increase included 0.9 points from our commercial casualty line of business, which experienced a 2018 increase of $41 million, compared with 2017, despite its earned premiums rising by only $3 million in 2018. Large losses, described below, and the corresponding ratios for new losses above $1 million, contributed a 0.3 percentage-point increase to the 2018 ratio. Those unfavorable contributions offset the favorable effects from various initiatives, such as those to improve pricing precision and loss experience related to claims and loss control practices.
In 2018, total large losses incurred increased by $32 million, or 13 percent, net of reinsurance. The corresponding ratio increased 0.8 percentage points. The 2018 increases on both a dollar and ratio basis were primarily due to higher amounts for our commercial casualty and commercial property lines of business. In 2017, total large losses incurred and the corresponding ratio were higher than in 2016, also largely due to higher amounts of large losses for our commercial casualty and commercial property lines of business. Our analysis indicated no unexpected concentration of these losses and reserve increases by geographic region, policy inception, agency or field
Premiums - Earned premiums and net written premiums continued to grow in 2018, primarily due to increases in renewal written premiums that reflected higher average pricing. Renewal written premiums rose $85 million, or 7 percent, in 2018, compared with 2017.
Combined ratio - The 2018 combined ratio improved 1.1 percentage points, compared with 2017, largely due to a 1.5 percentage-point decrease in the ratio for 2018 natural catastrophe losses. The total large loss ratio for losses of $1 million or more per claim, shown in the table below, decreased by 1.0 percentage point, reflecting lower losses for personal umbrella claims related to auto accidents.
For our homeowner line of business, the 2018 total loss and loss expense ratio was unsatisfactory but improved significantly in the second half of the year with a ratio below 67 percent, indicating an underwriting profit once underwriting expenses are considered.
We have increased our pricing precision and implemented numerous rate increases in recent years to improve our personal lines insurance segment results. In addition, we have made greater use of higher minimum loss deductibles and enhanced our property inspection processes to verify condition and insurance to value. We have
worked to improve our geographic diversification by expanding our personal lines operation to several states less prone to catastrophes.
The 62.8 percent ratio for current accident year loss and loss expenses before catastrophe losses for 2018 improved 1.2 percentage points compared with the 64.0 percent accident year 2017 ratio measured as of December 31, 2017. The improvement included a 1.1 percentage-point decrease in the ratio for current accident year losses of $1 million or more per claim, shown in the table below, that were primarily for personal umbrella claims related to auto accidents.
Personal lines loss and loss expense reserve development on prior accident years recognized in 2018 was unfavorable by $13 million, in aggregate, compared with $14 million of favorable reserve development in 2017. The 2018 net unfavorable reserve development included $24 million for our homeowner line of business, primarily for accident year 2017, and was partially offset by $14 million of favorable reserve development for personal auto. In 2017, our homeowner line of business prior accident year net reserve development was favorable by $11 million and offset a small amount of unfavorable reserve development for personal auto. Development by accident year and other trends for personal lines loss and loss expenses and the related ratios are further discussed in Liquidity and Capital Resources, Property Casualty Insurance Development of Estimated Reserves by Accident Year.
In 2018, personal lines total large losses incurred decreased by $10 million, or 19 percent, net of reinsurance. The ratio for 2018 large losses as a percent of earned premiums decreased 1.0 percentage point. The 2018 decreases on both a dollar and ratio basis were largely due to lower amounts for personal umbrella claims related to auto accidents. In 2017, total large losses increased, compared with 2016, primarily due to higher amounts of homeowner claims and personal umbrella claims related to auto accidents. Our analysis indicated no unexpected concentration of these losses and reserve increases by risk category, geographic region, policy inception, agency or field marketing territory. We believe the inherent volatility of aggregate loss experience for our portfolio of larger policies is greater than that of our portfolio of smaller policies, and we continue to monitor the volatility in addition to general inflationary trends in loss costs.
Personal lines commission expense as a percent of earned premiums increased slightly in 2018, compared with 2017. In 2018, other underwriting expenses as a percent of earned premiums decreased compared with 2017, as strategic investments that include enhancement of underwriting expertise were offset by the favorable effects of higher earned premiums and ongoing expense management efforts. Underwriting expenses as a percent of earned premiums in 2017 matched 2016.
We believe our personal lines premium growth rate will likely be higher than the industry projection for 2019, driven by our rate increases, new state entry, accelerated pace of new agency appointments in recent years and increased focus on the high net worth personal lines market.
Combined ratio - The combined ratio rose 2.4 percentage points in 2018, primarily due to less favorable reserve development on prior accident years.
Loss and loss expenses include both net paid losses and reserve changes for unpaid losses, as well as the associated loss expenses. The majority of the total incurred losses and loss expenses shown above in the three-year highlights table are for the respective current accident years, with reserve development on prior accident years shown separately. Since less than 20 percent of our 2018 excess and surplus lines current accident year incurred losses and loss expenses represents net paid amounts, a large majority represents reserves for our estimate of unpaid losses and loss expenses. These reserves develop over time, and we update our estimates of previously reported reserves as we learn more about the development of the related claims. The table below illustrates that development. For example, the 55.1 percent accident year 2017 loss and loss expense ratio reported as of December 31, 2017, developed favorably by 3.8 percentage points to 51.3 percent due to claims settling for less than previously estimated, or due to updated reserve estimates for unpaid claims, as of December 31, 2018. Accident years 2017 and 2016 for this segment have both developed favorably, as indicated by the progression over time of the ratios in the table.
The 53.9 percent ratio for current accident year loss and loss expenses before catastrophe losses for 2018 improved by 0.1 percentage point compared with the 54.0 percent accident year 2017 ratio measured as of December 31, 2017. The improvement was partially offset by a 0.3 percentage-point increase in the ratio for current accident year losses of $1 million or more per claim, shown in the table below.
Liquidity and Capital Resources, Property Casualty Insurance Loss and Loss Expense Obligations and Reserves. Development trends by accident year are further discussed in Property Casualty Insurance Development of Estimated Reserves by Accident Year.
Revenues - Earned premiums rose 8 percent for the year 2018, as shown in the table below that includes details by major line of business. Our largest life insurance product line, term life insurance, rose 9 percent. Net in-force policy face amounts rose 8 percent to $66.142 billion at year-end 2018 from $61.177 billion at year-end 2017 and $56.808 billion at year-end 2016.
Earned premiums rose $18 million in 2018, primarily due to growth in our term life insurance business, as shown in the table below. Growth in 2017 was also primarily due to term life insurance.
Contract holders’ benefits incurred, related to traditional life and interest-sensitive products, accounted for 78.1 percent of 2018 total benefits and expenses compared with 76.1 percent in 2017 and 76.4 percent in 2016. Total contract holders’ benefits increased as net death claims were higher in 2018, compared with 2017. Net death claims increased in 2018 and were slightly above our mortality projections while remaining within our range of pricing expectations.
We recognize that assets under management, capital appreciation and investment income are integral to evaluation of the success of the life insurance segment because of the long duration of life products. On a basis that includes investment income and investment gains or losses from life insurance-related invested assets, our life insurance subsidiary reported net income of $48 million in 2018, compared with net income of $155 million in 2017 and $48 million in 2016. Net income in 2017 included a nonrecurring item, a $111 million benefit from net deferred income tax liability revaluation due to U.S. tax reform. The life insurance subsidiary portfolio had an after-tax net investment loss of $4 million in 2018, compared with after-tax net investment gains of $4 million in 2017 and $5 million in 2016. Investment gains and losses are discussed under Investments Results. We exclude most of our life insurance company investment income from investments segment results.
We believe the life insurance market remains attractive due to our quality agency force. As the market continues to evolve and companies begin to debate the wisdom of pursuing direct-to-consumer models on new digital platforms, we are convinced that our distribution will benefit over the long term. We believe that technology should be leveraged to support the agent and enhance the buying experience, and we have several initiatives underway in that regard.
The investments segment contributes investment income and investments gains and losses to results of operations. Investments provide our primary source of pretax and after-tax profits.
Investment gains and losses - We reported an investment loss in 2018, primarily due to unfavorable changes in fair values of equity securities even though we continue to hold the securities or as otherwise required by GAAP. For both 2017 and 2016, we reported investment gains largely due to investment sales that were discretionary in timing and amount. Those gains were reduced by other-than-temporary impairment (OTTI) charges.
We believe it is useful to analyze our overall investment performance by using total investment return over several years. Total investment return considers changes in unrealized gains and losses that are not included in net income, in addition to net investment income and investment gains and losses that are included in net income. Changes in unrealized gains and losses shown in the table below include other invested assets. Considering total investment gains and losses over several years helps evaluate performance since gains and losses may experience typical variability during shorter periods of time.
The table below shows total return based on assumptions that simplify cash flow timing that is commonly used in total return measures. This simplified calculation uses data shown in our consolidated financial statements or notes to those statements. Added to invested asset amounts from our consolidated balance sheets are 50 percent of annual amounts pertaining to invested asset categories included in net cash used in investing activities from our consolidated statements of cash flows. The cash flow amounts are reduced by net gains from investment portfolio securities sales or called bonds, with the net result reduced by 50 percent to represent estimated new cash invested during each respective year. All new cash is assumed to be invested at the midpoint of the year.
In 2018, we continued to invest available cash flow in both fixed income and equity securities in a manner that we believe balances current income needs with longer-term invested asset growth goals. While our bond portfolio more than covers our insurance reserve liabilities, we believe our diversified common stock portfolio of mainly blue chip, dividend-paying companies represents one of our best investment opportunities for the long term. We position our portfolio with consideration to both the challenges presented by the current low interest rate environment and the risks presented by potential future inflation. As bonds in our generally laddered portfolio mature or are called over the near term, we will be challenged to replace their current yield. The table below summarizes pretax yield to amortized costs excluding any book value adjustments due to impairment for bonds in our fixed-maturity portfolio by various maturity periods.
The average pretax yield of 4.38 percent for fixed-maturity securities acquired during 2018, shown in the table below, was higher than the 4.20 percent average yield-to-amortized cost of the fixed-maturity securities portfolio at the end of 2018.
We had a $36 million income tax benefit in 2018 compared with a $315 million income tax benefit in 2017 and $221 million of income tax expense in 2016. Our corporate effective tax rate for 2018 was negative 14.3 percent compared with negative 43.2 percent in 2017 and 27.2 percent in 2016.
Historically, we have pursued a strategy of investing some portion of cash flow in tax-advantaged, fixed-maturity and equity securities to minimize our overall tax liability and maximize after-tax earnings. See Item 1, Our Segments, Fixed-Maturity Security Investments, for further discussion on municipal bond purchases in our fixed-maturity investment portfolio. For tax years 2017 and earlier, for our property casualty insurance subsidiaries, approximately 85 percent of interest from tax-advantaged fixed-maturity investments and approximately 60 percent of dividends from qualified equities were exempt from federal tax after applying proration from the 1986 Tax Reform Act. Our noninsurance companies own an immaterial amount of tax-advantaged, fixed-maturity investments. For our noninsurance companies, the dividend received deduction exempted 70 percent of dividends from qualified equities. Our life insurance company does not own tax-advantaged, fixed maturity investments or equities subject to the dividend received deduction.
We provide details of our three long-term notes in Item 8, Note 8 of the Consolidated Financial Statements. None of the notes are encumbered by rating triggers. The total principal amount of our long-term debt at December 31, 2018, was $793 million and included:
The company’s senior debt is rated investment grade by independent rating firms. None of the four rating agencies made changes to our debt ratings in 2018. Our debt ratings at February 21, 2019, were: a- from A.M. Best, A- from Fitch, A3 from Moody’s and BBB+ from S&P.
We are in compliance with all covenants under the credit agreement and believe we will remain in compliance. The credit agreement provides alternative interest charges based on the type of borrowing and our debt rating. The interest rate charged is adjusted LIBOR plus an applicable margin.
Capital resources consisting of shareholders’ equity and total debt represent our overall financial strength to support current obligations and growth in our insurance businesses. At December 31, 2018, we had total capital of $8.653 billion. Shareholders’ equity was $7.833 billion, a decrease of $410 million, or 5 percent, from the prior year. Our total debt was $820 million, up $9 million from a year ago. We seek to maintain a solid financial position and provide capital flexibility by keeping our ratio of debt to total capital moderate. At year-end 2018, the ratio was 9.5 percent, compared with 9.0 percent at year-end 2017.
Other operating expenses - Many of our operating expenses are not contractual obligations but reflect the ongoing expenses of our business. For example, we anticipate capitalizing development costs for approximately $7 million in spending for key technology initiatives in 2019, compared with actual capitalization totaling $7 million in 2018 and $7 million in 2017. These activities are conducted at our discretion, and we have no material contractual obligations for activities planned as part of these projects.
Other invested assets - We expect to fund approximately $71 million for our private equity and real estate investments over the next several years.
At December 31, 2018, we had $784 million in cash and cash equivalents. During 2019, our insurance subsidiary can declare $626 million in dividends to our parent company without regulatory approval. That strong liquidity and our consistent cash flows give us the flexibility to meet current obligations and commitments while building value by prudently investing where we see potential for both current income and long-term return. Our cash and cash equivalents provide adequate financial cushion when short-term operating results do not meet our objectives.
In any year, we consider the most likely source of pressure on liquidity would be an unusually high level of catastrophe loss payments within a short period of time. There could be additional obligations for our insurance operations due to increasing severity or frequency of noncatastrophe claims. To address the risk of unusually large insurance loss obligations including catastrophe events, we maintain property casualty reinsurance contracts with highly rated reinsurers, as discussed under 2019 Reinsurance Ceded Programs. We also monitor the financial condition of our reinsurers because their insolvency could jeopardize a portion of our $484 million reinsurance recoverable asset at December 31, 2018. Parent-company liquidity could also be constrained by Ohio regulatory requirements that restrict the dividends insurance subsidiaries can pay.
Additionally, since 2002, we have revised policy terms where permitted by state regulation to limit our exposure to mold claims prospectively and further reduce our exposure to other environmental claims generally. Finally, we have not engaged in any mergers or acquisitions through which such a liability could have been assumed. We continue to monitor our claims for evidence of material exposure to other mass tort classes, but we have found no such credible evidence to date.
Our estimates of gross property casualty loss and loss expense payments do not include reinsurance receivables or ceded losses. As discussed in 2019 Reinsurance Ceded Programs, we purchase reinsurance to mitigate our property casualty risk exposure. Ceded property casualty reinsurance unpaid receivables of $238 million at year-end 2018 are an offset to our gross property casualty loss and loss expense obligations. Our reinsurance program mitigates the liquidity risk of a single large loss or an unexpected rise in claim severity or frequency due to a catastrophic event. Reinsurance does not relieve us of our obligation to pay covered claims. The financial strength of our reinsurers is important because our ability to recover losses under our reinsurance agreements depends on the financial viability of the reinsurers.
We direct our associates and agencies to settle claims and pay losses as quickly as is practical, and we made $2.847 billion of net claim payments during 2018. At year-end 2018, total net property casualty reserves of $5.408 billion reflected $2.578 billion in unpaid amounts on reported claims (case reserves), $1.161 billion in loss expense reserves and $1.669 billion in estimates of claims that were incurred but had not yet been reported (IBNR). The specific amounts and timing of obligations related to case reserves and associated loss expenses are not set contractually. The amounts and timing of obligations for IBNR claims and related loss expenses are unknown. We discuss our methods of establishing loss and loss expense reserves and our belief that reserves are adequate in Critical Accounting Estimates, Property Casualty Insurance Loss and Loss Expense Reserves.
The historical pattern of using premium receipts for the payment of loss and loss expenses has enabled us to extend slightly the maturities of our investment portfolio beyond the estimated settlement date of the loss reserves. The effective duration of our consolidated property casualty fixed-maturity portfolio was 5.2 years at year-end 2018. By contrast, the duration of our loss and loss expense reserves was approximately 3.8 years. We believe this difference in duration does not affect our ability to meet current obligations because cash flow from operations is sufficient to meet these obligations. In addition, investment holdings could be sold, if necessary, to meet higher than anticipated loss and loss expenses.
The following table shows net reserve changes at year-end 2018, 2017 and 2016 by property casualty segment and accident year:
Favorable reserve development of $58 million for our workers’ compensation line accounted for approximately 37 percent of our commercial lines insurance segment net total in 2018, while favorable reserve development was $47 million for our commercial casualty line of business and $47 million for our commercial property line of business. Our homeowner line of business experienced $24 million of unfavorable reserve development on prior accident years recorded during 2018, and that 2018 measure for our commercial auto line of business was also unfavorable at $14 million. Drivers of significant reserve development typically reflect loss emergence on known claims that was more favorable or less favorable than previously anticipated for various lines of business and are discussed below.
Commercial casualty - During 2018, we experienced favorable development on prior accident years after seeing adverse development in 2017 for this line of business. We continue to watch this line so we can detect unfavorable trends should they reoccur.
Commercial auto - Loss emergence continued to develop unfavorably during calendar year 2018. This line of business has been troublesome for the industry as a whole in recent years. As part of the U.S. economic recession of a few years ago, slowing business activity influenced our estimates of reserves for ultimate losses and loss expenses during that period. As the economy slowly recovered, we believe we were slow to recognize some of the higher loss cost effects in current accident year reserve estimates for at least part of that period. As claims that occurred during that period have become more mature, paid and reported loss cost trends resulted in us increasing our estimated ultimate losses. Initiatives to improve profitability of our commercial auto line of business are discussed in Commercial Lines Insurance Results.
Personal auto - Loss emergence continued to develop unfavorably during calendar year 2018, for several older accident years. This line of business is subject to many of the same cost pressures related to the economic slowdown as commercial auto. Initiatives to improve profitability of our personal auto line of business are discussed in Personal Lines Insurance Results.
For the excess and surplus lines insurance segment, the table showing reserves by segment and lines of business in Property Casualty Loss and Loss Expense Obligations and Reserves, shows the components of gross reserves among case, IBNR and loss expense reserves. Total gross reserves were up $34 million from year-end 2017 primarily due to the increase in premiums and exposures for this segment, as we discussed in Excess and Surplus Lines Insurance Results. Favorable development during 2018 of $24 million for excess and surplus lines insurance segment reserves, shown in the table above, illustrates the potential for revisions inherent in estimating reserves.
Gross life policy reserves were $2.779 billion at year-end 2018, compared with $2.729 billion at year-end 2017. The increase was primarily due to reserves for traditional life insurance contracts. We establish reserves for traditional life insurance policies based on expected expenses, mortality, morbidity, withdrawal rates and investment yields, including a provision for uncertainty. Once these assumptions are established, they generally are maintained throughout the lives of the contracts. We use both our own experience and industry experience adjusted for historical trends in arriving at our assumptions for expected mortality and morbidity. We use our own experience and historical trends for setting our assumptions for expected withdrawal rates and expenses. We base our assumptions for expected investment income on our own experience adjusted for current and future expected economic conditions.
The modeled losses according to RMS in the table are based on its RiskLink version 18.0 catastrophe model and use a long-term storm catalog methodology. The modeled losses according to AIR in the table are based on its AIR Touchstone® version 6.0 catastrophe model and use a long-term methodology. The AIR and RMS storm catalogs include decades of documented weather events used in simulations for probable maximum loss projections.
For 2019, the primary participants on our standard market property and casualty per-risk and per-occurrence reinsurance ceded programs include Hannover Reinsurance Company, Munich Reinsurance America, Partner Reinsurance Company of the U.S. and Swiss Reinsurance America Corporation, all of which had A.M. Best insurer financial strength ratings of A (Excellent) or better as of December 31, 2018. Our property catastrophe program is subscribed through a broker by reinsurers from the United States, Bermuda, London and the European markets. The largest participant in our property catastrophe program, representing approximately 47 percent of total participation, is the Lloyd's of London placement that features numerous syndicates, with AXA XL and Liberty taking the largest participations. Other primary participants in our property catastrophe program include Amlin Underwriting Limited, Axis and Fidelis.
The following table shows our five largest property casualty reinsurance receivable amounts by reinsurer at year-end 2018 and 2017. Michigan Catastrophic Claims Association is a mandatory nonprofit association which runs a reinsurance program funded by an annual premium assessment per vehicle. This assessment covers Michigan’s automobile no-fault policies which provide unlimited lifetime coverage for medical expenses resulting from auto accidents. Third Point Reinsurance is one of several reinsurers that Cincinnati Re transacts business with to cede part of its risk to unaffiliated reinsurance companies through retrocessions. The A.M. Best insurer financial strength ratings as of the end of the two most recent years are also shown for each of those reinsurers that are rated by Best.
Primary components of the 2019 property and casualty reinsurance program are summarized below. The premium estimates below occurred near the beginning of each respective year, when direct written premiums that were subject to applicable reinsurance treaties were also estimated.
Property per risk treaty - The primary purpose of the property treaty is to provide capacity up to $50 million, adequate for the majority of the risks we write. It also includes protection for extra-contractual liability coverage losses. We retain the first $10 million of each loss. Losses between $10 million and $50 million are reinsured at 100 percent. The 2019 ceded premium estimate was $28 million, compared with $26 million for the 2018 estimate.
Property excess treaty - We purchased a property reinsurance treaty that provides an additional $50 million in protection for property losses. This treaty, along with the property per risk treaty, provides a total of $100 million of protection. The 2019 ceded premium estimate was approximately $2 million, essentially unchanged from the 2018 estimate.
Beginning in 2018, effective July 1, we added a new component to our property casualty reinsurance program, a property catastrophe occurrence and aggregate excess of loss treaty providing coverage not to exceed $50 million in aggregate. Key coverages include $50 million in excess of net $125 million per occurrence combining business written on a direct basis and by Cincinnati Re, $25 million in excess of $32 million for the aggregation of Cincinnati Re catastrophe occurrences subject to certain deductibles, $50 million in excess of $10 million for business written on a direct basis for the loss perils of earthquake, brushfire and wildfire in certain western states, or various combinations of occurrences with coverage up to the $50 million aggregate limit. The aggregate limit is $25 million if covered losses pertain only to Cincinnati Re. Ceded premiums for the first year of coverage from this treaty are estimated to be approximately $7 million.
Terrorism coverage at various levels has been secured in most of our reinsurance agreements. The broadest coverage for this peril is found in the property and casualty working treaties, the property per risk treaty and the casualty per occurrence treaty, which provide coverage for commercial and personal risks. Our property catastrophe treaty provides terrorism coverage for personal risks, and coverage for commercial risks with total insured values of $15 million or less. For insured values between $15 million and $100 million, there also may be coverage in the property working treaty.
A form of reinsurance is also provided through The Terrorism Risk Insurance Act of 2002 (TRIA). TRIA was originally signed into law on November 26, 2002, and extended on several occasions, including the most recent extension on January 12, 2015. TRIA provides a temporary federal backstop for losses related to the writing of the terrorism peril in property casualty insurance policies. Under regulations promulgated under this statute, insurers are required to offer terrorism coverage for certain lines of property casualty insurance, including property, commercial multi-peril, fire, ocean marine, inland marine, liability, aircraft and workers’ compensation. In the event of a terrorism event defined by TRIA, the federal government would reimburse terrorism claim payments subject to the insurer’s deductible. The deductible is calculated as a percentage of subject written premiums for the preceding calendar year. Our deductible in 2018 was $541 million (20 percent of 2017 subject premiums), and we estimate it is $551 million (20 percent of 2018 subject premiums) for 2019.
Property per risk treaty - The property treaty provides limits up to $5 million, which is adequate capacity for the risk profile we insure. It also includes protection for extra-contractual liability coverage losses. Cincinnati Specialty Underwriters retains the first $1 million of any policy loss. Losses between $1 million and $5 million are reinsured at 100 percent by The Cincinnati Insurance Company.
The company’s independent registered public accounting firm has issued an audit report on our internal control over financial reporting as of December 31, 2018.
We have audited the accompanying consolidated balance sheets of Cincinnati Financial Corporation and subsidiaries (the "Company") as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2018, and the related notes and the schedules listed in the Index at Item 15(c) (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.
As discussed in Note 1 to the financial statements, the Company adopted Accounting Standards Update No. 2016-01, Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Liabilities, using the modified retrospective approach on January 1, 2018.
The two CFC complementary subsidiaries are CSU Producer Resources Inc., which provides insurance brokerage services to our independent agencies so their clients can access our excess and surplus lines insurance products, and CFC Investment Company, which offers commercial leasing and financing services to our agents, their clients and other customers.
Our consolidated financial statements include the accounts of the parent and its wholly owned subsidiaries and are presented in conformity with accounting principles generally accepted in the United States of America (GAAP). All intercompany balances and transactions have been eliminated in consolidation.
Our portfolio investments are primarily in publicly traded fixed-maturity and equity security investments. Fixed-maturity investments (taxable bonds, tax-exempt bonds, redeemable preferred equities and commercial mortgage- backed securities) classified as available for sale and equity investments (common and nonredeemable preferred equities) are recorded at fair value in the consolidated financial statements. Beginning January 1, 2018, changes in fair value of equity securities are now reported in net income instead of other comprehensive income as stated below under 'Adopted Accounting Updates'. The number of fixed-maturity securities with fair value below 100 percent of amortized cost can be expected to fluctuate as interest rates rise or fall. Because of our strong capital and long-term investment horizon, our general intent is to hold fixed-maturity investments until maturity, regardless of short-term fluctuations in fair values.
Fair value is defined as the exit price or the amount that would be (1) received to sell an asset or (2) paid to transfer a liability in an orderly transaction between marketplace participants at the measurement date. When determining an exit price, we rely upon observable market data whenever possible. We primarily base fair value for investments in equity and fixed-maturity securities (including redeemable preferred stock and assets held in separate accounts) on quoted market prices or on prices from the company’s nationally recognized pricing vendor, an outside resource that supplies global securities pricing, dividend, corporate action and descriptive information to support fund pricing, securities operations, research and portfolio management. The company obtains and reviews the pricing service’s valuation methodologies and related inputs and validates these prices by replicating a sample across each asset class using a discounted cash flow model. When a price is not available from these sources, as in the case of securities that are not publicly traded, we determine the fair value using various inputs including quotes from independent brokers. The fair value of investments not priced by the company’s nationally recognized pricing vendor is less than 1 percent of the fair value of our total investment portfolio.
For the purpose of ASC 825 disclosure, we estimate the fair value of our long-term senior notes on market pricing of similar debt instruments that are actively trading. We estimate the fair value of our note payable on the year-end outstanding balance because it is short term and tied to a variable interest rate. We estimate the fair value of liabilities for investment contracts and annuities using discounted cash flow calculations across a wide range of economic interest rate scenarios with a provision for our nonperformance risk. We estimate the fair value for policyholder loans on insurance contracts using a discounted cash flow model. Determination of fair value for structured settlements assumes the discount rates used to calculate the present value of expected payments are the risk-free spot rates plus an A3 rated bond spread for financial issuers at December 31, 2018, to account for nonperformance risk. See Note 3, Fair Value Measurements, for further details.
The consolidated property casualty companies actively write property casualty insurance through independent agencies in 42 states. Our 10 largest states generated 58.4 percent and 59.7 percent of total earned premiums in 2018 and 2017, respectively. Ohio, our largest state, accounted for 15.9 percent and 16.2 percent of total earned premiums in 2018 and 2017, respectively. Illinois, Georgia, Indiana, North Carolina and Pennsylvania each accounted for between 5 percent and 6 percent of total earned premiums in 2018. Our largest single agency relationship accounted for approximately 0.8 percent of our total property casualty earned premiums in 2018. No aggregate agency relationship locations under a single ownership structure accounted for more than 4 percent of our total property casualty earned premiums in 2018. We record revenues for installment charges as fee revenues in the consolidated statements of income.
Property casualty written premiums are deferred and recorded as earned premiums on a pro rata basis over the terms of the policies. We record as unearned premiums the portion of written premiums that applies to unexpired policy terms. Expenses associated with successfully acquiring insurance policies - commissions, premium taxes and underwriting costs - are deferred and amortized over the terms of the policies. We assess recoverability of deferred acquisition costs at a level consistent with the way we acquire, service and manage insurance policies and measure profitability. We analyze our acquisition cost assumptions to reflect actual experience, and we evaluate potential premium deficiencies.
We have issued universal life contracts with guaranteed minimum returns, referred to as bank-owned life insurance contracts (BOLIs). A BOLI is designed so the bank is the policy owner and the policy beneficiary. We legally segregate and record as separate accounts the assets and liabilities for some of our BOLIs, based on the specific contract provisions. We guarantee minimum investment returns, account values and death benefits for our separate account BOLIs. Our other BOLIs are general account products.
See Note 11, Income Taxes, for further detail on our uncertain tax positions and other income tax items. Although no Internal Revenue Service (IRS) penalties currently are accrued, if incurred, they would be recognized as a component of income tax expense.
We record land at cost, and record building and equipment at cost less accumulated depreciation. Equipment held under capital leases also is classified as property and equipment with the related lease obligations recorded as liabilities. We capitalize and amortize costs for internally developed computer software during the application development stage. These costs generally consist of external consulting, internal payroll and payroll-related costs. Our depreciation is based on estimated useful lives (ranging from three years to 39.5 years) using straight-line and accelerated methods. Depreciation expense was $31 million for 2018, $28 million for 2017 and $30 million for 2016. We review our accumulated depreciation for our building, equipment and software assets and write off fully depreciated assets for obsolesce and nonuse. We monitor land, building and equipment and software assets for potential impairments. Potential impairments may include a significant decrease in the fair values of the assets, considerable cost overruns on projects, a change in legal factors or business climate or other factors that indicate that the carrying amount may not be recoverable or useful. There were no recorded land, building and equipment impairments for 2018, 2017 or 2016.
There were no subsequent events requiring adjustment to the consolidated financial statements and, with the exception of the above disclosure, no additional disclosures were required in the notes to our consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. The effective date of ASU 2016-15 is for interim and annual reporting periods beginning after December 15, 2017. The company adopted this ASU effective January 1, 2018, and it did not have a material impact on the company's consolidated financial position, cash flows, results of operations or disclosures.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The main provision of ASU 2016-02 requires the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. The effective date of ASU 2016-02 is for interim and annual reporting periods beginning after December 15, 2018, and will be applied prospectively. In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842 and ASU 2018-11,Targeted Improvements to Topic 842. ASU 2018-10 makes narrow-scope amendments to certain aspects of the new leasing standard while ASU 2018-11 provides relief from costs of implementing certain aspects of the new leasing standard. These ASU's have not yet been adopted and will not have a material impact on our company's consolidated financial position, cash flows or results of operations.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. ASU 2018-13 clarifies the fair value measurement disclosure requirements of ASC 820 by adding, eliminating and modifying disclosures. The effective date of ASU 2018-13 is for interim and annual reporting periods beginning after December 15, 2019. The ASU has not yet been adopted; however, it is not expected to have a material impact on our company's consolidated financial position, cash flows or results of operations.
ASU 2018-14, Compensation - Retirement Benefits - Defined Benefit Plans - General (Topic 715-20): Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans
In August 2018, the FASB issued ASU 2018-14, Compensation - Retirement Benefits - Defined Benefit Plans - General (Topic 715-20): Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans. ASU 2018-14 clarifies the guidance in ASC 715 to add, remove, and clarify disclosure requirements related to defined benefit pension and other postretirement plans. The effective date of ASU 2018-14 is for annual reporting periods ending after December 15, 2020. The ASU has not yet been adopted; however, it is not expected to have a material impact on our company's consolidated financial position, cash flows or results of operations.
ASU 2018-15, Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract
On January 1, 2018, we adopted ASU 2016-01, which resulted in changes in the fair value of equity securities still held being reported in net income instead of being reported in other comprehensive income. See Note 1, Summary of Significant Accounting Policies, for additional discussion.
The table below provides fair values and unrealized losses by investment category and by the duration of the securities’ continuous unrealized loss positions:
At December 31, 2018 and 2017, the company had fixed-maturity investments with a fair value of $112 million and $101 million, respectively, on deposit with various states in compliance with regulatory requirements. In addition, cash and fixed-maturity investments deposited with third parties used as collateral to secure liabilities on behalf of insureds, cedants and other creditors had a fair value of $75 million and $57 million at December 31, 2018 and 2017, respectively. In the normal course of investing activities, the company enters into investments in limited partnerships, including private equity and real estate investments, and asset-backed securities issued by third-parties. The company’s maximum exposure to loss with respect to these investments is limited to the investment carrying values included in the company’s consolidated balance sheets and any unfunded commitments.
The fair value hierarchy gives the highest priority to quoted prices with readily available independent data in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable market inputs (Level 3). When various inputs for measurement fall within different levels of the fair value hierarchy, the lowest observable input that has a significant impact on fair value measurement is used. Our valuation techniques have not changed from those used at December 31, 2017, and ultimately management determines fair value. Financial instruments reported at fair value in our consolidated financial statements are categorized based upon the following characteristics or inputs to the valuation techniques:
Quotes from brokers or other external sources where it cannot be determined that market participants would in fact transact for the asset or liability at the quoted price; or
The following table provides the change in Level 3 assets during 2018 and 2017:
The disclosures below are presented to provide information about the effects of current market conditions on financial instruments that are not reported at fair value in our consolidated financial statements.
Outstanding principal and interest for these life policy loans totaled $33 million and $31 million at December 31, 2018 and 2017, respectively. To determine the fair value, we make the following significant assumptions: (1) the discount rates used to calculate the present value of expected payments are the risk-free spot rates, as nonperformance risk is minimal; and (2) the loan repayment rate by which policyholders pay off their loan balances is in line with past experience.
Fair values for deferred annuities were calculated based upon internally developed models because active markets and observable inputs do not exist. To determine the fair value, we made the following significant assumptions: (1) the discount rates used to calculate the present value of expected payments are the risk-free spot rates plus an A3 rated bond spread for financial issuers at December 31, 2018 and 2017, to account for nonperformance risk; (2) the rate of interest credited to policyholders is the portfolio net earned interest rate less a spread for expenses and profit; and (3) additional lapses occur when the credited interest rate is exceeded by an assumed competitor credited rate, which is a function of the risk-free rate of the economic scenario being modeled.
Due to the uncertainties inherent with loss reserves, our ultimate loss experience could prove better or worse than what our carried reserves reflect. To the extent that reserves are inadequate and are required to be increased, the amount of the increase is a charge in that period, raising our loss and loss expense ratio and reducing earnings. To the extent that reserves are redundant and are required to be released, the amount of the release is a credit in that period, reducing our loss and loss expense ratio and increasing earnings.
In 2018, 2017 and 2016, the reserve for loss and loss expense in the consolidated balance sheets also included $61 million, $54 million and $50 million, respectively, for certain life and health loss and loss expense reserves. Additional disclosures for reserves related to these health claims are not material and therefore not provided.
Included in our lines of business are asbestos and environmental claims. We carried $89 million and $84 million of net loss and loss expense reserves for asbestos and environmental claims at December 31, 2018 and 2017, respectively. The asbestos and environmental claims amounts for each respective year constituted less than
The following table provides a reconciliation of the property casualty incurred losses and allocated loss adjustment expenses (ALAE) development and paid losses and ALAE development information at December 31, 2018.
For all lines of business, the claim counts reported are primarily measured by insurance coverages that are triggered when a loss occurs and a reserve is established. For this purpose, coverages are defined as unique combinations of certain attributes such as line of business and cause of loss. Claims that are opened and closed without payment are included in the reported claim counts. Claim counts are presented on a direct basis only and do not reflect any assumed or ceded reinsurance.
The following table shows the average annual percentage payout of incurred losses for the excess and surplus lines insurance segment. Excess and surplus lines consist mostly of commercial casualty and commercial property coverages. A majority of the incurred losses paid after year 2 are the result of commercial casualty losses.
We establish the reserves for traditional life insurance policies based on expected expenses, mortality, morbidity, withdrawal rates, timing of claim presentation and investment yields, including a provision for uncertainty. Once these assumptions are established, they generally are maintained throughout the lives of the contracts. We use both our own experience and industry experience, adjusted for historical trends, in arriving at our assumptions for expected mortality, morbidity and withdrawal rates as well as for expected expenses. We base our assumptions for expected investment income on our own experience adjusted for current and future economic conditions.
No premium deficiencies were recorded in the consolidated statements of income in 2018, 2017 and 2016, as the sum of the anticipated loss and loss expenses, policyholder dividends and unamortized deferred acquisition expenses did not exceed the related unearned premiums and anticipated investment income.
We had one line of credit through multiple commercial banks with a borrowing capacity of $225 million and an additional $50 million accordion feature. Our unsecured revolving credit facility had a term of five years that was due to expire May 13, 2019. We had no compensating balance requirements on short-term debt for either 2018 or 2017. At December 31, 2018 and 2017, $32 million and $24 million was drawn on the line of credit, respectively. The interest rate charged on our borrowings on this credit agreement ranged from 2.45 percent to 4.75 percent during 2018 and ranged from 1.65 percent to 2.45 percent during 2017.
Effective February 4, 2019, we amended our unsecured revolving line of credit to $300 million with an accordion feature of an additional $300 million. The agreement was extended for five years, amending the expiration to February 4, 2024, with the option of two one-year extensions. Terms and conditions are similar to the former agreement except the net worth covenant has been eliminated and the debt-to-total capital maximum shall not exceed 35 percent.
Capital lease obligations totaled $46 million and $40 million in 2018 and 2017, respectively. Below are the expected capital lease obligations, which includes $3 million of interest, that we expect to pay over the next six years:
Declared cash dividends per share were $2.12, $2.50 and $1.92 for the years ended December 31, 2018, 2017 and 2016, respectively.
Our insurance subsidiary declared dividends to the parent company of $500 million in 2018, $465 million in 2017 and $475 million in 2016. State regulatory requirements restrict the dividends insurance subsidiaries can pay. Generally, the most our insurance subsidiary can pay without prior regulatory approval is the greater of 10 percent of statutory capital and surplus or 100 percent of statutory net income for the prior calendar year. Dividends exceeding these limitations may be paid only with approval of the insurance department of the domiciliary state. During 2019, the total that our insurance subsidiary, which is the parent of all other insurance subsidiaries, may declare in dividends is approximately $626 million.
Our changes in 2017 direct incurred and ceded incurred compared to 2016 resulted primarily from a large settlement paid by USAIG, a joint underwriting association of individual insurance companies that collectively functions as a worldwide aviation insurance market. This settlement resulted in offsetting amounts to direct incurred and ceded incurred with no change to our net incurred loss and loss expense. We terminated our participation in the USAIG pool after policy year 2002.
Deferred tax assets are reduced by a valuation allowance when management believes it is more likely than not that some, or all, of the deferred tax assets will not be realized. After considering all positive and negative evidence of taxable income in the carryback and carryforward periods as permitted by law, we believe it is more likely than not that all of the deferred tax asset will be realized. As a result, we have no valuation allowance as of December 31, 2018 and 2017.
The differences between the 21 percent and 35 percent statutory federal income tax rate and our effective income tax rate were as follows:
On December 22, 2017, the Tax Act was enacted and represented one of the most comprehensive changes in U.S. corporate income taxation since 1986. The Tax Act revised the U.S. corporate income tax by lowering the corporate income tax rate from a top marginal rate of 35 percent to a flat rate of 21 percent. In addition to lowering tax rates, changes were made to the amount of the dividends received deduction and the required proration addback for qualified dividend income and tax exempt municipal interest. The Tax Act was effective January 1, 2018. The reduction in corporate income tax rate decreased our net deferred tax liability as of December 22, 2017, by $495 million. The effect of the rate change was recorded as a one-time noncash benefit to income tax expense in our consolidated statements of income for the year ended December 31, 2017. This benefit results from re-measuring our net deferred tax liability at the newly enacted corporate income tax rate of 21 percent (the rate at which the deferred items are expected to be reversed) versus the 35 percent rate at which the net deferred tax benefits were previously carried. Of this $495 million benefit, $492 million relates to net unrealized gains on investments and other AOCI amounts. The remainder relates to differences in the recognition of deferred acquisition costs, unearned premiums, insurance reserves and basis differences in the carrying value of investments held.
In 2018, we received approval from the IRS to change our method of tax accounting for certain items applicable for the 2017 tax year and tax return, primarily related to the valuation of our tax base unpaid losses. Accounting guidance does not allow recognition of the impact of certain tax accounting method changes until approved by the IRS. As a result, we recognized a $50 million income tax benefit in 2018 for the difference between the current tax rate and the 2017 tax rate for the related items. This reduced our effective tax rate by 19.9 percent for the twelve months ended December 31, 2018.
Our accounting for all elements of the Tax Act is now complete, consistent with the closing of the SAB 118 measurement period on December 22, 2018. As a result of guidance released by the IRS during the measurement period, we have adjusted our deferred tax balances related to property casualty tax base loss and loss expense reserve liabilities, tax base life policy reserve liabilities, and the transition liability associated with both property-casualty and life reserves. The recorded adjustments resulted in no impact on our recorded net deferred income tax liability. The recorded adjustments had no impact on our effective tax rate.
The provision for federal income taxes is based upon filing a consolidated income tax return for the company and its subsidiaries. As of December 31, 2018, 2017 and 2016, we have less than one million of life group operating loss carryforwards which we expect to receive benefit from in our 2018 tax return which will be filed in 2019. For the years ended December 31, 2018, 2017 and 2016, we have no capital loss carryforwards.
As of December 31, 2018, we had a gross unrecognized tax benefit of $34 million. We carry no amounts for unrecognized tax benefits for the years 2017 and 2016. The following is a tabular reconciliation of the total amounts of unrecognized tax benefits.
The statute of limitations for federal tax purposes has closed for tax years 2014 and earlier. There are no federal returns under examination and we have not been notified of any upcoming IRS examinations. In addition to our IRS filings, we file income tax returns with immaterial amounts in various state jurisdictions. The statute of limitations for state income tax purposes has closed for tax years 2014 and earlier. There are no state income returns under examination and we have not been notified of any upcoming state examinations.
Income taxes paid in our consolidated statements of cash flows are shown net of refunds received. We received no refunds in 2018, $18 million in 2017 and $2 million in 2016.
$16 million and $14 million during the years 2018, 2017 and 2016, respectively. Associates who are not accruing benefits under the pension plan are eligible to receive the company match of up to 6 percent of cash compensation. Participants vest in the company match for the 401(k) plan after three years of eligible service.
year-end 2018 and $9 million at year-end 2017, which is included in the projected benefit obligation. The company also makes available to a select group of associates the CFC Top Hat Savings Plan, a nonqualified deferred compensation plan, which had a fair value of $34 million and $31 million at December 31, 2018 and 2017, respectively. Company matching contributions to the CFC Top Hat Savings Plan totaled $1 million for the years 2018 and 2017 and less than $1 million for the year 2016.
The discount rate was decreased by 0.57 percentage points for the qualified pension plan and 0.49 percentage points for the SERP due to market interest rate conditions at the beginning of 2018. The discount rate assumptions for our benefit obligation generally track with high-quality rated corporate bond yields chosen in our theoretical settlement portfolio, and yearly adjustments reflect any changes to those bond yields. We believe the expected return on plan assets is representative of the expected long-term rate of return on these assets, which is consistent with 2018 expectations of interest rates and based partially on the fact that the plan’s common stock holdings pay dividends. We review historical actual return on plan assets when determining our expected long-term rate of return. Total portfolio return for 2018 was negative 1.7 percent and for 2017 was 17.4 percent. Our compensation increase assumptions in 2018 reflect anticipated rates of inflation, real return on wage growth and merit and promotional increases.
Our funded status improved for 2018 primarily due to actuarial gains from increases in discount rates and assumed lump sum rates partially offset by lower returns on plan assets.
The 2018 amount recognized in net periodic benefit cost and other comprehensive income increased from 2017. The 2018 change in the amount recognized in other comprehensive income from 2017 is largely due to changes in the actuarial loss resulting from decreases in discount and assumed lump sum rates. The estimated costs to be amortized from AOCI into net periodic benefit cost over the next year for our plans are $1 million in actuarial loss and less than $1 million in prior service cost.
Excluding cash, during 2018 we held approximately 75 percent of our pension portfolio in domestic common equity investments. The remainder of the portfolio consisted of 10 percent in states, municipalities and taxable political subdivisions fixed-maturity investments, 13 percent in domestic corporate fixed-maturity investments and 2 percent in United States government. Our common equity portfolio consisted of 21 percent in the financial sector, 20 percent in the information technology sector, 14 percent in the healthcare sector, 11 percent in the industrial sector and 10 percent in the consumer discretionary industrial sector at year-end 2018. No additional sectors accounted for 10 percent or more of our common equity portfolio balance at year-end 2018.
Investments in securities are valued based on the fair value hierarchy outlined in Note 3, Fair Value Measurements. The pension plan did not have any liabilities carried at fair value during the years ended December 31, 2018 and 2017. There have been no transfers between Level 1 and Level 2 for the years ended December 31, 2018 and 2017. The following table shows the fair value hierarchy for those assets measured at fair value on a recurring basis at December 31, 2018 and 2017. Excluded from the table below is cash on hand of $32 million and $18 million at December 31, 2018 and 2017, respectively.
Our pension plan assets included 232,113 shares of the company’s common stock at both December 31, 2018 and 2017, which had a fair value of $18 million and $17 million at December 31, 2018 and 2017, respectively. The defined benefit pension plan did not purchase or sell any shares of our common stock during 2018 and 2017. The company paid less than $1 million in 2018 and $1 million in 2017 in cash dividends on our common stock to the pension plan.
We estimate $4 million of benefit payments from the SERP during 2019. We expect to make the following benefit payments for our qualified plan and SERP, reflecting expected future service:
Insurance companies’ statutory financial statements are presented on the basis of accounting practices prescribed or permitted by applicable state insurance departments of domicile. Insurance companies use statutory accounting practices (SAP) as recognized by various states. We have adopted the National Association of Insurance Commissioners’ (NAIC) Accounting Practices and Procedures manual, version effective January 1, 2001, and updates through the current year as a component of prescribed or permitted practices by laws of the state of domicile. The primary differences between SAP and GAAP include the valuation of investment gains and losses, expensing of policy acquisition costs, actuarial assumptions for life insurance reserves and deferred income taxes based on differences in statutory and taxable income.
Statutory net income and capital and surplus are determined in accordance with SAP prescribed or permitted by insurance regulatory authorities for five legal entities, our insurance subsidiary and its four insurance subsidiaries. Statutory capital and surplus for our insurance subsidiary, The Cincinnati Insurance Company, includes capital and surplus of its four insurance subsidiaries. All capital and surplus amounts exceed statutory risk-based capital requirements. The statutory net income and statutory capital and surplus are presented below:
On a quarterly basis, we review these outstanding matters. Under current accounting guidance, we establish accruals when it is probable that a loss has been incurred and we can reasonably estimate its potential exposure. The company accounts for such probable and estimable losses, if any, through the establishment of legal expense reserves. Based on our quarterly review, we believe that our accruals for probable and estimable losses are reasonable and that the amounts accrued do not have a material effect on our consolidated financial condition or results of operations. However, if any one or more of these matters results in a judgment against us or settlement for an amount that is significantly greater than the amount accrued, the resulting liability could have a material effect on the company's consolidated results of operations or cash flows. Based on our most recent review, our estimate for any other matters for which the risk of loss is not probable, but more than remote, is immaterial.
Share-based compensation cost after tax was $23 million, $17 million and $15 million for the years ended
December 31, 2018, 2017 and 2016, respectively. The related income tax benefit recognized was $5 million,
Below is a summary of option information for the year 2018:
Expected volatility is based on each company's historical volatility using daily stock price observations with the period commensurate with the performance measurement period.
Fee revenues for the commercial, personal and excess and surplus insurance segments primarily represent installment fees. Fee revenues for the life insurance segment represent separate account investment management fees.
For commercial lines, personal lines and excess and surplus lines insurance segments, we calculate underwriting profit or loss as premiums earned and fee revenue minus loss and loss expenses and underwriting expenses incurred.
This table includes unaudited quarterly financial information for the years ended December 31, 2018 and 2017: