The following is a discussion and analysis of the Company’s financial condition and results of operations.
Net income of $2.52 billion, or $9.37 per share basic and $9.28 per share diluted
Total investments of $72.28 billion; fixed maturities and short-term securities comprise 93% of total investments
Total debt of $6.56 billion, resulting in a debt-to-total capital ratio of 22.3% (22.2% excluding net unrealized investment losses, net of tax, included in shareholders' equity)
Diluted net income per share of $9.28 in 2018 increased by 27% over diluted net income per share of $7.33 in 2017. Net income of $2.52 billion in 2018 increased by 23% over net income of $2.06 billion in 2017. The higher rate of increase in diluted net income per share reflected the impact of share repurchases in recent periods. The increase in income before income taxes primarily reflected the pre-tax impacts of (i) lower catastrophe losses, (ii) higher underwriting margins excluding catastrophe losses and prior year reserve development ("underlying underwriting margins") and (iii) higher net investment income, partially offset by (iv) lower net realized investment gains and (v) lower net favorable prior year reserve development. Catastrophe losses in 2018 and 2017 were $1.72 billion and $1.95 billion, respectively. Net favorable prior year reserve development in 2018 and 2017 was $517 million and $592 million, respectively. The higher underlying underwriting margins primarily resulted from the impacts of (i) earned pricing that exceeded loss cost trends in Personal Insurance, (ii) a lower level of international surety losses in Bond & Specialty Insurance and (iii) higher business volumes, partially offset by (iv) higher loss estimates in the commercial automobile product line for bodily injury liability coverages in Business Insurance and (v) higher non-catastrophe weather-related losses and non-weather related losses in Personal Insurance. Income tax expense in 2018 was lower than in 2017, primarily reflecting the impacts of (i) the lower U.S. corporate income tax rate resulting from the Tax Cuts and Jobs Act of 2017 (TCJA) and (ii) a net charge of $129 million in 2017 to reflect the change in tax laws and tax rates enacted in the U.S. on December 22, 2017 as part of the TCJA resulting primarily from revaluing the Company's deferred tax assets and liabilities and the tax imposed on accumulated foreign earnings, partially offset by (iii) the increase in income before income taxes and (iv) the $39 million reduction in income tax expense in 2017 as a result of the resolution of prior year tax matters.
Diluted net income per share of $7.33 in 2017 decreased by 29% from diluted net income per share of $10.28 in 2016. Net income of $2.06 billion in 2017 decreased by 32% from net income of $3.01 billion in 2016. The lower rate of decrease in diluted net income per share reflected the impact of share repurchases in recent periods. The decrease in income before income taxes primarily reflected the pre-tax impacts of (i) significantly higher catastrophe losses, (ii) lower net favorable prior year reserve development, (iii) lower underlying underwriting margins and (iv) lower other income in 2017 due to a favorable settlement of a reinsurance dispute in 2016, partially offset by (v) higher net realized investment gains and (vi) higher net investment income. Catastrophe losses in 2017 and 2016 were $1.95 billion and $877 million, respectively. Net favorable prior year reserve development in 2017 and 2016 was $592 million and $771 million, respectively. The lower underlying underwriting margins primarily resulted from the impacts of (i) loss cost trends that modestly exceeded earned pricing in Business Insurance, (ii) higher non-catastrophe fire-related losses in Business Insurance and (iii) higher non-catastrophe weather-related losses in Personal Insurance, partially offset by (iv) increased business volumes. Income tax expense in 2017 was lower than in 2016, primarily reflecting the impacts of (i) the decrease in income before income taxes, partially offset by (ii) the net charge of $129 million in 2017 related to the impact of the TCJA described above. In addition, income tax expense in 2017 was reduced by $39 million as a result of the resolution of prior year tax matters.
The Company has insurance operations in Canada, the United Kingdom, the Republic of Ireland and throughout other parts of the world as a corporate member of Lloyd’s, as well as in Brazil and Colombia, primarily through joint ventures. Because these operations are conducted in local currencies other than the U.S. dollar, the Company is subject to changes in foreign currency exchange rates. For the years ended December 31, 2018, 2017 and 2016, changes in foreign currency exchange rates impacted reported line items in the statement of income by insignificant amounts. The impact of these changes was not material to the Company’s net income or segment income for the periods reported.
Earned premiums in 2018 were $27.06 billion, $1.38 billion or 5% higher than in 2017. In Business Insurance, earned premiums in 2018 increased by 4% over 2017. In Bond & Specialty Insurance, earned premiums in 2018 increased by 5% over 2017. In Personal Insurance, earned premiums in 2018 increased by 7% over 2017. Earned premiums in 2017 were $25.68 billion, $1.15 billion or 5% higher than in 2016. In Business Insurance, earned premiums in 2017 increased by 2% over 2016. In Bond & Specialty Insurance, earned premiums in 2017 increased by 2% over 2016. In Personal Insurance, earned premiums in 2017 increased by 10% over 2016. Factors contributing to the increases in earned premiums in each segment in 2018 and 2017 compared with the respective prior year are discussed in more detail in the segment discussions that follow.
Net investment income in 2018 was $2.47 billion, $77 million or 3% higher than in 2017. Net investment income from fixed maturity investments in 2018 was $1.98 billion, $85 million higher than in 2017, primarily resulting from a higher average level of fixed maturity investments and higher long-term reinvestment rates available in the market. Net investment income from short-term securities in 2018 was $92 million, $30 million higher than in 2017, primarily resulting from higher short-term interest rates. Net investment income generated by the Company's remaining investment portfolios in 2018 was $441 million, $37 million lower
than in 2017, primarily reflecting lower returns from private equity limited partnerships and lower dividend income due to a lower level of investments in equity securities, partially offset by higher returns from real estate partnerships.
Net investment income in 2017 was $2.40 billion, $95 million or 4% higher than in 2016. Net investment income from fixed maturity investments in 2017 was $1.89 billion, $86 million lower than in 2016, primarily resulting from lower long-term reinvestment rates available in the market, partially offset by the impact of a slightly higher level of fixed maturity investments. Net investment income from short-term securities in 2017 was $62 million, $33 million higher than in 2016, primarily due to higher short-term interest rates and a higher average level of short-term investments. Net investment income generated by the Company's remaining investment portfolios in 2017 was $478 million, $148 million higher than in 2016, primarily due to higher returns from private equity limited partnerships.
Other net realized investment gains in 2018 included $92 million of net realized investment gains related to other investments, primarily resulting from the sale of a private equity limited partnership, $33 million of net realized gains related to fixed maturity investments, $23 million of net realized investment gains from real estate sales and $4 million of net realized investment losses related to equity securities sold.
Other revenues in all years presented included installment premium charges. Other revenues in 2018 and 2017 also included revenues from Simply Business, which was acquired in August 2017. Other revenues in 2017 and 2016 also included gains related to the settlement of reinsurance disputes (discussed in more detail in note 16 of notes to the consolidated financial statements). Other revenues in 2016 also included proceeds from the favorable settlement of a claims-related legal matter.
primarily resulted from wildfires in California, Hurricanes Florence and Michael, wind and hail storms in several regions of the United States and winter storms in the eastern United States.
is designated a catastrophe by internationally recognized organizations that track and report on insured losses resulting from catastrophic events, such as Property Claim Services (PCS) for events in the United States and Canada; and
The following table presents the amount of losses recorded by the Company for significant catastrophes that occurred in 2018, 2017 and 2016, the amount of net unfavorable (favorable) prior year reserve development recognized in 2018 and 2017 for catastrophes that occurred in 2017 and 2016, and the estimate of ultimate losses for those catastrophes at December 31, 2018, 2017 and 2016. For purposes of the table, a significant catastrophe is an event for which the Company estimates its ultimate losses will be $100 million or more after reinsurance and before taxes.
Amortization of deferred acquisition costs in 2018 was $4.38 billion, $215 million or 5% higher than in 2017. Amortization of deferred acquisition costs in 2017 was $4.17 billion, $181 million or 5% higher than in 2016. Amortization of deferred acquisition costs is discussed in more detail in the segment discussions that follow.
Interest expense in 2018, 2017 and 2016 was $352 million, $369 million and $363 million, respectively.
The Company’s effective tax rate was 15%, 25% and 26% in 2018, 2017 and 2016, respectively. The effective tax rates in all years were lower than the respective statutory rate of 21% in 2018 and 35% in both 2017 and 2016, primarily due to the impact of tax-exempt investment income on the calculation of the Company’s income tax provision. The effective tax rate in 2018 also included the impact of the reduction in income tax expense resulting from the Company's $200 million voluntary contribution to its qualified domestic pension plan in 2018, which provided a 35% tax benefit rather than a 21% tax benefit. In addition, the effective tax rate in 2017 reflected the net charge related to TCJA and the impact of the resolution of prior year tax matters, both discussed above.
The combined ratio of 96.9% in 2018 was 1.0 points lower than the combined ratio of 97.9% in 2017. The loss and loss adjustment expense ratio of 66.8% in 2018 was 0.4 points lower than the loss and loss adjustment expense ratio of 67.2% in 2017. The underwriting expense ratio of 30.1% in 2018 was 0.6 points lower than the underwriting expense ratio of 30.7% in 2017.
Catastrophe losses in 2018 and 2017 accounted for 6.3 points and 7.6 points, respectively, of the combined ratio. Net favorable prior year reserve development in 2018 and 2017 provided 1.9 points and 2.3 points of benefit, respectively, to the combined ratio. The combined ratio excluding prior year reserve development and catastrophe losses ("underlying combined ratio") in 2018 was 0.1 points lower than the 2017 ratio on the same basis.
Gross and net written premiums in 2018 both increased by 6% over 2017. Gross and net written premiums in 2017 increased by 4% and 5%, respectively, over 2016. Factors contributing to the changes in gross and net written premiums in each segment in 2018 and 2017 as compared with the respective prior year are discussed in more detail in the segment discussions that follow.
Segment income in 2017 was $1.61 billion, $369 million or 19% lower than segment income of $1.98 billion in 2016. The decrease in segment income before income taxes primarily reflected the pre-tax impacts of (i) significantly higher catastrophe losses, (ii) lower other income due to a favorable settlement of a reinsurance dispute in 2016 and (iii) lower underlying underwriting margins, partially offset by (iv) higher net investment income. Catastrophe losses in 2017 and 2016 were $858 million and $463 million, respectively. Net favorable prior year reserve development in 2017 and 2016 was $439 million and $424 million, respectively. The lower underlying underwriting margins primarily resulted from the impacts of (i) loss cost trends that modestly exceeded earned pricing and (ii) higher non-catastrophe fire-related losses. Income tax expense in 2017 was lower than in 2016, primarily reflecting the impacts of (i) the decrease in segment income before income taxes and (ii) the $15 million reduction in income taxes as a result of the resolution of prior year tax matters in 2017.
Earned premiums of $14.72 billion in 2018 were $576 million or 4% higher than in 2017. Earned premiums of $14.15 billion in 2017 were $291 million or 2% higher than in 2016. The increase in earned premiums in both 2018 and 2017 reflected increases in net written premiums over the preceding twelve months.
National Accounts is the primary source of fee income due to revenue from its large deductible policies and service businesses, which include risk management, claims administration, loss control and risk management information services provided to large companies that choose to self-insure a portion of their insurance risks, as well as claims and policy management services to workers’ compensation residual market pools. Fee income in 2018 was $412 million, $18 million or 4% lower than in 2017, primarily reflecting lower claim volume in the large deductible business and lower serviced premium volume in the workers' compensation residual market pools. Fee income in 2017 was $430 million, $12 million or 3% lower than in 2016, primarily reflecting lower serviced premium volume in the workers’ compensation residual market pools.
Claims and claim adjustment expenses in 2018 were $10.17 billion, $650 million or 7% higher than in 2017, primarily reflecting the impacts of (i) higher business volumes, (ii) lower net favorable prior year reserve development, (iii) loss cost trends and (iv) higher loss estimates in the domestic commercial automobile product line for bodily injury liability coverages, partially offset by (v) lower catastrophe losses. Claims and claim adjustment expenses in 2017 were $9.52 billion, $768 million or 9% higher than in 2016, primarily reflecting the impacts of (i) significantly higher catastrophe losses, (ii) loss cost trends, (iii) higher business volumes and (iv) higher non-catastrophe fire-related losses.
General and administrative expenses in 2018 were $2.62 billion, $60 million or 2% higher than in 2017, primarily reflecting the impact of the acquisition of Simply Business in August 2017. General and administrative expenses in 2017 of $2.56 billion were comparable with 2016.
The combined ratio of 99.1% in 2018 was 1.3 points higher than the combined ratio of 97.8% in 2017. The loss and loss adjustment expense ratio of 67.8% in 2018 was 1.9 points higher than the loss and loss adjustment expense ratio of 65.9% in 2017. The underwriting expense ratio of 31.3% in 2018 was 0.6 points lower than the underwriting expense ratio of 31.9% in 2017.
Select Accounts. Net written premiums of $2.83 billion in 2018 increased by 1% over 2017. Business retention rates remained strong in 2018. Renewal premium changes in 2018 remained positive and were higher than in 2017. New business premiums in 2018 increased over 2017. Net written premiums of $2.80 billion in 2017 increased by 3% over 2016. Business retention rates remained strong in 2017. Renewal premium changes in 2017 remained positive but were lower than in 2016. New business premiums in 2017 increased over 2016.
National Accounts. Net written premiums of $1.03 billion in 2018 increased by 1% over 2017. Business retention rates remained strong in 2018. Renewal premium changes in 2018 remained positive and were higher than in 2017. New business premiums in 2018 decreased from 2017. Net written premiums of $1.01 billion in 2017 decreased by 5% from 2016. Business retention rates remained strong in 2017. Renewal premium changes in 2017 remained slightly positive but were lower than in 2016. New business premiums in 2017 decreased from 2016.
National Property and Other. Net written premiums of $1.81 billion in 2018 increased by 7% over 2017. Business retention rates were strong in 2018 and increased over 2017. Renewal premium changes in 2018 remained positive and were higher than in 2017. New business premiums in 2018 increased over 2017. Net written premiums of $1.69 billion in 2017 decreased by 5% from 2016. Business retention rates in 2017 declined from 2016. Renewal premium changes in 2017 remained positive and were higher than in 2016. New business premiums in 2017 decreased from 2016.
Segment income in 2018 was $793 million, $237 million or 43% higher than segment income of $556 million in 2017. The increase in segment income before income taxes primarily reflected the pre-tax impacts of (i) higher net favorable prior year reserve development and (ii) higher underlying underwriting margins. Net favorable prior year reserve development in 2018 and 2017 was $266 million and $140 million, respectively. Catastrophe losses in 2018 and 2017 were $16 million and $6 million, respectively. The higher underlying underwriting margins primarily resulted from the impacts of (i) a lower level of international
Segment income in 2017 was $556 million, $156 million or 22% lower than segment income of $712 million in 2016. The decrease in segment income before income taxes primarily reflected the pre-tax impacts of (i) lower net favorable prior year reserve development and (ii) lower underlying underwriting margins. Net favorable prior year reserve development in 2017 and 2016 was $140 million and $350 million, respectively. Catastrophe losses in both 2017 and 2016 were $6 million. The lower underlying underwriting margins primarily reflected a higher level of international surety losses. Income tax expense in 2017 was lower than in 2016, primarily reflecting the impacts of (i) the decrease in segment income before income taxes and (ii) the $17 million reduction in income tax expense in 2017 as a result of the resolution of prior year tax matters.
Net investment income in 2018 was $233 million, $5 million or 2% higher than in 2017. Net investment income in 2017 was $228 million, $11 million or 5% lower than in 2016. Included in Bond & Specialty Insurance are certain legal entities whose invested assets and related net investment income are reported exclusively in this segment and not allocated among all business segments. As a result, reported net investment income in Bond & Specialty Insurance reflects a significantly smaller proportion of allocated net investment income, including net investment income from the Company’s non-fixed maturity investments that experienced a decrease in investment income in 2018 and an increase in investment income in 2017. Refer to the “Net Investment Income” section of the “Consolidated Results of Operations” discussion for a description of the factors contributing to the increases in the Company’s consolidated net investment income in 2018 and 2017 compared with the respective prior years. In addition, refer to note 2 of notes to the consolidated financial statements for a discussion of the Company’s net investment income allocation methodology.
Claims and claim adjustment expenses in 2018 were $772 million, $127 million or 14% lower than in 2017, primarily reflecting the impacts of (i) higher net favorable prior year reserve development and (ii) a lower level of international surety losses, partially offset by (iii) higher business volumes. Claims and claim adjustment expenses in 2017 were $899 million, $266 million or 42% higher than in 2016, primarily reflecting (i) lower net favorable prior year reserve development and (ii) a higher level of international surety losses.
Amortization of deferred acquisition costs in 2018 was $454 million, $22 million or 5% higher than in 2017. Amortization of deferred acquisition costs in 2017 was $432 million, $11 million or 3% higher than in 2016. The increases in both years were generally consistent with the increases in earned premiums.
General and administrative expenses in 2018 were $459 million, $5 million or 1% lower than in 2017. General and administrative expenses in 2017 were $464 million, $19 million or 4% higher than in 2016, primarily reflecting higher employee and technology related expenses.
Income tax expense in 2018 was $198 million, $10 million or 5% lower than in 2017, primarily reflecting the impacts of (i) the lower U.S. corporate income tax rate resulting from the TCJA, partially offset by (ii) the $227 million increase in income before income taxes in 2018 and (iii) the $17 million reduction in income tax expense in 2017 resulting from the resolution of prior year tax matters. Income tax expense in 2017 was $208 million, $101 million or 33% lower than in 2016, primarily reflecting the impact of the $257 million decrease in income before income taxes in 2017 and the $17 million reduction in income tax expense resulting from the resolution of prior year tax matters.
Net favorable prior year reserve development in 2018 and 2017 provided 11.0 points and 6.1 points of benefit, respectively, to the combined ratio. Catastrophe losses in 2018 and 2017 accounted for 0.6 points and 0.3 points, respectively, of the combined ratio. The underlying combined ratio in 2018 was 3.8 points lower than the 2017 ratio on the same basis, primarily reflecting the impacts of (i) a lower level of international surety losses and (ii) higher levels of earned premiums.
Domestic. Net written premiums in 2018 were $2.29 billion, $130 million or 6% higher than in 2017. Excluding the surety line of business, for which the following are not relevant measures, business retention rates remained strong in 2018. Renewal premium changes in 2018 remained positive but were lower than in 2017. New business premiums in 2018 increased over 2017. Net written premiums of $2.16 billion in 2017 increased by 3% over 2016. Excluding the surety line of business, for which the following are not relevant measures, business retention rates remained strong in 2017. Renewal premium changes in 2017 remained positive and were comparable with 2016. New business premiums in 2017 increased over 2016.
Segment income in 2017 was $128 million, $389 million or 75% lower than segment income of $517 million in 2016. The decrease in segment income before income taxes primarily reflected the pre-tax impacts of (i) significantly higher catastrophe losses, partially offset by (ii) higher net investment income, (iii) higher underlying underwriting margins and (iv) net favorable prior year reserve development as compared to net unfavorable prior year reserve development in 2016. Catastrophe losses in 2017 and 2016 were $1.09 billion and $408 million, respectively. Net favorable prior year reserve development in 2017 was $13 million, compared with net unfavorable prior year reserve development of $3 million in 2016. The higher underlying underwriting margins primarily resulted from the impacts of (i) increased business volumes and (ii) earned pricing that modestly exceeded loss cost trends, partially offset by (iii) higher non-catastrophe weather-related losses. Income tax expense in 2017 was lower than in 2016, primarily reflecting the impacts of (i) the decrease in segment income before income taxes and (ii) the $7 million reduction in income tax expense as a result of the resolution of prior year tax matters.
Earned premiums in 2018 were $9.92 billion, $687 million or 7% higher than in 2017. Earned premiums in 2017 were $9.23 billion, $811 million or 10% higher than in 2016. The increase in earned premiums in both 2018 and 2017 reflected increases in net written premiums over the preceding twelve months.
Net investment income in 2018 was $408 million, $25 million or 7% higher than in 2017. Net investment income in 2017 was $383 million, $21 million or 6% higher than in 2016. Refer to the “Net Investment Income” section of “Consolidated Results of Operations” for a discussion of the increases in the Company’s net investment income in 2018 and 2017 as compared with the respective prior year. In addition, refer to note 2 of notes to the consolidated financial statements for a discussion of the Company’s net investment income allocation methodology.
General and administrative expenses in 2018 were $1.19 billion, $74 million or 7% higher than in 2017, primarily reflecting the impact of variable costs associated with higher business volumes. General and administrative expenses in 2017 were $1.11 billion, $13 million or 1% lower than in 2016.
Income tax expense in 2018 was $42 million, compared with an income tax benefit of $(44) million in 2017, primarily reflecting the impacts of (i) the $255 million increase in income before income taxes in 2018 and (ii) the $7 million reduction in income tax expense in 2017 resulting from the resolution of prior year tax matters, partially offset by (iii) the lower U.S. corporate income tax rate resulting from the TCJA. The income tax benefit in 2017 was $(44) million, compared with income tax expense of $192 million in 2016, primarily reflecting the impacts of (i) the $625 million decrease in income before income taxes in 2017 and (ii) the $7 million reduction in income tax expense resulting from the resolution of prior year tax matters. The level of income tax expense (benefit) in all years reflected the impact of tax-exempt investment income on the calculation of the Company’s tax provision.
Catastrophe losses accounted for 10.7 points and 11.7 points of the combined ratio in 2018 and 2017, respectively. Net favorable prior year reserve development in 2018 and 2017 provided 1.1 and 0.1 points of benefit, respectively, to the combined ratio. The underlying combined ratio in 2018 was 0.5 points lower than the 2017 ratio on the same basis, primarily reflecting the impacts of (i) earned pricing that exceeded loss cost trends in Agency Automobile and (ii) the benefit of higher levels of earned premiums on the underwriting expense ratio, partially offset by (iii) higher non-catastrophe weather-related losses and non-weather related losses in Agency Homeowners and Other.
Domestic Agency Automobile net written premiums of $4.65 billion in 2017 were 13% higher than in 2016. Business retention rates remained strong in 2017. Renewal premium changes in 2017 remained positive and were higher than in 2016. New business premiums in 2017 decreased from 2016.
Domestic Agency Homeowners and Other net written premiums of $3.93 billion in 2017 were 4% higher than in 2016. Business retention rates remained strong in 2017. Renewal premium changes in 2017 remained positive but were lower than in 2016. New business premiums in 2017 increased over 2016.
Direct-to-Consumer net written premiums in 2018 were 10% higher than in 2017. Direct-to-Consumer net written premiums in 2017 were 17% higher than in 2016. The increase in 2018 was primarily driven by growth in both automobile and homeowners net written premiums. The increase in 2017 was primarily driven by growth in automobile net written premiums.
In addition to claims against policyholders, proceedings have been launched directly against insurers, including the Company, by individuals challenging insurers’ conduct with respect to the handling of past asbestos claims and by individuals seeking damages arising from alleged asbestos-related bodily injuries. It is possible that the filing of other direct actions against insurers, including the Company, could be made in the future. It is difficult to predict the outcome of these proceedings, including whether the plaintiffs would be able to sustain these actions against insurers based on novel legal theories of liability. The Company believes it has meritorious defenses to any such claims and has received favorable rulings in certain jurisdictions.
On January 29, 2009, the Company and PPG Industries, Inc. (PPG), along with approximately 30 other insurers of PPG, agreed in principle to settle asbestos-related coverage litigation under insurance policies issued to PPG (the “Agreement”). The Agreement was incorporated into the Modified Third Amended Plan of Reorganization (“Amended Plan”) proposed as part of the Pittsburgh Corning Corp. (PCC, which is 50% owned by PPG) bankruptcy proceeding. On April 27, 2016, the Amended Plan became effective and all the remaining conditions to the Agreement were satisfied. The Company fully satisfied its obligation under the Agreement by making a discounted payment in the second quarter of 2016. The Company’s payment totaled $524 million, of which $518 million was related to asbestos reserves.
Because each policyholder presents different liability and coverage issues, the Company generally reviews the exposure presented by each policyholder at least annually. Among the factors which the Company may consider in the course of this review are: available insurance coverage, including the role of any umbrella or excess insurance the Company has issued to the policyholder; limits and deductibles; an analysis of the policyholder’s potential liability; the jurisdictions involved; past and anticipated future claim activity and loss development on pending claims; past settlement values of similar claims; allocated claim adjustment expense; the potential role of other insurance; the role, if any, of non-asbestos claims or potential non-asbestos claims in any resolution process; and applicable coverage defenses or determinations, if any, including the determination as to whether or not an asbestos claim is a products/completed operation claim subject to an aggregate limit and the available coverage, if any, for that claim.
The policyholders with settlement agreements category includes certain policyholders with whom the Company has entered into permanent settlement agreements. Reserves in this category are based on the expected payout for each policyholder under the applicable agreement. The home office and field office category relates to all other policyholders and also includes IBNR reserves and reserves for the costs of defending asbestos-related coverage litigation. IBNR reserves in this category include amounts for
The Company’s quarterly asbestos reserve reviews include an analysis of exposure and claim payment patterns by policyholder category, as well as recent settlements, policyholder bankruptcies, judicial rulings and legislative actions. The Company also analyzes developing payment patterns among policyholders in the home office and field office category and the assumed reinsurance and other category as well as projected reinsurance billings and recoveries. In addition, the Company reviews its historical gross and net loss and expense paid experience, year-by-year, to assess any emerging trends, fluctuations, or characteristics suggested by the aggregate paid activity. Conventional actuarial methods are not utilized to establish asbestos reserves and the Company’s evaluations have not resulted in a reliable method to determine a meaningful average asbestos defense or indemnity payment.
The Company has also been, and continues to be, involved in litigation involving insurance coverage issues pertaining to environmental claims. The Company believes that some court decisions have interpreted the insurance coverage to be broader than the original intent of the insurers and policyholders. These decisions often pertain to insurance policies that were issued by the Company prior to the mid-1980s. These decisions continue to be inconsistent and vary from jurisdiction to jurisdiction. Environmental claims, when submitted, rarely indicate the monetary amount being sought by the claimant from the policyholder, and the Company does not keep track of the monetary amount being sought in those few claims which indicate a monetary amount.
In establishing environmental reserves, the Company evaluates the exposure presented by each policyholder and the anticipated cost of resolution, if any. In the course of this analysis, the Company generally considers the probable liability, available coverage and relevant judicial interpretations. In addition, the Company considers the many variables presented, such as: the nature of the
alleged activities of the policyholder at each site; the number of sites; the total number of potentially responsible parties at each site; the nature of the alleged environmental harm and the corresponding remedy at each site; the nature of government enforcement activities at each site; the ownership and general use of each site; the overall nature of the insurance relationship between the Company and the policyholder, including the role of any umbrella or excess insurance the Company has issued to the policyholder; the involvement of other insurers; the potential for other available coverage, including the number of years of coverage; the role, if any, of non-environmental claims or potential non-environmental claims in any resolution process; and the applicable law in each jurisdiction. Conventional actuarial methods are not used to estimate these reserves.
The Company continues to receive notices from policyholders tendering claims for the first time, frequently under policies issued prior to the mid-1980s. These policyholders continue to present smaller exposures, have fewer sites and are lower tier defendants. Further, in many instances, clean-up costs have been reduced because regulatory agencies are willing to accept risk-based site analyses and more efficient clean-up technologies. Over the past several years, the Company has experienced generally favorable trends in the number of new policyholders tendering environmental claims for the first time and in the number of pending declaratory judgment actions relating to environmental matters. However, the degree to which those favorable trends have continued has been less than anticipated. In addition, reserve development on existing environmental claims has been greater than anticipated, driven by claims and legal developments in a limited number of jurisdictions. As a result of these factors, in 2018, 2017 and 2016, the Company increased its net environmental reserves by $55 million, $65 million and $82 million, respectively.
becomes available and as claims develop. Changes in the legal, regulatory and legislative environment may impact the resolution of asbestos and environmental claims and result in adverse loss reserve development. The emergence of a greater number of asbestos or environmental claims beyond that which is anticipated may result in adverse loss reserve development. Changes in applicable legislation and future court and regulatory decisions and interpretations, including the outcome of legal challenges to legislative and/or judicial reforms establishing medical criteria for the pursuit of asbestos claims could affect the settlement of asbestos and environmental claims. It is also difficult to predict the ultimate outcome of complex coverage disputes until settlement negotiations near completion and significant legal questions are resolved or, failing settlement, until the dispute is adjudicated. This is particularly the case with policyholders in bankruptcy where negotiations often involve a large number of claimants and other parties and require court approval to be effective. As part of its continuing analysis of asbestos and environmental reserves, the Company continues to study the implications of these and other developments.
Because of the uncertainties set forth above, additional liabilities may arise for amounts in excess of the Company’s current insurance reserves. In addition, the Company’s estimate of claims and claim adjustment expenses may change. These additional liabilities or increases in estimates, or a range of either, cannot now be reasonably estimated and could result in income statement charges that could be material to the Company’s operating results in future periods.
The carrying value of the Company’s fixed maturity portfolio at December 31, 2018 was $63.46 billion. The Company closely monitors the duration of its fixed maturity investments, and investment purchases and sales are executed with the objective of having adequate funds available to satisfy the Company’s insurance and debt obligations. The weighted average credit quality of the Company’s fixed maturity portfolio, both including and excluding U.S. Treasury securities, was “Aa2” at both December 31, 2018 and 2017. Below investment grade securities represented 2.3% and 2.7% of the total fixed maturity investment portfolio at December 31, 2018 and 2017, respectively. The weighted average effective duration of fixed maturities and short-term securities was 4.5 (4.7 excluding short-term securities) at December 31, 2018 and 4.0 (4.3 excluding short-term securities) at December 31, 2017. The increase in duration compared with December 31, 2017 primarily reflected the increase in market interest rates as well as changes in the Company's investment portfolio following the enactment of the Tax Cuts and Jobs Act of 2017.
The Company bases its investment decision on the underlying credit characteristics of the municipal security. The weighted average credit rating of the municipal bond portfolio was “Aaa/Aa1” at December 31, 2018.
Rated using external rating agencies or by the Company when a public rating does not exist. The table includes $323 million of short-term securities which have high ratings issued by external rating agencies for short-term issuances. For purposes of this table, the short-term securities, which are rated “A-1+” and/or “P-1,” are included as “Aaa” rated securities.
The Company’s fixed maturity investment portfolio at December 31, 2018 and 2017 included $2.57 billion and $2.41 billion, respectively, of residential mortgage-backed securities, including pass-through-securities and collateralized mortgage obligations (CMOs), all of which are subject to prepayment risk (either shortening or lengthening of duration). While prepayment risk for securities and its effect on income cannot be fully controlled, particularly when interest rates move dramatically, the Company’s investment strategy generally favors securities that reduce this risk within expected interest rate ranges. The Company makes investments in residential CMOs that are either guaranteed by GNMA, FNMA or FHLMC, or if not guaranteed, are senior or super-senior positions within their respective securitizations. Both guaranteed and non-guaranteed residential CMOs allocate the distribution of payments from the underlying mortgages among different classes of bondholders. In addition, non-guaranteed residential CMOs provide structures that allocate the impact of credit losses to different classes of bondholders. Senior and super-senior CMOs are protected, to varying degrees, from credit losses as those losses are initially allocated to subordinated bondholders. The Company’s investment strategy is to purchase CMO tranches that are expected to offer the most favorable return given the Company’s assessment of associated risks. The Company does not purchase residual interests in CMOs. For more information regarding the Company’s investments in residential mortgage-backed securities, see note 3 of notes to the consolidated financial statements.
At December 31, 2018 and 2017, the Company held commercial mortgage-backed securities (including FHA project loans) of $1.22 billion and $1.17 billion, respectively. The Company does not believe this portfolio exposes it to a material adverse impact
on its results of operations, financial position or liquidity, due to the portfolio’s relatively small size and the underlying credit strength of these securities. For more information regarding the Company’s investments in commercial mortgage-backed securities, see note 3 of notes to the consolidated financial statements.
The Company also invests in private equity limited partnerships, hedge funds and real estate partnerships. Also included in other investments are non-public common and preferred equities and derivatives. These asset classes have historically provided a higher return than fixed maturities but are subject to more volatility. At December 31, 2018 and 2017, the carrying value of the Company's other investments was $3.56 billion and $3.53 billion, respectively. The Company has unfunded commitments to private equity limited partnerships and real estate partnerships in which it invests. These commitments totaled $1.60 billion and $1.56 billion at December 31, 2018 and 2017, respectively. It is the opinion of the Company’s management that the Company has adequate liquidity to meet these commitments.
The Company has, from time to time, engaged in securities lending activities from which it generates net investment income by lending certain of its investments to other institutions for short periods of time. At December 31, 2018 and 2017, the Company had $367 million and $304 million of securities on loan, respectively, as part of a tri-party lending agreement. The average monthly balance of securities on loan during 2018 and 2017 was $319 million and $318 million, respectively. Borrowers of these securities provide collateral equal to at least 102% of the market value of the loaned securities plus accrued interest. The Company has not incurred any investment losses in its securities lending program for the years ended December 31, 2018, 2017 and 2016.
At December 31, 2018, the amount of gross unrealized losses for all fixed maturity investments reported at fair value for which fair value was less than 80% of amortized cost for fixed maturity investments was not significant.
Impairment charges included in net realized investment gains in the consolidated statement of income were $1 million, $14 million and $29 million for the years ended December 31, 2018, 2017 and 2016, respectively. See note 3 of notes to the consolidated financial statements for further information.
The Company uses various analyses and methods, including proprietary and third-party computer modeling processes, to make underwriting and reinsurance decisions designed to manage its exposure to catastrophic events. There are no industry-standard methodologies or assumptions for projecting catastrophe exposure. Accordingly, catastrophe estimates provided by different insurers may not be comparable.
The percentage of common equity is calculated by dividing (a) indicated loss amounts in dollars by (b) total common equity excluding net unrealized investment gains and losses, net of taxes, included in shareholders’ equity. Net unrealized investment gains and losses can be significantly impacted by both discretionary and other economic factors and are not necessarily indicative of operating trends. Accordingly, the Company’s management uses the percentage of common equity calculated on this basis as a metric to evaluate the potential impact of a single hurricane or single earthquake on the Company’s financial position for purposes of making underwriting and reinsurance decisions.
The threshold loss amounts in the tables above, which are based on the Company’s in-force portfolio at December 31, 2018 and catastrophe reinsurance program at January 1, 2019, are net of reinsurance, after-tax and exclude unallocated claim adjustment expenses, which historically have been less than 10% of loss estimates. For further information regarding the Company’s reinsurance, see “Item 1 - Reinsurance.” The amounts for hurricanes reflect U.S. and Canadian exposures and include property exposures, property residual market exposures and an adjustment for certain non-property exposures. The hurricane loss amounts are based on the Company’s catastrophe risk model estimates and include losses from the hurricane hazards of wind and storm surge. The amounts for earthquakes reflect U.S. and Canadian property and workers’ compensation exposures. The Company does not believe that the inclusion of hurricane or earthquake losses arising from other geographical areas or other exposures would materially change the estimated threshold loss amounts.
For more information about the Company’s exposure to catastrophe losses, see “Item 1A - Risk Factors-Catastrophe losses could materially and adversely affect our results of operations, our financial position and/or liquidity, and could adversely impact our ratings, our ability to raise capital and the availability and cost of reinsurance” and “Item 1A - Risk Factors- We may be adversely affected if our pricing and capital models provide materially different indications than actual results.”
Severe weather events over the last two decades have underscored the unpredictability of future climate trends and created uncertainty regarding insurers’ exposures to financial loss as a result of catastrophes and other weather-related events. During that time period, the insurance industry experienced increased catastrophe losses due to a number of potential causal factors, including, in addition to weather/climate variability, more people living in high-risk areas, population growth in areas with weaker enforcement of building codes, urban expansion and an increase in the average size of a house. For example, hurricane and storm surge activity have impacted areas further inland than previously experienced, and demographic changes have resulted in larger populations in coastal areas which historically have been subject to severe storms, thus expanding the Company’s potential for losses from hurricanes. Additionally, both the frequency and severity of tornado and hail storms in the United States have been more volatile during the last decade. The frequency and severity of wildfire losses have been elevated in more recent years. Demographic changes in areas prone to wildfires have expanded the Company’s potential for losses from wildfires. Moreover, the Company’s catastrophe models may be less reliable due to the increased unpredictability in frequency and severity of severe weather events, emerging trends in climate conditions, inadequate reflection of regulatory changes and the other factors mentioned above. Accordingly, the Company may be subject to increased losses from catastrophes and other weather-related events.
(1) On September 12, 2018, Axa SA completed its acquisition of XL Group Ltd.
Included in reinsurance recoverables are amounts related to structured settlements, which are annuities purchased from various life insurance companies to settle certain personal physical injury claims, of which workers’ compensation claims comprise a significant portion. In cases where the Company did not receive a release from the claimant, the amount due from the life insurance company related to the structured settlement is included in the Company’s consolidated balance sheet as a reinsurance recoverable and the related claim cost is included in the liability for claims and claim adjustment expense reserves, as the Company retains the contingent liability to the claimant. If it is expected that the life insurance company is not able to pay, the Company would recognize an impairment of the related reinsurance recoverable if, and to the extent, the purchased annuities are not covered by state guaranty associations. In the event that the life insurance company fails to make the required annuity payments, the Company would be required to make such payments. The following table presents the Company’s top five groups by structured settlements at December 31, 2018 (in millions). Also included is the A.M. Best rating of the Company’s predominant insurer from each such insurer group at February 14, 2019:
(1) On October 23, 2016, Genworth Financial (Genworth) announced that they have entered into a definitive agreement under which China Oceanwide Holdings Group Co., Ltd. (China Oceanwide) agreed to acquire all of the outstanding shares of Genworth. China Oceanwide is a privately held, family-owned international financial holding group headquartered in Beijing, China. On March 7, 2017, Genworth stockholders adopted the merger agreement, and the acquisition is pending the receipt of required regulatory approvals. On January 30, 2019, the parties agreed to extend the closing deadline for the transaction to March 15, 2019.
Overall, the Company expects retention levels (the amount of expiring premium that renews, before the impact of renewal premium changes) will remain strong by historical standards during 2019. In Business Insurance, the Company expects that domestic renewal premium changes in 2019 will remain positive and will be broadly consistent with the levels attained in 2018. In Bond & Specialty Insurance, the Company expects that renewal premium changes with respect to domestic management liability business during 2019 will remain positive and will be broadly consistent with the levels attained in 2018. With respect to domestic surety business within Bond & Specialty Insurance, the Company expects that net written premium volume during 2019 will be slightly higher than the levels attained in 2018. In Personal Insurance, the Company expects that domestic Agency Automobile renewal premium changes during 2019 will remain positive but will be lower than the levels attained in 2018. The Company expects that domestic Agency Homeowners and Other renewal premium changes during 2019 will remain positive and will be higher than the levels attained in 2018. The need for state regulatory approval for changes to personal and many commercial property and casualty insurance prices, as well as competitive market conditions, may impact the timing and extent of renewal premium changes. Given the relatively smaller amount of premium that the Company generates from outside the United States and the transactional nature of some of those markets, particularly Lloyd’s, international renewal premium changes in each segment during 2019 could be somewhat higher, broadly consistent with or somewhat lower than the levels attained in 2018.
Property and casualty insurance market conditions are expected to remain competitive during the next twelve months for new business. In each of the Company’s business segments, new business generally has less of an impact on underwriting profitability than renewal business, given the volume of new business relative to renewal business. However, in periods of meaningful increases in new business, despite its positive impact on underwriting gains over time, the impact of higher new business levels may negatively impact the combined ratio for a period of time.
Economic conditions in the United States and elsewhere could change, due to a variety of factors, including the political and regulatory environment, changes to fiscal stimulus programs, inflation or deflation (including the impact of rapid changes in wages and/or commodity prices), the imposition of tariffs or other barriers to international trade, fluctuations in interest rates and foreign currency exchange rates, high levels of global debt after an extended period of low interest rates, the United Kingdom’s withdrawal
For a number of years, the Company’s results have included significant amounts of net favorable prior year reserve development driven by better than expected loss experience. However, given the inherent uncertainty in estimating claims and claim adjustment expense reserves, loss experience could develop such that the Company recognizes higher or lower levels of favorable prior year reserve development, no favorable prior year reserve development or unfavorable prior year reserve development in future periods. In addition, the ongoing review of prior year claims and claim adjustment expense reserves, or other changes in current period circumstances, may result in the Company revising current year loss estimates upward or downward in future periods of the current year.
In Personal Insurance, the Company expects underlying underwriting margins during 2019 in aggregate will be slightly higher than in 2018, and the underlying combined ratio during 2019 in aggregate will be broadly consistent with 2018. In Agency Automobile, the Company expects underlying underwriting margins and the underlying combined ratio during 2019 in aggregate will be broadly consistent with 2018. In the first half of 2019, the Company expects Agency Automobile underlying underwriting margins will be higher and the underlying combined ratio will be lower than in the same period of 2018. In the second half of 2019, the Company expects Agency Automobile underlying underwriting margins will be lower and the underlying combined ratio will be higher than in the same period of 2018. In Agency Homeowners and Other, the Company expects underlying underwriting margins during 2019 in aggregate will be slightly higher than in 2018, and the underlying combined ratio during 2019 in aggregate will be broadly consistent with 2018, assuming non-catastrophe weather-related losses and non-weather related losses return to lower and more normal levels. In the first half of 2019, the Company expects Agency Homeowners and Other underlying underwriting margins will be lower and the underlying combined ratio will be higher than in the same period of 2018. In the second half of 2019, the Company expects Agency Homeowners and Other underlying underwriting margins will be higher and the underlying combined ratio will be lower than in the same period of 2018.
The Company had a net pre-tax unrealized investment loss of $137 million ($113 million after-tax) in its fixed maturity investment portfolio at December 31, 2018. While the Company does not attempt to predict future interest rate movements, a rising interest rate environment would reduce the market value of fixed maturity investments and, therefore, reduce shareholders’ equity, and a declining interest rate environment would have the opposite effects. The Company’s investment portfolio has benefited from certain tax exemptions (primarily those related to interest from municipal bonds) and certain other tax laws, including, but not limited to, those governing dividends-received deductions and tax credits (such as foreign tax credits). Changes in these laws could adversely impact the value of the Company’s investment portfolio. See “Changes in U.S. tax laws or in the tax laws of other jurisdictions in which we operate could adversely impact us” included in “Part I-Item 1A - Risk Factors.”
Statement of Cash Flows for the years ended December 31, 2018, 2017 and 2016
We have audited the accompanying consolidated balance sheet of The Travelers Companies, Inc. and subsidiaries (the Company) as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2018, and the related notes and financial statement schedules as listed in the accompanying index to consolidated financial statements and schedules (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements 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 years in the three-year period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), 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, and our report dated February 14, 2019 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
The consolidated financial statements include the accounts of The Travelers Companies, Inc. (together with its subsidiaries, the Company). The preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and claims and expenses during the reporting period. Actual results could differ from those estimates. Certain reclassifications have been made to the 2017 and 2016 financial statements to conform to the 2018 presentation. All material intercompany transactions and balances have been eliminated.
In January 2016, the Financial Accounting Standards Board (FASB) issued updated guidance to address the recognition, measurement, presentation and disclosure of certain financial instruments. The updated guidance requires equity investments, except those accounted for under the equity method of accounting, that have readily determinable fair value to be measured at fair value with any changes in fair value recognized in net income. Equity securities that do not have readily determinable fair values may be measured at estimated fair value or cost less impairment, if any, adjusted for subsequent observable price changes, with changes in the carrying value recognized in net income. A qualitative assessment for impairment is required for equity investments without readily determinable fair values. The updated guidance also eliminates the requirement to disclose the method and significant assumptions used to estimate the fair value of financial instruments measured at amortized cost on the balance sheet. The updated guidance was effective for the quarter ended March 31, 2018. The adoption of this guidance resulted in the recognition of $22 million of net after-tax unrealized gains on equity investments as a cumulative effect adjustment that increased retained earnings as of January 1, 2018 and decreased accumulated other comprehensive income (AOCI) by the same amount. The Company elected to report changes in the fair value of equity investments in net realized investment gains (losses). At December 31, 2017, equity investments were classified as available-for-sale on the Company's balance sheet. However, upon adoption, the updated guidance eliminated the available-for-sale balance sheet classification for equity investments.
Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments
In August 2016, the FASB issued updated guidance on the classification of cash flows related to certain activities in the statement of cash flows to reduce diversity in practice. The updated guidance was effective for reporting periods beginning after December 15, 2017 and was applied retrospectively to all periods presented. Under the new guidance, distributions received on equity method investments that are considered to be a return on investment are reported as cash flows from operating activities. These distributions were previously reported as cash flows from investing activities. The adoption of this guidance did not have an effect on the Company’s results of operations, financial position or liquidity.
In February 2016, the FASB issued updated guidance to require lessees to recognize a right-of-use asset and a lease liability for leases with terms of more than 12 months. The updated guidance retains the two classifications of a lease as either an operating or finance lease (previously referred to as a capital lease). Both lease classifications require the lessee to record the right-of-use asset and the lease liability based upon the present value of cash flows. Finance leases will reflect the financial arrangement by recognizing interest expense on the lease liability separately from the amortization expense of the right-of-use asset. Operating leases will recognize lease expense (with no separate recognition of interest expense) on a straight-line basis over the term of the lease. The accounting by lessors is not significantly changed by the updated guidance. The updated guidance requires expanded qualitative and quantitative disclosures, including additional information about the amounts recorded in the financial statements.
In July 2018, the FASB amended the updated guidance on leases that was issued in February 2016 and provided an additional transition method with which to adopt the updated guidance. Under the additional transition method, entities may elect to recognize a cumulative-effect adjustment to the opening balance of retained earnings in the year of adoption. Consequently, if this transition
method is elected, an entity’s reporting for the comparative periods prior to adoption presented in the financial statements would continue to be in accordance with current lease guidance. The amendments also provide lessors with a practical expedient to combine nonlease components (e.g., a fee for common area maintenance when leasing office space) with the associated lease component rather than accounting for those components separately if certain criteria are met. The updated guidance requires entities to recognize a right-of-use asset and lease liability equal to the present value of lease payments for all leases other than those that are less than one year.
The updated guidance, as amended, is effective for reporting periods beginning after December 15, 2018. The Company plans to adopt the updated guidance effective January 1, 2019 using the additional transition method described above. The adoption of the updated guidance will result in the recognition of a right-of-use asset and a lease liability of the same amount, which will be less than 1% of total assets and total liabilities, and is not expected to have a material effect on the Company’s results of operations, financial position or liquidity.
The updated guidance is effective for reporting periods beginning after December 15, 2019 and is to be applied prospectively. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The adoption of this guidance is not expected to have a material effect on the Company’s results of operations, financial position or liquidity.
In August 2018, the FASB issued updated guidance to align the accounting for implementation costs incurred in a software hosting arrangement (i.e., a cloud computing arrangement) that is a service contract with the guidance for capitalizing implementation costs incurred to develop or obtain internal-use software. Accordingly, the updated guidance requires an entity to determine the stage of a project that the implementation activity relates to and the nature of the associated costs in order to determine whether those costs should be expensed as incurred or capitalized. The updated guidance also requires the entity to amortize the capitalized implementation costs as an expense over the term of the hosting arrangement.
The updated guidance is effective for reporting periods beginning after December 15, 2019. Early adoption is permitted. The Company plans to early adopt the updated guidance effective January 1, 2019 using the prospective method of adoption. The adoption of the updated guidance is not expected to have a material effect on the Company’s results of operations, financial position or liquidity.
The Company’s real estate investments include warehouses, office buildings and other commercial land and properties that are directly owned. Real estate is recorded on the purchase date at the purchase price, which generally represents fair value, and is supported by internal analysis or external appraisals that use discounted cash flow analyses and other acceptable valuation techniques. Real estate held for investment purposes is subsequently carried at cost less accumulated depreciation.
For fixed maturities where the Company records an other-than-temporary impairment, a determination is made as to the cause of the impairment and whether the Company expects a recovery in the value. For fixed maturities where the Company expects a recovery in value, not necessarily to par, the constant effective yield method is utilized, and the investment is amortized to the expected recovery amount.
investment prior to an anticipated recovery in value; and (5) the length of time and extent to which the fair value has been less than amortized cost.
For fixed maturity investments that the Company does not intend to sell or for which it is more likely than not that the Company would not be required to sell before an anticipated recovery in value, the Company separates the credit loss component of the impairment from the amount related to all other factors and reports the credit loss component in net realized investment gains (losses). The impairment related to all other factors is reported in other comprehensive income.
Amounts recoverable from reinsurers are estimated in a manner consistent with the associated claim liability. The Company reports its reinsurance recoverables net of an allowance for estimated uncollectible reinsurance recoverables. The allowance is based upon the Company’s ongoing review of amounts outstanding, length of collection periods, changes in reinsurer credit standing, disputes, applicable coverage defenses and other relevant factors. Amounts deemed to be uncollectible, including amounts due from known insolvent reinsurers, are written off against the allowance for estimated uncollectible reinsurance recoverables. Any subsequent collections of amounts previously written off are reported as part of claims and claim adjustment expenses. The Company evaluates and monitors the financial condition of its reinsurers under voluntary reinsurance arrangements to minimize its exposure to significant losses from reinsurer insolvencies.
Incremental direct costs of acquired, new and renewal insurance contracts, consisting of commissions (other than contingent commissions) and premium-related taxes, are capitalized and charged to expense pro rata over the contract periods in which the related premiums are earned. Deferred acquisition costs are reviewed to determine if they are recoverable from future income
and, if not, are charged to expense. Future investment income attributable to related premiums is taken into account in measuring the recoverability of the carrying value of this asset. All other acquisition expenses are charged to operations as incurred.
Under certain workers’ compensation insurance contracts with deductible features, the Company is obligated to pay the claimant for the full amount of the claim. The Company is subsequently reimbursed by the policyholder for the deductible amount. These amounts are included on a gross basis in the consolidated balance sheet in contractholder payables and contractholder receivables, respectively.
Included in other liabilities in the consolidated balance sheet is the Company’s estimate of its liability for guaranty fund and other insurance-related assessments. The liability for expected state guaranty fund and other premium-based assessments is recognized as the Company writes or becomes obligated to write or renew the premiums on which the assessments are expected to be based. The liability for loss-based assessments is recognized as the related losses are incurred. At December 31, 2018 and 2017, the Company had a liability of $217 million and $231 million, respectively, for guaranty fund and other insurance-related assessments and related recoverables of $16 million at both dates. The liability for such assessments and the related recoverables are not discounted for the time value of money. The loss-based assessments are expected to be paid over a period ranging from one year to the life expectancy of certain workers’ compensation claimants and the recoveries are expected to occur over the same period of time.
The Company assigns functional currencies to its foreign operations, which are generally the currencies of the local operating environment. Foreign currency amounts are remeasured to the functional currency, and the resulting foreign exchange gains or losses are reflected in earnings. Functional currency amounts are then translated into U.S. dollars. The foreign currency remeasurement and translation are calculated using current exchange rates for items reported in the balance sheets and average exchange rates for items recorded in earnings. The change in unrealized foreign currency translation gain or loss during the year, net of tax, is a component of other comprehensive income.
Middle Market provides mid-sized businesses with property and casualty insurance products and services, including workers’ compensation, general liability, commercial multi-peril, commercial automobile and commercial property, as well as risk management, claims handling and other services. Middle Market generally provides these products to mid-sized businesses through Commercial Accounts, as well as to targeted industries through Construction, Technology, Public Sector Services and Oil & Gas, and additionally, provides mono-line umbrella and excess coverage insurance through Excess Casualty. Middle Market also provides insurance for goods in transit and movable objects, as well as builders’ risk insurance, through Inland Marine; insurance for the marine transportation industry and related services, as well as other businesses involved in international trade, through Ocean Marine; and comprehensive breakdown for equipment, including property and business interruption, through Boiler & Machinery.
National Accounts provides large companies with casualty insurance products and services, including workers’ compensation, commercial automobile and general liability, generally utilizing loss-sensitive products, on both a bundled and unbundled basis. National Accounts also includes the Company’s commercial residual market business, which primarily offers workers’ compensation services to the involuntary market.
National Property and Other provides traditional and customized commercial property insurance programs to large and mid-sized customers through National Property. National Property and Other also provides insurance coverage for the commercial transportation industry through Northland Transportation, general liability and commercial property policies for small, difficult to place specialty classes of commercial business primarily on an excess and surplus lines basis through Northfield, and tailored property and casualty insurance programs on an admitted basis for customers with common risk characteristics or coverage requirements through National Programs. National Property and Other also serves small to medium-sized agricultural businesses, including farms, ranches, wineries and related operations, through Agribusiness.
Business Insurance also includes Simply Business, a leading provider of small business insurance policies primarily in the United Kingdom that was acquired in August 2017, as well as Business Insurance Other, which primarily comprises the Company’s asbestos and environmental liabilities, and the assumed reinsurance and certain other runoff operations.
Bond & Specialty Insurance surety business in Brazil and Colombia is conducted through Junto Holding Brasil S.A. (Junto) and Junto Holding Latam S.A. in Brazil. The Company owns 49.5% of both Junto, a market leader in surety coverages in Brazil, and Junto Holding Latam S.A., which owns a majority interest in JMalucelli Travelers Seguros S.A., a Colombian start-up surety provider. These joint venture investments are accounted for using the equity method and are included in “other investments” on the consolidated balance sheet.
The primary components of other assets at December 31, 2018 were accrued over-funded benefit plan assets related to the Company's qualified domestic pension plan and other intangible assets. The primary components of other assets at December 31, 2017 were accrued over-funded benefit plan assets related to the Company's qualified domestic pension plan, other intangible assets and deferred taxes.
The amortized cost and fair value of fixed maturities by contractual maturity follow. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
The Company’s fixed maturity investment portfolio at December 31, 2018 and 2017 included $2.57 billion and $2.41 billion, respectively, of residential mortgage-backed securities, which include pass-through securities and collateralized mortgage obligations (CMOs). Included in the totals at December 31, 2018 and 2017 were $859 million and $804 million, respectively, of GNMA, FNMA, FHLMC (excluding FHA project loans) and Canadian government guaranteed residential mortgage-backed pass-through securities classified as available for sale. Also included in those totals were residential CMOs classified as available for sale with a fair value of $1.71 billion and $1.61 billion at December 31, 2018 and 2017, respectively. Approximately 52% and 55% of the Company’s CMO holdings at December 31, 2018 and 2017, respectively, were guaranteed by or fully collateralized by securities issued by GNMA, FNMA or FHLMC. The weighted average credit rating of the $828 million and $717 million of non-guaranteed CMO holdings at December 31, 2018 and 2017, respectively, was “Aa1” and “A1,” respectively. The weighted average credit rating of all of the above securities was “Aaa/Aa1” and “Aa1” at December 31, 2018 and 2017, respectively.
Proceeds from sales of fixed maturities classified as available for sale were $3.55 billion, $1.85 billion and $1.42 billion in 2018, 2017 and 2016, respectively. Gross gains of $51 million, $42 million and $79 million and gross losses of $18 million, $38 million and $20 million were realized on those sales in 2018, 2017 and 2016, respectively.
Proceeds from the sale of real estate investments were $74 million, $23 million and $69 million in 2018, 2017 and 2016, respectively. Gross gains of $23 million, $10 million and $7 million were realized on those sales in 2018, 2017 and 2016, respectively, and there were no gross losses. Accumulated depreciation on real estate held for investment purposes was $383 million and $364 million at December 31, 2018 and 2017, respectively.
The following tables summarize, for all investments in an unrealized loss position at December 31, 2018 and 2017, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position. The fair value amounts reported in the tables are estimates that are prepared using the process described in note 4. The Company also relies upon estimates of several factors in its review and evaluation of individual investments, using the process described in note 1, in determining whether such investments are other-than-temporarily impaired.
At December 31, 2018 and 2017, other than U.S. Treasury securities and obligations of U.S. government and government agencies and authorities, the Company was not exposed to any concentration of credit risk of a single issuer greater than 5% of the Company’s shareholders’ equity.
Included in fixed maturities are below investment grade securities totaling $1.48 billion and $1.67 billion at December 31, 2018 and 2017, respectively. The Company defines its below investment grade securities as those securities rated below investment grade by external rating agencies, or the equivalent by the Company when a public rating does not exist. Such securities include below investment grade bonds that are publicly traded and certain other privately issued bonds that are classified as below investment grade loans.
From time to time, the Company enters into U.S. Treasury note futures contracts to modify the effective duration of specific assets within the investment portfolio. U.S. Treasury futures contracts require a daily mark-to-market and settlement with the broker. At December 31, 2018 and 2017, the Company had $0 and $400 million notional value of open U.S. Treasury futures contracts, respectively. Net realized investment gains and losses related to U.S. Treasury futures contracts in 2018, 2017 and 2016 were not significant.
The Company also holds certain fixed maturity investments which are not priced by the pricing service and, accordingly, estimates the fair value of such fixed maturities using an internal matrix that is based on market information regarding interest rates, credit spreads and liquidity. The underlying source data for calculating the matrix of credit spreads relative to the U.S. Treasury curve are observable market-based indices that relate to corporate and high-yield fixed maturity investments. The Company includes the fair value estimates of these corporate bonds in Level 2, since all significant inputs are market observable.
While the vast majority of the Company’s fixed maturities are included in Level 2, the Company holds a number of municipal bonds and corporate bonds which are not valued by the pricing service and also estimates the fair value of these bonds using another internal pricing matrix that includes some unobservable inputs that are significant to the valuation. Due to the limited amount of observable market information, the Company includes the fair value estimates for these particular bonds in Level 3. The fair value of the fixed maturities for which the Company used this internal pricing matrix was $82 million and $127 million at December 31, 2018 and 2017, respectively. Additionally, the Company holds a small amount of other fixed maturity investments that have characteristics that make them unsuitable for matrix pricing. For these fixed maturities, the Company obtains a quote from a broker (primarily the market maker). The fair value of the fixed maturities for which the Company received a broker quote was $104 million and $77 million at December 31, 2018 and 2017, respectively. Due to the disclaimers on the quotes that indicate that the price is indicative only, the Company includes these fair value estimates in Level 3.
For public common stock and non-redeemable preferred stocks, the Company receives prices from pricing services that are based on observable market transactions and includes these estimates in the amount disclosed in Level 1. When current market quotes in active markets are unavailable for certain non-redeemable preferred stocks held by the Company, the Company receives an estimate of fair value from the pricing services. The services utilize similar methodologies to price the non-redeemable preferred stocks as they do for the fixed maturities. The Company includes the fair value estimate for these non-redeemable preferred stocks in the amount disclosed in Level 2.
The Company holds investments in various publicly-traded securities which are reported in other investments. These investments include mutual funds and other small holdings. The $16 million and $19 million fair value of these investments at December 31, 2018 and 2017, respectively, was disclosed in Level 1. At December 31, 2018 and 2017, the Company held investments in non-public common and preferred equity securities, with fair value estimates of $36 million and $38 million, respectively, reported in other investments, where the fair value estimate is determined either internally or by an external fund manager based on recent
The Company also includes in Level 3 the put/call option entered into in connection with a business combination that is reported in other liabilities and had a fair value of $10 million at December 31, 2018.
The Company’s consolidated financial statements reflect the effects of assumed and ceded reinsurance transactions. Assumed reinsurance refers to the acceptance of certain insurance risks that other insurance companies have underwritten. Ceded reinsurance involves transferring certain insurance risks (along with the related written and earned premiums) the Company has underwritten
In order for a loss to be covered under the program (subject losses), the loss must meet certain aggregate industry loss minimums and must be the result of an event that is certified as an act of terrorism by the U.S. Secretary of the Treasury, in consultation with the Secretary of Homeland Security and the Attorney General of the United States. The annual aggregate industry loss minimum under the program is $180 million for 2019 and will increase to $200 million for 2020. The program excludes from participation the following types of insurance: Federal crop insurance, private mortgage insurance, financial guaranty insurance, medical malpractice insurance, health or life insurance, flood insurance, reinsurance, commercial automobile, professional liability (other than directors' and officers’), surety, burglary and theft, and farm-owners multi-peril. In the case of a war declared by Congress, only workers’ compensation losses are covered by the program. All commercial property and casualty insurers licensed in the United States are generally required to participate in the program. Under the program, a participating insurer, in exchange for making terrorism insurance available, is entitled to be reimbursed by the Federal Government for 81% of subject losses in 2019, after an insurer deductible, subject to an annual cap. This reimbursement percentage will decrease to 80% of subject losses in 2020.
The deductible for any calendar year is equal to 20% of the insurer’s direct earned premiums for covered lines for the preceding calendar year. The Company’s estimated deductible under the program is $2.52 billion for 2019. The annual cap limits the amount of aggregate subject losses for all participating insurers to $100 billion. Once subject losses have reached the $100 billion aggregate during a program year, participating insurers will not be liable under the program for additional covered terrorism losses for that program year. There have been no terrorism-related losses that have triggered program coverage since the program was established. Since the law is untested, there is substantial uncertainty as to how it will be applied if an act of terrorism is certified under the program. It is also possible that future legislative action could change or eliminate the program. Further, given the unpredictable frequency and severity of terrorism losses, as well as the limited terrorism coverage in the Company’s own reinsurance program, future losses from acts of terrorism, particularly involving nuclear, biological, chemical or radiological events, could be material to the Company’s operating results, financial position and/or liquidity in future periods. In addition, the Company may not have sufficient resources to respond to claims arising from a high frequency of high severity natural catastrophes and/or of man-made catastrophic events involving conventional means. While the Company seeks to manage its exposure to man-made catastrophic events involving conventional means, the Company may not have sufficient resources to respond to claims arising out of one or more man-made catastrophic events involving nuclear, biological, chemical or radiological means.
(1) Goodwill at December 31, 2018 included $26 million associated with a business acquisition in 2018, none of which will be deductible for tax purposes.
billion, at December 31, 2018 and 2017, respectively. Accretion of the discount is reported as part of “claims and claim adjustment expenses” in the consolidated statement of income and was $49 million, $50 million and $50 million in 2018, 2017 and 2016, respectively.
Personal Insurance. Net favorable prior year reserve development in 2017 was not significant and totaled $13 million.
In 2016, estimated claims and claim adjustment expenses incurred included $680 million of net favorable development for claims arising in prior years, including $771 million of net favorable prior year reserve development and $50 million of accretion of discount that impacted the Company's results of operations.
Business Insurance. Net favorable prior year reserve development in 2016 totaled $424 million, primarily driven by better than expected loss experience in the Company’s domestic operations in (i) the workers’ compensation product line for multiple accident years and (ii) the general liability product line (excluding an increase to asbestos and environmental reserves), related to both primary and excess coverages for multiple accident years, partially offset by (iii) a $225 million increase to asbestos reserves and (iv) a $82 million increase to environmental reserves, as well as net favorable prior year reserve development in the segment's international operations in Europe.
The following is a summary of claims and claim adjustment expense reserves, including certain components, for the Company’s major product lines by reporting segment at December 31, 2018.
Net discount amount includes discount of $70 million on reinsurance recoverables for long-term disability and annuity claim payments.
Primarily includes residual market, international (other than operations in Canada within the Personal Insurance segment) and runoff assumed reinsurance business.
The paid loss development method assumes that the future change (positive or negative) in cumulative paid losses for a given cohort of claims will occur in a stable, predictable pattern from year-to-year, consistent with the pattern observed in past cohorts.
The Bornhuetter-Ferguson method uses an initial estimate of ultimate losses for a given product line reserve component, typically expressed as a ratio to earned premium. The method assumes that the ratio of additional claim activity to earned premium for that component is relatively stable and predictable over time and that actual claim activity to date is not a credible predictor of further activity for that component. The method is used most often for more recent accident years where claim data is sparse and/or volatile, with a transition to other methods as the underlying claim data becomes more voluminous and therefore more credible.
At December 31, 2018 and 2017, the Company’s claims and claim adjustment expense reserves included $1.62 billion and $1.64 billion, respectively, for asbestos and environmental-related claims, net of reinsurance.
In the third quarter of 2018, the Company completed its annual in-depth asbestos claim review, including a review of active policyholders and litigation cases for potential product and “non-product” liability, and noted the continuation of the following trends:
In the home office and field office category, which accounts for the vast majority of policyholders with active asbestos-related claims, the number of policyholders tendering asbestos claims for the first time, the number of policyholders with open asbestos claims and net asbestos-related payments declined slightly when compared to 2017. Payments on behalf of policyholders in this category continue to be influenced by a high level of litigation activity in a limited number of jurisdictions where individuals alleging serious asbestos-related injury, primarily mesothelioma, continue to target defendants who were not traditionally primary targets of asbestos litigation.
Asbestos and Environmental Reserves. As a result of the processes and procedures discussed above, management believes that the reserves carried for asbestos and environmental claims are appropriately established based upon known facts, current law and management’s judgment. However, the uncertainties surrounding the final resolution of these claims continue, and it is difficult to determine the ultimate exposure for asbestos and environmental claims and related litigation. As a result, these reserves are subject to revision as new information becomes available and as claims develop. Changes in the legal, regulatory and legislative environment may impact the future resolution of asbestos and environmental claims and result in adverse loss reserve development. The emergence of a greater number of asbestos or environmental claims beyond that which is anticipated may result in adverse loss reserve development. Changes in applicable legislation and future court and regulatory decisions and interpretations, including the outcome of legal challenges to legislative and/or judicial reforms establishing medical criteria for the pursuit of asbestos claims, could affect the settlement of asbestos and environmental claims. It is also difficult to predict the ultimate outcome of complex coverage disputes until settlement negotiations near completion and significant legal questions are resolved or, failing settlement, until the dispute is adjudicated. This is particularly the case with policyholders in bankruptcy where negotiations often involve a large number of claimants and other parties and require court approval to be effective. As part of its continuing analysis of asbestos and environmental reserves, the Company continues to study the implications of these and other developments.
The Company has geographic exposure to catastrophe losses, which can be caused by a variety of events, including, among others, hurricanes, tornadoes and other windstorms, earthquakes, hail, wildfires, severe winter weather, floods, tsunamis, volcanic eruptions and other naturally-occurring events, such as solar flares. Catastrophes can also result from terrorist attacks and other intentionally destructive acts including those involving nuclear, biological, chemical and radiological events, cyber events, explosions and destruction of infrastructure. The incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophes are restricted to small geographic areas; however, hurricanes, earthquakes and wildfires may produce significant damage in larger areas, especially those that are heavily populated. The Company generally seeks to mitigate its exposure to catastrophes through individual risk selection and the purchase of catastrophe reinsurance.
2016 Debt Issuance. On May 11, 2016, the Company issued $500 million aggregate principal amount of 3.75% senior notes that will mature on May 15, 2046. The net proceeds of the issuance, after the deduction of underwriting and other expenses, totaled approximately $491 million. Interest on the senior notes is payable semi-annually in arrears on May 15 and November 15. Prior to November 15, 2045, the senior notes may be redeemed, in whole or in part, at the Company’s option, at any time or from time to time, at a redemption price equal to the greater of (a) 100% of the principal amount of any senior notes to be redeemed or (b) the sum of the present values of the remaining scheduled payments of principal and interest on any senior notes to be redeemed (exclusive of interest accrued to the date of redemption) discounted to the date of redemption on a semi-annual basis (assuming a 360-day year consisting of twelve 30-day months) at the then current Treasury Rate (as defined in the senior notes), plus 20 basis points. On or after November 15, 2045, the senior notes may be redeemed, in whole or in part, at the Company’s option, at any time or from time to time, at a redemption price equal to 100% of the principal amount of any senior notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date.
Junior Subordinated Debentures-The Company’s three junior subordinated debenture instruments are all similar in nature to each other. Three separate business trusts issued preferred securities to investors and used the proceeds to purchase the Company’s junior subordinated debentures. Interest on each of the instruments is paid semi-annually.
The Company’s Board of Directors has approved common share repurchase authorizations under which repurchases may be made from time to time in the open market, pursuant to pre-set trading plans meeting the requirements of Rule 10b5-1 under the Securities Exchange Act of 1934, in private transactions or otherwise. The authorizations do not have a stated expiration date. The timing and actual number of shares to be repurchased in the future will depend on a variety of factors, including the Company’s financial position, earnings, share price, catastrophe losses, maintaining capital levels commensurate with the Company’s desired ratings from independent rating agencies, funding of the Company’s qualified pension plan, capital requirements of the Company’s operating subsidiaries, legal requirements, regulatory constraints, other investment opportunities (including mergers and acquisitions and related financings), market conditions and other factors. In April 2017, the Board of Directors approved a share repurchase authorization that added an additional $5.0 billion of repurchase capacity. The following table summarizes repurchase activity in 2018 and remaining repurchase capacity at December 31, 2018.
The Company’s Amended and Restated 2004 Stock Incentive Plan and the Amended and Restated 2014 Stock Incentive Plan provide settlement alternatives to employees in which the Company retains shares to cover payroll withholding taxes in connection with the vesting of restricted stock unit awards and performance share awards, and to cover the price of certain stock options that were exercised. During the years ended December 31, 2018 and 2017, the Company acquired $51 million and $62 million, respectively, of its common stock under these plans.
The Company’s U.S. insurance subsidiaries, domiciled principally in the State of Connecticut, are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid by each insurance subsidiary to its respective parent company without prior approval of insurance regulatory authorities. A maximum of $2.52 billion is available by the end of 2019 for such dividends to the holding company, TRV, without prior approval of the Connecticut Insurance Department. The Company may choose to accelerate the timing within 2019 and/or increase the amount of dividends from its insurance subsidiaries in 2019, which could result in certain dividends being subject to approval by the Connecticut Insurance Department.
TRV is not dependent on dividends or other forms of repatriation from its foreign operations to support its liquidity needs. The undistributed earnings of the Company’s foreign operations are intended to be permanently reinvested in those operations, and such earnings were not material to the Company's financial position or liquidity at December 31, 2018.
On December 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act of 2017 (TCJA) which, among other changes, reduced the U.S. federal tax rate from 35% to 21% beginning on January 1, 2018 and imposed a tax on undistributed and previously untaxed post-1986 foreign earnings and profits (accumulated foreign earnings). Total income tax expense for 2017 included a net charge of $129 million to reflect the estimated impacts of the changes in tax laws and tax rates included in TCJA at the date of enactment, primarily reflecting the revaluation of the Company's deferred tax assets and liabilities at the new statutory federal tax rate of 21%, and the recognition of tax imposed on accumulated foreign earnings. The estimated effects of enactment of TCJA were reflected in the Company's net deferred tax asset and current income tax receivable reported on the Company’s consolidated balance sheet at December 31, 2017.
In computing taxable income, property and casualty insurers reduce underwriting income by claims and claim adjustment expenses incurred. The deduction for claims incurred is discounted at the interest rates and for the claim payment patterns prescribed by the U.S. Treasury. TCJA changed the prescribed interest rates to rates based on corporate bond yield curves and extended the applicable time periods for the claim payment pattern. These changes were effective for tax years beginning after 2017 and are subject to a transition rule that spreads the additional tax payment from the amount determined by applying these changes over the subsequent eight years beginning in 2018. This item is a taxable temporary difference and had no direct impact on total tax expense for 2017 and will not directly impact total tax expense in future years. The required additional tax payments are currently estimated to approximate $23 million per year over the eight-year period through 2025 and will result in a modest reduction in net investment income over that period.
If the Company determines that any of its deferred tax assets will not result in future tax benefits, a valuation allowance must be established for the portion of these assets that are not expected to be realized. The net change in the valuation allowance for deferred tax assets was an increase of $2 million in 2018 relating to the Company’s consolidated Brazilian subsidiary. Based upon a review of the Company’s anticipated future taxable income, and also including all other available evidence, both positive and negative, the Company’s management concluded that it is more likely than not that the net deferred tax assets will be realized.
For tax return purposes, as of December 31, 2018, the Company had net operating loss (NOL) carryforwards in the United States, Brazil, Canada and the United Kingdom. The amount and timing of realizing the benefits of NOL carryforwards depend on future taxable income and limitations imposed by tax laws. Only the benefits of the United Kingdom NOL carryforwards have been recognized in the consolidated financial statements and are included in net deferred tax assets. The NOL amounts by jurisdiction and year of expiration are as follows:
The Company recognized $41 million of tax expense resulting from deemed repatriation of foreign earnings as part of the net charge of $129 million to record the effect of TCJA at enactment during December 2017. These undistributed foreign earnings are intended to be permanently reinvested in those operations.
Stock option awards granted to eligible officers and key employees have a ten-year term. All stock options are granted with an exercise price equal to the closing price of the Company’s common stock on the date of grant. The stock options granted generally vest upon meeting certain years of service criteria. Except as the Compensation Committee of the Board of Directors may allow in the future, stock options cannot be sold or transferred by the participant. Stock options outstanding under the 2014 Incentive Plan and the 2004 Incentive Plan generally vest three years after grant date (cliff vest).
The Company also has a Performance Share Awards Program established pursuant to the 2004 Incentive Plan and which continues pursuant to the 2014 Incentive Plan. Under the program, the Company may issue performance share awards to certain employees of the Company who hold positions of Vice President (or its equivalent) or above. The performance share awards provide the recipient the right to earn shares of the Company’s common stock based upon the Company’s attainment of certain performance goals and the recipient meeting certain years of service criteria. The performance goals for performance share awards are based on the Company’s adjusted return on equity over a three-year performance period. Vesting of performance shares is contingent upon the Company attaining the relevant performance period minimum threshold return on equity and the recipient meeting certain
years of service criteria, generally three years for full vesting, subject to proration for certain termination conditions. If the performance period return on equity is below the minimum threshold, none of the performance shares will vest. If performance meets or exceeds the minimum performance threshold, a range of performance shares will vest (50% to 150% for awards granted in 2017, 2018 and 2019), depending on the actual return on equity attained.
The fair value of restricted stock units, deferred stock units and performance shares is measured at the market price of the Company stock at date of grant. Under terms of the 2014 Incentive Plan, holders of deferred stock units and performance shares may receive dividend equivalents.
A summary of restricted stock units, deferred stock units and performance share activity under the 2014 Incentive Plan and the legacy plans as of and for the year ended December 31, 2018 is as follows:
95,953 shares of restricted common stock were also issued outside of the 2014 Incentive Plan in 2017 in connection with the acquisition of Simply Business, of which 92,995 shares remain unvested and are not included in this table. See note 9.
In addition to the nonvested shares presented in the above table, there are related nonvested dividend equivalent shares. The number of nonvested dividend equivalent shares related to deferred stock units was 379 at the beginning of the year and 329 at the end of the year and the number of nonvested dividend equivalent shares related to performance shares was 26,584 at the beginning of the year and 24,876 at the end of the year. The dividend equivalent shares are subject to the same vesting terms as the deferred stock units and performance shares.
On February 5, 2019, the Company, under the 2014 Incentive Plan, granted 929,391 common stock awards in the form of restricted stock units, deferred stock units and performance share awards to participating officers, non-employee directors and other key employees. The restricted stock units and deferred stock units totaled 557,637 shares while the performance share awards totaled 371,754 shares. The fair value per share attributable to the common stock awards on the date of grant was $126.18.
The amount of compensation cost for awards subject to a service condition is based on the number of shares expected to be issued and is recognized over the time period for which service is to be provided (requisite service period). Awards granted to retiree-eligible employees or to employees who become retiree-eligible before an award’s vesting date are considered to have met the requisite service condition. The compensation cost for awards subject to a performance condition is based upon the probable outcome of the performance condition, which on the grant date reflects an estimate of attaining 100% of the performance shares granted. The compensation cost reflects an estimated annual forfeiture rate from 3.5% to 4.5% over the requisite service period of the awards. That estimate is revised if subsequent information indicates that the actual number of instruments expected to vest is likely to differ from previous estimates. Compensation costs for awards are recognized on a straight-line basis over the requisite service period. For awards that have graded vesting terms, the compensation cost is recognized on a straight-line basis over the requisite service period for each separate vesting portion of the award as if the award was, in substance, multiple awards. The total compensation cost for all share-based incentive compensation awards recognized in earnings for the years ended December 31, 2018, 2017 and 2016 was $140 million, $136 million and $155 million, respectively. Included in these amounts are compensation cost adjustments of $3 million, $3 million and $11 million, for the years ended December 31, 2018, 2017 and 2016, respectively, that reflected the cost associated with the updated estimate of performance shares due to attaining certain performance levels from the date of the initial grant of the performance awards. The related tax benefits recognized in earnings were $26 million, $45 million and $52 million for the years ended December 31, 2018, 2017 and 2016, respectively.
At December 31, 2018, there was $141 million of total unrecognized compensation cost related to all nonvested share-based incentive compensation awards. This includes stock options, restricted and deferred stock units and performance shares granted under the 2014 Incentive Plan and restricted common stock issued in connection with a 2017 business acquisition. The unrecognized compensation cost is expected to be recognized over a weighted-average period of 1.8 years. Cash received from the exercise of employee stock options under share-based compensation plans totaled $132 million and $173 million in 2018 and 2017, respectively. The tax benefit for tax deductions from employee stock options exercised during 2018 and 2017 totaled $14 million and $31 million, respectively.
The total accumulated benefit obligation for the Company’s defined benefit pension plans was $3.53 billion and $3.77 billion at December 31, 2018 and 2017, respectively. The qualified domestic pension plan accounted for $3.32 billion and $3.55 billion of the total accumulated benefit obligation at December 31, 2018 and 2017, respectively, whereas the nonqualified and foreign plans accounted for $0.21 billion and $0.22 billion of the total accumulated benefit obligation at December 31, 2018 and 2017, respectively.
For pension plans with a projected benefit obligation in excess of plan assets, the aggregate projected benefit obligation was $203 million and $183 million at December 31, 2018 and 2017, respectively, and the aggregate plan assets were $87 million and $60 million at December 31, 2018 and 2017, respectively. For pension plans with an accumulated benefit obligation in excess of plan assets, the aggregate accumulated benefit obligation was $195 million and $174 million at December 31, 2018 and 2017, respectively, and the aggregate plan assets were $87 million and $60 million at December 31, 2018 and 2017, respectively. For postretirement benefit plans with an accumulated benefit obligation in excess of plan assets, the aggregate accumulated benefit obligation was $203 million and $225 million at December 31, 2018 and 2017, respectively, and the aggregate plan assets were $12 million and $13 million at December 31, 2018 and 2017, respectively.
The $273 million actuarial gain experienced in 2018 for the qualified domestic pension plan was largely driven by the increase in the assumed discount rate from the prior year that was used to determine the projected benefit obligation at December 31, 2018. The $258 million actuarial loss experienced in 2017 for the qualified domestic pension plan was largely driven by the decrease in the assumed discount rate from the prior year that was used to determine the projected benefit obligation at December 31, 2017.
The Company has discretion regarding whether to provide additional funding and when to provide such funding to its qualified domestic pension plan. In 2018, 2017 and 2016, there were no required contributions to the qualified domestic pension plan. In 2018, 2017 and 2016, the Company voluntarily made contributions totaling $200 million, $300 million and $200 million, respectively, to the qualified domestic pension plan. There is no required contribution to the qualified domestic pension plan
during 2019, and the Company has not determined whether or not additional funding will be made during 2019. With respect to the Company’s foreign pension plans, there are no significant required contributions in 2019.
In choosing the expected long-term rate of return on plan assets, the Company selected the rate that was set as the return objective by the Company’s Benefit Plans Investment Committee, which had considered the historical returns of equity and fixed maturity markets in conjunction with prevailing economic and financial market conditions.
The Company has a savings plan, The Travelers 401(k) Savings Plan (the Savings Plan), in which substantially all U.S. domestic Company employees are eligible to participate. Under the Savings Plan, the Company matches employee contributions up to 5% of eligible pay, with a maximum annual match of $6,500 which becomes 100% vested after three years of service. The Company’s matching contribution is made in cash and invested according to the employee’s current investment elections and can be reinvested into other investment options in accordance with the terms of the Savings Plan. The Company’s non-U.S. employees participate in separate savings plans. The total expense related to all of the savings plans was $118 million, $119 million and $114 million for the years ended December 31, 2018, 2017 and 2016, respectively.
On May 1, 2017, the Company agreed to a settlement of this dispute with the two remaining defendants, along with the settlement of several other disputes with these same parties. As a result of the settlement of all of these matters, the Company recorded an immaterial gain in “other revenues” in its consolidated statement of income for the three months ended June 30, 2017, and the reinsurance recoverable of $31 million in the Company’s balance sheet was fully satisfied.
Investment Commitments - The Company has unfunded commitments to private equity limited partnerships and real estate partnerships in which it invests. These commitments totaled $1.60 billion and $1.56 billion at December 31, 2018 and 2017, respectively.
The Company also has contingent obligations for guarantees related to certain investments, third-party loans related to certain investments, certain insurance policy obligations of former insurance subsidiaries and various other indemnifications. The Company also provides standard indemnifications to service providers in the normal course of business. The indemnification clauses are often standard contractual terms. The maximum amount of the Company’s obligation for guarantees of certain investments and third-party loans related to certain investments that are quantifiable was $45 million at December 31, 2018, approximately $23 million of which is indemnified by a third party. The maximum amount of the Company’s obligation related to the guarantee of certain insurance policy obligations of a former insurance subsidiary was $480 million at December 31, 2018, all of which is indemnified by a third party.
Certain of the guarantees and indemnifications described above have no stated or notional amounts or limitation to the maximum potential future payments, and, accordingly, the Company is unable to provide an estimate of the maximum potential payments for such arrangements.
The following consolidating financial statements of the Company have been prepared pursuant to Rule 3-10 of Regulation S-X. These consolidating financial statements have been prepared from the Company’s financial information on the same basis of accounting as the consolidated financial statements. The Travelers Companies, Inc. (excluding its subsidiaries, TRV) has fully and unconditionally guaranteed certain debt obligations of Travelers Property Casualty Corp. (TPC) and Travelers Insurance Group Holdings, Inc. (TIGHI), which totaled $700 million at December 31, 2018.
Total other-than-temporary impairments (OTTI) for the year ended December 31, 2018, and the amounts comprising total OTTI that were recognized in net realized investment gains (losses) and in other comprehensive income (OCI), were as follows:
Income tax expense for the fourth quarter and full year of 2017 included a net charge of $129 million to reflect the change in tax laws and tax rates enacted in the U.S. on December 22, 2017 as part of the Tax Cuts and Jobs Act of 2017, resulting primarily from revaluing the Company’s deferred tax assets and liabilities and the tax imposed on accumulated foreign earnings.