Our headquarters occupy a 315,000 square foot building located on a 56-acre site zoned for office and professional use in Branchville, New Jersey and is also the home to our newly-installed solar facility. The site is owned by a subsidiary that also owns abutting property in Frankford, New Jersey. We lease all our other facilities from unrelated parties. The principal office locations of our insurance operations are listed in the “Geographic Markets” section of Item 1. “Business.” of this Form 10-K. Our Investments operations are principally located in leased space in Farmington, Connecticut. We believe our facilities provide adequate space for our present needs and that additional space, if needed, would be available on reasonable terms.
3Non-GAAP operating income is used as an important financial measure by us, analysts, and investors, because the realization of net investment gains and losses on sales of securities in any given period is largely discretionary as to timing. In addition, these net realized investment gains and losses, as well as OTTI that are charged to earnings, unrealized gains and losses on equity securities, the deferred tax asset charge that was recognized in 2017 in relation to the Tax Cuts and Jobs Act of 2017 ("Tax Reform"), and debt retirement costs could distort the analysis of trends.
Factors that could cause our actual results to differ materially from those we have projected, forecasted or estimated in forward-looking statements are discussed in further detail in Item 1A. “Risk Factors.” of this Form 10-K. These risk factors may not be exhaustive. We operate in a business environment that changes constantly, and new risk factors may emerge at any time. We can neither predict these new risk factors nor assess their impact, if any, on our businesses or the extent to which any new factor or combination of factors may cause actual results to differ materially from any forward-looking statements. In light of these risks, uncertainties and assumptions, it is possible that the forward-looking events discussed in this report might not occur.
For further details regarding these segments, refer to Note 1. "Organization" and Note 11. "Segment Information" in Item 8. “Financial Statements and Supplementary Data.” of this Form 10-K.
Our ten insurance subsidiaries are collectively referred to as the "Insurance Subsidiaries."
In Management's Discussion and Analysis ("MD&A"), we will discuss and analyze the consolidated results of operations and financial condition, as well as known trends and uncertainties that may have a material impact in future periods. Within the MD&A, all prior year amounts for non-catastrophe property losses, and the related ratios, have been adjusted to include the related loss expenses, which is consistent with the current year presentation. The MD&A will discuss and analyze our 2019 results compared to our 2018 results. For discussion and analysis of our 2018 results compared to our 2017 results, refer to Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations." of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.
Financial Highlights of Results for Years Ended December 31, 2019, 2018, and 2017;
Prior accident years’ ultimate losses and loss expenses are held constant from the prior period. Similar to the current accident year, the associated IBNR provision is set equal to the ultimate loss and loss expense minus the amounts paid and reserved in case for reported claims.
various methods, considering the strengths and weaknesses of the methods as they apply to the specific line and accident year. The selected reserves by line of business and accident year are aggregated in order to assess the overall reserve adequacy.
In addition to the process described above, we have an external consulting actuary perform an independent review of our reserves semi-annually. While we do not explicitly rely on the results of the external consulting actuary's semi-annual independent reviews, we do review and discuss their findings and consider any insights and observations when establishing our reserves. While not required to be performed by an independent external actuary, our independent external actuary issues the annual statutory Statement of Actuarial Opinion for our Insurance Subsidiaries.
Each quarter a reserve review produces updated reserve estimates for the current and prior accident years, which in turn leads to changes in the recorded reserves; favorable or unfavorable. In 2019, we experienced overall net favorable prior year loss development of $50.3 million, compared to $29.9 million in 2018 and $39.2 million in 2017. The following table summarizes prior year development by line of business:
By its nature, this line presents a diverse set of exposures, and can be influenced by a variety of developments, including legislative enactments, judicial decisions, and social inflation. Potential increases in either economic or social inflation could impact the loss trends for this line of business. Sources of social inflation could include decreased public trust in business, non-profit, social service, religious organizations, government, and the press that lead to increases in our loss expenses and or loss experience from (a) an increased number of claimants who engage lawyers earlier in the claims process and (b) higher awards and verdicts in litigation.
We have exposure to abuse and molestation claims through insurance policies that we: (i) principally underwrite through our Community and Public Services ("CAPS") strategic business unit; and (ii) issue to schools, religious institutions, daycares, and other social services. Through 2017, our exposure to abuse and molestation risk had been increasing, reflective of the growth in our CAPS book. In 2018, we introduced more stringent underwriting eligibility guidelines and partnered with a third party to better assess exposure and introduce greater loss control measures. In 2019, we filed and approved significant rate increases for this exposure. These actions have limited our growth in this strategic business unit.
We also have exposure to abuse and molestation claims from recently enacted state laws that extend the statute of limitations or permit windows to be opened for abuse and molestation claims and lawsuits that were previously barred by statutes of limitations. It is possible, as a result, that we may receive claims decades after the allegations occurred from coverages provided by predecessor companies that will require complex claims coverage determinations, potential litigation, and the need to collect from reinsurers under older reinsurance agreements.
To better understand our exposure to abuse and molestation, we have instituted enhanced claims coding to identify and classify abuse and molestation claims. Our claims and actuarial departments actively monitor these claims to identify changes in frequency or severity and any emerging or shifting trends. While these actions should help us better understand this rapidly evolving exposure, the ultimate impact of social, political, and legal trends remains highly uncertain, and as a result, our loss and loss expense reserves remain highly uncertain.
At December 31, 2019, our workers compensation line of business recorded reserves, net of reinsurance, of $895 million, which represented 25% of our total net reserves. During 2019, this line experienced favorable development of $68.0 million, driven by accident years 2017 and prior. During 2018, this line experienced favorable development of $83.0 million, driven by accident years 2017 and prior. During 2019, this line again showed lower loss emergence than expected, due, in part, to: (i) lower medical inflation than originally anticipated; (ii) our proactive underwriting actions; and (iii) various significant claims initiatives that we have implemented. Because of the length of time that injured workers receive medical treatment, decreases in medical inflation can cause favorable loss development across an extended number of accident years.
Changes in statutory workers compensation benefits - Benefit changes may be enacted that affect all outstanding claims, including claims that have occurred in the past. Depending upon the social and political climate, these changes may either increase or decrease associated claim costs;
In 2018, this line experienced unfavorable prior year reserve development of $36.7 million, which was mainly driven by higher than expected severities in accident years 2015 through 2017.
For both us and the industry, the commercial automobile line has experienced unfavorable trends in recent years. Increased frequencies are likely due to increased miles driven as a result of lower unemployment and lower gasoline prices, coupled with poor road quality, as well as an increase in distracted driving. We have seen rising severities on both bodily injury and property damage claims. On bodily injury claims, we have seen an increase in the average value of our paid loss settlements, which may be related to higher awards driven by aggressive attorney representation. Increasing property damage severities may be the result of the increasing complexity of vehicles and the technology they incorporate, which results in increased repair costs.
Over the last several years, we have taken actions to improve the profitability of this line of business, including:
Implementing new tools to score drivers to underwrite more effectively and align rate with exposure.
At December 31, 2019, our personal automobile line of business had recorded reserves, net of reinsurance, of $105 million, which represented 3% of our total net reserves. In 2019, this line experienced unfavorable prior year reserve development of $4.4 million, mainly attributable to higher loss severities in accident year 2018. In 2018, this line experienced unfavorable prior year reserve development of $3.0 million, which was mainly attributable to an increase in accident years 2016 and 2017.
Some of the sames issues affecting the commercial automobile line are also affecting this line. Increased miles driven and vehicle repair costs, poor road quality, coupled with social trends such as distracted driving, are likely causes of increased frequencies and rising severities. We continue to recalibrate our predictive models and refine our underwriting and pricing approaches. While we believe these changes will ultimately lead to improved profitability and greater stability, they may impact paid and reported development patterns, thereby increasing the uncertainty in the reserves in the near-term.
Our E&S casualty lines results have improved over recent years. Our E&S casualty lines underwriting operations have exited from several targeted classes of business that have historically produced volatile results, which include commercial auto liability, liquor liability, and snow removal.
Claims have been segregated into “litigated” and “non-litigated” categories. Separate claim handling teams have been created, with the required skill sets, to appropriately handle these two types of claims.
We implemented the following expense improvement initiatives regarding outside adjusters and legal counsel:
Maximized use of staff counsel, increasing staff where necessary to support claims volume;
United States ("U.S.") monetary policy and global economic conditions bring additional uncertainty in the long term given the length of time required for claim settlement and the impact of medical cost trends relating to longer-tail liability and workers compensation claims. Uncertainty regarding future inflation or deflation creates the potential for additional volatility in our reserves for these lines of business.
The importance of any single assumption depends on several considerations, such as the line of business and the accident year. If the actual experience emerges differently than the assumptions used in the process to establish reserves, changes in our reserve estimate are possible and may be material to the results of operations in future periods. Set forth below are sensitivity tests that highlight potential impacts to loss and loss expense reserves under different scenarios, for the major casualty lines of business. These tests consider each assumption and line of business individually, without any consideration of correlation between lines of business and accident years. Therefore, the results in the tables below do not constitute an actuarial range. While the figures represent possible impacts from variations in key assumptions identified by management, there is no assurance that future emergence of our loss and loss expense experience will be consistent with either our current or alternative sets of assumptions.
While the sources of variability discussed above are generated by different internal and external trends and operational changes, they ultimately manifest themselves as changes in the expected loss and loss expense development patterns. These patterns are a key assumption in the reserving process. In addition to the expected development patterns, the expected loss and loss expense ratios are another key assumption in the reserving process. These expected ratios are developed through a rigorous process of projecting recent accident years' experience to an ultimate settlement basis, and then adjusting it to the current accident year's pricing and loss cost levels. Impact from changes in the underwriting portfolio and to claims handling practices are also quantified and reflected, where appropriate. As is the case with all estimates, the ultimate loss and loss expense ratios may differ from those currently estimated.
The discount rate enables us to state expected future cash flows at their present value on the measurement date. The purpose of the discount rate is to determine the interest rates inherent in the prices at which pension benefits could be effectively settled. Our discount rate selection is based on high-quality, long-term corporate bonds. A higher discount rate reduces the present value of benefit obligations. Conversely, a lower discount rate increases the present value of benefit obligations. Our discount rate decreased 113 basis points, to 3.33%, as of December 31, 2019, compared to 4.46% as of December 31, 2018. The decrease was driven by a decrease in interest rates and a contraction of corporate credit spreads in 2019. For additional information regarding our discount rate selection, refer to Note 14. “Retirement Plans” in Item 8. “Financial Statements and Supplementary Data.” of this Form 10-K.
The expected long-term rate of return on the plan assets is determined by considering the current and expected asset allocation, as well as historical and expected returns on each plan asset class. A higher expected rate of return on pension plan assets would decrease pension expense. Our long-term expected return on plan assets decreased 70 basis points, to 5.80%, as of December 31, 2019, compared to 6.50% as of December 31, 2018. The decrease was due to lower expected returns within our longer-dated fixed income securities portfolio, as interest rates and credit spreads declined significantly in 2019.
The fair value of our investment portfolio is defined under accounting guidance as the exit price or the amount that would be: (i) received to sell an asset; or (ii) paid to transfer a liability in an orderly transaction between market participants. When determining an exit price we must, when available, rely on observable market data. The majority of securities in our equity portfolio have readily determinable fair values and, as such, are recorded at fair value with changes in unrealized gains or losses being recognized through income. Additionally, our available-for-sale ("AFS") fixed income securities portfolio is recorded at fair value and the related unrealized gains or losses are reflected in stockholders' equity, net of tax. For both our AFS and held-to-maturity ("HTM") fixed income securities portfolios, fair value is a key factor in the evaluation of a security for OTTI.
The fair value of approximately 99% of our investment portfolio is classified as either Level 1 or Level 2 in the fair value hierarchy. Fair value measurements in Level 1 represent quoted prices in active markets for identical assets. Fair value measurements in Level 2 represent prices determined using observable data from similar securities that have traded in the
Our investment portfolio is subject to market declines below amortized cost that may be other than temporary, and therefore, may result in the recognition of OTTI losses. Factors considered in the determination of whether or not a decline is other than temporary require significant judgment and include, but are not limited to, the financial condition of the issuer, the expected near-term and long-term prospects of the issuer, and our evaluation of the projected cash flow stream from the security. We also consider whether or not we have the intent to sell securities that are in an unrealized loss position. For additional information regarding our OTTI process and OTTI charges recorded, see item (c) of Note 2. "Summary of Significant Accounting Policies" and item (j) of Note 5. "Investments" within Item 8. "Financial Statements and Supplementary Data." of this Annual Report, respectively.
Reinsurance recoverables on paid and unpaid loss and loss expense represent estimates of the portion of such liabilities that will be recovered from reinsurers. Each reinsurance contract is analyzed to ensure that the transfer of risk exists to properly record the transactions in the Financial Statements. Amounts recovered from reinsurers are recognized as assets at the same time as, and in a manner consistent with, the paid and unpaid losses associated with the reinsured policies. An allowance for estimated uncollectible reinsurance is recorded based on an evaluation of balances due from reinsurers and other available information. However, reinsurers often purchase and rely on their own retrocessional reinsurance programs to manage their capital position and improve their financial strength ratings. The details of these retrocessional reinsurance programs are not always adequately disclosed, which can make it difficult to assess the inherent counterparty credit risk and exposure of our reinsurers. Our allowance for estimated uncollectible reinsurance totaled $4.4 million at December 31, 2019 and $4.5 million at December 31, 2018. We continually monitor developments that may impact recoverability from our reinsurers and have available to us contractually provided remedies if necessary. For further information regarding reinsurance, see the “Reinsurance” section below and Note 8. “Reinsurance” in Item 8. “Financial Statements and Supplementary Data.” of this Form 10-K.
In 2019, we generated net income per diluted share of $4.53, compared to $3.00 in 2018. Non-GAAP operating income per diluted share was $4.40 for 2019, compared to $3.66 for 2018. The 2019 non-GAAP operating income per diluted share results were primarily impacted by (i) lower levels of non-catastrophe property loss and loss expenses of $0.27 per diluted share, (ii) lower levels of catastrophe property losses of $0.17 per diluted share, (iii) higher levels of favorable prior year casualty reserve development of $0.21 per diluted share, and (iv) an increase in net investment income of $0.33 per diluted share. These improvements were partially offset by an increase in underwriting expenses of $0.21 per diluted share, mainly due to higher profit-based expenses to our employees and agents. In addition, net income per diluted share benefited from after-tax net realized and unrealized gains of $0.18 per diluted share in 2019, compared to $0.66 of after-tax net realized and unrealized losses per diluted share in 2018.
2019 marks our sixth consecutive year of double-digit operating ROEs, placing us among an elite group of insurance companies that have achieved this level of performance. Our non-GAAP operating ROE of 13.3% in 2019 was 130 basis points above our 2019 non-GAAP operating ROE target of 12%, and 80 basis points higher than our non-GAAP operating ROE in 2018. Despite exceeding our target, our 2019 non-GAAP operating ROE was negatively impacted by net unrealized after-tax gains of $169 million on our fixed income securities portfolio, which decreased our non-GAAP operating ROE by 60 basis points, and will lower our 2020 ROE by approximately 100 basis points.
On March 1, 2019, Selective issued 5.375% Senior Notes with an aggregate principal amount of $300 million, the proceeds of which were used, in part, to redeem our 5.875% Senior Notes with an aggregate principal balance of $185 million that became callable in 2018. As a result of this redemption, we incurred after-tax debt retirement costs of $3.3 million, which reduced our ROE by 0.2 points in 2019. These costs have been excluded from non-GAAP operating income.
Looking ahead to 2020, there remain a number of areas that require our continued focus to maintain our financial position:
Delivering on our strategy for continued disciplined growth, which will be driven by the addition of new agents, greater share of wallet in our agents’ offices, and geographic expansion over the longer term. Our longer-term Standard Commercial Lines target is to attain a 3% market share in the states in which we operate, by appointing partner relationships approximating 25% of their markets and seeking an average share of wallet of 12% across the relationships. This goal represents an additional premium opportunity in excess of $2.7 billion.
In addition to maintaining our strong financial position in 2020 and beyond, we also continue to enhance our customer experience strategy, including by offering value-added technologies and services. During 2019, we made a number of enhancements to our self-service and digital service offerings, including (i) our “Selective® Drive” program, which was first introduced to certain commercial automobile policyholders through our distribution partners in the fourth quarter of 2018, (ii) proactive communications of product recalls, possible loss activity, policy changes, and risk management activities, (iii) Security Mentor, a product provided to our customers to better understand and manage cybersecurity risks, (iv) technology usage to reduce claim cycle time, such as SWIFTClaim® fast tracking, and (v) other digital self-service capabilities for our customers. Our new marketing tagline, "Be Uniquely Insured," was rolled out in 2019, and speaks to our differentiated value proposition for our customers and distribution partners. Investing in and building out technologies that improve the customer experience journey remains a core focus for us.
A GAAP combined ratio, excluding catastrophe losses, of 91.5%. This assumes no prior-year casualty reserve development;
The 1.7-point decrease in the loss and loss expense ratio in 2019 compared to 2018 was driven by the following:
While the impact of the favorable prior year casualty reserve development on this line in 2019 was relatively minor, in 2018 we had 1.5 points attributable to lower than expected loss adjustment expenses in accident years 2013 through 2017, partially offset by higher than expected loss emergence in accident years 2016 and 2017.
While this line experienced continued favorable prior year casualty reserve development in 2019, it is also exposed to the impacts of certain unfavorable recent trends, including social inflation and state laws enacted that extend the statute of limitations or open windows for previously time-barred actions. As these trends evolve, we continue to adjust our underwriting, pricing, and claims handling practices to better manage the risks these exposures present.
NPW of 14% in 2019 compared to 2018 reflects an 8% growth in vehicle counts and a 7.5% renewal pure price increase, reflecting our efforts to improve profitability on this line by actively implementing price increases in recent years.
The 7.8-point decrease in the combined ratio in 2019 compared to 2018 was primarily driven by the items in the tables below.
This line of business remains an area of focus for both us and the industry, as profitability challenges continue to generate
combined ratios that are higher than our risk-adjusted targeted combined ratio. To address profitability in this line, we have been actively implementing price increases, which averaged 7.5% in 2019. In addition to price increases, we have also been actively managing our new and renewal business, which we expect will have a positive impact on profitability through business mix improvement.
While reported profitability on this line remains strong due to favorable emergence on prior year reserves, current accident year
Insurance and independent state rating bureaus. A reduction or reversal in the trend of favorable frequencies and severities has
NPW growth in this line in 2019 compared to 2018 was primarily due to direct new business as outlined in the table above, coupled with strong retention and renewal pure price increases.
The 7.1-point decrease in the combined ratio in 2019 compared to 2018 was driven by lower weather and non-weather related property losses, as shown in the table below. The higher non-catastrophe property losses in 2018 were principally related to the January deep freeze in our footprint states, coupled with the relatively large number of fire losses during the year and continued increases in non-catastrophe loss severities. The higher catastrophe losses in 2018 included the impact of two hurricanes, Hurricane Florence and Hurricane Michael, and severe winter storms including Grayson and Riley that impacted our footprint states.
The loss and loss expense ratio increased 0.7 points in 2019 compared to 2018, the primary drivers of which were as follows:
Quantitative information regarding our property losses and prior year casualty reserve development are as follows:
The unfavorable prior year casualty reserve development for 2019 was relatively minor. In 2018, we had unfavorable prior year casualty reserve development that was driven by higher than expected frequencies and severities in accident years 2015 and 2016.
Permit all of the Insurance Subsidiaries to obtain a uniform rating from A.M. Best Company ("A.M. Best").
The following illustrates the pooling percentages by Insurance Subsidiary as of December 31, 2019:
Property Reinsurance - includes our property excess of loss treaties purchased for protection against large individual property losses and our property catastrophe treaties purchased to provide protection for the overall property portfolio against severe catastrophic events. Facultative reinsurance is primarily used for property risks that are in excess of our treaty capacity.
Casualty Reinsurance - purchased to provide protection for both individual large casualty losses and catastrophic casualty losses involving multiple claimants or customers. Facultative reinsurance may also be used for casualty risks that are in excess of our treaty capacity.
Flood Reinsurance - as a servicing carrier in the WYO, we receive a fee for writing flood business, for which the related premiums and losses are 100% ceded to the federal government.
In addition to the above categories, as part of the acquisition of MUSIC in December 2011, we entered into several reinsurance agreements with Montpelier Re Insurance Ltd., which subsequently merged into Endurance Specialty Insurance Ltd in December 2015 and purchased by Sompo Holdings Inc. in March 2017. Together, these agreements provide protection for losses on policies written prior to the acquisition and any development on reserves established by MUSIC as of the date of acquisition. The reinsurance recoverables under these treaties are collateralized.
The property catastrophe treaty, which covers both our standard market and E&S business, was renewed effective January 2020. We also renewed the separate catastrophe treaty of $35 million in excess of $5 million that covers events outside of our original 22-state footprint, in support of our growing E&S property book and geographic expansion into Arizona, New Hampshire, Colorado, Utah, and New Mexico. Both treaties were renewed with substantially the same terms as the expiring treaties. Overall catastrophe ceded premium for 2020 increased modestly primarily due to increases in expected underlying property premium. On a risk-adjusted basis, the expiring layers saw modest rate increases, in line with market conditions for loss-free accounts sharing our geographic footprint.
We seek ways to minimize credit risk inherent in a reinsurance transaction by transacting with highly-rated reinsurance partners and purchasing collateralized reinsurance products, particularly for high-severity, low-probability events. The current reinsurance program includes $242 million in collateralized limit, primarily in the top layer of the catastrophe program.
1This amount represents reported and unreported gross losses estimated as of December 31, 2019.
There are six layers covering 100% of $88 million in excess of $2 million. Losses other than terrorism losses are subject to the following:
We have other reinsurance treaties, such as our (i) Surety and Fidelity Excess of Loss Reinsurance Treaty, (ii) National Workers Compensation Reinsurance Pool Quota Share, which covers business assumed from the involuntary workers compensation pool, (iii) Equipment Breakdown Coverage Reinsurance Treaty, (iv) Multi-line Quota Share, which covers additional personal lines coverages, and (iv) Cyber Liability Quota Share, which covers our CyCurity® product.
We regularly evaluate our overall reinsurance program and try to develop effective ways to manage the transfer of risk. Our analysis is based on a comprehensive process that includes periodic analysis of modeling results, review of our own loss experience, aggregation of exposures, exposure growth, diversification of risks, limits written, projected reinsurance costs, financial strength of reinsurers, and projected impact on earnings, equity, and statutory surplus. We strive to balance considerations of reinsurer credit quality, price, terms, and our appetite for retaining a certain level of risk.
The primary objective of the investment portfolio is to maximize after-tax net investment income and the overall total return of the portfolio, while maintaining a high credit quality core fixed income securities portfolio and managing our duration risk profile. The effective duration of the fixed income securities portfolio, including short-term investments, was 3.6 years as of December 31, 2019, compared to the Insurance Subsidiaries’ liability duration of approximately 3.6 years. The effective duration of the fixed income securities portfolio, including short-term investments, is monitored and managed to maximize yield while managing interest rate risk at an acceptable level. We maintain a well-diversified portfolio across sectors, with credit quality and maturities that provide ample liquidity. Purchases and sales are made with the intent of maximizing investment returns in the current market environment while balancing capital preservation. Over time, we may seek to increase or decrease the duration and overall credit quality of the portfolio based on market conditions.
The 12% increase in invested assets at December 31, 2019 compared to December 31, 2018 was driven by (i) operating cash flow that was 18% of NPW; (ii) pre-tax net unrealized gains in our fixed income and equity securities portfolios of $205 million, due to a reduction in interest rates and tightening corporate credit spreads; and (iii) net proceeds of $106 million from the issuance of our 5.375% Senior Notes. Despite the 12% growth in invested assets in 2019, our GAAP equity increased by 22% in 2019 due to strong profitability and the after-tax impact of net unrealized gains in our fixed income securities portfolio, which led to the reduction in invested assets per dollar of stockholders' equity to $3.05 at December 31, 2019 from $3.33 at December 31, 2018.
At December 31, 2019, our fixed income securities and short-term investment portfolio represented 96% of our total invested assets, compared to 95% at December 31, 2018. These portfolios maintained a weighted average credit rating of "AA-" as of both December 31, 2019 and 2018, with 97% and 98% of the securities within the portfolio being investment grade quality, respectively. The sector composition and credit quality of our major asset categories within our fixed income securities portfolio did not significantly change from December 31, 2018. Additionally, as of December 31, 2019, approximately 19% of our fixed income securities portfolio was comprised of investment securities that have a non-fixed base interest rate. Included in this 19% is a 12% allocation to floating rate securities that are primarily tied to the U.S. dollar-denominated London Interbank Offered Rate ("LIBOR").
For further details on the composition, credit quality, and the various risks to which our portfolio is subject, see
We have audited the accompanying consolidated balance sheets of Selective Insurance Group, Inc. and subsidiaries (the Company) as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2019, and the related notes and financial statement schedules I to V (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, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.
We identified the evaluation of the estimate of reserves for loss and loss expense as a critical audit matter. The process to evaluate the Company’s estimate of reserves involved a high degree of auditor judgment due to the inherent uncertainties in adjusting past experience for current developments and anticipated trends for predicting future events. These uncertainties may be affected by a number of considerations, including internal factors such as changes to underwriting and claim practices, and external factors such as economic conditions, legislative enactments, judicial decisions, and social trends. Evaluating the impact of all of these factors required specialized skills and auditor judgment.
The primary procedures we performed to address this critical audit matter included the following. We tested, with the involvement of actuarial professionals when appropriate, certain internal controls related to the Company’s actuarial analyses and determination of the Company’s best estimate of recorded reserves. We also involved actuarial professionals with specialized skills and knowledge, who assisted in:
Developing an independent consolidated range of reserves based on generally accepted actuarial techniques and comparing to the Company's recorded reserves; and
Our investment portfolio is primarily comprised of fixed income securities. We also hold equity securities, short-term investments, and other investments. A description of our portfolio holdings, and the related presentation in our Consolidated Balance Sheets, is provided below.
State and municipal obligations, including special revenue and general obligation bonds;
The amortized cost of fixed income securities is adjusted for the amortization of premiums and the accretion of discounts over the expected life of the security using the effective yield method. Callable debt securities held at a premium are amortized to the earliest call date. Premiums and discounts arising from the purchase of RMBS, CMBS, CLO and other ABS are amortized over the expected life of the security based on future principal payments, giving additional consideration to prepayments. These prepayments are estimated based on historical and projected cash flows. Prepayment assumptions are reviewed quarterly and adjusted to reflect actual prepayments and changes in expectations. Future amortization of any premium and/or discount is adjusted to reflect the revised assumptions.
Equity securities may include common and non-redeemable preferred stocks. Equity securities with readily determinable fair values are recorded at fair value. Equity securities without readily determinable fair values are recorded at net asset value ("NAV") as a practical expedient.
Other investments include alternative investments, which principally include limited partnership investments in private equity, private credit, real estate, and infrastructure investment funds, Federal Home Loan Bank stock (“FHLB stock”), and tax credit investments. Alternative investments are accounted for using the equity method, with income typically recognized on a one-quarter lag. The FHLB stock is recorded at cost. Accounting for our tax credit investments is dependent on the type of credit we have purchased, as follows:
All other tax credits in our investment portfolio are accounted for using the equity method.
Net investment income earned on our Consolidated Statements of Income includes the following:
Interest income, as well as amortization and accretion, on fixed income securities;
Income recognized on our alternative and other investments accounted for under the equity method of accounting, except for federal tax credits, as discussed below.
Changes in unrealized gains or losses on our equity securities that are recorded at fair value; and
Other-than-temporary impairment ("OTTI") charges that are credit related or related to our intent to sell.
We review our fixed income securities and short-term investments that are in an unrealized loss position to determine: (i) if we have the intent to sell the security; (ii) if it is more likely than not that we will be required to sell the security before its anticipated recovery; (iii) if the decline is other than interest-rate related; and (iv) if the decline is other than temporary. Broad changes in the overall market or interest rate environment generally will not lead to a write down. If we determine that we have either the intent or requirement to sell the security, we write down its amortized cost to its fair value through an OTTI charge to earnings. If we do not have either the intent or requirement to sell the security, our evaluation for OTTI may include, but is not limited to, evaluation of the following factors:
The effective interest rate in effect as of the reporting date for non-fixed rate securities; and
Non-redeemable preferred stocks that are classified as fixed income securities are evaluated using the OTTI method described above unless the security is below investment grade. In this situation, we would determine: (i) if we do not intend to hold the security to its forecasted recovery; or (ii) if the decline is other than temporary, which includes declines driven by market volatility for which we cannot assert recovery in the near term. If we determine either that we do not intend to hold the security, or the decline is other than temporary, we write down the security's cost to its fair value through an OTTI charge to earnings.
Our evaluation for OTTI of an alternative investment may include, but is not limited to, conversations with the management of the alternative investment concerning the following:
Our evaluation for OTTI of our other investments (tax credits and FHLB stock) include a qualitative assessment of impairment indicators, which include, but are not limited to, the following:
An adverse development of the expected receipt of remaining tax credits and other tax benefits; and
If there is a decline in the fair value of an alternative or other investment that we do not intend to hold, or if we determine the decline is other than temporary, we write down the carrying value of the investment through an OTTI charge to earnings.
We utilize a market approach for our Level 2 securities, using primarily matrix pricing models prepared by external pricing services. Matrix pricing models use mathematical techniques to value debt securities by relying on the securities' relationship to other benchmark quoted securities, and not relying exclusively on quoted prices for specific securities, as the specific securities are not always frequently traded. As a matter of policy, we consistently use one pricing service as our primary source and secondary pricing services if prices are not available from the primary pricing service. Fixed income securities portfolio pricing is reviewed for reasonableness in the following ways: (i) comparing our pricing to other third-party pricing services as well as benchmark indexed pricing; (ii) comparing fair value fluctuations between months for reasonableness; and (iii) reviewing stale prices. If further analysis is needed, a challenge is sent to the pricing service for review and confirmation of the price.
Less than 1% of our portfolio cannot be priced using our primary or secondary pricing service. At times, we may use valuations performed by the issuer or non-binding broker quotes to determine the fair value of these securities. We internally review these fair value measurements for reasonableness.
Reinsurance recoverable represents estimates of amounts that will be recovered from reinsurers under our various treaties. Generally, amounts recoverable from reinsurers are recognized as assets at the same time and in a manner consistent with the paid and unpaid losses associated with the reinsured policies. We require collateral to secure all, or a portion of, reinsurance recoverables primarily from our reinsurance carriers that are not authorized, otherwise approved, or certified to do business in one or more of our ten insurance subsidiaries' domiciliary states. Our ten insurance subsidiaries are collectively referred to as the "Insurance Subsidiaries." This collateral is typically in the form of a letter of credit or cash. An allowance for estimated uncollectible reinsurance is recorded based on an evaluation of balances due from reinsurers and other available information, such as each reinsurer's credit rating from A.M. Best Company ("A.M. Best") or Standard & Poor's Rating Services ("S&P"). We charge off reinsurance recoverables on paid losses when it becomes probable that we will not collect the balance.
Deferred policy acquisition costs are limited to costs directly related to the successful acquisition of insurance contracts. Costs meeting this definition typically include, among other things, sales commissions paid to our distribution partners, premium taxes, and the portion of employee salaries and benefits directly related to time spent on acquired contracts. These costs are deferred and amortized over the life of the contracts.
There were no premium deficiencies for any of the reported years, as the sum of the anticipated loss and loss expense, unamortized acquisition costs, policyholder dividends, and other expenses for each segment did not exceed that segment’s related unearned premium and anticipated investment income. The investment yields assumed in the premium deficiency assessment for each reporting period, which were based on our actual average investment yield before tax as of the September 30 calculation date, were 3.5% for 2019, 3.3% for 2018, and 2.9% for 2017.
Goodwill results from business acquisitions where the cost of assets and liabilities acquired exceeds the fair value of those assets and liabilities. A quantitative goodwill impairment analysis is performed if our quarterly qualitative analysis indicates that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Goodwill is allocated to the reporting units for purposes of these analyses. Based on our analysis at December 31, 2019, goodwill was not impaired.
on known or reopened claims. IBNR reserves are established based on the results of the Insurance Subsidiaries’ internal reserve analysis, supplemented with other internal and external information.
The internal reserve review is performed quarterly, and relies upon generally accepted actuarial techniques. Such techniques assume that past experience, adjusted for the effects of current developments and anticipated trends, are an appropriate basis for predicting future events. Our analyses rely upon historical paid and case loss and loss expense experience organized by line of business, accident year, and maturity (i.e., “triangles”). Generally accepted actuarial techniques are applied to this history, producing a set of estimated ultimate loss and loss expenses. Ultimate loss and loss expenses are selected from the various methods, considering the strengths and weaknesses of the methods as they apply to the specific line and accident year.
Some insured events may span multiple years and trigger multiple policies, as in the case of asbestos, environmental, and abuse and molestation claims, where the injury is deemed to occur over an extended period of time. These types of losses often do not lend themselves to traditional actuarial methods. Where we deem appropriate, our experience may be analyzed without differentiating by accident year, using alternative methods and metrics. In these cases, the associated selected ultimate loss and loss expenses are then allocated to the applicable accident years for reporting.
While the reserve review is the primary basis for determining the recorded IBNR reserves, other internal and external factors are considered. Internal factors include (i) changes to our underwriting and claims practice, (ii) supplemental data regarding claims reporting and settlement trends, (iii) exposure estimates for reported claims, along with recent development on those estimates with respect to individual large claims and the aggregate of all claims, (iv) the rate at which new large or complex claims are being reported, and (v) additional trends observed by claims personnel or reported to them by defense counsel. External factors considered include (i) legislative enactments, (ii) judicial decisions, (iii) social inflation and heightened awareness of sources of liability, and (iv) trends in general economic conditions, including the effects of inflation.
The combination of the IBNR estimates along with the case reserve estimates on individual claims results in our total reserves for loss and loss expense. These reserves are expected to be sufficient for settling loss and loss expense obligations under our policies on unpaid claims, including changes in the volume of business written, claims frequency and severity, the mix of business, claims processing, and other items that management expects to affect our ultimate settlement of loss and loss expense. However, the ultimate claim settlements may be higher or lower than reserves established. As our experience emerges and other information develops, we revise our reserve estimates accordingly. The changes in these estimates, resulting from the continuous review process and the differences between estimates and ultimate payments, are reflected in the Consolidated Statements of Income for the period in which such estimates are changed. The associated impacts may be material to the results of operations in future periods.
Our loss and loss expense reserves implicitly include anticipated recoveries for salvage and subrogation claims.
Claims are counted at the occurrence, line of business, and policy level. For example, if a single occurrence (e.g. an auto accident) leads to a claim under an auto and an associated umbrella policy, they are each counted separately. Conversely, multiple claimants under the same occurrence/line/policy would contribute only a single count. The claim counts provided are on a reported basis. A claim is considered reported when a reserve is established or a payment is made. Therefore, claims closed without payment are included in the count as long as there was an associated case reserve at some point in its life cycle.
The Insurance Subsidiaries' net premiums written (“NPW”) include direct insurance policy writings, plus reinsurance assumed and estimates of premiums earned but unbilled on the workers compensation and general liability lines of business, less reinsurance ceded. The estimated premium on the workers compensation and general liability lines is referred to as audit premium. We estimate this premium, as it is anticipated to be either billed or returned on policies subsequent to expiration based on exposure levels (i.e. payroll or sales). Audit premium is based on historical trends adjusted for the uncertainty of future economic conditions. Economic instability could ultimately impact our estimates and assumptions, and changes in our estimate may be material to the results of operations in future periods. Premiums written are recognized as revenue over the period that coverage is provided using the semi-monthly pro-rata method. Unearned premiums and prepaid reinsurance premiums represent that portion of premiums written that are applicable to the unexpired terms of policies in force.
The Financial Accounting Standards Board ("FASB") issued new leasing guidance through ASU 2016-02, Leases, which was issued in February 2016, as well as additional implementation guidance that was issued in 2018 and 2019 (collectively referred to as "ASU 2016-02"). ASU 2016-02 requires all lessees to recognize assets and liabilities on their balance sheets for the rights and obligations created by leases with terms longer than 12 months. For leases with a term of 12 months or less, an accounting policy election is allowed to recognize lease expense on a straight-line basis over the lease term.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement: Disclosure Framework - Changes to the Disclosure
In August 2018, the FASB issued ASU 2018-14, Compensation - Retirement Benefits - Defined Benefit Plans - General: Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans (“ASU 2018-14”). ASU 2018-14 modifies the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. These modifications include: (i) removing the requirement to disclose the amount in accumulated other comprehensive income ("AOCI") expected to be recognized as components of net periodic benefit cost over the next fiscal year; and (ii) adding the requirement to disclose an explanation of the reasons for significant gains or losses related to changes in the benefit obligation for the period. We elected to early adopt this update in the fourth quarter of 2019. As the requirements of this literature are disclosure only, ASU 2018-14 does not have impact our financial condition or results of operations.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses, as well as additional implementation guidance issued in 2018 and 2019 (collectively referred to as “ASU 2016-13”) that changes the way entities recognize impairment of financial assets. The new guidance requires immediate recognition of estimated credit losses expected to occur over the remaining life of many financial assets through the establishment of a valuation allowance. The valuation allowance is a measurement of expected losses based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. Additionally, ASU 2016-03 requires the presentation of the impacted financial assets on the consolidated balance sheet net of the valuation allowance.
In December 2019, the FASB issued ASU 2019-12, Income Taxes - Simplifying the Accounting for Income Taxes (“ASU 2019-12”). Among other items, the amendments in ASU 2019-12 simplify the accounting treatment of tax law changes and year-to-date losses in interim periods. An entity generally recognizes the effects of a change in tax law in the period of enactment; however, there is an exception for tax laws with delayed effective dates. Under current guidance, an entity may not adjust its annual effective tax rate for a tax law change until the period in which the law is effective. This exception was removed under ASU 2019-12, thereby providing that all effects of a tax law change are recognized in the period of enactment, including adjustment of the estimated annual effective tax rate. Regarding year-to-date losses in interim periods, an entity is required to estimate its annual effective tax rate for the full fiscal year at the end of each interim period and use that rate to calculate its income taxes on a year-to-date basis. However, current guidance provides an exception that when a loss in an interim period exceeds the anticipate loss for the year, the income tax benefit is limited to the amount that would be recognized if the year-to-date loss were the anticipated loss for the full year. ASU 2019-12 removes this exception and provides that in this situation, an entity would compute its income tax benefit at each interim period based on its estimated annual effective tax rate. ASU 2019-12 is effective for fiscal years beginning after December 15, 2020, including interim periods within those annual periods. Early adoption is permitted. We are currently evaluating the impact of this guidance on our financial condition and results of operations.
1Upon adoption of ASU 2016-02, effective January 1, 2019, we are required to disclose cash paid for amounts included in the measurement of operating lease liabilities, as well as supplemental non-cash information on operating lease liabilities arising from obtaining operating lease assets.
(a) Net unrealized gains on investments included in OCI by asset class were as follows for the years ended December 31, 2019, 2018, and 2017:
1Upon adoption of ASU 2016-01, we recognized a $30.7 million cumulative-effect adjustment to the opening balance of AOCI, which represents the after-tax net unrealized gain on our equity portfolio as of December 31, 2017. Additionally, upon adoption of ASU 2018-02, we recognized a one-time reclassification from AOCI to retained earnings for $17.9 million representing the stranded tax assets related to our investment portfolio that were created in AOCI from the enactment of the Tax Cuts and Jobs Act of 2017 ("Tax Reform").
(e) Fixed income securities at December 31, 2019, by contractual maturity are shown below. Mortgage-backed securities are included in the maturity tables using the estimated average life of each security. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
We have reviewed various investments included in the table above and have concluded that they are VIEs, but that we are not the primary beneficiary and therefore, consolidation is not required. We do not have a future obligation to fund losses or debts
Direct Lending: This strategy provides privately negotiated loans to U.S. middle market companies. Typically, these are floating rate, senior secured loans diversified across industries. Loans are made to companies that may or may not have private equity sponsors to finance LBOs, recapitalizations, and acquisitions.
(k) Net realized and unrealized gains and losses included the following:
Realized gains and losses on the sale of investments are determined on the basis of the cost of the specific investments sold. Proceeds from the sale of AFS fixed income securities were $594.7 million, $2,030.7 million, and $1,197.9 million in 2019, 2018, and 2017, respectively. Proceeds from sale of equity securities were $137.3 million, $113.3 million, and $38.0 million in 2019, 2018, and 2017, respectively.
(b) The balances of, and changes in, each component of AOCI (net of taxes) as of December 31, 2019 and 2018 were as follows:
1 Upon adoption of ASU 2016-01 and ASU 2018-02 in the first quarter of 2018, we recognized a $25.0 million cumulative-effect adjustment to the opening balance of AOCI, which represents the after-tax net unrealized gain on our equity portfolio as of December 31, 2017 and the one-time reclassification from AOCI to retained earnings for the stranded tax assets that were created in AOCI from the enactment of Tax Reform.
The financial assets in our investment portfolio are primarily measured at fair value as disclosed on the Consolidated Balance Sheets. The following table presents the carrying amounts and estimated fair values of our financial liabilities as of December 31, 2019 and 2018:
1In accordance with ASU 2015-07, investments amounting to $37.8 million and $37.3 million at December 31, 2019 and December 31, 2018, respectively, were measured at fair value using the net asset value per share (or its practical expedient) and have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to total assets measured at fair value.
The following table provides a summary of the changes in the fair value of securities measured using Level 3 inputs and related quantitative information during 2019:
There were no material changes in the fair value of securities measured using Level 3 prices during 2018.
The following tables provide quantitative information regarding our financial assets and liabilities that were not measured, but were disclosed at fair value at December 31, 2019 and 2018:
As a Standard Commercial Lines and E&S Lines writer, we are subject to the Terrorism Risk Insurance Program Reauthorization Act ("TRIPRA"), which was extended by Congress to December 31, 2027. TRIPRA requires private insurers and the U. S. government to share the risk of loss on future acts of terrorism certified by the U.S. Secretary of the Treasury. Under TRIPRA, each participating insurer is responsible for paying a deductible of specified losses before federal assistance is available. This deductible is based on a percentage of the prior year’s applicable Standard Commercial Lines and E&S Lines premiums. In 2020, our deductible, before tax, is approximately $359 million. For losses above the deductible, the federal government will pay 80% of losses to an industry limit of $100 billion, and the insurer retains 20%.
The following table contains a listing of direct, assumed, and ceded reinsurance amounts for premiums written, premiums earned, and loss and loss expense incurred:
In 2019, we experienced overall net favorable prior year loss development of $50.3 million, compared to $29.9 million in 2018 and $39.2 million in 2017. The following table summarizes the prior year reserve development by line of business:
favorable medical trends in accident years 2017 and prior. Partially offsetting this net favorable reserve development was $37.5 million of unfavorable casualty reserve development in the commercial auto line of business, driven by increases in frequencies and severities in accident years 2015 through 2017. In addition, our E&S casualty lines experienced unfavorable reserve development of $12.0 million in 2018.
(b) We have exposure to abuse and molestation claims within our general liability line of business through insurance policies that we issue to schools, religious institutions, daycares, and other social services. We also have exposure to abuse and molestation claims from recently enacted state laws that extend the statute of limitations or permit windows to be opened for abuse and molestation claims and lawsuits that were previously barred by statutes of limitations. The emergence of these claims is slow and highly unpredictable. There are significant uncertainties in estimating our exposure to abuse and molestation claims (for both case and IBNR reserves) resulting from (i) lack of relevant historical data, (ii) the delayed and inconsistent reporting patterns associated with these claims, (iii) the obligation of an insurer to defend a claim, (iv) the extent to which a party can prove the existence of coverage, and (v) uncertainty as to the number and identity of claimants. It is possible, as a result, that we may receive claims decades after the allegations occurred from coverages provided by us, including predecessor companies, that will require complex claims coverage determinations, potential litigation, and the need to collect from reinsurers under older reinsurance agreements. We do not discount to present value that portion of our loss and loss expense reserves expected to be paid in future periods.
(d) The following is information about incurred and paid claims development as of December 31, 2019, net of reinsurance, as well as cumulative claim frequency and the associated IBNR liabilities. During the experience period, we implemented a series of claims-related initiatives and claims management changes. These initiatives focused on claims handling and reserving, medical claims costs, and loss expenses. As a result of these initiatives, several historical patterns have changed and may no longer be appropriate to use as the sole basis for projections.
The table below provides a summary of our outstanding debt at December 31, 2019 and 2018:
1 Concurrent with the adoption of ASU 2016-02 discussed in Note 3. "Adoption of Accounting Pronouncements," finance lease obligations are now captured in Long-term debt on our Consolidated Balance Sheets.
On August 5, 2019, SICA borrowed short-term funds of $15 million from the FHLBNY at an interest rate of 2.29%. This borrowing was repaid on August 12, 2019.
On December 20, 2019, the Parent entered into a Credit Agreement (the “Line of Credit”) among the Parent, the lenders named therein (the “Lenders”), and Bank of Montreal, Chicago Branch, as Administrative Agent. Under the Line of Credit, the Lenders have agreed to provide the Parent with a $50 million revolving credit facility, which can be increased to $125 million with the consent of the Lenders. The Line of Credit will mature on December 20, 2022 and has an interest rate, which varies and is based on, among other factors, the Parent’s debt ratings. The Parent, as borrower, was a party to a Credit Agreement, dated December 1, 2015, for a $30 million revolving credit facility, which could be increased to $50 million with the consent of the lenders, with the lenders named therein, and Wells Fargo Bank, National Association, as Administrative Agent (“Wells Fargo”), which was scheduled to mature on December 1, 2020 (the “Prior Credit Agreement”). In anticipation of entering into the Line of Credit, the Parent exercised termination rights under the Prior Credit Agreement by sending a termination letter to
Our Line of Credit contains representations, warranties, and covenants that are customary for credit facilities of this type, including, without limitation, financial covenants under which we are obligated to maintain a minimum consolidated net worth, a maximum ratio of consolidated debt to total capitalization, and covenants limiting our ability to: (i) merge or liquidate; (ii) incur debt or liens; (iii) dispose of assets; (iv) make investments and acquisitions; and (v) engage in transactions with affiliates.
(2) In the first quarter of 2009, Selective Insurance Company of South Carolina ("SICSC") and Selective Insurance Company of the Southeast ("SICSE"), which are collectively referred to as the "Indiana Subsidiaries" as they are domiciled in Indiana, joined, and invested in, the FHLBI, which provides them with access to additional liquidity. The Indiana Subsidiaries’ aggregate investment in the FHLBI was $2.8 million at December 31, 2019 and December 31, 2018. Our investment provides us the ability to borrow approximately 20 times the total amount of the FHLBI common stock purchased with additional collateral, at comparatively low borrowing rates. The proceeds from the FHLBI borrowing on December 16, 2016 of $60 million were used to repay a $45 million borrowing from the FHLBI that was outstanding at the time, with the remaining $15 million used for general corporate purposes. All borrowings from the FHLBI require security. There are no financial debt covenants to which we are required to comply with in regards to these borrowings. For information on investments that are pledged as collateral for these borrowings, see Note 5. "Investments" above.
(4) In November 2005, we issued $100 million of 6.70% Senior Notes due 2035. These notes were issued at a discount of $0.7 million resulting in an effective yield of 6.754%. Net proceeds of approximately $50 million were used to fund an irrevocable trust that subsequently funded certain payment obligations in respect of our outstanding debt. The remainder of the proceeds was used for general corporate purposes. The agreements covering these notes contain a standard default cross-acceleration provision that provides the 6.70% Senior Notes will enter a state of default upon the failure to pay principal when due or upon
The disaggregated results of our four reportable segments are used by senior management to manage our operations. These reportable segments are evaluated as follows:
Our Standard Commercial Lines, Standard Personal Lines, and E&S Lines are evaluated based on before and after-tax underwriting results (net premiums earned, incurred loss and loss expense, policyholders dividends, policy acquisition costs, and other underwriting expenses), return on equity ("ROE") contribution, and combined ratios.
Our combined insurance operations are subject to certain geographic concentrations, particularly in the Eastern region of the country. In 2019, approximately 19% of NPW were related to insurance policies written in New Jersey.
In the fourth quarter of 2018, the IRS published the loss reserve discount factors to be used for calculating the beginning and ending 2018 discounted loss reserves under the industry experience approach. Based on these factors, we calculated a pre-tax decrease to our discounted loss reserves of $125 million, which resulted in a deferred tax asset of $26.3 million, an increase from the $7.5 million estimate described above. The $26.3 million adjustment was being taken into income over eight years, beginning with 2018, at approximately $3.3 million per year.
12018 includes approximately $3.8 million of capital loss carry back items to prior tax years at the previous 35% statutory tax rate.
Net deferred income tax assets decreased by $46.8 million in 2019, primarily driven by a $44.8 million increase in gross deferred tax liabilities as reduced interest rates increased unrealized gains on our fixed income securities portfolio.
After considering all evidence, both positive and negative, with respect to our federal tax loss carryback availability, expected levels of pre-tax financial statement income, and federal taxable income, we believe it is more likely than not that the existing deductible temporary differences will reverse during periods in which we generate net federal taxable income or have adequate federal carryback availability. As a result, we had no valuation allowance recognized for federal deferred tax assets at December 31, 2019 or 2018. We do not have unrecognized tax expense or benefit as of December 31, 2019.
SICA offers a voluntary defined contribution 401(k) plan that is available to most of our employees and is a tax-qualified retirement plan subject to ERISA. Expense recorded for this plan was $17.0 million in 2019, and $15.8 million in both 2018 and 2017.
SICA offers a non-qualified deferred compensation plan, the Selective Insurance Company of America Deferred Compensation Plan ("Deferred Compensation Plan") to a group of management or highly compensated employees as a method of recognizing and retaining such employees. The Deferred Compensation Plan provides these employees the opportunity to elect to defer receipt of specified portions of compensation and to have such deferred amounts deemed to be invested in specified investment options. In addition to the employee deferrals, SICA may choose to make matching contributions to some or all of the participants in this plan to the extent the participant did not receive the maximum matching or non-elective contributions permissible under the Retirement Savings Plan due to limitations under the Internal Revenue Code or the Retirement Savings Plan. Expense recorded for these contributions was $0.3 million in 2019, $0.4 million in 2018, and $0.2 million in 2017.
The following tables provide details on the Pension Plan for 2019 and 2018:
Our latest measurement date was December 31, 2019, at which time we decreased our expected return on plan assets to 5.80%, due to lower expected returns within our longer-dated fixed income portfolio, as interest rates and credit spreads declined significantly year-over-year.
The Pension Plan had no investments in the Parent’s common stock as of December 31, 2019 or 2018. For information regarding investments in funds of our related parties, refer to Note 16. "Related Party Transactions" below.
The investments in private limited partnerships and other private equity securities are valued utilizing net asset value as a practical expedient for fair value. These investments are not classified in the fair value hierarchy.
Short-term investments are recorded at cost, which approximates fair value. Given that these investments are listed on active exchanges, coupled with their liquid nature, these investments are classified as Level 1 in the fair value hierarchy.
We presently do not anticipate contributing to the Pension Plan in 2020, as we have no minimum required contribution amounts.
The 2014 Omnibus Stock Plan, As Amended and Restated Effective as of May 2, 2018 (the "Stock Plan");
1Awards outstanding under the 2005 Stock Plan consisted of 32,906 shares deferred by our non-employee directors and 26,823 stock options.
A summary of the stock option transactions under our 2005 Stock Plan is as follows:
The liability recorded in connection with our Cash Plan was $8.6 million at December 31, 2019 and $21.6 million at December 31, 2018. The decrease of $13 million in the liability recorded is primarily due to the structural changes we made to our Cash Plan in early 2017. The remaining cost associated with the CIUs is expected to be recognized over a weighted average period of 1.1 years. The CIU payments made were $18.4 million in 2019, $20.2 million in 2018, and $14.2 million in 2017.
The grant date fair value of RSUs is based on the market price of our common stock on the grant date, adjusted for the present value of our expected dividend payments. The expense recognized for share-based awards is based on the number of shares or units expected to be issued at the end of the performance period and the grant date fair value.
volatility of the Parent's stock price over a historical period comparable to the expected term. In applying Black Scholes, we use the weighted average assumptions illustrated in the following table:
The following table provides share-based compensation expense in 2019, 2018, and 2017:
Rue Insurance placed insurance policies with the Insurance Subsidiaries for its customers and itself. Direct premiums written associated with these policies were $11.0 million in 2019, $10.1 million in 2018, and $11.1 million in 2017. In return, the Insurance Subsidiaries paid standard market commissions, including supplemental commissions, to Rue Insurance of $2.0 million in 2019, $2.1 million in 2018, and $2.3 million in 2017. Amounts due to Rue Insurance at December 31, 2019 and December 31, 2018 were $0.3 million and $0.4 million, respectively. All contracts and transactions with Rue Insurance were consummated in the ordinary course of business on an arm's-length basis.
We are required to disclose related party information for our transactions with BlackRock. BlackRock is highly regulated, serves its clients as a fiduciary, and has a diverse platform of active (alpha) and index (beta) investment strategies across asset classes that enables it to tailor investment outcomes and asset allocation solutions for clients. BlackRock also offers the BlackRock Solutions® investment and risk management technology platform, Aladdin®, risk analytics, advisory, and technology services and solutions to a broad base of institutional and wealth management investors. We incurred expenses related to BlackRock for services rendered of $2.2 million in 2019, and $2.0 million in both 2018 and 2017. Amounts payable for such services at December 31, 2019 and December 31, 2018, were $1.1 million and $1.0 million, respectively.
As part of our overall investment diversification, we may invest in various Vanguard funds from time to time. As of December 31, 2019, we had no investments in Vanguard funds, and our investment in these funds at December 31, 2018 was less than 1% of invested assets at that time and was recorded within Equity securities on our Consolidated Balance Sheet. During 2019, we sold $11.8 million of a Vanguard ETF, recorded dividend income of $0.2 million and recorded capital gains of $1.3 million from such ETF, with no amounts receivable on the settlement of this transaction at December 31, 2019. During 2018, we purchased $11.5 million of a Vanguard ETF and recorded dividend income of $0.4 million from such ETF, with no amounts payable on the settlement of this transaction at December 31, 2018. We had no transactions with Vanguard in 2017.
Upon adoption of ASU 2016-02 on January 1, 2019, we recorded operating lease right-of-use assets of $20.7 million with related lease liabilities of $21.0 million. The differential of $0.3 million was recognized, on an after-tax basis, as a cumulative-effect adjustment to the opening balance of retained earnings as of January 1, 2019. Financing lease right-of-use assets and the related lease liabilities were $0.9 million as of January 1, 2019. See Note 2. "Summary of Significant Accounting Policies" and Note 3. "Adoption of Accounting Pronouncements" in this Form 10-K for additional information regarding our accounting policy on leases and ASU 2016-02, respectively.
The components of lease expense for the year ended December 31, 2019 were as follows:
Operating and finance lease asset and liability balances are included within the following line items on the Consolidated Balance Sheets:
At December 31, 2018, the maturities of our lease liabilities for capital and operating leases were as follows:
As of December 31, 2019, we do not believe we are involved in any legal action that could have a material adverse effect on our consolidated financial condition, results of operations, or cash flows.
From time to time, our Insurance Subsidiaries also are named as defendants in other legal actions, some of which assert claims for substantial amounts. Plaintiffs may style these actions as putative class actions and seek judicial certification of a state or national class for allegations involving our business practices, such as improper reimbursement of medical providers paid under workers compensation and personal and commercial automobile insurance policies or improper reimbursement for automobile parts. Similarly, our Insurance Subsidiaries can be named in individual actions seeking extra-contractual damages, punitive damages, or penalties, often alleging bad faith in the handling of insurance claims. We believe that we have valid defenses to these allegations and we account for such activity through the establishment of unpaid loss and loss expense reserves. In these other legal actions, we expect that any potential ultimate liability, after consideration of provisions made for estimated losses, will not be material to our consolidated financial condition. Nonetheless, litigation outcomes are inherently unpredictable and, because the amounts sought in certain of these actions are large or indeterminate, it is possible that any adverse outcomes could have a material adverse effect on our consolidated results of operations or cash flows in particular quarterly or annual periods.
The Insurance Subsidiaries are required to maintain certain minimum amounts of statutory surplus to satisfy the requirements of their various state insurance departments of domicile. RBC requirements for property and casualty insurance companies are designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policyholders. The Insurance Subsidiaries' combined total adjusted capital exceeded the authorized control level RBC, as defined by the NAIC based on their 2019 statutory financial statements. In addition to statutory capital requirements, we are impacted by various rating agency requirements related to certain rating levels. These required capital levels may be more than statutory requirements.
In addition to regulatory restrictions on the availability of dividends that our Insurance Subsidiaries can pay to the Parent, the maximum amount of dividends the Parent can pay our shareholders is limited by certain New Jersey corporate law provisions that limit dividends if either: (i) the Parent would be unable to pay its debts as they became due in the usual course of business; or (ii) the Parent’s total assets would be less than its total liabilities. The Parent’s ability to pay dividends to shareholders also are impacted by covenants in its Line of Credit agreement that obligate it, among other things, to maintain a minimum consolidated net worth and a maximum ratio of consolidated debt to total capitalization.
The table below provides the following information: (i) quantitative data regarding all Insurance Subsidiaries' dividends paid to the Parent in 2019 for debt service, shareholder dividends, and general operating purposes; and (ii) the maximum ordinary dividends that can be paid to the Parent by the Insurance Subsidiaries in 2020, based on the 2019 statutory financial statements.