Subsequent to the announcement of the sale of our life insurance business on September 19, 2017, we operate and report one business segment, which contains our continuing operations. Our life insurance business was considered held for sale and reported as discontinued operations throughout this Form 10-K, unless otherwise noted. For more information, refer to Part II, Item 8, Note 10 "Segment Information."
For 2018, approximately 48.9 percent of our property and casualty statutory direct premiums written were written in Texas, California, Iowa, Missouri and Colorado.
In 2018, 2017 and 2016 the direct statutory premiums written by our property and casualty insurance operations were distributed as follows:
Our life insurance subsidiary marketed its products primarily in the Midwest, East Coast and West. In 2018, 2017 and 2016 the direct statutory premiums written by our life insurance operations were distributed as follows:
Our profitability is influenced by many factors, including price, competition, economic conditions, investment returns, interest rates, catastrophic events and other natural disasters, man-made disasters, state regulations, court decisions, and changes in the law. To manage these risks and uncertainties, we seek to achieve consistent profitability through strong agency relationships, exceptional customer service, fair and prompt claims handling,
In 2017, our net income benefited from the Tax Cuts and Jobs Act ("Tax Act"), which resulted in a tax benefit of $21.9 million for the year. Income from continuing operations before income taxes decreased 72.8 percent, from 2016, primarily driven by an 11.2 percent increase in losses and loss settlement expenses due to an increase in catastrophe losses and deterioration of our core loss ratio. A portion of this deterioration was driven by an increase in large losses, which we define as losses greater than $500 thousand, in our commercial automobile lines of business in the first three quarters of 2017. Also contributing to the decrease in income from continuing operations before income taxes was an increase in other underwriting expenses due to a deterioration in the profitability of the commercial and personal auto lines of business, which limits the amount of expenses which can be deferred into our deferred acquisition costs, partially offset by a decrease in post-retirement benefit expenses. These increases were partially offset by a 6.6 percent increase in net premiums earned.
Assumed premiums written decreased $1.7 million in 2017 as compared to 2016 due to a drop in reinsurance rates. In 2017, we renewed our participation in all of our assumed programs.
In 2017, the increase in catastrophe losses was primarily due to hurricanes (Harvey, Irma, Maria) in the third quarter and destructive California wildfires in the second half of the year. In 2017, our catastrophe losses included 50 catastrophes and our largest single pre-tax catastrophe loss totaled $9.0 million. Catastrophe losses in 2017 added 7.4 percentage points to the combined ratio. In 2016, our catastrophe losses included 41 catastrophes, where our largest single pre-tax catastrophe loss totaled $10.4 million. Catastrophe losses in 2016 added 6.5 percentage points to the combined ratio.
The following table represents the primary reinsurers we utilize and their financial strength ratings as of December 31, 2018:
The following table depicts our net loss ratios for 2018, 2017 and 2016:
The net loss ratio in our commercial lines of business, excluding assumed reinsurance, was 71.4 percent in 2018 compared to 69.9 percent in 2017 and 69.6 percent in 2016. The net loss ratio in 2018 is up slightly compared to 2017 with a deterioration in our other liability line of business from an increase in auto related bodily injury claims due to an adverse litigious environment. The net loss ratio in 2017 as was comparable to 2016 with an increase in losses in commercial auto and fidelity and surety offset by decreases in other liability and workers' compensation.
Incurred losses from construction defect claims were $15.9 million in 2018 compared to $15.7 million and $10.4 million in 2017 and 2016, respectively. At December 31, 2018, we had $44.5 million in construction defect loss and loss settlement expense reserves (excluding IBNR reserves which are calculated at the overall other liability commercial line), which consisted of 2,706 claims. In comparison, at December 31, 2017, we had reserves of $34.4 million, excluding IBNR reserves, consisting of 1,857 claims. The increase in the incurred losses is due to continued improvement in the economic environment which increases construction activity. Our West Coast and Rocky Mountain regions continue to be the origin of the majority of the construction defect claim activity.
As a result of our acquisition of Mercer Insurance Group in 2011, we added construction defect exposure in the states of California, Nevada and Arizona. Mercer Insurance Group has been writing in these states for more than 20 years. In order to minimize our exposure to construction defect claims in this region, we continually review the coverage we offer and our pricing models. In an effort to limit our exposure from residential multi-unit buildings, we started including condominium and townhouse construction policy exclusions in 2012 for our contracting policies in
The net loss ratio improved 10.9 percentage points in 2018 compared to 2017. This improvement is attributable to a decrease in frequency of losses along with favorable changes in loss reserves for reported claims and loss IBNR compared to the same period in 2017. We continue to make steady progress in improving our core loss ratio, however, the performance of this line of business remains below our expectations. Our strategy to improve profitability continues to be: aggressively seeking rate increases, focusing on loss control initiatives and taking action on underperforming accounts. The deterioration in our commercial automobile insurance line in 2017 as compared to 2016 was due to an increase in the number of severe losses of claims in the first three quarters of 2017.
We consider our workers' compensation business to be a companion product; we rarely write stand-alone workers' compensation policies. Our workers' compensation insurance covers primarily small- to mid-size accounts. The net loss ratio improved 7.7 percentage points in 2018 compared to 2017. The improvement in 2018 is attributable to a lower increase in reserves for reported claims during 2018 as compared to 2017. The improvement in our workers' compensation line of business in 2017 as compared to 2016 was due to the presence of relatively stronger claim reserves for prior accident years. As claims were paid and closed the release of reserves for reported claims was more than sufficient to offset claim payments.
The net loss ratio improved 1.1 percentage points in 2018 compared to 2017. This improvement is attributable to a decrease in reserves for reported claims in 2018 compared to an increase in 2017. In 2017, the change in the loss ratio was primarily due to claims from a large contractor’s bankruptcy which occurred during the fourth quarter. During 2017 the claims from the large contractor’s bankruptcy exceed our $1.5 million reinsurance retention level.
Our personal lines consist primarily of fire and allied lines (including homeowners) and automobile lines. The net loss ratio improved 9.3 percentage points in 2018 compared to 2017. This improvement was primarily driven by our personal auto line of business due to a decrease in frequency and severity of paid losses and reserves for reported claims. In 2017 our net loss ratio deteriorated 16.7 percentage points as compared to 2016. The 2017 deterioration is attributable to increased frequency and severity for personal automobile as well as an increase in the volume of claims from homeowners.
In December 2017, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 118, which addresses how a company recognizes provisional amounts when a company does not have the necessary information available, prepared or analyzed in reasonable detail to complete its accounting for the effect of the changes in the Tax Act. The measurement period ends when a company has obtained, prepared and analyzed the information necessary to finalize its accounting, but cannot extend beyond one year. As of December 31, 2018 we have completed accounting for the tax effects of enactment of the Tax Act, and no adjustment was made during the measurement period.
As of December 31, 2018, we had no alternative minimum tax credit carryforwards.
The investment landscape experienced a meaningful transition in 2018. Overall, U.S. economic fundamentals were strong, as robust labor markets, easing regulatory costs and solid growth provided a good tailwind to both business and consumer sentiment. In spite of an early jump in volatility due to factors more technical than fundamental in nature, risk assets traded higher through most of the year, however, the mood among investors shifted dramatically in the fourth quarter because of tightening financial condition and although the broad economic backdrop remained positive, signs the economy may be cooling emerged. The uncertainty prompted a significant increase in market volatility, and most every major global asset class produced negative total returns in 2018 in spite of healthy performance for three quarters of the year. The S&P 500 Index lost 14 percent in the fourth quarter to close the year down 6.2 percent. Treasury yields were higher year-over-year, though well-inside peak levels reached in November when the US 10 year Treasury Rate hit 3.25 percent. Cash was the rare market segment that traded to the positive for the year.
The amortized cost and fair value of available-for-sale and trading fixed maturity securities at December 31, 2018, by contractual maturity, are shown in the following table. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Asset-backed securities, mortgage-backed securities and collateralized mortgage obligations may be subject to prepayment risk and are therefore not categorized by contractual maturity.
possible that we could recognize impairment charges in future periods on securities that we own at December 31, 2018 if future events and information cause us to determine that a decline in value is other-than-temporary. However, we endeavor to invest in high quality assets to provide protection from future credit quality issues and corresponding other-than-temporary impairment write-downs.
In 2017, our investment income for continuing operations, net of investment expenses, decreased $4.1 million to $51.2 million as compared to 2016, primarily due to the change in value of our investments in limited liability partnerships, specifically related to financial institutions.
In 2018, 84.8 percent of our gross investment income from continuing operations originated from interest on fixed maturities, compared to 77.9 percent and 69.8 percent in 2017 and 2016, respectively.
The following table summarizes the components of our net realized investment gains or losses:
As of December 31, 2018, net unrealized investment losses, after tax, totaled $9.3 million compared to gains of$214.9 million and $133.9 million as of December 31, 2017 and 2016, respectively. The decrease in net unrealized investment gains in 2018 is primarily the result of the cumulative change in accounting principles on recognizing the change in the value of equity securities in the income statement. The change in accounting principles required unrealized gains on equity securities of $191.2 million, after-tax, as of January 1, 2018, to be reclassified to retained earnings from accumulated other comprehensive income, both within shareholders equity. The remaining decrease is due to a decrease in the value of the fixed maturity portfolio due to rising interest rates.
The increase in unrealized gains in 2016 is the result of an increase in the fair value of the equity securities portfolio due to an increase in the financial markets, partially offset by a decline in the fair value of the fixed maturity portfolio due to an increase in interest rates.
The amounts set forth in the following table detail the impact of hypothetical interest rate changes on the fair value of fixed maturity securities held at December 31, 2018. The sensitivity analysis measures the change in fair values arising from immediate changes in selected interest rate scenarios. We employed hypothetical parallel shifts in the yield curve of plus or minus 100 and 200 basis points in the simulations. Additionally, based upon the yield curve shifts, we employ estimates of prepayment speeds for mortgage-related products and the likelihood of call or put options being exercised within the simulations.
fluctuations that could cause the amount to be realized upon the future sale of the securities to differ significantly from the current reported value. The fluctuations may result from perceived changes in the underlying economic characteristics of the security issuer, the relative price of alternative investments, general market conditions, and supply/demand factors related to a particular security.
We have no direct exposure in any of the guarantors of our investments. Our largest indirect exposure with a single guarantor totaled $20.0 million or 19.5 percent of our insured municipal securities at December 31, 2018, as compared to $20.0 million or 20.8 percent at December 31, 2017. Our five largest indirect exposures to financial guarantors accounted for 73.7 percent and 66.6 percent of our insured municipal securities at December 31, 2018 and 2017, respectively.
The following table displays a summary of cash sources and uses in 2018, 2017 and 2016 from continuing and discontinued operations:
Net cash flows used in investing activities totaled $19.2 million, $62.0 million and $112.4 million in 2018, 2017 and 2016, respectively. In 2018, we had cash inflows from scheduled and unscheduled investment maturities,
redemptions, prepayments, and sales of investments, from continuing operations, that totaled $263.8 million compared to $205.1 million and $328.1 million for the same period in 2017 and 2016, respectively. In 2018, we had cash inflows from scheduled and unscheduled investment maturities, redemptions, prepayments, and sales of investments, from discontinued operations, that totaled $29.7 million compared to $148.6 million and $223.0 million for the same period in 2017 and 2016, respectively.
Our cash outflows for investment purchases from continuing operations totaled $540.4 million in 2018, compared to $267.5 million and $448.2 million for the same period in 2017 and 2016, respectively. Our cash outflows for investment purchases from discontinued operations totaled $15.4 million in 2018, compared to $131.0 million and $207.7 million for the same period in 2017 and 2016, respectively.
Net cash flows used in financing activities totaled $115.2 million, $107.5 million and $97.6 million in 2018, 2017 and 2016, respectively. Net cash flows used in financing activities from continuing operations totaled $103.6 million, $52.3 million and $19.2 million in 2018, 2017 and 2016, respectively. The change is due to an increase in the payment of cash dividends partially offset by a decrease in the repurchases of common stock. Net cash flows used in financing activities from discontinued operations totaled $11.5 million, $55.3 million and $78.3 million in 2018, 2017 and 2016, respectively, primarily due to net annuity withdrawals.
Stockholders' equity decreased 8.7 percent to $888.4 million at December 31, 2018, from $973.4 million at December 31, 2017. The decrease is primarily attributed to the payment of stockholder dividends of $105.4 million, and a decrease in net unrealized investment gains of $32.9 million, net of tax, and share repurchases of $5.4 million, all offset by net income of $27.7 million and the change in benefits and the valuation of our post-retirement benefit obligations of $25.4 million. As of December 31, 2018, the book value per share of our common stock was $35.40, compared to $39.06 at December 31, 2017.
The NAIC adopted risk-based capital requirements, which requires us to calculate a minimum capital requirement for each of our insurance companies based on individual company insurance risk factors. These "risk-based capital" results are used by state insurance regulators to identify companies that require regulatory attention or the initiation of regulatory action. At December 31, 2018, all of our insurance companies had capital well in excess of required levels.
The following table shows our contractual obligations and commitments, including our estimated payments due by period at December 31, 2018:
We estimate the pension contribution for 2019 in accordance with the Pension Protection Act of 2006 (the "Act"). Contributions for future years are dependent on a number of factors, including actual performance versus assumptions made at the time of the actuarial valuations and maintaining certain funding levels relative to regulatory requirements. Contributions in 2019, and in future years, are expected to be at least equal to the IRS minimum required contribution in accordance with the Act.
We hold investments in limited liability partnerships as part of our investment strategy. At December 31, 2018, pursuant to an agreement with our limited liability partnership investments, we are contractually committed to make consolidated capital contributions up to $22.3 million upon request of the partnerships through July 31, 2028. These partnerships are included in our other invested assets on the Consolidated Balance Sheets with a current fair value of $8.8 million, or less than 0.5% of our total invested assets, at December 31, 2018. We recognized investment income of $0.5 million from these two investments during 2018.
Upon acquisition, we classify investments in marketable securities as held-to-maturity, available-for-sale, or trading. We record investments in held-to-maturity fixed maturity securities at amortized cost. We record investments in available-for-sale and trading fixed maturity securities and equity securities at fair value. Other long-term investments consist primarily of our interests in limited liability partnerships that are recorded on the equity method of accounting. We record mortgage loans at their amortized cost less any valuation allowance.
We continually monitor the difference between our cost basis and the estimated fair value of our investments. Our accounting policy for impairment recognition requires OTTI charges to be recorded when we determine that it is more likely than not that we will be unable to collect all amounts due according to the contractual terms of the fixed maturity security. Impairment charges on investments are recorded based on the fair value of the investments at the measurement date or based on the value calculated using a discounted cash flow model. Factors considered in evaluating whether a decline in value is other-than-temporary include: the length of time and the extent to which fair value has been less than cost; the financial condition and near-term prospects of the issuer; our intention to hold the investment; and the likelihood that we will be required to sell the investment.
At December 31, 2018 and 2017, we had a number of securities with fair value less than the cost basis. The total unrealized loss on these securities was $23.6 million at December 31, 2018, compared with $16.9 million at December 31, 2017. Our rationale for not recording OTTI charges on these securities is discussed in Part II, Item 8, Note 2 "Summary of Investments."
We record an asset for certain costs of underwriting new business, primarily commissions, premium taxes and variable underwriting and policy issue expenses that have been deferred. The amount of underwriting compensation expense eligible for deferral is based on time studies and a ratio of success in policy placement. At December 31, 2018 and 2017, our DAC asset was $92.8 million and $88.1 million, respectively.
The following table illustrates the hypothetical impact on the premium deficiency charge recorded for the quarter ended December 31, 2018, of reasonably likely changes in the assumed loss and loss settlement expense ratios utilized for purposes of this calculation. The entire impact of these changes would be recognized through income as other underwriting expenses. The following table illustrates the impact of potential changes in the expected loss and loss settlement expense ratios for all lines of business on the premium deficiency charge. The base amount indicated below is the actual premium deficiency charge recorded as an offset against the DAC asset established as of the quarter ended December 31, 2018:
The amounts of the case-basis loss reserves that we establish for claims in long-tail lines of business depends upon various factors, including individual claim facts (including type of coverage, severity of loss and underlying policy limits), company historical loss experience, changes in underwriting practice, legislative enactments, judicial decisions, legal developments in the awarding of damages, changes in political attitudes and trends in general economic conditions, including inflation. As with our short-tail lines of business, we review and make changes to long-tail case-based reserves based on our review of continually evolving facts as they become available to us
during the claims settlement process. Our adjustments to case-based reserves are reported in the financial statements in the period that new information arises about the claim. Examples of facts that become known that could cause us to change our case-based reserves include, but are not limited to: evidence that loss severity is different than previously assessed; new claimants who have presented claims; and the assessment that no coverage exists.
Due to the formula-based nature of our IBNR and loss settlement expense reserve calculations, changes in the key assumptions utilized to generate these reserves can impact our reported results. It is not possible to isolate and measure the potential impact of just one of these factors, and future loss trends could be partially impacted by all factors concurrently. Nevertheless, it is meaningful to view the sensitivity of the reserves to potential changes in these variables. To demonstrate the sensitivity of reserves to changes in significant assumptions, the following example is presented. The amounts reflect the pre-tax impact on earnings from a hypothetical percentage change in the calculation of IBNR and loss settlement expense reserves at December 31, 2018. The impact to pre-tax earnings would be a decrease if the reserves were to be adjusted upwards and an increase if the reserves were to be adjusted downwards. We believe that the changes presented are reasonably likely based upon an analysis of our historical IBNR and loss settlement expense reserve experience.
Included in the other liability and assumed reinsurance lines of business are reserves for asbestos and other environmental losses and loss settlement expenses. At December 31, 2018 and 2017, we had $3.0 million and $2.6 million, respectively, in direct and assumed asbestos and environmental loss reserves. The estimation of loss reserves for environmental claims and claims related to long-term exposure to asbestos and other substances is one
of the most difficult aspects of establishing reserves, especially given the inherent uncertainties surrounding such claims. Although we record our best estimate of loss and loss settlement expense reserves, the ultimate amounts paid upon settlement of such claims may be more or less than the amount of the reserves, because of the significant uncertainties involved and the likelihood that these uncertainties will not be resolved for many years.
The following reserve development section should be read in conjunction with the "Consolidated Results of Operations" section of this Item 7.
A change in any one or more of these assumptions is likely to result in an ultimate liability different from the original actuarial estimate. Such changes in estimates may be material. For example, a 100 basis point decrease in our estimated discount rate would increase the pension and post-retirement benefit obligation at December 31, 2018,
In addition, for the post-retirement benefit plan, a 100 basis point decrease in the medical trend rate would decrease the post-retirement benefit obligation at December 31, 2018, by $4.1 million, while a 100 basis point increase in the medical trend rate would increase the benefit obligation at December 31, 2018, by $5.1 million.
A 100 basis point decrease in our estimated long-term rate of return on pension plan assets would increase the benefit expense for the year ended December 31, 2018, by $1.6 million, while a 100 basis point increase in the rate would decrease benefit expense by $1.6 million, for the same period.
For the post-retirement benefit plan, a 100 basis point increase in our estimated medical trend rate would increase the benefit expense for the year ended December 31, 2018, by $0.7 million, while a 100 basis point decrease in the rate would decrease benefit expense by $0.5 million, for the same period.
Information specific to accounting standards that we adopted in 2018 or pending accounting standards that we expect to adopt in the future is incorporated by reference from Note 1 "Summary of Significant Accounting Policies" contained in Part II, Item 8, "Financial Statements and Supplementary Data."
The change in liability for underfunded employee benefit plans is net of income taxes.
We have historically reported our operations in two business segments: property and casualty insurance and life insurance. On September 18, 2017, the Company signed a definitive agreement to sell its subsidiary, United Life Insurance Company ("United Life"), to Kuvare US Holdings, Inc. ("Kuvare") and on March 30, 2018, the sale closed. As a result, our life insurance business, previously a separate segment, was considered held for sale and reported as discontinued operations in the Consolidated Balance Sheets, Consolidated Statements of Income and Comprehensive Income and Consolidated Statements of Cash Flows (collectively, the "Consolidated Financial Statements"). Subsequent to the announcement of this sale, our continuing operations are reported as one business segment. All current and prior periods reflected in this Form 10-K have been presented as continuing and discontinued operations, unless otherwise noted. For more information, refer to Note 17 "Discontinued Operations."
The accompanying Consolidated Financial Statements have been prepared on the basis of U.S. generally accepted accounting principles ("GAAP"), which differ in some respects from those followed in preparing our statutory reports to insurance regulatory authorities. Our stand-alone subsidiary financial statements submitted to insurance regulatory authorities are presented on the basis of accounting practices prescribed or permitted by the insurance departments of the states in which we are domiciled ("statutory accounting principles").
We record our best estimate of reserves for claim litigation that arises in the ordinary course of business. We consider all of our pending litigation as of December 31, 2018 to be ordinary, routine and incidental to our business.
Our whole life and term insurance (i.e., traditional business) premiums are reported as earned when due and benefits and expenses are associated with premium income in order to result in the recognition of profits over the lives of the related contracts. Premiums receivable are presented net of an estimated allowance for doubtful accounts. Income annuities with life contingencies (single premium immediate annuities and supplementary contracts) have premium recorded and any related expense charge fees recorded as income and expense when the contract is issued. On universal life and deferred annuity policies (i.e., non-traditional business), income and expenses are reported when charged and credited to policyholder account balances in order to result in recognition of profits over the lives of the related contracts. We accomplish this by means of a provision for future policy benefits and the deferral and subsequent amortization of policy acquisition costs.
Liabilities for future policy benefits for traditional products are computed by the net level premium method, using interest assumptions ranging from 3.15 percent to 6.0 percent and withdrawal, mortality and morbidity assumptions appropriate at the time the policies were issued. Liabilities for non-traditional business are stated at policyholder account values before surrender charges. Liabilities for traditional immediate annuities are based primarily upon
future anticipated cash flows using assumptions for mortality and interest rates. Liabilities for deferred annuities are carried at the account value.
We review all of our investment holdings for appropriate valuation on an ongoing basis. Refer to Note 2 "Summary of Investments" for a discussion of our accounting policy for impairment recognition.
In 2018, 2017, and 2016, we made cash payments for income taxes of $29,071, $7,667 and $24,034, respectively. In addition, we received federal tax refunds of $1,503 and $13,383 in 2018 and 2017, respectively, that resulted from the utilization of our 2011 net operating losses and net capital losses in the carryforward period. In 2016, we did not receive any federal tax refunds. We made no interest payments in 2018, 2017 and 2016. These payments exclude interest credited to policyholders' accounts.
For the discontinued operations traditional life insurance policies, DAC is amortized to income over the premium-paying period in proportion to the ratio of the expected annual premium revenue to the expected total premium revenue. Expected premium revenue and gross profits are based on the same mortality and withdrawal assumptions used in determining future policy benefits. These assumptions are not revised after policy issuance unless the recorded DAC asset is deemed to be unrecoverable from future expected profits.
For the discontinued operations non-traditional life insurance policies, DAC is amortized over the anticipated terms in proportion to the ratio of the expected annual gross profits to the total expected gross profits. Changes in the amount or timing of expected gross profits result in adjustments to the cumulative amortization of these costs. The effect on amortization of DAC for revisions to estimated gross profits is reported in earnings in the period the estimated gross profits are revised.
The effect on DAC that results from the assumed realization of unrealized gains (losses) on investments allocated to non-traditional life insurance business is recognized with an offset to net unrealized investment appreciation as of the balance sheet date. The impact of unrealized gains (losses) on available-for-sale securities decreased the DAC asset by $6,294 and $6,413 at December 31, 2017 and 2016, respectively. There was no impact of unrealized gains and losses on available-for-sale securities on the DAC asset at December 31, 2018 because the non-traditional life insurance business is part of discontinued operations, which was sold on March 30, 2018.
Depreciation is computed primarily by the straight-line method over the following estimated useful lives:
Depreciation expense totaled $4,455, $3,805 and $5,266 for 2018, 2017 and 2016, respectively.
Goodwill and other intangible assets arise as a result of business combinations and consist of the excess of the fair value of consideration paid over the tangible assets acquired and liabilities assumed. All of our goodwill and the majority of our intangible assets relate to the acquisition of Mercer Insurance Group on March 28, 2011. We evaluate goodwill and other intangible assets for impairment at least on an annual basis or whenever events or changes in circumstances indicate that it is more likely than not that the carrying amount of goodwill and other intangible assets may exceed its implied fair value. Goodwill is evaluated at the reporting unit level. Any impairment is charged to operations in the period that the impairment is identified. In 2016 we performed a quantitative impairment assessment of our goodwill and in 2018 and 2017, we performed a qualitative impairment assessment of our goodwill. As a result of these assessments, we did not recognize an impairment charge on our goodwill in 2018, 2017 or 2016.
Our other intangible assets, which consist primarily of agency relationships, trade names, state insurance licenses, and software, are being amortized by the straight-line method over periods ranging from 2 years to 15 years, with the exception of state insurance licenses, which are indefinite-lived and not amortized. In 2016 we performed a quantitative impairment assessment of our indefinite-lived intangible assets and, in 2018 and 2017, we performed a qualitative impairment assessment of our indefinite lived intangible assets. As a result of these assessments, we did not recognize an impairment charge on our intangible assets in 2018, 2017 and 2016. Amortization expense totaled $719 in 2018, 2017 and 2016, respectively.
In May 2014, the FASB issued comprehensive new guidance on revenue recognition which supersedes nearly all existing revenue recognition guidance under GAAP. The new guidance requires a company to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The standard creates a five-step model that requires companies to exercise judgment when considering the terms of the contract(s) and all relevant facts and circumstances. Insurance contracts are not within the scope of this new guidance. The new guidance is effective for annual and interim periods beginning after December 15, 2017. The Company adopted the guidance as of January 1, 2018. The adoption of the new guidance had no impact on the Company's reporting and disclosure of net premiums earned from insurance contracts, net investment income or net realized gains and losses, as these revenue streams are not within the scope of this new guidance. The remaining revenue streams are immaterial and not impacted by the new standard.
In January 2016, the FASB issued guidance updating certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments in this update supersede the guidance to classify equity securities with readily determinable fair values into different categories (for example, trading or available-for-sale) and require equity securities to be measured at fair value with changes in the fair value recognized through net income. The new guidance also simplifies the impairment process for equity investments without readily determinable fair values. The new guidance is effective for annual periods beginning after December 15, 2017 and interim periods within those years. The Company adopted the new guidance as of January 1, 2018. The adoption of the new guidance resulted in a reclassification from accumulated other comprehensive income to retained earnings of $191,244 after tax, which is equal to the amount of net unrealized gains and losses on available-for-sale equity securities on January 1, 2018. Also, in the period ended December 31, 2018, the Company recognized an after-tax net realized investment loss from continuing operations of $17,375 in net income from the change in value of equity securities in accordance with the adoption of this new accounting guidance.
Statement of Cash Flows - Classification of Certain Cash Receipts and Payments
In February 2016, the FASB issued guidance on the accounting for leases. The new guidance requires lessees to place a right-of-use asset and a lease liability on their balance sheets. The lease liability will be based on the present value of the future lease payments and the right-of-use asset will be based on the liability. Expenses will be recognized on the income statement in a similar manner as previous methods. The new guidance also requires companies to classify all leases as operating leases or financing leases. We believe all of our leases will be classified as operating leases. The new guidance is effective for annual periods beginning after December 15, 2018 and interim periods within those years. The Company will adopt the new guidance under a modified retrospective transition approach using the package of practical expedients and the Company will not adopt the hindsight practical expedient as of January 1, 2019. We expect to use the accounting standard adoption date as our date of initial application.
The Company has a small inventory of property leases for which the Company is the lessor. For these leases, the Company has made the election not to evaluate whether certain sales taxes are the primary obligation of the lessor as owner of the leased asset. The Company has reviewed and updated its processes and controls under the new guidance. Management currently believes that the adoption will not have a significant impact on the Company's financial position or results of operations.
In October 2016, the FASB issued new guidance on the income tax treatment of intra-entity transfers. The new guidance replaces the current guidance which prohibits the recognition of current and deferred income taxes of intra-entity transfers until the asset is sold externally. Under the new guidance, the exemption is eliminated and income taxes will be recognized on transfers of intra-entity assets. The new guidance is effective for annual periods beginning after December 15, 2018 and interim periods beginning after December 15, 2019. The Company will adopt the new guidance as of January 1, 2019. Management currently believes that the adoption will have an immaterial impact on the Company's financial position and results of operations.
In June 2016, the FASB issued new guidance on the measurement of credit losses for most financial instruments. The new guidance replaces the current incurred loss model for recognizing credit losses with an expected loss model for instruments measured at amortized cost and requires allowances to be recorded for available-for-sale debt securities rather than reduce the carrying amount. These allowances will be remeasured each reporting period. The new guidance is effective for annual periods beginning after December 15, 2019 and interim periods within those years. The new guidance will impact the Company's portfolio of mortgage loan investments which are carried at amortized cost and the impairment model related to our available-for-sale fixed-maturity portfolio. The Company will adopt the new guidance as of January 1, 2020 and is currently evaluating the impact on the Company's financial position, results of operations and key processes.
In August 2018, the FASB issued new guidance which modifies the disclosure requirements on fair value measurements of financial instruments. The new guidance removes the requirement for disclosing the amount and reason for transfers between Level 1 and Level 2 investment securities and the valuation processes for Level 3 fair value measurements. The guidance also requires additional disclosures on the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The new guidance is effective for annual and interim periods beginning after December 15, 2019. The Company will adopt the new guidance as of January 1, 2020. Management currently believes the new guidance will modify existing fair value disclosures, but will not have an impact on the Company's financial position and results of operations.
The table that follows is a reconciliation of the amortized cost (cost for equity securities) to fair value of investments in held-to-maturity and available-for-sale fixed maturity and available-for-sale equity securities, presented on a consolidated basis, including both continuing and discontinued operations as of December 31, 2018 and 2017.
Net realized gains (losses) on disposition of investments are computed using the specific identification method and are included in the computation of net income. A summary of net realized investment gains (losses) for 2018, 2017 and 2016, is as follows:
Represents the change in value of our interests in limited liability partnerships that are recorded on the equity method of accounting.
A summary of changes in net unrealized investment appreciation for 2018, 2017 and 2016, is as follows for continuing operations and discontinued operations:
We have evaluated the near-term prospects of the issuers of our fixed maturity securities in relation to the severity and duration of the unrealized loss and determined that these losses did not warrant the recognition of an OTTI charge in 2018, 2017 or 2016. All fixed maturity securities in the investment portfolio continue to pay the expected coupon payments under the contractual terms of the securities. We believe the unrealized depreciation in value of other securities in our fixed maturity portfolio is primarily attributable to changes in market interest rates and not the credit quality of the issuer. We have no intention to sell and it is more likely than not that we will not be required to sell these securities until the fair value recovers to at least equal to our cost basis or the securities mature.
The following tables are a reconciliation for continuing and discontinued operations of our total fixed maturity and equity securities that were in an unrealized loss position at December 31, 2017. The securities are presented by the length of time they have been continuously in an unrealized loss position:
The fair value of our mortgage loans is determined by modeling performed by us based on the stated principal and coupon payments provided for in the loan agreements. These cash flows are then discounted using an appropriate risk-adjusted discount rate to determine the loan's fair value, which is a Level 3 fair value measurement.
A summary of the carrying value and estimated fair value of our financial instruments from continuing operations at December 31, 2018 and 2017 is as follows:
A summary of the carrying value and estimated fair value of our financial instruments from discontinued operations at December 31, 2018 and 2017 is as follows:
We use a market-based approach for valuing all of our Level 2 securities and receive them primarily from a third-party valuation service provider. Any of these securities not valued by this service provider are submitted to another third-party valuation service provider for pricing. Both service providers use a market approach to find pricing of similar financial instruments. The market inputs our service providers normally seek to value our securities include the following, listed in approximate order of priority: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including market research publications. The method and inputs for these securities classified as Level 2 are the same regardless of industry category, credit quality, duration, geographical concentration or economic characteristics. For our mortgage-backed securities, collateralized mortgage obligations and asset-backed securities, our service providers use additional market inputs to value these securities, including the following: new issue data, periodic payment information, monthly payment information, collateral performance and real estate analysis from third parties. Our service providers prioritize inputs based on market conditions, and not all inputs listed are available for use in the valuation process for each security on any given day.
For the year ended December 31, 2018, the change in our available-for-sale securities categorized as Level 1 and Level 2 is the result of investment purchases that were made using funds held in our money market accounts, disposals and the change in unrealized gains on both fixed maturities and equity securities. During the twelve month period ended December 31, 2018, there were no securities transferred between Level 1 and Level 2.
The following table provides a summary of the changes in fair value of our Level 3 securities, from continuing operations for 2018:
(1) Unrealized gains (losses) are recorded as a component of comprehensive income.
We account for premiums, written and earned, and losses incurred net of reinsurance ceded. The ceding of insurance does not legally discharge us from primary liability under our policies, and we must pay the loss if the reinsurer fails to meet its obligation. We periodically monitor the financial condition of our reinsurers to confirm that they are financially stable. We believe that all of our reinsurers are in an acceptable financial condition and there were no reinsurance balances at December 31, 2018 for which collection is at risk that would result in a material impact on our Consolidated Financial Statements. The amount of reinsurance recoverable on paid losses totaled $3,779 and $2,859 at December 31, 2018 and 2017, respectively.
We have several programs that provide reinsurance coverage. This reinsurance coverage limits the risk of loss that we retain by reinsuring direct risks in excess of our retention limits. The following table provides a summary of our primary reinsurance programs. Retention amounts reflect the accumulated retentions and co-participation of all layers within a program. For 2018, there was an all lines annual aggregate excess of loss program with variable retention of 6.78 percent of gross net earned premium with a minimum retention of $58.5 million and a maximum of $71.5 million. Our all lines aggregate recovery is also limited to $30.0 million. For 2017, there was an all lines annual aggregate excess of loss program with a variable retention of 7.02 percent of gross net earned premium with a minimum retention of $58.5 million and a maximum of $71.5 million. Our all lines aggregate recovery is also limited to a maximum of $30.0 million. For 2016, there was an all lines annual aggregate excess of loss program with a variable retention of 7.73 percent of gross net earned premium with a minimum retention of $52.0 million and a maximum of $65.0 million. Our all lines aggregate recovery is also limited to a maximum of $30.0 million.
Our IBNR methodologies and assumptions are reviewed periodically, but changes are infrequent. In response to an increase in miles driven by commercial vehicles and an increase in distracted driving claims, we revised our commercial automobile severity assumptions, resulting in an increase to our carried loss IBNR. We also reviewed our methodology and assumptions in our product liability line, associated with our construction defects business, and decreased our frequency and severity assumptions due to improvement in development patterns related to the
The significant drivers of the favorable reserve development in 2018 were our workers' compensation, reinsurance assumed, commercial automobile and fidelity and surety. During 2018 the only individual line with unfavorable development was commercial liability. Workers' compensation favorable development was primarily from reserve reductions for both reported claims and loss IBNR which were more than sufficient to offset paid loss with additional favorable development coming from loss adjustment expenses ("LAE") where the LAE IBNR reduction was more than sufficient to offset paid LAE which continues to benefit from additional litigation management efforts when compared to prior years. Reinsurance assumed favorable development is attributable reductions in reserves for both reported claims and loss IBNR as we reviewed our book of business and released excess reserves during 2018. Commercial automobile favorable development was driven by loss adjustment expense where LAE
IBNR reductions were more than sufficient to offset paid LAE. Fidelity and surety favorable development is attributable reductions in reserves for both reported claims and loss IBNR which were more than sufficient to offset paid loss. Commercial liability adverse development is attributable to reserve strengthening for both reported claims and loss IBNR primarily in response to an increase in umbrella auto related claims while loss adjustment expense developed favorably with reductions of LAE IBNR more than sufficient to offset paid LAE.
The significant drivers of the favorable reserve development in 2017 were our commercial liability and workers' compensation lines of business. Much of the favorable commercial liability development came from loss adjustment expense and is attributed to our continued litigation management efforts combined with some favorable development coming from decreases in reserves, which were more than sufficient to pay claims as they closed. Workers' compensation favorable development was due to the combined effects of decreases in claim reserves along with favorable changes affecting loss adjustment expense. Our personal lines also contributed favorable development. The lines that experienced adverse development during the year, which partially offset the favorable development mentioned earlier, were assumed reinsurance and commercial automobile. The adverse development for assumed reinsurance is due to increases in prior year reserves for unpaid claims while the adverse development for commercial auto is due to paid losses which were greater than reductions in reported loss reserves and reserves for claims incurred but not reported. No other single line of business contributed a significant portion of the total development.
The following tables provide information about incurred and paid losses and loss settlement expense development as of December 31, 2018, net of reinsurance, as well as cumulative development, cumulative claim frequency and IBNR liabilities. Claim data for Mercer Insurance Group, which was acquired on March 28, 2011, is presented retrospectively.
State laws and regulations generally limit the amount of funds that an insurance company may distribute to a parent as a dividend without Commissioner approval. As a holding company with no independent operations of its own, United Fire Group, Inc. relies on dividends received from its insurance company subsidiaries in order to pay dividends to its common shareholders. Dividends payable by our insurance subsidiaries are governed by the laws in the states in which they are domiciled. In all cases, these state laws permit the payment of dividends only from earned surplus arising from business operations. For example, under Iowa law, the maximum dividend or distribution that may be paid within a 12-month period without prior approval of the Iowa Insurance Commissioner is generally restricted to the greater of 10 percent of statutory surplus as of the preceding December 31, or net income of the preceding calendar year on a statutory basis, not greater than earned statutory surplus. Other states in which our insurance company subsidiaries are domiciled may impose similar restrictions on dividends and distributions. Based on these restrictions, at December 31, 2018, our insurance company subsidiary, United Fire & Casualty, is able to make a minimum of $106.2 million in dividend payments without prior regulatory approval. At December 31, 2018, we were in compliance with applicable state laws and regulations. These restrictions will not have a material impact in meeting our cash obligations. In addition, United Fire Group, Inc. maintains a credit agreement, as discussed in Note 14 "Credit Facility," which permits us to borrow up to an aggregate principal amount of $50,000 and allows the Company to increase the aggregate amount of the commitments thereunder by up to $100,000.
Our property and casualty subsidiaries are required to prepare and file statutory-basis financial statements in conformity with the National Association of Insurance Commissioners ("NAIC") Accounting Practices and Procedures Manual, subject to any deviations prescribed or permitted by the applicable insurance commissioner and/or director. The accounting principles used to prepare these statutory-basis financial statements follow prescribed or permitted accounting practices that differ from GAAP. Prescribed statutory accounting principles include state laws, regulations and general administrative rules issued by the state of domicile, as well as a variety of publications and manuals of the NAIC. Permitted accounting practices encompass all accounting practices not prescribed, but allowed by the state of domicile. No material permitted accounting practices were used to prepare our statutory-basis financial statements during 2018, 2017 and 2016. Statutory accounting principles primarily differ from GAAP in that policy acquisition and certain sales inducement costs are charged to expense as incurred, goodwill is amortized, life insurance reserves are established based on different actuarial assumptions and the values reported for investments, pension obligations and deferred taxes are established on a different basis.
We are directed by the state insurance departments' solvency regulations to calculate a required minimum level of statutory capital and surplus based on insurance risk factors. The risk-based capital results are used by the NAIC and state insurance departments to identify companies that merit regulatory attention or the initiation of regulatory action. United Fire & Casualty Company and its property and casualty insurance subsidiaries and affiliates had statutory capital and surplus in regards to policyholders well in excess of their required levels at December 31, 2018.
We offer a noncontributory defined benefit pension plan in which all of our employees are eligible to participate after they have completed one year of service, attained 21 years of age and have met the hourly service requirements. Retirement benefits under our pension plan are based on the number of years of service and level of compensation. Our policy to fund the pension plan on a current basis to not less than the minimum amounts required by the Employee Retirement Income Security Act of 1974, as amended, and the Internal Revenue Code of 1986, as amended, is to assure that plan assets will be adequate to provide retirement benefits. We estimate that we will contribute approximately $4,000 to the pension plan in 2019.
We also offer a health and dental benefit plan to all of our eligible employees and retirees that consists of two programs: (1) the self-funded employee health and dental benefit plan and (2) the self-funded (pre-65) and fully-funded (post-65) retiree health and dental benefit plan (the "post-retirement benefit plan"). Effective January 1, 2017, there was a plan amendment, which included the following changes: eliminated the pre-65 retirement plan with a $500 hundred dollar deductible; for retirements after January 1, 2017, the retiree will pay 50 percent of the lower cost supplemental plan if they are 65 or older and 100 percent of the premium if less than 65; and removed spousal coverage after the death of the participant. The financial impact of the changes were reflected in accumulated other comprehensive income at December 31, 2016. Effective January 1, 2019, there was a plan amendment, which requires spouses to pay 100 percent of the medical, dental & vision premiums and the subsidy for the post-65 retirees is based off the lowest cost Medicare Supplement Plan (Plan 1). The financial impact of the changes were reflected in accumulated other comprehensive income at December 31, 2018.
Our investment policy and objective for the pension plan is to generate long-term capital growth and income by way of a diversified investment portfolio along with appropriate employer contributions, which will allow us to provide for the pension plan's benefit obligation.
The investments held by the pension plan at December 31, 2018 include the following asset categories:
The following is a summary of the pension plan's actual and target asset allocations at December 31, 2018 and 2017 by asset category:
In October 2014, the Society of Actuaries finalized a new mortality table and a new mortality improvement scale. The mortality improvement scale was further refined by the Society of Actuaries in 2015, 2016 and 2017. In October 2018, the mortality assumption has been updated to reflect the annual historical U.S. mortality data to 2016 published by the Society of Actuaries. These updated tables reflect improved life expectancies and an expectation that the trend will continue. We have reviewed these updated tables and have updated the mortality assumptions based on this information and also based on research provided by our external actuaries. We will continue to monitor mortality assumptions and make changes as appropriate to reflect additional research and our resulting best estimate of future mortality rates.
Increasing interest rates resulted in an increase in the discount rates we use to value our respective plan's benefit obligations at December 31, 2018 compared to December 31, 2017.
We anticipate amortization of the net actuarial losses for our pension plan in 2019 to be $3,603. We anticipate amortization of the net actuarial losses for our post-retirement benefit plan in 2019 to be $894.
A portion of the service cost component of net periodic pension and postretirement benefit costs are capitalized and amortized as part of deferred acquisition costs and is included in the income statement line titled "amortization of deferred policy acquisition costs." The portion not related to the compensation and the other components of net periodic pension and postretirement benefit costs are included in the income statement line titled "other underwriting expenses."
plan). The Board of Directors may also take any action it deems necessary and appropriate for the administration of the Director Plan.
As of December 31, 2018, we had $6,803 in stock-based compensation expense that has yet to be recognized through our results of operations. We expect this compensation to be recognized in subsequent years according to the following table, except with respect to awards that are accelerated by the Board of Directors, in which case we will recognize any remaining compensation expense in the period in which the awards are accelerated.
The analysis below details the award activity for the restricted stock and restricted stock unit awards outstanding at December 31, 2018:
On September 19, 2017, the Company announced that it had agreed to sell its subsidiary, United Life, to Kuvare. The sale closed on March 30, 2018. As a result, our life insurance business was considered held for sale and reported as discontinued operations in the Consolidated Financial Statements and all comparable prior periods have been presented to conform to the current year presentation. For more information, refer to Note 17. "Discontinued Operations."
We write both commercial and personal lines of property and casualty insurance. We focus on our commercial lines, which represented 93.1% of our property and casualty insurance premiums earned for 2018. Our personal lines represented 6.9% of our property and casualty insurance premiums earned for 2018.
The following table sets forth our selected unaudited quarterly financial information from discontinued operations:
We determine the dilutive effect of our outstanding stock options using the "treasury stock" method. Under this method, we assume the exercise of all of the outstanding stock options whose exercise price is less than the weighted-average market value of our common stock during the reporting period. This method also assumes that the proceeds from the hypothetical stock option exercises are used to repurchase shares of our common stock at the weighted-average market value of the stock during the reporting period. The net of the assumed stock optio
ns exercised and assumed common shares repurchased represents the number of dilutive common shares, which we add to the denominator of the earnings per share calculation.
At December 31, 2018, we were obligated under noncancelable operating lease agreements for office space, vehicles, computer equipment and office equipment. Most of our leases include renewal options, purchase options or both. These provisions may be exercised by us upon the expiration of the related lease agreements. Rental expense under our operating lease agreements was $6,644, $7,197 and $6,908 for 2018, 2017 and 2016, respectively. Our most significant lease commitment is for mainframe computer equipment. This lease was signed in November 2016 and has a term of 5 years. The monthly lease payments for this lease are $154.
The Credit Agreement contains customary representations, conditions to borrowing, covenants and events of default, including certain covenants that limit or restrict, subject to certain exceptions, the ability of the Company and its subsidiaries to sell or transfer assets, enter into a merger or consolidate with another company, create liens, impose restrictions on subsidiary dividends, enter into sale-leaseback transactions, make investments or acquisitions, enter into certain reinsurance agreements, pay dividends during any period of default, enter into transactions with affiliates, change the nature of its business, or incur indebtedness. The Credit Agreement also includes financial covenants that require the Company to (i) maintain a minimum consolidated net worth, (ii) maintain a minimum consolidated statutory surplus and (iii) not exceed a 0.35 to 1.0 debt to total capitalization ratio. As of December 31, 2018 we were in compliance with all covenants of the Credit Agreement.