Includes a loss on extinguishment of debt of $2.2 million for the year ended December 31, 2012.
For all periods presented, share and per share amounts reflect the effect of the two-for-one stock split effected in the form of a stock dividend that was effective December 27, 2012.
The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes to those statements which accompany this report. A glossary of insurance terms and phrases is available on the investor section of our website. Throughout the discussion, references to “ProAssurance”, “PRA”, “Company”, “we”, “us” and “our” refer to ProAssurance Corporation and its consolidated subsidiaries. The discussion contains certain forward-looking information that involves risks and uncertainties. As discussed under the heading "Forward-Looking Statements”, our actual financial condition and operating results could differ significantly from these forward-looking statements.
We report our results in four distinct segments, based on the operational focus of the segment. Our Specialty Property and Casualty (Specialty P&C) segment includes our professional liability business and our medical technology and life sciences business. Our Workers' Compensation segment includes the business acquired through our January 1, 2014 purchase of Eastern and includes workers' compensation insurance for employers, groups and associations. Our Lloyd's Syndicate segment includes operating results from our participation in Lloyd's Syndicate 1729, which began operations January 1, 2014. Information regarding Lloyd's operations derived from U.K. based entities is reported on a quarter delay, although investment results associated with our Funds at Lloyd's (FAL) investments are reported concurrently as those results are available on an earlier time frame. Our Corporate segment includes our U.S. investment operations which are managed at the corporate level, non-premium revenues generated outside of our insurance entities, corporate expenses, interest and U.S. income taxes. Additional information regarding our segments is included in Note 15 of the Notes to Consolidated Financial Statements and in Part I.
We expect our long-term growth to come through controlled expansion of our existing operations and through the acquisition of other specialty insurance companies or books of business. Growth through acquisition is often opportunistic and cannot be predicted.
We have expanded our lines of business in new directions by acquiring Eastern, a provider of workers' compensation insurance, on January 1, 2014 and Medmarc, an underwriter of products liability insurance for medical technology and life sciences companies, on January 1, 2013. We have also been a consistent acquirer of other physician insurers, most recently IND in 2012, APS in 2010 and PICA in 2009. Other 2009 acquisitions included an agency largely focused on the professional liability needs of allied healthcare providers and an insurer focused on the legal professional liability market. We continue to see new opportunities from each of the acquisitions and believe each will provide organic growth through expansion in their existing markets and relationships.
Late in 2013, we completed the process of becoming a corporate member of Lloyd's of London, an internationally recognized specialist insurance market. We are the majority (58%) capital provider to Syndicate 1729, which began underwriting and reinsuring business as of January 1, 2014. Syndicate 1729 will cover a range of property and casualty insurance and reinsurance lines, and has a maximum underwriting capacity of £75 million for the 2015 underwriting year, of which £43.2 million ($67.2 million at December 31, 2014) is our allocated underwriting capacity as a corporate member.
The combined ratio is the sum of the underwriting expense ratio and the net loss ratio and measures underwriting profitability.
We particularly focus on our combined ratio and investment returns, both of which directly affect our ROE and growth in our book value. Historically we have targeted a long-term average ROE of 12% to 14%. Given the persistent low interest rate environment which prevails in the United States and the soft pricing environment for our products, the realization of this long-term ROE target in the next few years will likely prove difficult.
The acquisition of Eastern, which specializes in workers' compensation insurance and reinsurance, on January 1, 2014 increased our loss reserve by $153.2 million which represented the fair value of Eastern's loss reserve at the time of the acquisition. The fair value of the reserve for losses and loss adjustment expenses and related reinsurance recoverables was based on an actuarial estimate of the expected future net cash flows, a reduction of those cash flows for the time value of money determined utilizing the U.S. Treasury Yield Curve, and a risk adjustment to reflect the net present value of profit that an investor would demand in return for the assumption of the associated risks. Expected net cash flows were derived from the expected loss payment patterns included in an actuarial analysis of Eastern's reserve performed as of December 31, 2013. The fair value of the reserve, including the risk margin discussed above, exceeded the undiscounted loss reserve previously established by Eastern by $9.3 million; this fair value adjustment is being amortized over the average expected life of the reserve of 6 years.
Specialty P&C Segment. Professional and product liability loss costs are impacted by many factors, including but not limited to, the nature of the claim, including whether or not the claim is an individual or a mass tort claim, the personal situation of the claimant or the claimant's family, the outcome of jury trials, the legislative and judicial climate where any potential litigation may occur, general economic conditions and, for claims involving bodily injury, the trend of healthcare costs. Within our Specialty P&C segment, for our healthcare professional liability (HCPL) business (62% of consolidated gross premiums earned for the year ended December 31, 2014), we set an initial reserve using the average loss ratio used in our pricing, plus an additional provision in consideration of the historical loss volatility we and others in the industry have experienced. For our HCPL business our target loss ratio during recent accident years has approximated 75% and the provision for loss volatility has ranged from 8 to 10 percentage points, producing an overall average initial loss ratio for our HCPL
The risks insured in our medical technology and life sciences products liability business (5% of consolidated gross premiums earned for the year ended December 31, 2014) are more varied, and policies are individually priced based on the risk characteristics of the policy. Therefore, for this business we establish an initial reserve using our most recently developed actuarial estimates of losses expected to be incurred based on factors which include: results from prior analysis of similar business, industry indications, observed trends and judgment. The products liability line of business exhibits similar volatility to HCPL, and the actuarial pricing estimate includes a provision for this volatility.
For both the Specialty P&C and Workers' Compensation segments the analysis performed by the consulting actuaries analyzes each partition of our business in a variety of ways and uses multiple actuarial methodologies in performing these analyses, including:
Bornhuetter-Ferguson Method. We use both the Paid and the Reported Bornhuetter-Ferguson methods. The Paid method assigns partial weight to initial expected losses for each accident year (initial expected losses being the first established case and IBNR reserves for a specific accident year) and partial weight to paid to-date losses. The Reported method assigns partial weight to the initial expected losses and partial weight to current expected losses. The weights assigned to the initial expected losses decrease as the accident year matures.
Even though the actuarial process is highly technical, it is also highly judgmental, both as to the selection of the data used in the various actuarial methodologies (e.g., initial expected loss ratios and loss development factors) and in the interpretation of the output of the various methods used. Each actuarial method generally returns a different value and for the more recent accident years the variations among the various methodologies can be significant. For each partition of our reserves, the results of the various methods, along with the supplementary statistical data regarding such factors as closed with and without indemnity ratios, claim severity trends, the expected duration of such trends, changes in the legal and legislative environment and the current economic environment, are used to develop a point estimate based upon management's judgment and past
experience. The process of selecting the point estimate is based upon the judgment of management taking into consideration the actuarial methods and other environmental factors discussed previously. The series of selected point estimates is then combined to produce an overall point estimate for ultimate losses.
Because of the implicit and wide-ranging nature of severity trend assumptions on the loss reserving process it is not practical to specifically isolate the impact of changing severity trends. However, because severity is an explicit component of our HCPL pricing process we can better isolate the impact that changing severity can have on our loss costs and loss ratios as regards our pricing models for this business component. Our current HCPL pricing models assume a severity trend of 2% to 3% in most states and lines of business. If the severity trend were to be higher by 1 percentage point, the impact would be an increase in our expected loss ratio for this business of 3.2 percentage points, based on current claim disposition patterns. An increase in the severity trend of 3 percentage points would result in a 10.1 percentage point increase in our expected loss ratio. Due to the long tailed nature of our claims and the previously discussed historical volatility of loss costs, selection of a severity trend assumption is a subjective process that is inherently likely to prove inaccurate over time. Given the long-tail and volatility, we are generally cautious in making changes to the severity assumptions within our pricing models. Also of note is that all open claims and accident years are generally impacted by a change in the severity trend, which compounds the effect of such a change.
Workers' Compensation. Severity has not historically been an influential factor affecting our workers' compensation analysis of reserves, as claims are typically resolved more quickly. As previously mentioned, the determination and calculation of loss development factors requires considerable judgment. In particular the selection of tail factors requires considerable judgment as they are determined in the absence of direct loss development history and thus require reliance upon industry data which may not be representative of the Company’s data and experience.
An extended period of time is required to get a clear estimate of the loss cost for a given accident year. As an example, looking at the 2009 accident year for our professional liability reserves, we had resolved 80.6% of the known claims by the end of 2012, 89% of the known claims by the end of 2013, and 94.9% of the known claims by the end of 2014. These statistics are based on the number of reported claims; since many non-meritorious claims are resolved early, percentages of ultimate loss payments known at the same points in time are considerably lower. A similar pattern can be seen in each open accident year as demonstrated in the above table.
Based upon the additional claims closed during 2014, 2013 and 2012, as shown above, and better than expected severity trends, management reduced its expected ultimate losses in each of these years resulting in the recognition of corresponding amounts of favorable development in the income statements of those periods. At December 31, 2014, 2013 and 2012
management reserve estimates for the three most recent prior accident years (which have closed claim percentages below 85%) were influenced by the initial reserve estimate set for these years, moderated to reflect consideration of better than anticipated claims experience observed during the periods. Estimates for older accident years with higher percentages of closed claims were more heavily influenced by the more moderate severity trend, particularly with regard to claims closed during the periods.
The following table presents additional information about the loss development for our medical technology and life sciences products liability line of business:
Due to the size of our consolidated reserve for losses and the large number of claims outstanding at any point in time, even a small percentage adjustment to our total reserve estimate could have a material effect on our results of operations for the period in which the adjustment is made.
We make a determination of the amount of insurance risk we choose to retain based upon numerous factors, including our risk tolerance and the capital we have to support it, the price and availability of reinsurance, volume of business, level of experience with a particular set of claims and our analysis of the potential underwriting results. We purchase reinsurance from a number of companies to mitigate concentrations of credit risk. We utilize a reinsurance broker to assist us in the placement of our reinsurance programs and in the analysis of the credit quality of our reinsurers. The determination of which reinsurers we choose to do business with is based upon an evaluation of their then-current financial strength, rating and stability.
Because of the number of securities we own and the complexity and cost of developing accurate fair values, we utilize multiple independent pricing services to assist us in establishing the fair value of individual securities. The pricing services provide fair values based on exchange traded prices, if available. If an exchange traded price is not available, the pricing
When a pricing service does not provide a value for one of our fixed maturity securities, management estimates fair value using either a single non-binding broker quote or pricing models that utilize market based assumptions which have limited observable inputs. The process involves significant judgment in selecting the appropriate data and modeling techniques to use in the valuation process. For disclosure purposes we classify fixed maturity securities valued using limited observable inputs as Level 3 securities.
Certain of our investments, in accordance with GAAP for the type of investment, are measured using methodologies other than fair value. At December 31, 2014 these investments represented approximately 6% of total investments, and are detailed in the following table. Additional information about these investments is provided in Notes 3 and 4 of the Notes to Consolidated Financial Statements.
our internal assessments and those of our external portfolio managers regarding specific circumstances surrounding a security, which can cause us to believe the security is more or less likely to recover its value than other securities with a similar structure;
our intent to sell and whether it is more likely than not we will be required to sell the security before the recovery of its amortized cost basis.
Our investments in tax credit partnerships are evaluated for OTTI by considering both qualitative and quantitative factors which include: whether cash flows currently expected from the investment, primarily tax benefits, equal or exceed the carrying value of the investment, whether currently expected cash flows are less than those expected at the time the investment was acquired, and our ability and intent to hold the investment until the recovery of its carrying value.
Deferred federal income taxes arise from the recognition of temporary differences between the bases of assets and liabilities determined for financial reporting purposes and the bases determined for income tax purposes. Our temporary differences principally relate to our loss reserve, unearned premiums, deferred policy acquisition costs, unrealized investment gains (losses), and basis differences on investment assets. Deferred tax assets and liabilities are measured using the enacted tax rates expected to be in effect when such benefits are realized. We review our deferred tax assets quarterly for impairment. If we determine that it is more likely than not that some or all of a deferred tax asset will not be realized, a valuation allowance is recorded to reduce the carrying value of the asset. In assessing the need for a valuation allowance, management is required to make certain judgments and assumptions about our future operations based on historical experience and information as of the measurement period regarding reversal of existing temporary differences, carryback capacity, future taxable income (including its capital and operating characteristics) and tax planning strategies. We did not have any significant valuation allowances as of December 31, 2014.
We evaluate tax positions taken on tax returns and recognize positions in our financial statements when it is more likely than not that we will sustain the position upon resolution with a taxing authority. If recognized, the benefit is measured as the largest amount of benefit that has a greater than fifty percent probability of being realized. We review uncertain tax positions each period, considering changes in facts and circumstances, such as changes in tax law, interactions with taxing authorities and developments in case law, and make adjustments as we consider necessary. Adjustments to our unrecognized tax benefits may affect our income tax expense, and settlement of uncertain tax positions may require the use of cash. At December 31, 2014, our liability for unrecognized tax benefits approximated $0.6 million.
Management evaluates the carrying value of goodwill at the segment (or reporting unit) level annually as of October 1st. If, at any time during the year, events occur or circumstances change that would more likely than not reduce the fair value below the carrying value, we also evaluate goodwill at that time.
The goodwill impairment assessment requires evaluating qualitative factors or performing a quantitative assessment to determine if a reporting unit’s carrying value is likely to exceed its fair value. For our reporting units, we elected to assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. When using the qualitative approach, we considered macroeconomic factors such as industry and market conditions. We also considered reporting unit-specific events, actual financial performance versus expectations and management’s future
Workers’ compensation premiums are determined based upon the payroll of the insured, the applicable premium rates and, where applicable, an experience based modification factor. An audit of the policyholders’ records is conducted after policy expiration to make a final determination of applicable premiums. Audit premium due from or due to a policyholder as a result of an audit is reflected in net premiums earned when billed. We track, by policy, the amount of additional premium billed in final audit invoices as a percentage of payroll exposure and use this information to estimate the probable additional amount of earned, but unbilled, (EBUB) premium as of the balance sheet date. We include changes to the EBUB premium estimate in net premiums earned in the period recognized.
The comparative effect resulting from operations acquired or begun in the current year is shown separately in the reconciliation and is therefore excluded from the other amounts in the reconciliation and the related explanations below.
Payments to reinsurers. Reinsurance contracts are generally for premiums written in a specific annual period, but, absent a commutation agreement, remain in effect until all claims under the contract have been resolved. Some contracts require annual settlements while others require settlement only after a number of years have elapsed, thus the amounts paid can vary widely from period to period. The increase in payments to reinsurers in 2014 was primarily attributable to expansion of our
shared risk arrangements and to payments made pursuant to our quota share reinsurance agreement with Syndicate 1729. Our 58% share of Syndicate 1729 net cash flows, identified below, reflects receipt of these payments.
Cash received from investments. Receipts from fixed income securities have declined due to both lower yields and a smaller fixed income portfolio. Also, the timing of dividend receipts and income distributions from our investment LPs/LLCs is uneven.
Cash paid for other expenses and operating liabilities. Variations were attributable to the following:
We report Syndicate 1729 activity on a one quarter lag, and, for consistency, have reported the reinsurance payment made to Syndicate 1729 during the fourth quarter of 2014 as an operating liability payment.
GAAP requires that excess tax benefits recognized when shares are issued under stock compensation plans be reflected as a reduction to operating cash flows and as an increase to financing cash flows in the period the shares are issued.
Both 2014 and 2013 were affected by a refund received in 2013 of $3.3 million related to pre-acquisition tax periods of acquired entities. Comparatively, our 2012 cash flows were lower than in 2011 due to refunds received in 2011 of $17.3 million related to pre-acquisition tax periods of acquired entities and capital loss carry backs, and a payment made in 2011 of $5.9 million which related to previously recorded tax liabilities for the 2008 and 2007 tax years.
Primarily attributable to transaction costs, loss payments related to accident years prior to the acquisition, and normal expense payments for which the timing of the payment differs from the recognition of the expense.
The following may be helpful in understanding the Analysis of Reserve Development:
The section entitled “Cumulative net paid, as of” reflects the cumulative amounts paid as of the end of each succeeding year with respect to the previously recorded Balance Sheet Reserves.
Reserves for 2013 include gross and net reserves acquired in 2013 business combinations of $201.1 million and $126.0 million, respectively.
Activity in our net reserve for losses during 2014, 2013 and 2012 is summarized below:
(1) Includes a net reserve reduction of $3.3 million in 2013 due to the re-estimation of reserves acquired in a 2012 business combination.
(3) Includes prior year paid losses of $70.7 million in 2014 and $33.4 million for 2013 attributable to reserves acquired in a business combination completed in 2014 and 2013, respectively.
We generally reinsure risks under annual treaties (our excess of loss reinsurance arrangements) pursuant to which the reinsurers agree to assume all or a portion of all risks that we insure above our individual risk retention levels, up to the maximum individual limits offered. These arrangements are negotiated and renewed annually. Renewal dates for our professional liability, products liability and workers' compensation treaties are October 1, January 1 and May 1, respectively. There were no significant changes in the cost or structure of the agreements upon the latest renewal of each. The significant terms of our excess of loss reinsurance arrangements are detailed in the following table.
Large professional liability risks that are above the limits of our basic reinsurance treaties are reinsured on a facultative basis, whereby the reinsurer agrees to insure a particular risk up to a designated limit. We also have in place a number of risk sharing arrangements that apply to the first $1 million of losses for certain large healthcare systems and other insurance entities.
The remaining premium written in our alternative market business of $6.3 million is 100% ceded to an unaffiliated captive insurer.
Within our Lloyd's Syndicate segment, Syndicate 1729 purchases reinsurance to limit its liability on individual risks and to protect against catastrophic loss. The level of reinsurance that the Syndicate purchases is dependent on a number of factors, including its underwriting risk appetite for catastrophe risk, the specific risks inherent in each line or class of business risk written and the pricing, coverage and terms and conditions available from the reinsurance market. Both quota share reinsurance and excess of loss reinsurance is utilized to manage the net loss exposure. The Syndicate may still be exposed to loss that exceeds the level of reinsurance purchased, as well as to reinstatement premiums triggered by additional loss events.
The following table identifies those reinsurers for which our recoverables for both paid and unpaid claims (net of amounts due to the reinsurer) and our prepaid balances are aggregately $20 million or more as of December 31, 2014:
In 2013 we received a Notice of Proposed Adjustment (NOPA) from the IRS related to the examination of our 2009 and 2010 tax years. We subsequently protested certain issues in the NOPA, all of which related to the timing of deductions, and also made a related $20.6 million protective payment. In April 2014, we reached a final settlement with the IRS on all contested issues, which did not increase our tax liability. We received refunds from the IRS related to the NOPA in July 2014 of $30.6 million in total, exclusive of interest, which included a refund from the settlement of non-contested issues addressed by the NOPA and the return of the protective payment.
A detailed listing of our investment holdings as of December 31, 2014 is provided in the Investor Supplement we make available in the Investor Relations section of our website, www.ProAssurance.com, or directly at www.ProAssurance.com/investorrelations/supplemental.aspx.
Our acquisition of Eastern added the following to our investment holdings as of January 1, 2014, the date of acquisition:
As discussed under the heading "Business Combinations and Ventures" and in Note 4 of the Notes to Consolidated Financial Statements, our fixed maturity and short term investments include securities deposited with Lloyd's in order to meet our FAL requirement. At December 31, 2014 securities on deposit with Lloyd's included fixed maturities having a fair value of $85.0 million and short term investments with a fair value of $0.2 million.
Our reinsurers typically operate globally and have large investment portfolios which may be linked directly or indirectly to the European economy. As of December 31, 2014, two of our largest reinsurers were domiciled in Europe; our net receivables with these reinsurers totaled approximately $45 million. Net amounts due from reinsurers approximated $259.1 million at December 31, 2014.
Our Board of Directors declared cash dividends during 2014, 2013 and 2012 as follows:
We have available a revolving credit agreement (the "Credit Agreement") of up to $200 million which may be used for general corporate purposes, including, but not limited to, short-term working capital, share repurchases as authorized by the Board, and support for other activities we enter into in the normal course of business. The Credit Agreement expires in April 2016. No borrowings were outstanding under the Credit Agreement during 2014. We drew $125.0 million against the line from December 2012 to September 2013 on a secured basis to partially fund our acquisition of Medmarc, as this permitted us to continue to hold rather than liquidate certain higher yielding securities. Similarly, we drew $100 million against the line in January 2015 on a secured basis to partially fund our special dividend. We are in compliance with the financial covenants of the Credit Agreement.
We are a member of a number of FHLBs. Through membership, we have access to secured cash advances which can be used for liquidity purposes or other operational needs. To date, we have not established a FHLB line of credit or materially utilized our membership.
We have a revolving credit agreement with Syndicate 1729 to provide operating funds of up to £10.0 million, of which £3.4 million ($5.3 million) had not yet been funded as of December 31, 2014. The revolving credit agreement expires on December 31, 2016. See Note 9 of the Notes to Consolidated Financial Statement for more information on this arrangement. We have no other off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
We believe that our operating cash flow and funds from our investment portfolio are adequate to meet our contractual obligations.
The above table presumes no borrowings or related interest under our revolving credit agreement through expiration of the agreement as the obligation is presented as of December 31, 2014. In January 2015, we drew $100 million on the revolving credit agreement. For more information regarding these agreements see Note 10 of the Notes to Consolidated Financial Statements.
Net realized investment gains (losses) decreased $53.3 million for the year ended December 31, 2014 as compared to 2013. The changes primarily related to trading securities carried at fair value. Net impairments were approximately $1.2 million in the year ended December 31, 2014 and nominal in the year ended December 31, 2013.
The changes in renewal pricing shown for healthcare facilities and products liability lines of business in particular are reflective of changes in our exposure base, deductibles, self-insurance retention limits and other policy terms. Changes in renewal pricing by component are as follows:
Ceded premiums represent the amounts owed to our reinsurers for their assumption of a portion of our losses. Through our current excess of loss reinsurance arrangements we retain the first $1 million in risk insured by us and cede any coverages in excess of this amount, and for our products liability coverages, we also retain 20% of the next $9 million of risk for coverages in excess of $1 million. We pay our reinsurers a ceding premium in exchange for their accepting the risk, the ultimate amount of which is determined by the loss experience of the business ceded, subject to certain minimum and maximum amounts.
Net premiums earned consist of gross premiums earned less the portion of earned premiums that we cede to our reinsurers for their assumption of a portion of our losses. Because premiums are generally earned pro rata over the entire policy period, fluctuations in premiums earned tend to lag those of premiums written. Generally, our policies carry a term of one year, but as discussed above, we write certain policies with a twenty-four month term, and certain of our medical technology and life sciences products liability policies carry a multi-year term. Tail coverage premiums are generally 100% earned in the period written because the policies insure only incidents that occurred in prior periods and are not cancellable. Additionally, ceded premium changes due to changes to estimates of premiums owed under reinsurance agreements are fully earned in the period of change.
The decrease in gross premiums earned in 2014 primarily reflects the pro rata effect of lower physician premiums written during the preceding twelve months, partially offset by an increase in premiums earned due to growth associated with our shared risk arrangements. The increase in premiums ceded during 2014 primarily reflects growth associated with certain shared risk arrangements that were either new in 2014 or not in effect for all of 2013 and premiums ceded under the quota share arrangement with Syndicate 1729. Also, prior accident year ceded premiums reductions were $0.7 million lower in 2014 than in 2013 (see discussion under the heading "Ceded Premiums Written").
Our Workers' Compensation segment provides traditional workers' compensation insurance products primarily to employers with 1,000 employees or fewer and alternative market solutions, as discussed in Note 15 to the Notes to Consolidated Financial Statements. Our Workers' Compensation operations are the primary business operations acquired through our purchase of Eastern in 2014. Segment operating results reflect pre-tax underwriting profit or loss, and does not include investment results which are reported in our Corporate segment. Segment operating results for the year ended December 31, 2014 were $6.5 million and included the following:
Retention, renewal price change, new business and audit premium for both the traditional business and the alternative market business for 2014 are shown in the table below:
(2) The pricing of our business includes an assessment of the underlying policy exposure and the effects of current market conditions. We continue to base our pricing on expected losses, as indicated by our historical loss data.
Ceded premiums written reflect our external reinsurance programs and alternative market business ceded to an unaffiliated captive insurance company.
Ceded premiums written for the year ended December 31, 2014 were as follows:
Net premiums earned for the year ended December 31, 2014 were as follows:
The following table summarizes calendar year net loss ratios by separating losses between the current accident year and all prior accident years. The components of the calendar year loss ratio were as follows:
We recognized favorable prior year development at the segment level for our workers' compensation business of $1.3 million for the year ended December 31, 2014. Our traditional business produced $1.6 million in favorable development related to amortization associated with the purchase accounting fair value adjustment, which was offset by unfavorable development of $0.3 million related to our alternative market business, primarily reflecting medical severity-related claims activity in the 2013 accident year.
We recognized audit premium from customers in both our traditional and alternative market business during 2014, which reduced the current accident year net loss ratio. Audit premium from customers results in a decrease in the net loss ratio, whereas audit premium returned to customers results in an increase in the net loss ratio.
Our expense ratio for the year ended December 31, 2014, including the impact of audit premium and certain discrete items in our traditional and alternative market business, was as follows:
Our Workers' Compensation segment provides turn-key workers' compensation alternative market solutions that include program design, fronting, claims administration, risk management, SPC rental, asset management and SPC management services. The asset management and SPC management services are outsourced to a third party. Alternative market customers include individual companies, groups and/or associations (known as SPC dividend participants). SPC dividend expense for each period represents the profit or loss attributable to the alternative market business ceded to the SPC's of Eastern Re, net of any participation we have taken in the SPC's.
Segment gross premiums written by component as well as a reconciliation to net premiums written are shown in the following table.
Operating results of this segment are subject to both U.K and U.S. income tax law. No tax benefit has been recognized related to the operations of this segment as the loss is not currently deductible for tax purposes in either the U.K. or the U.S. and does not meet GAAP criteria for recognition of a deferred tax asset.
The decrease in our income from fixed maturity securities was primarily due to lower average investment balances. Although we added fixed securities valued at $107 million to our portfolio in 2014 as a result of the Eastern acquisition, we reduced the size of our fixed portfolio over the last year in order to purchase Eastern, repay debt, repurchase stock, pay dividends and invest in other asset classes. On an overall basis our average investment in fixed securities was approximately 6% lower in 2014 as compared to 2013.
Yields on fixed maturity securities decreased as compared to the same period in the prior year. Average income yields for the year ended December 31, 2014 primarily reflected a 6 basis point decline resulting from fixed maturity securities acquired in the Eastern transaction. In accordance with purchase accounting guidance, all Eastern securities were valued at fair value on the date acquired, which resulted in these securities having a lower yield on average than our other securities.
Investment fees and expenses increased for the year ended December 31, 2014 due to the addition of Eastern and some associated transition expenses in 2014.
Our effective tax rates for both 2014 and 2013 were different from the statutory Federal income tax rate primarily due to the following:
we utilized tax credits transferred to us from our tax credit partnership investments
Our net investment result (which includes both net investment income and earnings from unconsolidated subsidiaries) increased $7.6 million or 5.9%. Net investment income decreased during 2013, primarily due to reduced earnings on our fixed income portfolio, partially offset by increased earnings from our equities portfolio and distributions received from a cost method investment LP in 2013. Earnings from unconsolidated subsidiaries increased $14.4 million in 2013. Earnings from unconsolidated subsidiaries principally reflects earnings recognized as a result of a change of an LP from the cost method to the equity method in the fourth quarter of 2013 as well as higher earnings from a private equity LP, slightly offset by higher tax credit partnership amortization.
Our Specialty P&C segment focuses on professional liability insurance and medical technology and life sciences products liability insurance as discussed in Note 13 of the Notes to Condensed Consolidated Financial Statements. Specialty P&C segment operating results reflect pre-tax underwriting profit or loss from these insurance lines, exclusive of investment results, which are included in our Corporate segment. Segment operating results for the years ended December 31, 2013 were $176.7 million, as compared to $250.8 million for 2012, and included the following:
Physician policies were our greatest source of premium revenues in both 2013 and 2012. In addition to the effects of retention and renewal pricing discussed above, our 2013 twelve month term physician premium volume reflected the following:
The acquisition of IND contributed approximately $10.5 million of physician premium to 2013.
Ceded premiums represent the amounts owed to our reinsurers for their assumption of a portion of our losses. In general we retain the first $1 million in risk insured by us and cede any coverages in excess of this amount. We pay our reinsurers a ceding premium in exchange for their accepting the risk, the ultimate amount of which is determined by the loss experience of the business ceded, subject to certain minimum and maximum amounts.
As discussed previously, the premium that we cede under our reinsurance arrangements is determined, in part, by the losses ceded under these arrangements. Ceded premiums decreased due to lower premiums in 2013, and beginning with the second quarter of 2012, we projected (estimated) lower losses for our ceded coverages and reduced our estimate of the associated ceded premium for the current accident year. The year ended December 31, 2013 reflected those lower projections for the full period in 2013 as compared to two quarters in 2012.
We have secondary arrangements with certain large healthcare groups that include quota share, fronting and other risk sharing arrangements. Growth in these arrangements increased ceded premium in 2013 as compared to 2012. These arrangements are primarily comprised of the following:
* Effect shown for 2013 is net of an increase to the ratio of approximately 0.3 percentage points attributable to business combinations.
Gross premiums earned in 2013 reflected additional premiums contributed by acquisitions of approximately $53.9 million offset by the pro rata effect of lower physician premiums written by our other subsidiaries during the preceding twelve months, and a decline in tail premium of $8.9 million. Our 2013 gross premiums earned includes approximately $25.1 million in gross premiums earned associated with Medmarc and IND policies written prior to our acquisition of these operations. We expect Medmarc and IND policies written pre-acquisition to contribute gross premiums earned of approximately $3.0 million in 2014 and beyond.
The following table summarizes calendar year net loss ratios by separating losses between the current accident year and all prior accident years. Additionally, the table shows our current accident year net loss ratio was significantly affected by revisions to our estimate of premiums owed to reinsurers related to coverages provided in prior accident years. Our current accident year net loss ratios for December 31, 2013 and 2012 compare as follows:
We recognized favorable loss development related to previously established reserves, on a gross basis, of $248.5 million in 2013 and $321.5 million in 2012. On a net basis, we recognized favorable development of $222.7 million in 2013 and $272.0 million in 2012. The net basis reflects the favorable development recognized with respect to our ceded coverage layers.
Assumptions used in establishing our reserve are regularly reviewed and updated by management as new data becomes available. Any adjustments necessary are reflected in the current operations. Due to the size of our reserve, even a small percentage adjustment to the assumptions can have a material effect on our results of operations for the period in which the change is made, as was the case in both 2013 and 2012.
*Effect shown for 2013 is net of an increase to the ratio of approximately 0.1 percentage
The operating expenses of Medmarc and IND, exclusive of transaction costs, had a minor effect on our 2013 ratio as these entities also increased net premium earned. However, as previously discussed, recorded deferred policy acquisition cost amortization for these entities was lower in 2013 than would be considered normal due to the application of GAAP purchase accounting rules. Normalizing these costs increases our 2013 ratio by approximately 0.8 percentage points.
Segment operating results for our Corporate segment for the year ended December 31, 2013 were $120.8 million and were $24.7 million for 2012. Results included the following:
The tax benefits received from our tax credit partnerships, which are not reflected in our investment results above, reduced our tax expenses in 2013 and 2012 as follows:
All impairments of debt securities recognized during 2013 and 2012 were credit-related.
Gains (losses) from changes in the fair value of liabilities in 2012 were entirely attributable to our note payable due 2019 and related interest rate swap, both of which we repaid in July 2012.
Interest expense for 2013 and 2012 is provided in the following table:
Consolidated Balance Sheets - December 31, 2014 and December 31, 2013
Consolidated Statements of Changes in Capital - Years Ended December 31, 2014, 2013 and 2012
Consolidated Statements of Income and Comprehensive Income - Years Ended December 31, 2014, 2013 and 2012
Consolidated Statements of Cash Flows - Years Ended December 31, 2014, 2013 and 2012
The Supplementary Financial Information required by Item 302 of Regulation S-K is included in Note 17 of the Notes to Consolidated Financial Statements of ProAssurance and its subsidiaries.