An important part of our strategy is to form new operating units to capitalize on various business opportunities. Over the years, the Company has formed numerous new operating units that are focused on important parts of the economy in the U.S., including healthcare, energy and agriculture, and on growing international markets, including Scandinavia, Australia, the Asia-Pacific region and South America.
The profitability of the Company’s insurance business is affected primarily by the adequacy of premium rates. The ultimate adequacy of premium rates is not known with certainty at the time an insurance policy is issued because premiums are determined before claims are reported. The ultimate adequacy of premium rates is affected mainly by the severity and frequency of claims, which are influenced by many factors, including natural and other disasters, regulatory measures and court decisions that define and change the extent of coverage and the effects of economic inflation on the amount of compensation for injuries or losses. General insurance prices are also influenced by available insurance capacity, i.e., the level of statutory capital and surplus employed in the industry, and the industry’s willingness to deploy that capital.
The key assumptions used in calculating the most recent estimate of the loss reserves are reviewed each quarter and adjusted, to the extent necessary, to reflect the latest reported loss data, current trends and other factors observed. If the actual level of loss frequency and severity are higher or lower than expected, the ultimate losses will be different than management’s estimate. The following table reflects the impact of changes (which could be favorable or unfavorable) in frequency and severity, relative to our assumptions, on our loss estimate for claims occurring in 2015:
Our net reserves for losses and loss expenses of approximately $9.2 billion as of December 31, 2015 relate to multiple accident years. Therefore, the impact of changes in frequency or severity for more than one accident year could be higher or lower than the amounts reflected above. The impact of such changes would likely be manifested gradually over the course of many years, as the magnitude of the changes became evident.
Net prior year development (i.e, the sum of prior year reserve changes and prior year earned premiums changes) for each of the three years ended December 31, 2015 are as follows:
For the Insurance-Domestic segment, favorable development in 2014 of $92 million was driven primarily by other liability business for accident years 2006 through 2010, primarily related to our excess and surplus lines casualty business. Reported losses during these years continued to be below our initial expectations at the time the business was written, largely as a result of persistent improvement in claim frequency trends (i.e., number of reported claims per unit of exposure). As these accident years have matured, the weighting of actuarial methods has shifted from methods based on initial expected losses to
methods based on actual reported losses. We believe the favorable claim frequency trends we have seen during this time period are due to changes in the mix of business written and to the general slowdown in the economy. Commercial automobile reported unfavorable development primarily as a result of large losses for long-haul trucking business in 2012 and 2013.
For the Insurance-International segment, adverse reserve development in 2014 of $23 million was driven primarily by unexpected large losses from accident years 2009-2012 in the professional indemnity line of business in the United Kingdom.
Favorable prior year reserve development (net of additional and return premiums) was $98 million in 2013.
Reserve Discount. The Company discounts its liabilities for certain workers’ compensation reserves. The amount of workers’ compensation reserves that were discounted was $2,308 million and $2,187 million at December 31, 2015 and 2014, respectively. The aggregate net discount for those reserves, after reflecting the effects of ceded reinsurance, was $699 million and $746 million at December 31, 2015 and 2014, respectively. At December 31, 2015, discount rates by year ranged from 2.0% to 6.5%, with a weighted average discount rate of 3.9%.
Assumed Reinsurance Premiums. The Company estimates the amount of assumed reinsurance premiums that it will receive under treaty reinsurance agreements at the inception of the contracts. These premium estimates are revised as the actual amount of assumed premiums is reported to the Company by the ceding companies. As estimates of assumed premiums are made or revised, the related amount of earned premiums, commissions and incurred losses associated with those premiums are recorded. Estimated assumed premiums receivable were approximately $62 million and $85 million at December 31, 2015 and December 31, 2014, respectively. The assumed premium estimates are based upon terms set forth in reinsurance agreements, information received from ceding companies during the underwriting and negotiation of agreements, reports received from ceding companies and discussions and correspondence with reinsurance intermediaries. The Company also considers its own view of market conditions, economic trends and experience with similar lines of business. These premium estimates represent management’s best estimate of the ultimate amount of premiums to be received under its assumed reinsurance agreements.
Other-Than-Temporary Impairments (OTTI) of Investments. The cost of securities is adjusted where appropriate to include a provision for decline in value which is considered to be other-than-temporary. An other-than-temporary decline is considered to occur in investments where there has been a sustained reduction in fair value and where the Company does not expect the fair value to recover prior to the time of sale or maturity. Since equity securities do not have a contractual cash flow
or maturity, the Company considers whether the price of an equity security is expected to recover within a reasonable period of time.
Fixed Maturity Securities - For securities that we intend to sell or, more likely than not, would be required to sell, a decline in value below amortized cost is considered to be OTTI. The amount of OTTI is equal to the difference between amortized cost and fair value at the balance sheet date. For securities that we do not intend to sell or expect to be required to sell, a decline in value below amortized cost is considered to be an OTTI if we do not expect to recover the entire amortized cost basis of a security (i.e., the present value of cash flows expected to be collected is less than the amortized cost basis of the security).
The following table provides a summary of fixed maturity securities in an unrealized loss position as of December 31, 2015:
which were considered due to credit factors. There were no OTTI of fixed maturity securities for the year ended December 31, 2014.
Common Stocks - At December 31, 2015, there were two common stocks in an unrealized loss position with an aggregate fair value of $26.5 million and a gross unrealized loss of $19.2 million. Based on management's view of the underlying securities, the Company does not consider the common stocks to be OTTI. For the year ended December 31, 2015, OTTI for common stocks were $10.9 million. There were no OTTI for common stocks for the year ended December 31, 2014.
Loans Receivable - The Company monitors the performance of its loans receivable, including current market conditions for each loan and the ability to collect principal and interest. For loans where the Company determines it is probable that the contractual terms will not be met, an analysis is performed and a valuation reserve is established, if necessary, with a charge to earnings. Loans receivable are reported net of a valuation reserve of $2 million and $3 million at December 31, 2015 and 2014, respectively.
The following is a summary of pricing sources for the Company's fixed maturity securities available for sale as of December 31, 2015:
Results of Operations for the Years Ended December 31, 2015 and 2014
The Company reported net income of $504 million in 2015 compared to $649 million in 2014. The 22% decrease in net income was primarily due to decreases in after-tax net investment gains of $106 million and after-tax net investment income of $60 million partially offset by an increase in after-tax underwriting income of $14 million. The number of weighted average diluted shares decreased as a result of the Company’s repurchases of its common stock in 2015 and 2014.
Premiums. Gross premiums written were $7,250 million in 2015, an increase of 3% from $7,063 million in 2014. The growth was due to a combination of increased exposures and higher rates. Approximately 77% of policies expiring in 2015 were renewed, compared with a 79% renewal retention rate for policies expiring in 2014.
Reinsurance-Global gross premiums decreased 8% to $643 million in 2015 from $695 million in 2014. Gross premiums written decreased $36 million (8%) for casualty lines and $16 million (7%) for property lines.
Net Investment Income. Following is a summary of net investment income for the years ended December 31, 2015 and 2014:
Net investment income decreased 15% to $513 million in 2015 from $601 million in 2014 primarily due to a decrease in income from energy investment funds. Investment funds are reported on a one quarter lag. The average annualized yield for fixed maturity securities declined to 3.2% from 3.4% due to lower long-term reinvestment yields available in the market. The effective duration of the fixed maturity portfolio was 3.3 years at December 31, 2015 compared with 3.2 years at December 31, 2014. Average invested assets, at cost (including cash and cash equivalents), were $16.0 billion in 2015 and $15.6 billion in 2014.
Insurance Service Fees. The Company earns fees from an insurance distribution business and as a servicing carrier of workers' compensation assigned risk plans for certain states. Service fees increased 19% to $139 million in 2015 from $117 million in 2014 primarily as a result of an increase in fees from assigned risk plans.
Other-Than-Temporary Impairments. The cost of securities is adjusted where appropriate to include a provision for a decline in value that is considered to be other-than-temporary. Other-than-temporary impairments of $33 million in 2015 were primarily related to equity securities. There were no other-than-temporary impairments in 2014.
Losses and Loss Expenses. Losses and loss expenses increased to $3,656 million in 2015 from $3,491 million in 2014. The consolidated loss ratio was 60.5% in 2015 and 60.8% in 2014. Catastrophe losses, net of reinsurance recoveries and reinstatement premiums, were $58 million in 2015 compared with $87 million in 2014, a decrease of 0.4 loss ratio points. Favorable prior year reserve development (net of premium offsets) was $63 million in 2015 compared with $85 million in 2014, a difference of 0.3 loss ratio points (see "- Critical Accounting Estimates - Reserves for Losses and Loss Expenses"). The loss ratio excluding catastrophe losses and prior year reserve development decreased 0.2 points to 60.6% in 2015 from 60.8% in 2014. A summary of loss ratios in 2015 compared with 2014 by business segment follows:
Insurance-International - The loss ratio of 58.2% in 2015 was 4.6 points lower than the loss ratio of 62.8% in 2014. Catastrophe losses were $5 million in 2015 compared with $20 million in 2014, a decrease of 1.9 loss ratio points. Favorable prior year reserve development was $5 million in 2015 compared with adverse development of $23 million in 2014, a difference of 3.7 loss ratio points. The loss ratio excluding catastrophe losses and prior year reserve development increased 1.0 points to 58.4% in 2015 from 57.4% in 2014.
Reinsurance-Global - The loss ratio of 58.4% in 2015 was 3.6 points lower than the loss ratio of 62.0.% in 2014. Catastrophe losses were $3 million in 2015 compared with $2 million in 2014, an increase of 0.2 loss ratio points. Favorable prior year reserve development was $11 million in 2015 compared with $16 million in 2014, a difference of 0.6 loss ratio points. The loss ratio excluding catastrophe losses and prior year reserve development decreased 4.4 points to 59.7% in 2015 from 64.1% in 2014.
Underwriting expenses are comprised of commissions paid to agents and brokers, premium taxes and other assessments and internal underwriting costs. Underwriting expenses increased 6%, compared with an increase in net premiums earned of 5%. The expense ratio (underwriting expenses expressed as a percentage of premiums earned) increased to 33.2% in 2015 from 33.0% in 2014 due primarily to lower earned premiums for the Insurance-International and Reinsurance-Global business segments.
Service expenses, which represent the costs associated with the fee-based businesses, increased 24% to $127 million, as a result of the acquisition of a specialty property and casualty insurance distribution company in late 2014.
Net foreign currency losses (gains) result from transactions denominated in a currencies other than an operating unit’s functional currency.
Income Taxes. The effective income tax rate was 31% in 2015 compared to 32% in 2014. The lower tax rate in 2015 was due, in part, to the utilization of foreign tax credits. The effective income tax rate differs from the federal income tax rate of 35% primarily because of tax-exempt investment income.
Following is a summary of gross and net premiums written, net premiums earned, loss ratios (losses and loss expenses incurred expressed as a percentage of net premiums earned), expense ratios (underwriting expenses expressed as a percentage of net premiums earned) and GAAP combined ratios (sum of loss ratio and expense ratio) for each of our business segments for the years ended December 31, 2014 and 2013. The GAAP combined ratio represents a measure of underwriting profitability, excluding investment income. A GAAP combined ratio in excess of 100 indicates an underwriting loss; a number below 100 indicates an underwriting profit.
Premiums. Gross premiums written were $7,063 million in 2014, an increase of 8% from $6,511 million in 2013. The growth was due to a combination of rate increases and increased exposures. Approximately 79% of policies expiring in 2014 were renewed, compared with a 76% renewal retention rate for policies expiring in 2013.
Insurance-International gross premiums increased 10% to $984 million in 2014 from $899 million in 2013. Gross premiums increased $77 million (16%) for short-tail lines, $21 million (23%) for other liability and $10 million (9%) for professional liability and decreased $13 million (15%) for workers' compensation and $10 million (8%) for commercial auto. In local currency terms, gross premiums increased 17%.
Net premiums written were $5,997 million in 2014, an increase of 9% from $5,500 million in 2013. Ceded reinsurance premiums as a percentage of gross written premiums were 15% in 2014 and 16% in 2013. The decrease in the percentage of business ceded was due to changes in the reinsurance terms and costs.
Insurance Service Fees. The Company earns fees from an insurance distribution business and as a servicing carrier of workers' compensation assigned risk plans for certain states. Service fees increased to $117 million in 2014 from $108 million in 2013 primarily as a result of an increase in fees from assigned risk plans.
Losses and Loss Expenses. Losses and loss expenses increased to $3,491 million in 2014 from $3,197 million in 2013. The consolidated loss ratio was 60.8% in 2014 and 61.2% in 2013. Catastrophe losses, net of reinsurance recoveries and reinstatement premiums, were $87 million in 2014 compared with $65 million in 2013, an increase of 0.3 loss ratio points. Favorable prior year reserve development (net of premium offsets) was $85 million in 2014 compared with $98 million in 2013, a difference of 0.3 loss ratio points (see "- Critical Accounting Estimates - Reserves for Losses and Loss Expenses"). The loss ratio excluding catastrophe losses and prior year reserve development decreased 1.0 points to 60.8% in 2014 from 61.8% in 2013. A summary of loss ratios in 2014 compared with 2013 by business segment follows:
Service expenses, which represent the costs associated with the fee-based businesses, increased 16% to $103 million. The increase was due to an increase in general and administrative expenses and to additional costs associated with new programs.
At December 31, 2015, investments in foreign government fixed maturity securities were as follows:
Investment Funds. At December 31, 2015, the carrying value of investment funds was $1,170 million, including investments in real estate funds of $581 million, energy funds of $94 million and hedged equity funds of $71 million. Investment funds are primarily reported on a one-quarter lag.
Cash Flow. Cash flow provided from operating activities increased to $881 million in 2015 from $735 million in 2014. The increase in cash flow was due primarily to an increase in cash flow from underwriting activities and a decrease in income taxes paid. Paid losses as a percent of earned premiums were 54% in both 2015 and 2014.
As a holding company, the Company derives cash from its subsidiaries in the form of dividends, tax payments and management fees. Maximum amounts of dividends that our insurance companies can pay without regulatory approval are prescribed by statute. During 2016, the maximum amount of dividends which can be paid without regulatory approval is approximately $684 million. The ability of the holding company to service its debt obligations is limited by the ability of its insurance subsidiaries to pay dividends. In the event dividends, tax payments and management fees available to the holding company were inadequate to service its debt obligations, the Company would need to raise capital, sell assets or restructure its debt obligations.
The Company's insurance subsidiaries' principal sources of cash are premiums, investment income, service fees and proceeds from sales and maturities of portfolio investments. The principal uses of cash are payments for claims, taxes, operating expenses and dividends. The Company expects its insurance subsidiaries to fund the payment of losses with cash received from premiums, investment income and fees. The Company generally has targeted an effective duration for its investment portfolio that is within one year of the average duration of its liabilities so that portions of its investment portfolio mature throughout the claim cycle and are available for the payment of claims if necessary. In the event operating cash flow and proceeds from maturities and prepayments of fixed income securities are not sufficient to fund claim payments and other cash requirements, the remainder of the Company's cash and investments is available to pay claims and other obligations as they become due. The Company's investment portfolio is highly liquid, with approximately 80% invested in cash, cash equivalents and marketable fixed income securities as of December 31, 2015. If the sale of fixed maturity securities were to become necessary, a realized gain or loss equal to the difference between the cost and sales price of securities sold would be recognized.
Debt. At December 31, 2015, the Company had senior notes, subordinated debentures and other debt outstanding with a carrying value of $2,185 million and a face amount of $2,208 million. The maturities of the outstanding debt are $43 million in 2016, $37 million in 2017, $450 million in 2019, $300 million in 2020, $426 million in 2022, $2 million in 2029, $250 million in 2037, $350 million in 2044 and $350 million in 2053.
In August 2014, the Company issued $350 million of 4.75% senior notes due 2044. A portion of the proceeds was used to repay $200 million of 5.60% senior notes on May 15, 2015.
Total Capital. Total capitalization (equity, senior notes and other debt and subordinated debentures) was $6.8 billion at December 31, 2015. The percentage of the Company’s capital attributable to senior notes, subordinated debentures and other debt was 32% at December 31, 2015 and 35% at December 31, 2014.
The Company follows customary industry practice of reinsuring a portion of its exposures in exchange for paying reinsurers a part of the premiums received on the policies it writes. Reinsurance is purchased by the Company principally to reduce its net liability on individual risks and to protect it against catastrophic losses. Although reinsurance does not legally discharge an insurer from its primary liability for the full amount of the policies, it does make the assuming reinsurer liable to the insurer to the extent of the reinsurance coverage. The Company monitors the financial condition of its reinsurers and attempts to place its coverages only with substantial and financially sound carriers. Reinsurance coverage and retentions vary depending on the line of business, location of the risk and nature of loss. The Company’s reinsurance purchases include the following:
Property reinsurance treaties - The Company purchases property reinsurance to reduce its exposure to large individual property losses and catastrophe events. Following is a summary of significant property reinsurance treaties in effect as of January 1, 2016: The Company’s property per risk reinsurance generally covers losses between $2.5 million and $50 million. The Company’s catastrophe excess of loss reinsurance program provides protection for net losses between $30 million and $305 million for the majority of business written by its U.S. companies. The Company has separate catastrophe excess of loss reinsurance for business written through its Lloyd’s Syndicate that provides protection for losses between $15 million and $55 million for events in North America. For North American losses greater than $55 million, the business written through the company's Lloyd's Syndicate is protected within the U.S. program up to $305 million. The Company’s catastrophe reinsurance agreements are subject to certain limits, exclusions and reinstatement premiums.
Ceded earned premiums increased 2% in 2015 to $1,051 million, less than the increase in direct and assumed earned premiums of 5%. The ceded losses and loss expenses ratio increased 2 points to 48% in 2015 from 46% in 2014.
(2) Includes the aggregate recoverables from Ace Group and Chubb Group.
(3) Secured by letters of credit or other forms of collateral.
(4) Many states require licensed insurers that provide workers' compensation insurance to participate in programs that provide workers' compensation to employers that cannot procure coverage from an insurer on a voluntary basis. Insurers can fulfill this residual market obligation by participating in pools where results are shared by the participating companies. The Company acts as a servicing carrier for workers' compensation pools in certain states. As a servicing carrier, the Company writes residual market business directly and then cedes 100% of this business to the respective pool. As a servicing carrier, the Company receives fee income for its services. The Company does not retain underwriting risk, and credit risk is limited as ceded balances are jointly shared by all the pool members.
Following is a summary of the Company's contractual obligations as of December 31, 2015:
We have audited the accompanying consolidated balance sheets of W. R. Berkley Corporation and subsidiaries as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2015. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of W. R. Berkley Corporation and subsidiaries as of December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), W. R. Berkley Corporation's internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 22, 2016 expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.
Audit premiums are recognized when they are reliably determinable. The change in accruals for earned but unbilled audit premiums increased net premiums written and premiums earned by $3 million, $9 million and $12 million in 2015, 2014 and 2013, respectively.
Insurance service fee revenue represents servicing fees for program administration and claims management services provided by the Company, including workers compensation assigned risk plans, as well as insurance brokerage and risk management services. Fees for program administration, claims management and risk management services are primarily recognized ratably over the related contract period for which the underlying services are rendered. Commissions for insurance brokerage are generally recognized when the underlying insurance policy is effective.
Investment funds are carried under the equity method of accounting. For certain investment funds, the Company's share of the earnings or losses is reported on a one-quarter lag in order to facilitate the timely completion of the Company's consolidated financial statements.
The unearned portion of premiums ceded to reinsurers is reported as prepaid reinsurance premiums and earned ratably over the policy term. The estimated amounts of reinsurance recoverable on unpaid losses are reported as due from reinsurers. To the extent any reinsurer does not meet its obligations under reinsurance agreements, the Company must discharge its liability. Amounts due from reinsurers are reflected net of funds held where the right of offset is present. The Company has provided reserves for estimated uncollectible reinsurance.
Goodwill and other intangible assets are tested for impairment on an annual basis and at interim periods where circumstances require. The Company's impairment test as of December 31, 2015 indicated that there were no impairment losses related to goodwill and other intangible assets. Intangible assets of $94 million and $96 million are included in other assets as of December 31, 2015 and 2014, respectively.
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Customers. ASU 2014-09 clarifies the principles for recognizing revenue. While insurance contracts
are not within the scope of this updated guidance, the Company’s insurance service fee revenue will be subject to this updated guidance. The updated guidance requires an entity to recognize revenue as performance obligations are met, in order to reflect the transfer of promised goods or services to customers in an amount that reflects the consideration the entity is entitled to receive for those goods or services. The updated guidance, as amended by ASU 2015-14, is effective for public business entities for annual and interim reporting periods beginning after December 15, 2017. The adoption of this guidance is not expected to have a material effect on the Company’s financial condition or results of operations.
In February 2015, the FASB issued ASU 2015-02, Consolidation. ASU 2015-02 makes targeted amendments to the current consolidation accounting guidance, in response to accounting complexity concerns. The guidance simplifies consolidation accounting by reducing the number of approaches to consolidation. The updated guidance is effective for annual and interim reporting periods beginning after December 15, 2015. The adoption of this guidance is not expected to have a material effect on the Company’s financial condition or results of operations, but will result in additional disclosures.
In May 2015, the FASB issued ASU 2015-09, Disclosures about Short-Duration Contracts. ASU 2015-09 requires companies that issue short duration insurance contracts to disclose additional information, including: (i) incurred and paid claims development tables; (ii) frequency and severity of claims; and (iii) information about material changes in judgments made in calculating the liability for unpaid claim adjustment expenses, including reasons for the change and the effects on the financial statements. ASU 2015-09 is effective for annual periods beginning after December 15, 2015, and interim periods within annual periods beginning after December 15, 2016. The amendments in ASU 2015-09 should be applied retrospectively by providing comparative disclosures for each period presented, except for those requirements that apply only to the current period. As the requirements of this literature are disclosure only, the adoption of this guidance will not impact our financial condition or results of operations.
In 2014, the Company acquired a specialty property and casualty insurance distribution company for $83 million. The fair values of the assets acquired and liabilities assumed have been estimated based on a valuation prepared by a third party. The estimated useful lives of the intangible assets acquired range from 7 years to 15 years, with approximately $10 million having an indefinite life.
At December 31, 2015 and 2014, the fair value and carrying value of the arbitrage trading account were $377 million and $451 million, respectively. The primary focus of the trading account is merger arbitrage. Merger arbitrage is the business of investing in the securities of publicly held companies which are the targets in announced tender offers and mergers. Arbitrage investing differs from other types of investing in its focus on transactions and events believed likely to bring about a change in value over a relatively short time period (usually four months or less).
In 2015, properties in operation included a long-term ground lease in Washington, D.C. and office buildings in West Palm Beach and Palm Beach, Florida. Properties in operation are net of accumulated depreciation and amortization of $9,073,000 and $1,609,000 as of December 31, 2015 and 2014, respectively. Related depreciation expense was $7,425,000 and $4,808,000 for the years ended December 31, 2015 and 2014, respectively. Future minimum rental income expected on operating leases relating to properties in operation is $13,141,756 in 2016, $15,483,248 in 2017, $14,623,307 in 2018, $11,967,190 in 2019, $9,584,128 in 2020 and $352,328,662 thereafter.
Properties under development represent the following: an office building in London, a mixed-use project in Washington D.C. and an office complex in New York City.
Fixed Maturity Securities - A summary of the Company’s non-investment grade fixed maturity securities that were in an unrealized loss position at December 31, 2015 is presented in the table below:
For the year ended December 31, 2015, OTTI for fixed maturities recognized in earnings were $9.0 million, all of which was considered due to credit factors. There were no OTTI of fixed maturity securities for the year ended December 31, 2014.
The Company’s fixed maturity and equity securities classified as available for sale and its trading account securities are carried at fair value. Fair value is defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” The Company utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels, as follows:
The decrease in estimates for claims occurring in prior years is net of loss reserve discount. On an undiscounted basis, the estimates for claims occurring in prior years decreased by $64,971,000, $116,866,000 and $77,430,000 in 2015, 2014 and 2013, respectively.
For certain retrospectively rated insurance polices and reinsurance agreements, reserve development is offset by additional or return premiums. Favorable reserve development, net of additional and return premiums, was $63 million, $85 million and $98 million in 2015, 2014 and 2013, respectively.
For commercial automobile business, adverse development was primarily related to large losses for long-haul trucking business and to accident years 2011 through 2014. The higher loss cost trends for the commercial automobile industry are attributable, in part, to the increase in miles driven as the economy has improved and fuel prices have declined over the past several years.
For the Reinsurance-Global segment, favorable reserve development in 2014 of $16 million was driven primarily by assumed professional liability excess of loss and umbrella treaty business, as well as direct facultative business. This was partially offset by adverse development on brokerage facultative business caused by completed operations losses associated with construction projects in accident years prior to 2009.
The Company’s net reserves for losses and loss expenses relating to asbestos and environmental claims was $33 million at December 31, 2015 and $36 million at December 31, 2014. The Company’s gross reserves for losses and loss expenses relating to asbestos and environmental claims were $51 million and $56 million at December 31, 2015 and 2014, respectively. Net incurred losses and loss expenses for reported asbestos and environmental claims decreased approximately $2 million in 2015 and increased by approximately $4 million and $5 million in 2014 and 2013, respectively. Net paid losses and loss expenses for asbestos and environmental claims were approximately $2 million in 2015, $3 million in 2014 and $3 million in 2013. The estimation of these liabilities is subject to significantly greater than normal variation and uncertainty because it is difficult to make an actuarial estimate of these liabilities due to the absence of a generally accepted actuarial methodology for these exposures and the potential effect of significant unresolved legal matters, including coverage issues, as well as the cost of litigating the legal issues. Additionally, the determination of ultimate damages and the final allocation of such damages to financially responsible parties are highly uncertain.
(1) Includes the aggregate recoverables from Ace Group and Chubb Group.
Indebtedness consisted of the following as of December 31, 2015 (the difference between the face value and the carrying value is unamortized discount):
Income before income taxes from domestic operations was $689 million, $910 million and $598 million for the years ended December 31, 2015, 2014 and 2013, respectively. Income before income taxes from foreign operations was $43 million, $42 million and $101 million for the years ended December 31, 2015, 2014 and 2013, respectively.
A reconciliation of the income tax expense and the amounts computed by applying the Federal and foreign income tax rate of 35% to pre-tax income are as follows:
At December 31, 2015 and 2014, the tax effects of differences that give rise to significant portions of the deferred tax asset and deferred tax liability are as follows:
The Company had current tax receivables of $55,763,000 and $67,623,000 at December 31, 2015 and 2014, respectively. At December 31, 2015, the Company had foreign net operating loss carryforwards $6.1 million that expire beginning in 2031, and an additional $43.2 million that have no expiration date. At December 31, 2015, the Company had a valuation allowance of $4.0 million, as compared to $1.3 million at December 31, 2014. The Company has provided a valuation allowance against future tax benefits of certain foreign operations. The statute of limitations has closed for the Company’s tax returns through December 31, 2011.
The significant variances between SAP and GAAP are that for statutory purposes bonds are carried at amortized cost, acquisition costs are charged to income as incurred, deferred Federal income taxes are subject to limitations, excess and assumed workers’ compensation reserves are discounted at different discount rates and certain assets designated as “non-admitted assets” are charged against surplus. The Commissioner of Insurance of the State of Delaware has allowed BIC to discount non-tabular workers' compensation loss reserves, which is a permitted practice that differs from SAP. The effect of using this permitted practice was to increase BIC’s statutory capital and surplus by $294 million at December 31, 2015.
The National Association of Insurance Commissioners (“NAIC”) has risk-based capital (“RBC”) requirements that require insurance companies to calculate and report information under a risk-based formula which measures statutory capital and surplus needs based on a regulatory definition of risk in a company’s mix of products and its balance sheet. This guidance is used to calculate two capital measurements: Total Adjusted Capital and RBC Authorized Control Level. Total Adjusted Capital is equal to the Company’s statutory capital and surplus excluding capital and surplus derived from the use of permitted practices that differ from statutory accounting practices. RBC Authorized Control Level is the capital level used by regulatory authorities to determine whether remedial action is required. Generally, no remedial action is required if Total Adjusted Capital is 200% or more of the RBC Authorized Control Level. At December 31, 2015, BIC’s Total Adjusted Capital of $5.002 billion was 456% of its RBC Authorized Control Level.
The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments as of December 31, 2015 and 2014:
Upon vesting, shares of the Company’s common stock equal to the number of vested RSUs are issued or deferred to a later date, depending on the terms of the specific award agreement. As of December 31, 2015, 4,275,474 RSUs had been deferred. RSUs that have not yet vested and vested RSUs that have been deferred are not considered to be issued and outstanding shares.
The fair value of RSUs at the date of grant are recorded as unearned compensation, a component of stockholders’ equity, and expensed over the vesting period. Following is a summary of changes in unearned compensation for the three years ended December 31, 2015:
Insurance-International - insurance business primarily in the United Kingdom, Continental Europe, South America, Canada, Scandinavia, Asia, and Australia;
Reinsurance-Global - reinsurance business on a facultative and treaty basis, primarily in the United States, United Kingdom, Continental Europe, Australia, the Asia-Pacific Region, and South Africa.