1 Includes reserve increases of $750.8 million and $698.2 million in 2018 and 2014, respectively, related to our long-term care closed block business. See Note 6 of the "Notes to Consolidated Financial Statements" contained herein in Item 8 for further discussion of the 2018 reserve increase.
2 Includes the net change in deferred acquisition costs as well as compensation expense and other expenses. Includes $64.4 million in 2014 related to a settlement loss for a pension plan amendment.
Our Unum International segment reported an increase of 2.0 percent in adjusted operating income, as measured in U.S. dollars. Our Unum UK line of business reported a decrease of 3.0 percent in adjusted operating income compared to 2017, as measured in local currency, due primarily to lower net investment income, partially offset by an increase in premium income. The benefit ratio for our Unum UK line of business was 74.4 percent in both 2018 and 2017. Unum UK sales, as measured in local currency, decreased 6.4 percent in 2018 compared to 2017. Persistency was favorable relative to the prior year and is consistent with our expectations. The results of our Unum Poland line of business were not material to our 2018 results of operations.
Our Closed Block segment reported an increase in adjusted operating income of 1.3 percent in 2018 compared to 2017 due primarily to an increase in net investment income and overall favorable benefits experience, partially offset by lower premium income. Benefits experience for individual disability remains within our range of expectations and was favorable in 2018 compared to 2017. Benefits experience in our long-term care line of business, excluding the reserve increase, was consistent with our expectations.
Although our profit margins continue to be pressured by the impact of the low interest rate environment on our net investment income yields, our invested asset quality remains strong. The net unrealized gain on our fixed maturity securities was $2.7 billion at December 31, 2018, compared to $5.7 billion at December 31, 2017, with the decrease due to higher credit spreads and U.S. Treasury rates during 2018. The earned book yield on our investment portfolio was 5.15 percent for 2018 compared to a yield of 5.23 percent for 2017.
We believe our capital and financial positions are strong. At December 31, 2018, the RBC ratio for our traditional U.S. insurance subsidiaries, calculated on a weighted average basis using the NAIC Company Action Level formula, was
Beginning in 2011, a number of state regulators began requiring insurers to cross-check specified insurance policies with the Social Security Administration’s Death Master File to identify potential matches. If a potential match was identified, insurers were requested to determine if benefits were due, locate beneficiaries, and make payments where appropriate. We initiated this process where requested, and in 2012 we began implementing this process in all states on a forward-looking basis. In addition to
implementing this on a forward-looking basis, in 2013 we began an initiative to search for potential claims from previous years. During 2013, we completed our assessment of benefits which we estimated would be paid under this initiative, and as such, established additional reserves for payment of these benefits.
Similar to other insurers, we have undergone an examination by a third party acting on behalf of a number of state treasurers concerning our compliance with the unclaimed property laws of the participating states. In the fourth quarter of 2017, we started the process to reach a Global Resolution Agreement with the third party regarding settlement of the examination, which we finalized in January of 2018. During the fourth quarter of 2017, we established reserves which reflected our estimate of the liability expected to be paid as we execute on the terms of the settlement. Claim reserves were increased $18.5 million for Unum US group life, $8.1 million for Unum US voluntary life, and $12.4 million for Colonial Life voluntary life, for a total reserve increase of $39.0 million before tax and $25.4 million after tax.
During 2016, the U.K. held a referendum and voted to leave the EU. The U.K. subsequently invoked Article 50 of the Treaty on European Union (EU) and is due to leave the EU on March 29, 2019. We expect to see continued dampening of growth in the U.K. as well as earnings volatility due to the current disruption and uncertainty in the U.K. economy. We may also experience volatility in the fair values of our investments in U.K. and EU-based issuers, but we do not expect a material increase in other-than-temporary impairments or defaults, nor do we believe this volatility will impact our ability to hold these investments. The magnitude and longevity of potential negative economic impacts on our growth will depend on whether an agreement is reached between the U.K. and EU as a result of exit negotiations and, if reached, the nature of the agreement and the resulting response of the U.K. marketplace. There are currently no indications that capital requirements for our U.K. operations will change, but economic conditions may cause volatility in our solvency ratios. Our reported consolidated financial results may continue to be impacted by fluctuations in the British pound sterling to dollar exchange rate. See "Regulation" contained herein in Item 1 and "Unum International Segment" contained herein this Item 7.
We believe our disciplined approach to providing financial protection products at the workplace puts us in a position of strength as we seek to capitalize on the growing and largely unfilled need for our products and services. We believe the need for our products and services remains strong, and we intend to continue protecting our solid margins and returns through our pricing and risk actions. Our strategy is underpinned by our core values and is centered on market growth through the expansion of our product portfolio, distribution system, and geographic footprint, and enhancing the customer experience through efficiency, simplification, and investment in digital capabilities.
Our outlook for 2019 is for continued solid premium growth trends in our core businesses, with stable persistency and a disciplined approach to sales growth. We expect to have generally stable benefits experience due to our focus on disciplined pricing, risk selection, and management of renewals. We will maintain our commitment to expense discipline and improving our operational efficiencies.
We analyze our performance using non-GAAP financial measures. A non-GAAP financial measure is a numerical measure of a company's performance, financial position, or cash flows that excludes or includes amounts that are not normally excluded or included in the most directly comparable measure calculated and presented in accordance with GAAP. The non-GAAP financial measure of "after-tax adjusted operating income" differs from net income as presented in our consolidated operating results and income statements prepared in accordance with GAAP due to the exclusion of net realized investment gains and losses and certain other items as specified in the reconciliations below. We believe after-tax adjusted operating income is a better performance measure and better indicator of the profitability and underlying trends in our business.
We may at other times exclude certain other items from our discussion of financial ratios and metrics in order to enhance the understanding and comparability of our operational performance and the underlying fundamentals. We exclude these items as we believe them to be infrequent or unusual in nature, but this exclusion is not an indication that similar items may not recur and does not replace net income or net loss as a measure of our overall profitability.
See "Executive Summary" contained herein in Item 7 and Notes 6, 7, and 14 of the "Notes to Consolidated Financial Statements" contained herein in Item 8 for further discussion regarding the impacts of the long-term care reserve increase, the TCJA, the unclaimed death benefit reserve increase, and the loss from a guaranty fund assessment, respectively.
Reserves for policy and contract benefits are our largest liabilities and represent claims that we estimate we will eventually pay to our policyholders. The two primary categories of reserves are policy reserves for claims not yet incurred and claim reserves for claims that have been incurred or are estimated to have been incurred but not yet reported to us. Reserves for policy and contract benefits equaled $43.3 billion and $42.1 billion at December 31, 2018 and 2017, respectively, or approximately 81.3 percent and 77.4 percent of our total liabilities, respectively. Reserves ceded to reinsurers were $7.2 billion at both December 31, 2018 and 2017 and are reported as a reinsurance recoverable in our consolidated balance sheets.
The discount rate, which is used in calculating both policy reserves and incurred and IBNR claim reserves, is the interest rate that we use to discount future claim payments to determine the present value. A higher discount rate produces a lower reserve. If the discount rate is higher than our future investment returns, our invested assets will not earn enough investment income to support our future claim payments. In this case, the reserves may eventually be insufficient. We set our assumptions based on our current and expected future investment yield of the assets supporting the reserves, considering current and expected future market conditions. If the investment yield on new investments that are purchased differs from the investment yield of the existing investment portfolio, it is likely that the discount rate assumption on claims will be adjusted to reflect the impact of the new investment yield.
The claim resolution rate, used for both policy reserves and incurred and IBNR claim reserves, is the probability that a disability or long-term care claim will close due to recovery or death of the insured. It is important because it is used to estimate how long benefits will be paid for a claim. Estimated resolution rates that are set too high will result in reserves that are lower than they need to be to pay the claim benefits over time. Claim resolution assumptions involve many factors, including the cause of disability, the policyholder's age, the type of contractual benefits provided, and the time since initial disability. We primarily use our own claim experience to develop our claim resolution assumptions. These assumptions are established for the
In 2018, both short-term and long-term interest rates increased. The long-term interest rates supporting the majority of our lines of business remain below historical norms. The assumptions we used to discount reserves during this period were slightly lower for certain of our product lines. Reserve discount rate assumptions for new policies and new claims are periodically adjusted to reflect our current and expected net investment returns. Changes in our average discount rate assumptions tend to occur gradually over a longer period of time because of the long-duration investment portfolios which support the reserves for the majority of our lines of business.
Our claim resolution rate assumption used in determining reserves is our expectation of the resolution rate we will experience over the life of the block of business and will vary from actual experience in any one period, both favorably and unfavorably. Claim resolution rates are very sensitive to operational and environmental changes and have a greater chance of significant variability in a shorter period of time than our other reserve assumptions. These rates are reviewed on a quarterly basis for the death and recovery components separately. Claim resolution rates in our Unum US group long-term disability product line and in our Closed Block individual disability product line have exhibited some variability over the last several years. Relative to the resolution rate we expect to experience over the life of the block of business, actual quarterly rates during 2018 and 2017 have varied between +10 and -13 percent in our Closed Block individual disability line of business. Actual quarterly rates during 2018 and 2017 have varied by +5 and -5 percent in our Unum US group long-term disability line of business. During 2018, claim resolution rates pertaining to overall mortality experience were relatively consistent with the levels of 2017 and 2016. On
an annual basis for the years 2016 to 2018, our overall claim resolution rates were fairly consistent with or slightly favorable to our long-term assumptions.
During the third quarter of 2018, we completed our annual review of policy reserve adequacy for our long-term care line of business, which incorporated our most recent experience and included a review of all assumptions. The review utilized internal and external data and outside consulting firms for quality assurance and industry benchmarking. Based on our analysis, we updated our reserve assumptions as discussed in the following paragraphs. In addition, we have also included a sensitivity analysis for these assumptions for both favorable and unfavorable deviations applied throughout the entire life of the block. This sensitivity analysis was completed as of the date of our assumption update announcement in the third quarter of 2018 and will not be updated unless reserves are again determined to be deficient in the future.
We updated our active policy termination assumptions, which are affected by both policyholder mortality and lapses. We aligned our mortality assumptions with industry data based on a 2012 individual annuitant mortality industry table, adjusted for our experience in earlier policy durations. We also lowered our lapse assumptions for individual policies based on emerging company experience, which resulted in an ultimate lapse rate of 0.25 percent. A six percent unfavorable change in the active policy termination assumption would result in approximately a $330 million decrease to reserve margin and a six percent favorable change would result in approximately a $320 million increase to reserve margin.
We have observed morbidity improvement in our own claims experience over a ten year period of approximately three percent per year, normalized for variables such as age and claim type. However, we believe that a longer-term view is the best way to evaluate this type of improvement. Accordingly, we updated our morbidity assumptions to reflect minor improvement, one percent per year, including a partially offsetting assumption of 0.6 percent per year mortality improvement. If no improvement occurs in the morbidity and mortality assumptions, reserve margin would decrease by approximately $1 billion. If a three percent per year improvement in the morbidity and mortality assumptions occurs, reserve margin would increase by approximately $1.6 billion.
As of December 31, 2018, the key assumptions we generally used to estimate the fair value of these types of securities included those listed below. Where appropriate, we have noted the assumption used for the prior period as well as the reason for the change.
Risk-free interest rates of 2.51 percent for five-year maturities to 3.02 percent for 30-year maturities were derived from the December 31, 2018 yield curve for U.S. Treasury Bonds with similar maturities. This compares to interest rates of 2.21 percent for five-year maturities to 2.74 percent for 30-year maturities used at December 31, 2017.
One of the significant estimates related to investments is our impairment valuation. In determining when a decline in fair value below amortized cost of a fixed maturity security is other than temporary, we evaluate the following factors:
Investment risk is measured and monitored on an ongoing basis through annual liability measurements, periodic asset/liability studies, and quarterly investment portfolio reviews. Risk tolerance is established through consideration of plan liabilities, plan funded status, and corporate financial condition. We believe our investment portfolios are well
The amortization of the unrecognized actuarial gain or loss and the unrecognized prior service credit is a component of our net periodic benefit cost and equaled $22.1 million, $19.6 million, and $15.8 million in 2018, 2017, and 2016, respectively.
See "Regulation" contained herein in Item 1. See Note 7 of the "Notes to Consolidated Financial Statements" contained herein in Item 8.
The weighted average pound/dollar exchange rate for our Unum UK line of business was 1.336, 1.290, and 1.357 for the years ended 2018, 2017, and 2016, respectively. If the 2017 and 2016 results for our U.K. operations had been translated at the 2018 exchange rate, our adjusted operating revenue by segment would have been higher by approximately $23 million in 2017 and lower by approximately $9 million in 2016. Additionally, our adjusted operating income would have been higher by approximately $4 million in 2017 and lower by approximately $2 million in 2016. However, it is important to distinguish between translating and converting foreign currency. Except for a limited number of transactions, we do not actually convert pounds into dollars. As a result, we view foreign currency translation as a financial reporting item and not a reflection of operations or profitability in the U.K.
We continued to report year-over-year premium growth in 2018 and 2017 in each of our principal operating business segments, as measured in local currency, due to overall sales growth, the expansion of our dental and vision products, and generally stable persistency. Premium income continues to decline, as expected, in our Closed Block segment.
Net investment income increased slightly in 2018 relative to 2017 due primarily to an increase in the level of invested assets and higher miscellaneous investment income, partially offset by a decline in the yield on invested assets. Net investment income decreased slightly in 2017 relative to 2016 due primarily to a decrease in yield on invested assets and the unfavorable impact of the lower foreign currency exchange rate on translated financial results, mostly offset by an increase in the level of invested assets, higher income from inflation index-linked bonds in our Unum International segment, and higher miscellaneous investment income.
Overall benefits experience was unfavorable in 2018 relative to the prior periods, with a consolidated benefit ratio of 89.3 percent in 2018 compared to 82.1 percent in 2017 and 83.1 percent in 2016. Excluding the 2018 long term care reserve increase and the 2017 unclaimed death benefits reserve increase, the benefit ratios for 2018 and 2017 were 80.9 percent and 81.6 percent, respectively. The underlying benefits experience for each of our operating business segments is discussed more fully in "Segment Results" contained herein in this Item 7.
Commissions and the deferral of acquisition costs increased year-over-year in 2018 and 2017 due primarily to overall sales growth. The amortization of deferred acquisition costs increased year-over-year in 2018 and 2017 due to growth in the level of the deferred asset in our Unum US and Colonial Life segments.
Other expenses, including compensation expense, increased in each of the years presented above. Excluding the loss from a guaranty fund assessment in 2017, the year-over-year premium growth rates mostly offset the growth rates in compensation and other expenses as we continue our focus on expense management and operating efficiencies, resulting in a generally stable other expense ratio relative to the prior years.
Our effective income tax rate for 2018 was 16.6 percent, compared to 29.2 percent in 2017 and 30.9 percent in 2016. The TCJA was enacted in December 2017 and stipulated a reduction of the U.S. statutory rate from 35 percent to 21 percent effective in 2018. Our 2018 effective tax rate differed from the U.S. statutory rate due to favorable tax credits and adjustments related to our prior year tax return. Our effective tax rate for 2017 was favorably impacted by the enactment of the TCJA, which reduced the net deferred tax liability related to our U.S. operations by $97.9 million in 2017 partially offset by a tax of $66.4 million Deemed Repatriation Tax. Our effective tax rate in 2016 differed from the U.S. statutory rate due to tax credits and foreign earnings taxed at lower rates than the U.S. statutory rate including a favorable impact of the enactment of an income tax rate reduction by the U.K. government. This enactment reduced the net deferred tax liability related to our U.K. operations by $4.5 million in 2016.
Shown below are sales results for our three principal operating business segments.
Year Ended December 31, 2018 Compared with Year Ended December 31, 2017
We had goodwill of $8.9 million at December 31, 2018, none of which is currently believed to be at risk for future impairment.
Premium income increased compared to 2016, driven primarily by growth in the in-force block due to higher sales, partially offset by lower persistency. Net investment income was lower relative to 2016 due to a decline in yield and a lower level of invested assets, partially offset by higher miscellaneous investment income. Other income is comprised primarily of fees from administrative services products.
Commissions and the deferral of acquisition costs were higher compared to 2016 due to sales growth. The amortization of deferred acquisition costs increased relative to 2016 due to growth in the level of the deferred asset. Our other expense ratio for 2017 increased slightly compared to 2016 due to the continued investment in the growth of our business balanced with our continued focus on expense management and operating efficiencies.
Benefits experience was favorable compared to 2017 due to the previously discussed 2017 reserve increase for unclaimed death benefits in our group life product line and favorable 2018 experience in our accidental death and dismemberment product line. Excluding the 2017 reserve increase, benefits experience was generally consistent with the prior year.
Benefits experience was unfavorable compared to 2016 due to the 2017 reserve increase for unclaimed death benefits in the group life product line. Excluding this reserve increase, benefits experience was favorable due primarily to favorable average claim size in our group life product line, partially offset by higher incidence in the accidental death and dismemberment product line.
Benefits experience for the individual disability product line compared to 2017 was less favorable due to a prior year reserve release of $19.5 million resulting from our 2017 annual reserve adequacy update that did not recur and unfavorable claims activity, partially offset by favorable mortality experience in 2018. Benefits experience for voluntary benefits was favorable compared to 2017 due primarily to the previously discussed 2017 reserve increase for unclaimed death benefits. Excluding this reserve increase, benefits experience was favorable across most of our voluntary product lines. Benefits experience for the dental and vision product line was favorable compared to 2017 and was within our expectations.
We had goodwill of $271.1 million at December 31, 2018, none of which is currently believed to be at risk for future impairment.
Net investment income was higher compared to 2016 due to an increase in the level of invested assets and higher miscellaneous investment income, partially offset by a decline in yield. Other income decreased relative to 2016 due primarily to the expected decline in surrender fees as our interest sensitive life products mature.
Benefits experience was favorable for the individual disability product line compared to 2016 due primarily to lower claim volumes and a reserve release of $19.5 million resulting from our annual reserve adequacy update, partially offset by the impact to our benefit ratio from the reinsurance agreement we entered into during the fourth quarter of 2016. Benefits experience for voluntary benefits was unfavorable compared to 2016 due primarily to the 2017 reserve increase for unclaimed death benefits. Excluding this reserve increase, benefits experience was favorable driven primarily by a continued shift in product mix and favorable claims experience, primarily in our critical illness product line. The dental and vision product line will typically have a higher benefit ratio than the other product lines reported in our supplemental and voluntary line of business, but did experience less favorable claims experience relative to 2016.
Group sales increased compared to 2016 due to higher sales to new customers in both the core market segment and in the large case market segment. The sales mix in the group market sector for 2017 was approximately 58 percent core market and 42 percent large case market.
Individual disability sales increased compared to 2016 due to higher sales to new customers. Voluntary benefits sales increased compared to 2016, primarily driven by higher sales in both the core and large case markets. Also contributing to supplemental and voluntary sales in 2017 compared to 2016 were higher sales of the dental and vision products resulting from the Starmount acquisition in the third quarter of 2016.
The Unum International segment is comprised of our operations in both the United Kingdom and Poland and includes insurance for group long-term disability, group life, and supplemental lines of business which include dental, individual disability, critical illness, and our Unum Poland products. Unum International's products are sold primarily through field sales personnel and independent brokers and consultants.
Shown below are financial results and key performance indicators for the Unum International segment.
The functional currency of Unum UK and Unum Poland is the British pound sterling and the Polish zloty, respectively. Unum UK's and Unum Poland's premium income, net investment income, claims, and expenses are received or paid in the functional currency, and we hold functional currency-denominated assets to support Unum UK's and Unum Poland's functional currency-denominated policy reserves and liabilities. We translate Unum UK's and Unum Poland's functional currency-denominated financial statement items into dollars for our consolidated financial reporting. We translate income statement items using an average exchange rate for the reporting period, and we translate balance sheet items using the exchange rate at the end of the period. We report unrealized foreign currency translation gains and losses in accumulated other comprehensive income in our consolidated balance sheets.
Fluctuations in exchange rates have an effect on Unum UK's and Unum Poland's reported financial results and our consolidated financial results. In periods when the functional currency strengthens relative to the preceding period, translation increases current period results relative to the prior period. In periods when the functional currency weakens, translation decreases current period results relative to the prior period.
Premium income was higher compared to 2017 due primarily to growth in the in-force block driven by higher persistency and rate increases in our group long-term disability product line.
Net investment income was lower compared to 2017 due primarily to a lower yield on our fixed-rate bonds, partially offset by a higher level of invested assets and higher investment income from inflation index-linked bonds, which we invest in to support the claim reserves associated with certain of our group policies that provide for inflation index-linked increases in benefits. The increase in net investment income attributable to these index-linked bonds was offset by an increase in the reserves for future claims payments related to inflation index-linked group long-term disability and group life policies.
Commissions and the deferral of acquisition costs were lower relative to 2017 driven by lower sales. The amortization of acquisition costs was lower in 2018 compared to 2017 due to a decline in the deferred asset. The other expense ratio was lower relative to 2017 due to higher premiums and our continued focus on expense management and operating efficiencies.
Premium income was higher compared to 2016 due primarily to growth in the in-force block, resulting from sales growth and stable persistency.
Overall benefits experience was unfavorable compared to 2016 due primarily to a higher average claim size and unfavorable claim incidence in our group long-term disability product line, partially offset by favorable claim incidence in our group life product line. Also contributing to the less favorable benefits experience was the impact of inflation-linked increases in benefits and an 80 basis point decrease in the discount rate on new claim incurrals implemented in the first quarter of 2017 across several of our products.
Group long-term disability sales decreased compared to 2017 due to lower sales to new customers in the large case market, partially offset by higher sales to both new and existing customers in our core market, or employee groups with fewer than 500 employees, and higher sales to existing customers in our large case market.
Group life sales decreased compared to 2017 due to lower sales to new and existing customers in our large case market, partially offset by an increase in sales to new and existing customers in our core market.
Group long-term disability sales decreased compared to 2016 due to lower sales to new customers in our core market and to existing customers in our large case market, mostly offset by higher sales to new customers in our large case market.
Supplemental sales increased compared to 2016 due primarily to an increase in the group critical illness and dental product lines, partially offset by a decline in individual disability sales.
We expect the current environment to continue to have a negative impact on our growth expectations in the near-term and may also lead to a higher rate of claim incidence, lower levels of claim recoveries, or lower claim discount rates. As part of our continued pricing discipline and our reserving strategy, we continuously monitor emerging interest rate experience and adjust our pricing and reserve discount rates, as appropriate. We will likely continue to experience volatility in net investment income and our benefit ratio due to fluctuations in the level of inflation in the U.K., however, we do not expect this to have a significant impact on adjusted operating income. There are no indications currently that capital requirements for our U.K. operations will change, but economic conditions may in the near term cause volatility in our solvency ratios. We continuously monitor key indicators to assess our risks and attempt to adjust our business plans accordingly to respond to external challenges.
Benefits experience was less favorable in 2017 compared to 2016 due to the 2017 reserve increase for unclaimed death benefits. Excluding the reserve increase, benefits experience was generally consistent with 2016, with marginally less favorable experience in each line of business.
Sales were higher in 2018 compared to 2017 due to growth in both new and existing customer account sales and the expansion of our dental and vision products. Commercial market sales increased primarily due to higher new and existing customer account sales in the core market, which we define as accounts with fewer than 1,000 employees, and higher existing sales in the large case market. The slight increase in our public sector market for 2018 was primarily driven by an increase in existing customer account sales, partially offset by a decrease in new account sales. The number of new accounts increased 9.8 percent in 2018 compared to 2017, while the average new case size decreased 4.0 percent.
We remain committed to providing employees and their families with simple, modern, and personal benefit solutions. During 2019, we will continue to focus on expanding our distribution system through the growth and development of our agency sales force and establishing effective broker partnerships. We will also invest in new solutions and digital capabilities to enhance the customer experience for our business partners and further improve productivity. We will seek to capitalize on the expansion of our new dental products, which we believe will open doors for new cases while also allowing for further cross-selling opportunities to existing clients. We will continue to focus on accelerating growth during 2019 through territory expansion, territory growth, persistency investments, and increased participation rates. We believe our distribution system, customer service capabilities, the expansion of our new dental products, and ability to serve all market sizes position us well for future growth.
We expect to see continued favorable sales, premium, and adjusted operating earnings growth trends in 2019. We also anticipate a decline in the operating expense ratio as we continue to balance operating efficiencies with the continued investments in our future growth. The lower interest rate environment will continue to have an unfavorable impact on our profit margins, and volatility in miscellaneous investment income is likely to continue. We expect our annual benefit ratio for 2019 to be generally consistent with the level of 2018. While we believe our underlying profitability will remain strong, current economic conditions and increasing competition in the voluntary workplace market are seen as external risks to achievement of our business plans. We continuously monitor key indicators to assess our risks and attempt to adjust our business plans accordingly.
Individual disability benefits experience was favorable relative to 2016 due to lower new claim volumes and a reduction in the claim reserve discount rate taken in 2016 to recognize the impact on future portfolio yields from increased levels experienced for bond tenders and calls. Long-term care benefits experience was consistent with 2016 as unfavorable policyholder terminations, due primarily to mortality experience, offset by the impact of a large group case moving to an individual policy ported status during 2016. Also impacting benefits experience relative to 2016 was unfavorable mortality experience in our group pension product.
The other expense ratio was slightly higher than 2016 due to the expected decline in premium income for individual disability, partially offset by our continued focus on expense management and operating efficiencies.
The Corporate segment includes investment income on corporate assets not specifically allocated to a line of business, interest expense on corporate debt other than non-recourse debt, and certain other corporate income and expenses not allocated to a line of business.
At December 31, 2018, we held two below-investment grade fixed maturity securities with a gross unrealized loss greater than $10.0 million. One security is related to a global pharmaceutical company and had a fair value of $61.5 million and a gross unrealized loss of $15.5 million. The other security is related to a U.S. based oil and natural gas producer and had a fair value of $5.0 million and a gross unrealized loss of $11.0 million. We also held one investment grade fixed maturity security at December 31, 2018 related to a large U.S. based utility with a fair value of $99.5 million and a gross unrealized loss of $7.3 million which, in January 2019, filed for reorganization under Chapter 11 in the U.S. Bankruptcy Court and was downgraded to below-investment grade. We intend to and have the ability to continue to hold these securities to maturity and believe that the declines in fair value are temporary.
We had no individual realized investment losses of $10.0 million or greater from other-than-temporary impairments during 2018 or 2017 and no individual realized investment losses of $10.0 million or greater from the sale of fixed maturity securities during 2018, 2017, or 2016.
At December 31, 2018, our mortgage/asset-backed securities had an average life of 6.38 years, effective duration of 5.06 years, and a weighted average credit rating of Aaa. The mortgage/asset-backed securities are valued on a monthly basis using
We have no exposure to subprime mortgages, "Alt-A" loans, or collateralized debt obligations in our investment portfolios. We have not invested in mortgage-backed derivatives, such as interest-only, principal-only, or residuals, where market values can be highly volatile relative to changes in interest rates. The credit quality of our mortgage-backed securities portfolio has not been negatively impacted by the issues in the market concerning subprime mortgage loans. The change in value of our mortgage-backed securities portfolio has moved in line with that of prime agency-backed mortgage-backed securities.
We use derivative financial instruments primarily to manage reinvestment, duration, foreign currency, and credit risks. Historically, we have utilized current and forward interest rate swaps and options on forward interest rate swaps and U.S. Treasury rates, current and forward currency swaps, forward treasury locks, currency forward contracts, forward contracts on specific fixed income securities, and credit default swaps. Our credit exposure on derivatives, which is limited to the value of those contracts in a net gain position, including accrued interest receivable less collateral held, was $0.9 million at December 31, 2018. We held $24.0 million of cash collateral from our counterparties at December 31, 2018. The carrying value of fixed maturity securities posted as collateral to our counterparties was $33.4 million at December 31, 2018. We had nine hundred thousand cash collateral posted to our counterparties at December 31, 2018. We believe that our credit risk is mitigated by our use of multiple counterparties, all of which have an investment-grade credit rating, and by our use of cross-collateralization agreements.
The liquidity requirements of the holding company Unum Group include common stock dividends, interest and debt service, acquisitions, and ongoing investments in our businesses. Unum Group's liquidity requirements are met by assets held by Unum Group and our intermediate holding companies, dividends from primarily our insurance subsidiaries, and issuance of common stock, debt, or other capital securities and borrowings from existing credit facilities, as needed. As of December 31, 2018, Unum Group and our intermediate holding companies held fixed maturity securities, short-term investments, and cash of $602 million. Fixed maturity securities consisted primarily of mortgage/asset-backed securities with an average maturity of 5.9 years. Short-term investments consisted primarily of commercial paper. No significant restrictions exist on our ability to use or access funds in any of our U.S. or foreign intermediate holding companies. As a result of the TCJA, future amounts repatriated from our foreign subsidiaries are eligible for a 100 percent exemption from U.S. income tax but may be subject to tax on foreign currency gain or loss. See "Regulation" contained herein in Item 1 for further discussion regarding the TCJA and, specifically, a transition tax on undistributed and previously untaxed foreign earnings and profits at reduced rates.
As part of our capital deployment strategy, we repurchase shares of Unum Group's common stock, as authorized by our board of directors. Our current share repurchase program was approved by our board of directors in May 2018 and authorizes the repurchase of up to $750 million of common stock through November 2019, with the pace of repurchase activity to depend upon various factors such as the level of available cash, alternative uses for cash, and our stock price. During 2018, we repurchased 8.7 million shares at a cost of approximately $350 million. The dollar value of shares remaining under the current repurchase program was approximately $500 million at December 31, 2018. See Note 10 of the "Notes to Consolidated Financial Statements" contained herein in Item 8.
The ability of Unum Group and certain of its intermediate holding company subsidiaries to continue to receive dividends from their insurance subsidiaries also depends on additional factors such as RBC ratios and capital adequacy and/or solvency requirements, funding growth objectives at an affiliate level, and maintaining appropriate capital adequacy ratios to support desired ratings. The impacts of the decrease in the U.S. corporate tax rate due to the TCJA resulted in both the reduction of our admitted deferred tax assets at December 31, 2017, and a decrease in our RBC ratios at December 31, 2018 as a result of the NAIC's modification of the RBC factors in 2018. Although the RBC ratios for our U.S. insurance subsidiaries are lower, the RBC ratios are in line with our expectations and are significantly above the level that would require state regulatory action.
The payment of dividends to the parent company from our subsidiaries also requires the approval of the individual subsidiary's board of directors.
The amount available during 2018 for the payment of ordinary dividends from Unum Group's traditional U.S. insurance subsidiaries, which excludes our captive reinsurers, was approximately $797 million, of which $670.5 million was declared and paid. The traditional U.S. insurance subsidiaries also paid extraordinary dividends of $89.8 million in 2018. The amount available during 2018 from Unum Limited was approximately £200 million, of which £115.0 million was declared and paid to one of our U.K. holding companies. During 2018, Northwind Re paid dividends of $98.0 million to Northwind Holdings. Fairwind paid no dividends during 2018.
There are no significant financial covenants associated with any of our outstanding debt obligations. We continually monitor our debt covenants to ensure we remain in compliance. We have not observed any current trends that would cause a breach of any debt covenants.
In 2017, we purchased and retired the remaining $3.4 million of principal on our senior secured floating rate notes acquired through our purchase of Starmount.
In 2018, we issued $300.0 million of 6.25% junior subordinated notes due 2058. The notes are redeemable at or above par on or after June 15, 2023 and rank equally in the right of payment with our other junior subordinated debt securities.
See Note 8 of the "Notes to Consolidated Financial Statements" contained herein in Item 8 for additional information on our debt.
The following table summarizes contractual obligations and our reinsurance recoverable by period as of December 31, 2018:
Policyholder liability maturities and the related reinsurance recoverable represent the projected payout of the current in-force policyholder liabilities and the expected cash inflows from reinsurers for liabilities ceded and therefore incorporate uncertainties as to the timing and amount of claim payments. We utilize extensive liability modeling to project future cash flows from the in-
Operating leases include noncancelable obligations on certain office space, equipment, and software. Purchase obligations include commitments of $515.6 million to fund certain of our investments. These are included in the preceding table based on the expiration date of the commitments. The funds are due upon satisfaction of contractual notice from appropriate external parties and may or may not be funded. Also included are obligations with outside parties for computer data processing services, software maintenance agreements, and consulting services. The aggregate obligation remaining under these agreements was $57.1 million at December 31, 2018.
Our investment policy permits us to lend fixed maturity securities to unaffiliated financial institutions in short-term securities lending agreements, which increases our investment income with minimal risk. We account for all of our securities lending
agreements and repurchase agreements as secured borrowings. We had $0.1 million of securities lending agreements outstanding which were collateralized by cash at December 31, 2018 and were reported as payables for collateral on investments in our consolidated balance sheets. The cash received as collateral was reinvested in short-term investments. The average balance during the year ended December 31, 2018 was $12.2 million, and the maximum amount outstanding at any month end was $29.9 million. In addition, at December 31, 2018, we had $171.4 million of off-balance sheet securities lending agreements which were collateralized by securities that we were neither permitted to sell nor control. The average balance of these off-balance sheet transactions during the year ended December 31, 2018 was $145.9 million, and the maximum amount outstanding at any month end was $219.4 million.
The variance in the change in insurance reserves and liabilities to reconcile net income to net cash provided by operating activities as reported in our consolidated statements of cash flows for 2018 compared to the prior two years was due primarily to the 2018 reserve increase for our long-term care line of business.
AM Best, Fitch, Moody's, and S&P are among the third parties that assign issuer credit ratings to Unum Group and financial strength ratings to our insurance subsidiaries. We compete based in part on the financial strength ratings provided by rating agencies. A downgrade of our financial strength ratings can be expected to adversely affect us and could potentially, among other things, adversely affect our relationships with distributors of our products and services and retention of our sales force, negatively impact persistency and new sales, particularly large case group sales and individual sales, and generally adversely affect our ability to compete. A downgrade in the issuer credit rating assigned to Unum Group can be expected to adversely affect our cost of capital or our ability to raise additional capital.
We have audited the accompanying consolidated balance sheets of Unum Group and subsidiaries (the Company) as of December 31, 2018 and 2017, and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2018, and the related notes and financial statement schedules listed in the Index at Item 15(a)(2) (collectively referred to as the "financial statements"). In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2018 and 2017, and the consolidated results of operations and its cash flows for each of the three years in the period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control -Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 19, 2019 expressed an unqualified opinion thereon.
These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
Description of Business: We are a leading provider of financial protection benefits in the United States and the United Kingdom. Our products include disability, life, accident, critical illness, dental and vision, and other related services. We market our products primarily through the workplace.
Policy Loans: Policy loans are presented at unpaid balances directly related to policyholders. Interest income is accrued on the principal amount of the loan based on the loan's contractual interest rate. Included in policy loans are $3,449.3 million and $3,307.5 million of policy loans ceded to reinsurers at December 31, 2018 and 2017, respectively.
Our investments in private equity partnerships are passive in nature and represent funds that are primarily invested in private credit, private equity, and real assets. We account for our investments in these partnerships using either the equity method or at fair value through net income depending on the level of ownership and the degree of our influence over partnership operating and financial policies. For investments in partnerships accounted for under the equity method, we report our investments at our share of the partnership's net asset value (NAV) and record our portion of partnership earnings is recorded as a component of net investment income. For investments in partnerships accounted for at fair value through net income, we also report our investments at our share of the partnership's NAV as a practical expedient for fair value with increases or decreases recorded as a component of net investment income. Distributions received from the funds arise from income generated by the underlying investments as well as the liquidation of the underlying investments and there is generally not a public market for these investments.
See notes 2 and 3 for further discussion of our other long-term investments.
Property and Equipment: Property and equipment is reported at cost less accumulated depreciation, which is calculated on the straight-line method over the estimated useful life. The accumulated depreciation for property and equipment was $1,151.8 million and $1,067.7 million as of December 31, 2018 and 2017, respectively.
for the various product lines. Unlike policy reserves for which assumptions are generally established and locked in at the time of policy issuance, claim reserves are subject to revision as current claim experience and projections of future factors affecting claim experience change. Claim reserves do not include a provision for adverse deviation. See Note 6.
Short-term and Long-term Debt: Debt is generally carried at the unpaid principal balance, net of unamortized discount or premium and deferred debt issuance costs. Short-term debt consists of debt due within the next twelve months, including that portion of debt otherwise classified as long-term. Original issue discount or premium as well as debt issuance costs are recognized as a component of interest expense over the period the debt is expected to be outstanding. The carrying amount of long-term debt that is part of a fair value hedge program includes an adjustment to reflect the effect of the change in fair value attributable to the risk being hedged. Net interest settlements for fair value hedges on our long-term debt are recognized as a component of interest expense. See Note 8.
Premium Tax Expense: Premium tax expense is included in other expenses in the consolidated statements of income. For the years ended December 31, 2018, 2017, and 2016, premium tax expense was $155.8 million, $158.0 million, and $152.5 million, respectively.
Earnings Per Share: We compute basic earnings per share by dividing net income by the weighted average number of common shares outstanding for the period. Earnings per share assuming dilution is computed by dividing net income by the weighted average number of shares outstanding for the period plus the shares representing the dilutive effect of stock-based awards. In computing earnings per share assuming dilution, only potential common shares resulting from stock-based awards that are dilutive (those that reduce earnings per share) are included. We use the treasury stock method to account for the effect of outstanding stock options and nonvested stock awards on the computation of earnings per share assuming dilution. See Note 10.
This update provided clarifying guidance intended to reduce the diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The update addressed eight specific cash flow issues that relate to various types of transactions. The guidance was applied retrospectively.
The adoption of these updates did not have an impact on our financial position or results of operations and did not result in expanded disclosures due to the immaterial nature of our fee-based service products relative to our overall business.
The adoption of this update resulted in the reclassification of service cost from the other expenses line item to the compensation expense line item on our consolidated statements of income but had no effect on our financial position or results of operations. We elected to use the practical expedient for the retrospective application of this update. See the summary tables contained herein for the financial statement impacts of this retrospective adoption.
This update eliminated the exception that required the tax effect of intra-entity asset transfers other than inventory to be deferred until the transferred asset is sold to a third party or otherwise recovered through use. It required recognition of tax expense from the sale of the asset in the seller’s tax jurisdiction when the transfer occurs, even though the pre-tax effects of that transaction are eliminated in consolidation. The guidance was applied retrospectively.
The adoption of this update did not have an impact on our financial position or results of operations.
This update provided targeted improvements to accounting for hedging activities for both nonfinancial and financial risk components, aligns the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements, eases certain documentation and effectiveness assessment requirements, and enhances transparency through expanded disclosures. For cash flow and net investment hedges existing at the date of adoption, the guidance was applied using a modified retrospective approach through a cumulative-effect adjustment to accumulated other comprehensive income with a corresponding adjustment to retained earnings as of the beginning of the fiscal year the guidance is adopted. The amended presentation and disclosure guidance were required prospectively. Early adoption was permitted.
This update amended the fair value measurement guidance by removing or clarifying certain existing disclosure requirements, while also adding new disclosure requirements. Specifically, this update removed certain disclosures related to Level 1 and Level 2 transfers and also removed the discussion regarding valuation processes of Level 3 fair value measurements. The update modifies guidance related to investments in certain entities that calculate net asset value to explicitly require disclosure regarding timing of liquidation of the investee's assets and timing of redemption restrictions. The update adds disclosures around the changes in unrealized gains and losses in other comprehensive income for recurring Level 3 investments held at the end of the reporting period and adds disclosures regarding certain unobservable inputs on Level 3 fair value measurements. The guidance was applied retrospectively or prospectively depending on the specific requirement of the update. Entities are permitted to early adopt any removed or modified disclosures and may delay adoption of the additional disclosures until their effective date.
Summary of Financial Statement Impacts of Accounting Updates Adopted in 2018:
For the adoption of these updates, certain reclassifications have been made to prior year amounts in order to conform to current year presentation.
This update changed the accounting and disclosure requirements for certain aspects of share-based payments to employees. The update required all income tax effects of stock-based compensation awards to be recognized in the income statement when the awards vest or are settled. The update also allows an employer to repurchase more of an employee's shares than it can today for tax withholding purposes without triggering liability accounting and to make a policy election to account for forfeitures as they occur. Additionally, the update required reclassification of tax-related cash flows resulting from share-based payments to be classified as operating activities instead of financing activities on the statement of cash flows. Transition guidance for the amendments varied between the retrospective, modified retrospective, and prospective methods depending on the specific requirement of the update.
This update simplified the presentation of deferred debt issuance costs by requiring these costs to be presented in the balance sheet as a reduction of the carrying amount of the debt liability to which the deferred costs relate, rather than classifying the deferred costs as an asset. This classification is consistent with the treatment of debt discounts. We applied the amendments in the update retrospectively, adjusting all prior periods in our consolidated financial statements and accompanying notes.
The adoption of this update resulted in reclassification adjustments to our consolidated balance sheets but had no effect on our financial position or results of operations.
The adoption of this update will expand certain of our disclosures but will have no impact on our financial position or results of operations because we do not intend to make the optional accounting policy election to reclassify the stranded tax effects resulting from the TCJA from accumulated other comprehensive income to retained earnings.
This update shortens the amortization period to the earliest call date for certain callable debt securities held at a premium. This update does not impact securities held at a discount. The guidance is to be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption, with early adoption permitted.
We have determined that certain of our callable debt securities are within the scope of this update. The adoption of this update will not have a material impact on our financial position or results of operations.
This update generally aligns the accounting guidance for share-based payments issued to non-employees with guidance for share-based payments issued to employees. Specifically, the update requires non-employee share-based payments to be measured using the grant date fair value of the equity instruments that an entity is obligated to issue when the good has been delivered or the service has been rendered rather than being remeasured through the performance completion date. Additionally, for non-employee share-based payments that contain performance conditions, the update will change the criteria regarding the recognition of compensation cost to when achievement of a performance condition is probable rather than upon actual achievement of the performance condition. The guidance is to be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption, with early adoption permitted. For purposes of determining the cumulative effect adjustment, the guidance shall be applied only to equity-classified non-employee share-based payments for which a measurement date has not been established and liability-classified non-employee share-based payments that have not been settled as of the date of adoption.
This update changes the accounting for leases, requiring lessees to report most leases on their balance sheets, regardless of whether the lease is classified as a finance lease or an operating lease. For lessees, the initial lease liability is equal to the present value of lease payments, and a corresponding right-of-use asset, adjusted for certain items, is also recorded. Expense recognition for lessees will remain similar to current accounting requirements for capital and operating leases. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases. The guidance may be applied using a modified retrospective approach at either the beginning of the earliest comparative period presented or as of the beginning of the period of adoption. The guidance also allows practical expedients related to adoption considerations for leases that commenced before the date of adoption. Early adoption is permitted.
We will adopt this update using the modified retrospective transition option that allows for application of the guidance at the beginning of the period of adoption. The adoption of this update on January 1, 2019 will result in the recognition of a lease liability of approximately $125 million with a corresponding right-of-use asset, less an immaterial cumulative-effect decrease to retained earnings related to our operating leases. We will elect to apply the package of practical expedients available to leases that commenced prior to the date of adoption. We do not expect this update to have an impact to our results of operations but it will expand our disclosures.
This update amends the guidance on the impairment of financial instruments. The update adds an impairment model known as the current expected credit loss model that is based on expected losses rather than incurred losses and will generally result in earlier recognition of allowances for losses. The current expected credit loss model applies to financial instruments such as mortgage loans, fixed maturity securities classified as held-to-maturity, and certain receivables. The update also modifies the other-than-temporary impairment model used for available-for-sale fixed maturity securities such that credit losses are recognized as an allowance rather than as a reduction in the amortized cost of the security. The reversal of previously recognized credit losses on available-for-sale fixed maturity securities is allowed under specified circumstances. Additional disclosures will also be required, including information used to develop the allowance for losses. The guidance is to be applied to most instruments in scope using a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. For available-for-sale fixed maturity securities, the update is applied prospectively. Other-than-temporary impairment losses recognized on available-for-sale fixed maturity securities prior to adoption of the update cannot be reversed. Early adoption is permitted.
This update amends the defined benefit pension and other postretirement benefit guidance by removing or clarifying certain existing disclosures requirements, while also adding new disclosure requirements. Specifically, this update removes the requirement to disclose the effects of a one-percentage point change in the assumed healthcare cost trend and the requirement to disclose amounts in accumulated other comprehensive income expected to be recognized as part of net periodic benefit cost of the next year. This update adds a requirement to describe the reasons for significant gains and losses related to changes in the benefit obligation for the period. The update also clarifies that the projected benefit obligation (PBO) and accumulated benefit obligation (ABO) and fair value of plan assets are to be disclosed for plans with PBOs or ABOs in excess of plan assets. The guidance is to be applied retrospectively and early adoption is permitted.
This update significantly amends the accounting and disclosure requirements for long-duration insurance contracts. These changes include a requirement to review, and if necessary, update cash flow assumptions used to measure the liability for future policy benefits for traditional and limited-payment contracts at least annually, with changes recognized in earnings. In addition, an entity will be required to update the discount rate assumption at each reporting date using a yield that is reflective of an upper-medium grade fixed-income instrument, with changes recognized in other comprehensive income. These changes result in the elimination of the provision for risk of adverse deviation and premium deficiency (or loss recognition) testing. The update also requires that an entity measure all market risk benefits associated with deposit contracts at fair value, with changes recognized in earnings except for the portion attributable to a change in the instrument-specific credit risk, which is to be recognized in other comprehensive income. This update also simplifies the amortization of deferred acquisition costs by requiring amortization on a constant level basis over the expected term of the related contracts. Deferred acquisition costs are required to be written off for unexpected contract terminations but are no longer subject to an impairment test. Significant additional disclosures will also be required, which include disaggregated rollforwards of certain liability balances and the disclosure of qualitative and quantitative information about expected cash flows, estimates, and assumptions. The application of this guidance will vary based upon the specific requirements of the update but will generally result in either a modified retrospective or full retrospective approach with changes applied as of the beginning of the earliest period presented. Early adoption is permitted.
We classify financial instruments in accordance with a fair value hierarchy consisting of three levels based on the observability of valuation inputs:
Level 1 - the highest category of the fair value hierarchy classification wherein inputs are unadjusted and represent quoted prices in active markets for identical assets or liabilities at the measurement date.
3.6 percent of our fixed maturity securities were valued based on one or more non-binding broker quotes, if validated by observable market data, or on TRACE prices for identical or similar assets absent current market activity. When only one price is available, it is used if observable inputs and analysis confirms that it is appropriate. These assets, for which we were able to validate the price using other observable market data, were classified as Level 2.
9.7 percent of our fixed maturity securities were valued based on prices of comparable securities, matrix pricing, market models, and/or internal models or were valued based on non-binding quotes with no other observable market data. These assets were classified as either Level 2 or Level 3, with the categorization dependent on whether there was other observable market data.
Changes in assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) are as follows:
Long-term Debt: Fair values for long-term debt are obtained from independent pricing services or discounted cash flow analyses based on current incremental borrowing rates for similar types of borrowing arrangements.
Unfunded Commitments to Investment Partnerships: Unfunded equity commitments represent amounts that we have committed to fund certain investment partnerships. These commitments are legally binding, subject to the partnerships meeting specified conditions. Carrying amounts of these financial instruments approximate fair value.
At December 31, 2018 and 2017, all fixed maturity securities were classified as available-for-sale. The amortized cost and fair values of securities by security type are shown as follows:
As of December 31, 2018, we held 552 individual investment-grade fixed maturity securities and 135 individual below-investment-grade fixed maturity securities that were in an unrealized loss position, of which 204 investment-grade fixed maturity
securities and 32 below-investment-grade fixed maturity securities had been in an unrealized loss position continuously for over one year.
We held no fixed maturity securities as of December 31, 2018 and 2017, for which a portion of an other-than-temporary impairment was recognized in accumulated other comprehensive income.
As of December 31, 2018, the carrying amount of our variable interest entity investments that are not consolidated in our financial statements was $575.3 million, comprised of $91.5 million of tax credit partnerships and $483.8 million of private equity partnerships. At December 31, 2017, the carrying amount of our variable interest entity investments that are not consolidated in our financial statements was $535.4 million, comprised of $128.2 million of tax credit partnerships and $407.2 million of private equity partnerships. These variable interest entity investments are reported as other long-term investments in our consolidated balance sheets.
Contractually, we are a limited partner in these tax credit partnerships, and our maximum exposure to loss is limited to the carrying value of our investment, which includes $2.3 million of unfunded unconditional commitments at December 31, 2018. See Note 2 for commitments to fund private equity partnerships.
There have been no changes to our accounting policies or methodology from the prior period regarding estimating the allowance for credit losses on our mortgage loans. There was no activity in the allowance for credit losses for the years ended December 31, 2018, 2017 or 2016 other than previously mentioned impairment loss of $0.2 million.
Our average investment in impaired mortgage loans was $2.3 million and $2.2 million for the years ended December 31, 2018 and 2016, respectively. We did not hold any impaired mortgage loans for the year ended December 31, 2017. We did not recognize any interest income during 2018, 2017 or 2016 on mortgage loans subsequent to impairment.
As of December 31, 2018, the carrying amount of fixed maturity securities loaned to third parties under our securities lending program was $164.1 million, for which we received collateral in the form of cash and securities of $0.1 million and $171.4 million, respectively. As of December 31, 2017, the carrying amount of fixed maturity securities loaned to third parties under our securities lending program was $159.2 million, for which we received collateral in the form of cash and securities of $30.5 million and $135.6 million, respectively. We had no outstanding repurchase agreements at December 31, 2018 or 2017.
1 The net unrealized loss recognized in net investment income for the year ended December 31, 2018 related to equity securities still held at December 31, 2018 was $3.9 million.
Foreign currency interest rate swaps are used to hedge the currency risk of certain foreign currency-denominated fixed maturity securities owned for portfolio diversification. Under these swap agreements, we agree to pay, at specified intervals, fixed rate foreign currency-denominated principal and interest payments in exchange for fixed rate payments in the functional currency of the operating segment.
Foreign currency interest rate swaps previously designated as hedges were used to hedge the currency risk of certain foreign currency-denominated fixed maturity securities owned for portfolio diversification. These derivatives were effective hedges prior to novation to a new counterparty. In conjunction with the novation, these derivatives were de-designated as hedges. We agree to pay, at specified intervals, fixed rate foreign currency-denominated principal and interest payments in exchange for fixed rate payments in the functional currency of the operating segment. We hold offsetting swaps wherein we agree to pay fixed rate principal and interest payments in the functional currency of the operating segment in exchange for fixed rate foreign currency-denominated payments.
Interest rate swap was used to effectively convert certain of our floating rate, long-term debt into fixed rate long-term debt. Under this swap agreement, we received a variable rate of interest and paid a fixed rate of interest.
See Note 3 for further discussion of our master netting agreements.
The majority of our derivative instruments contain provisions that require us to maintain specified issuer credit ratings and financial strength ratings. Should our ratings fall below these specified levels, we would be in violation of the provisions, and our derivatives counterparties could terminate our contracts and request immediate payment. The aggregate fair value of all derivative instruments with credit risk-related contingent features that were in a liability position was $38.0 million and $52.2 million at December 31, 2018 and 2017, respectively.
As of December 31, 2018, we expect to amortize approximately $70.0 million of net deferred gains on derivative instruments during the next twelve months. This amount will be reclassified from accumulated other comprehensive income into earnings and reported on the same income statement line item as the hedged item. The income statement line items that will be affected by this amortization are net investment income and interest and debt expense. Additional amounts that may be reclassified from accumulated other comprehensive income into earnings to offset the earnings impact of foreign currency translation of hedged items are not estimable.
As of December 31, 2018, we had $78.1 million notional amount of receive fixed, pay fixed, open current and forward foreign currency interest rate swaps to hedge fixed income foreign currency-denominated securities.
As of December 31, 2018 and 2017, we had 250.0 million notional amount of receive fixed, pay variable interest rate swaps to hedge the changes in the fair value of certain fixed rate long-term debt. These swaps effectively convert the associated fixed rate long-term debt into floating rate debt and provide for a better matching of interest rates with our short-term investments, which have frequent interest rate resets similar to a floating rate security. During 2016, $350.0 million notional amount of receive
The following table summarizes the carrying amount of hedged assets and liabilities and the related cumulative basis adjustments related to our fair value hedges:
Components of our accumulated other comprehensive income (loss), after tax, and related changes are as follows:
Our consolidated statements of income include amounts subject to both domestic and foreign taxation. The income and related tax expense (benefit) are as follows. The federal statutory rates used were 21 percent for 2018 and 35 percent for 2017 and 2016:
On December 22, 2017, the U.S. Federal government enacted the TCJA, which reduced the federal corporate tax rate from 35 percent to 21 percent effective January 1, 2018. Although the TCJA's 21 percent corporate tax rate became effective on January 1, 2018, we are required to adjust deferred tax assets and liabilities through continuing operations on the date of enactment. As a result, in 2017 we recorded an income tax benefit of $97.9 million for the TCJA's corporate tax rate reduction and an income tax expense of $66.4 million for the deemed repatriation transition tax on accumulated foreign E&P.
Effective January 1, 2018, the TCJA created a U.S. shareholder tax on certain foreign subsidiary income above a routine equity return on tangible depreciable business assets, or a tax on Global Intangible Low-taxed Income (GILTI). The FASB has provided additional guidance to address the accounting effects of GILTI, requiring companies to elect to either recognize deferred taxes related to GILTI or include in tax expense in the period incurred. We have elected to treat GILTI as a period cost.
We recognize interest expense and penalties, if applicable, related to unrecognized tax benefits in tax expense. We recognized a de minimis amount of interest expense related to unrecognized tax benefits during 2018, 2017 and 2016. We held a de minimis liability in our consolidated balance sheets for accrued interest related to unrecognized tax benefits at December 31, 2018, 2017 and 2016.
We file state income tax returns in nearly every state in the United States. Tax years subsequent to 2013 remain subject to examination depending on the statute of limitation established by the various states, which is generally three to four years. Tax years subsequent to 2010 remain subject to examination in California.
We have an accumulated federal net operating loss carryforward of $6.5 million as of December 31, 2018 and had none as of December 31, 2017. Current year net operating losses relate to subsidiaries not yet included in the consolidated U.S. federal tax return and are not expected to expire unused. Our federal capital loss carryforward, also related to subsidiaries not included in the consolidated U.S. federal return, was $0.7 million at both December 31, 2018 and 2017 and is expected to be utilized by the time it expires in 2022. We have net operating loss carryforwards for state and local income tax of approximately $195 million most of which is expected to expire unused between 2019 and 2038.
We record valuation allowances to reduce deferred tax assets to the amount that is more likely than not to be realized. Our valuation allowance was $18.4 million and $20.3 million at December 31, 2018 and 2017, the majority of which related to our cumulative deferred state income tax benefits. The de minimis remaining amount of our valuation allowance relates to unrealized tax losses on buildings which we own and occupy in the U.K.
Northwind Holdings is required to repay a portion of the outstanding principal under the Northwind notes at par on the quarterly scheduled payment dates under the Northwind notes in an amount equal to the lesser of (i) a targeted amortization amount as defined in the Northwind indenture and (ii) the amount of the remaining available funds in the DSCA minus an amount equal to the minimum balance that is required to be maintained in the DSCA under the Northwind indenture, provided that Northwind Holdings has sufficient funds available to pay its other expenses, including interest payments on the Northwind notes, and to maintain the minimum balance in the DSCA as required under the Northwind indenture. Northwind Holdings made principal payments on the Northwind notes of $60.0 million in both 2018 and 2017, and $64.0 million in 2016.
As of December 31, 2018 and 2017, we had $250.0 million notional amount of an interest rate swap which effectively converts certain of our unsecured senior notes into floating rate debt. Under this agreement, we receive a fixed rate of interest and pay a variable rate of interest, based off of three-month LIBOR. See Note 4 for further information on the interest rate swap.
In May 2018, we issued $300.0 million of 6.25% junior subordinated notes due 2058. The notes are redeemable at or above par on or after June 15, 2023 and rank equally in the right of payment with our other junior subordinated debt securities.
capital securities offering. The debentures mature in 2038. The sole assets of the trust are the junior subordinated debt securities.
Effective August 1, 2016, we amended the retiree medical benefits portion of our OPEB plan to transition a majority of participants to a private exchange for their health insurance coverage. Prior to the plan amendment, participants paid a subsidized premium for their health insurance coverage, but if they elect to continue participation in the plan they will now purchase coverage on a private exchange and will subsequently be reimbursed through a Health Reimbursement Account (HRA) for an amount equivalent to the subsidy that was previously provided. Participants who continued in the plan received a one-time subsidy to minimize the initial out-of-pocket cost of purchasing health insurance. The amendment did not materially change the benefit obligation of the plan.
The amounts recognized in our consolidated balance sheets for our pension and OPEB plans at December 31, 2018 and 2017 are as follows.
Level 1 investments consist of individual holdings that are valued based on unadjusted quoted prices from active markets for identical securities. Level 2 investments consist of individual holdings that are valued using observable inputs through market corroborated pricing.
Certain equity, opportunistic credit, and real estate investments are valued based on the NAV of the underlying holdings. We made no adjustments to the NAV for 2018 or 2017. These investments have no unfunded commitments and no specific redemption restrictions.
Alternative investments are valued based on NAV in a period ranging from one month to one quarter in arrears. We evaluate the need for adjustments to the NAV based on market conditions and discussions with fund managers in the period subsequent to the valuation date and prior to issuance of the financial statements. We made no adjustments to the NAV for 2018 or 2017. The private equity direct investments and private equity funds of funds generally cannot be redeemed by investors. Distributions of capital from the sale of underlying fund assets may occur at any time, but are generally concentrated between five and eight years from the formation of the fund.
Our long-term rate of return on plan assets assumption is selected from a range of probable return outcomes from an analysis of the asset portfolio. Our expectations for the future investment returns of the asset categories are based on a combination of historical market performance, evaluations of investment forecasts obtained from external consultants and economists, and current market yields. The methodology underlying the return assumption includes the various elements of the expected return for each asset class such as long-term rates of return, volatility of returns, and the correlation of returns between various asset classes. The expected return for the total portfolio is calculated based on the plan's strategic asset allocation. Investment risk is measured and monitored on an ongoing basis through annual liability measurements, periodic asset/liability studies, and quarterly investment portfolio reviews. Risk tolerance is established through consideration of plan liabilities, plan funded status, and corporate financial condition.
The expected return assumption for the life insurance reserve for our OPEB plan is based on full investment in fixed income securities with an average book yield of 4.73 percent and 4.76 percent in 2018 and 2017, respectively.
At December 31, 2018 and 2017, the annual rates of increase in the per capita cost of covered postretirement health care benefits assumed for the next calendar year are 7.00 percent for benefits payable to both retirees prior to Medicare eligibility as well as Medicare eligible retirees. The rates are assumed to change gradually to 5.00 percent by 2024 for measurement at December 31, 2018 and remain at that level thereafter. The annual rates of increase in the per capita cost of covered postretirement health benefits do not apply to retirees whose postretirement health care benefits are provided through an exchange.
A one percent increase or decrease in the assumed health care cost trend rate at December 31, 2018 would have increased (decreased) the service cost and interest cost by a de minimis amount, respectively, and the postretirement benefit obligation by $0.6 million and $(0.5) million, respectively.
The funding policy for our U.S. qualified defined benefit plan is to contribute annually an amount at least equal to the minimum annual contribution required under ERISA and other applicable laws, but generally not greater than the maximum amount that can be deducted for federal income tax purposes. We had no regulatory contribution requirements for our U.S. qualified defined benefit plan in 2018 and made a de minimis amount of voluntary contributions during 2018. We do not expect to make any contributions in 2019. The funding policy for our U.S. non-qualified defined benefit pension plan is to contribute the amount of the benefit payments made during the year. Our expected return on plan assets and discount rate will not affect the cash contributions we are required to make to our U.S. pension plan because such contributions are determined under the minimum funding requirements as set forth in ERISA.
We made no contributions to our U.K. plan during 2018, nor do we expect to make any contributions in 2019, either voluntary or those required to meet the minimum funding requirements under U.K. legislation.
We use the treasury stock method to account for the effect of outstanding stock options, nonvested restricted stock units, and nonvested performance share units on the computation of diluted earnings per share. Under this method, these potential common shares will each have a dilutive effect, as individually measured, when the average market price of Unum Group common stock during the period exceeds the exercise price of the stock options and the grant price of the nonvested restricted stock units and the nonvested performance share units. The outstanding stock options have exercise prices ranging from $23.35 to $26.29; the nonvested restricted stock units have grant prices ranging from $27.85 to $55.26; and the nonvested performance share units have grant prices ranging from $27.85 to $49.86. See Note 11.
In computing earnings per share assuming dilution, only potential common shares that are dilutive (those that reduce earnings per share) are included. Potential common shares not included in the computation of diluted earnings per share because the impact would be antidilutive, based on then current market prices, approximated 0.6 million, 0.3 million, and 0.4 million for the years ended December 31, 2018, 2017, and 2016, respectively.
The May 2018 share repurchase program has an expiration date of November 24, 2019.
During 2018, 2017, and 2016, we issued PSUs with a weighted average grant date fair value per share of $44.19, $51.37, and $28.41, respectively. Vesting for the PSUs occurs at the end of a three-year period and is contingent upon our achievement of prospective company performance goals and our total shareholder return relative to a board-approved peer group during the three-year period. Actual performance, including modification for relative total shareholder return, may result in the ultimate award of 40 to 180 percent of the initial number of PSUs issued, with the potential for no award if company performance goals are not achieved during the three-year period. Forfeitable dividend equivalents on PSUs are accrued in the form of additional PSUs.
At December 31, 2018, we had approximately $5.9 million of unrecognized compensation cost related to PSUs that will be recognized over a weighted average period of 1.6 years. The estimated compensation expense is adjusted for actual performance experience and is recognized ratably during the service period, or remaining service period, if and when it becomes probable that the performance conditions will be satisfied. Compensation cost for PSUs subject to accelerated vesting at the date of retirement eligibility is recognized over the implicit service period.
All outstanding stock options at December 31, 2018 have vested. Stock options vest over a one to three-year service period, beginning at the date of grant, and the compensation cost is recognized ratably during the vesting period. Compensation cost for stock options subject to accelerated vesting at the date of retirement eligibility is recognized over the implicit service period. At December 31, 2018, we had no unrecognized compensation cost related to stock options.
Cash received under all share-based payment arrangements for the years ended December 31, 2018, 2017, and 2016 was $4.6 million, $10.8 million, and $8.5 million, respectively.
Thirteen major companies account for approximately 92 percent of our reinsurance recoverable at December 31, 2018, and all are rated A or better by A.M. Best Company (AM Best) or are fully securitized by letters of credit or investment-grade fixed maturity securities held in trust. Approximately seven percent of our reinsurance recoverable relates to business reinsured either with companies rated A- or better by AM Best, with overseas entities with equivalent ratings or backed by letters of credit or trust agreements, or through reinsurance arrangements wherein we retain the assets in our general account. The remaining one percent of our reinsurance recoverable is held by companies either rated below A- by AM Best or not rated.
We have three principal operating business segments: Unum US, Unum International, and Colonial Life. Our other segments are Closed Block and Corporate.
The Unum US segment is comprised of group long-term disability, which includes our new medical stop-loss product, and short-term disability insurance, group life and accidental death and dismemberment products, and supplemental and voluntary lines of business. The supplemental and voluntary lines of business are comprised of individual disability, voluntary benefits, and dental and vision products. These products are marketed through our field sales personnel who work in conjunction with independent brokers and consultants.
In connection with our acquisition of Pramerica Zycie TUiR S.A., (which we have subsequently renamed Unum Zycie TUiR S.A. and refer to as Unum Poland) in the fourth quarter of 2018, we changed the name of our Unum UK segment to Unum International. The Unum International segment is now comprised of our Unum UK line of business and the newly acquired Unum Poland line of business. See "Acquisitions of Business" below for further information. Unum UK's business includes insurance for group long-term disability, group life, and supplemental lines of business which include dental, individual disability, and critical illness products. Unum UK's products are sold primarily in the United Kingdom through field sales personnel and independent brokers and consultants. Unum Poland's business primarily includes insurance for individual and group life with accident and health riders. Unum Poland's products are sold only in Poland, primarily through a combination of independent agents and field sales personnel. Unum Poland 's results are included within the supplemental product of the Unum International segment in U.S. dollars.
The Colonial Life segment includes insurance for accident, sickness, and disability products, which includes our expanded dental and vision products, life products, and cancer and critical illness products marketed to employees, on both a group and an individual basis, at the workplace through an independent contractor agency sales force and brokers.
On October 1, 2018, we acquired 100 percent of the shares and voting interests in Unum Poland, a financial protection benefits provider in Poland. This acquisition will expand our European presence, which we believe to be an attractive market for financial protection benefits.
On January 1, 2018, we acquired 100 percent of the shares and voting interests in Leavelogic, Inc (Leavelogic), a leave management technology provider. The acquisition of Leavelogic will enhance our current leave management offerings by providing tools for employers and employees to better manage the family leave process and is reported in our Unum US segment.
Total assets were valued at $93.1 million as of the acquisition date and were primarily comprised of bonds, cash, accounts receivable, and intangible assets attributable to the value of business acquired and the value of existing state licenses. Total liabilities were valued at $55.7 million as of the acquisition date and were primarily comprised of outstanding claim liabilities and reserves for future claims. The total purchase price exceeded the fair value of the identifiable net assets by $111.2 million and has been identified as goodwill, primarily attributable to the value of adding dental and vision to our current employee benefit offerings. Goodwill was allocated to the reporting units expected to benefit from the acquisition. Approximately 75 percent was allocated to our Unum US supplemental and voluntary product lines and approximately 25 percent to Colonial Life. The goodwill is not deductible for income tax purposes except upon disposition of the acquired entity.
Revenue is primarily derived from sources in the United States and the United Kingdom. There are no material revenues or assets attributable to foreign operations other than those reported in our Unum International segment.
At December 31, 2018, we had unfunded commitments of $515.6 million for certain of our investments, the amount of which may or may not be funded.
Similar to other insurers, we were the subject of an examination by a third party acting on behalf of a number of state treasurers concerning our compliance with the unclaimed property laws of the participating states. We cooperated fully with this examination and in the fourth quarter of 2017, we started the process to reach a Global Resolution Agreement with the third party regarding settlement of the examination, which we finalized in January of 2018. Under the terms of the agreement, the third party acting on behalf of the signatory states compared insured data to the Social Security Administration's Death Master File (SSDMF) to identify deceased insureds and contract holders where a valid claim has not been made. During the fourth quarter of 2017, we established reserves which reflect our estimate of the liability expected to be paid as we execute on the terms of the settlement. We also are cooperating with a Delaware Market Conduct examination involving the same issue, which is currently inactive. The legal and regulatory environment around unclaimed death benefits continues to evolve. It is possible that the current settlement and/or similar investigations by other state jurisdictions may result in payments to beneficiaries, the payment of abandoned funds under state law, and/or administrative penalties, the total of which may be in excess of the reserves established.
of Pennsylvania. Under Pennsylvania law, payment of covered claims and other related insurance obligations are provided, within prescribed limits, by state guaranty associations. These guaranty associations assess fees to meet these obligations on insurance companies that sell insurance within the state, which are generally based on a company's pro rata portion of average premiums written or received for several years prior to the insolvency. In March 2017, a formal order of liquidation was issued, and as such, we were subject to an assessment by those guaranty associations that are responsible for policyholder claims, and accordingly accrued, in the first quarter of 2017, an estimated loss contingency. We continue to submit payment to satisfy this assessment as requests for payment are received from the guaranty associations.
On June 13, 2018, an alleged securities class action lawsuit entitled Cynthia Pittman v. Unum Group, Richard McKenney, John McGarry, and Daniel Waxenberg was filed in the United States District Court for the Eastern District of Tennessee. The plaintiff seeks to represent purchasers of Unum Group publicly traded securities between January 31, 2018 and May 2, 2018. The plaintiff alleges the Company caused its shares to trade at artificially high levels by failing to disclose information about the rate of long-term care policy terminations and long-term care claim incidence resulting in misleading statements about capital management plans and long-term care reserves. The complaint asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder and seeks compensatory damages in an amount to be proven at trial. The Company strongly denies these allegations and will vigorously defend the litigation.
and seeks compensatory damages in an amount to be proven at trial as well as costs, expenses, and attorney’s fees. The Company strongly denies these allegations and will vigorously defend the litigation.
Shareholder Derivative Actions: Three alleged derivative lawsuits have been filed against individual defendants and Unum Group, as nominal defendant, as follows:
On October 23, 2018, a purported shareholder derivative lawsuit entitled Steven Jenkins, Derivatively on Behalf of Unum Group v. Richard P. McKenney, John F. McGarry, Daniel J. Waxenberg, Steve Zabel, Kevin T. Kabat, E. Michael Caulfield, Gloria C. Larson, Timothy F. Keaney, Theodore H. Bunting, Jr., Cynthia L. Egan, Ronald P. O'Hanley, Francis J. Shammo, Joseph J. Echevarria, Thomas R. Watjen, Pamela H. Godwin, Edward J. Muhl, and Unum Group as nominal defendant was filed in the United States District Court for the District of Delaware. The defendants, allegations, and damages claimed mirror those in the Gusinsky matter. The Company strongly denies these allegations and will vigorously defend the litigation.
Fairwind, which is domiciled in the state of Vermont, is required to follow GAAP in accordance with Vermont reporting requirements for pure captive insurance companies, unless the commissioner permits the use of some other basis of accounting. Fairwind has permission from Vermont to follow accounting practices that are generally consistent with current NAIC statutory accounting principles for its insurance reserves and invested assets supporting reserves. All other assets and liabilities are accounted for in accordance with GAAP, as prescribed by Vermont, which allows for the full recognition of deferred tax assets which are more likely than not to be realized. Statutory accounting principles have a stricter limitation for the recognition of deferred tax assets. The impact of following the prescribed and permitted practices of Vermont rather than statutory accounting principles prescribed by the NAIC resulted in higher capital and surplus for Fairwind of approximately $137 million and $142 million as of December 31, 2018 and 2017 respectively. Included in the 2018 results for Fairwind was the assumed portion of the statutory impact of the long-term care reserve increase from Unum America. Included in the 2017 results for Fairwind was the revaluation of the deferred tax asset at the new corporate rate of 21 percent resulting from the enactment of TCJA. Northwind Re has no material state prescribed accounting practices that differ from statutory accounting principles prescribed by the NAIC.
The operating results and capital and surplus of our traditional U.S. life insurance subsidiaries and our captive reinsurers, prepared in accordance with prescribed or permitted accounting practices of the NAIC or states of domicile, are presented separately below.
Risk-based capital (RBC) standards for U.S. life insurance companies are prescribed by the NAIC. The domiciliary states of our U.S. insurance subsidiaries have all adopted a version of the RBC model formula of the NAIC, which prescribes a system for assessing the adequacy of statutory capital and surplus for all life and health insurers. The basis of the system is a risk-based formula that applies prescribed factors to the various risk elements in a life and health insurer's business to report a minimum capital requirement proportional to the amount of risk assumed by the insurer. The life and health RBC formula is designed to measure annually (i) the risk of loss from asset defaults and asset value fluctuations, (ii) the risk of loss from adverse mortality and morbidity experience, (iii) the risk of loss from mismatching of asset and liability cash flow due to changing interest rates, and (iv) business risks. The formula is used as an early warning tool to identify companies that are potentially inadequately capitalized. State insurance laws grant insurance regulators the authority to require various actions by, or take various actions against, insurers whose total adjusted capital does not meet or exceed certain RBC levels. The impacts of the TCJA, particularly the decrease in the U.S. corporate tax rate, resulted in both the reduction of our admitted deferred tax assets and the increase of RBC factors adopted by the NAIC, which has reduced our RBC ratios; however, the total adjusted capital of each of our U.S. insurance subsidiaries at December 31, 2018 is in excess of those RBC levels.
Based on the restrictions under current law, $994.9 million is available, without prior approval by regulatory authorities, during 2019 for the payment of dividends to Unum Group from its traditional U.S. life insurance subsidiaries. The ability of our captive insurers to pay dividends to their respective parent companies will depend on their satisfaction of applicable regulatory requirements and on the performance of the business reinsured.
First quarter of 2017 loss from a guaranty fund assessment related to an unaffiliated insurer that was declared insolvent of $20.6 million before tax and $13.4 million after tax.