The Company leases its principal executive offices in New York, New York, as well as approximately 224 field and claim offices totaling approximately 4.5 million square feet throughout the United States under leases or subleases with third parties. The Company also leases offices in Canada, the United Kingdom, the Republic of Ireland, Brazil, India and China that house operations (primarily for Business Insurance) in those locations. The Company owns six buildings in Hartford, Connecticut, consisting of approximately 1.8 million square feet of office space. The Company also owns buildings located in other areas of Connecticut; Norcross, Georgia; St. Paul, Minnesota; and Omaha, Nebraska. The Company owns a building in London, England, which houses a portion of Business Insurance's operations in the United Kingdom.
• Income tax expense included a net charge of $129 million to reflect the change in tax laws and tax rates enacted in the United States on December 22, 2017 as part of the Tax Cuts and Jobs Act of 2017, resulting primarily from revaluing the Company's deferred tax assets and liabilities and the tax imposed on accumulated foreign earnings
• Net unrealized investment gains of $1.41 billion ($954 million after-tax)
Effective April 1, 2017, the Company's results are reported in the following three business segments-Business Insurance, Bond & Specialty Insurance and Personal Insurance, reflecting a change in the manner in which the Company's businesses were being managed as of that date, as well as the aggregation of products and services based on the type of customer, how the business is marketed and the manner in which risks are underwritten. While the segmentation of the Company's domestic businesses was unchanged, the Company's international businesses, which were previously managed and reported in total within the Business and International Insurance segment, were disaggregated by product type among the three newly aligned reportable business segments. All prior periods presented have been reclassified to conform to this presentation. In connection with these changes, the Company revised the names and descriptions of certain businesses comprising the Company's segments and has reflected other related changes. The following discussion of segment results is based on the realigned reportable business segment structure effective April 1, 2017.
Diluted net income per share of $7.33 in 2017 decreased by 29% from diluted net income per share of $10.28 in 2016. Net income of $2.06 billion in 2017 decreased by 32% from net income of $3.01 billion in 2016. The lower rate of decrease in diluted net income per share reflected the impact of share repurchases in recent periods. The decrease in net income primarily reflected the pre-tax impacts of (i) significantly higher catastrophe losses, (ii) lower net favorable prior year reserve development, (iii) lower underwriting margins excluding catastrophe losses and prior year reserve development ("underlying underwriting margins") and (iv) lower other income in 2017 due to a favorable settlement of a reinsurance dispute in 2016, partially offset by (v) higher net realized investment gains and (vi) higher net investment income. Catastrophe losses in 2017 and 2016 were $1.95 billion and $877 million, respectively. Net favorable prior year reserve development in 2017 and 2016 was $592 million and $771 million, respectively. The lower underlying underwriting margins primarily resulted from the impacts of (i) loss cost trends that modestly exceeded earned pricing in
Business Insurance, (ii) higher non-catastrophe fire-related losses in Business Insurance and (iii) higher non-catastrophe weather-related losses in Personal Insurance, partially offset by (iv) increased business volumes. Partially offsetting this net pre-tax decrease in income was a related decrease in income tax expense. Income tax expense also included a net charge of $129 million to reflect the change in tax laws and tax rates enacted in the U.S. on December 22, 2017 as part of the Tax Cuts and Jobs Act of 2017 (TCJA), resulting primarily from revaluing the Company's deferred tax assets and liabilities and the tax imposed on accumulated foreign earnings. In addition, income tax expense in 2017 was reduced by $39 million as a result of the resolution of prior year tax matters.
Earned premiums in 2017 were $25.68 billion, $1.15 billion or 5% higher than in 2016. In Business Insurance, earned premiums in 2017 increased by 2% over 2016. In Bond & Specialty Insurance, earned premiums in 2017 increased by 2% over 2016. In Personal Insurance, earned premiums in 2017 increased by 10% over 2016. Earned premiums in 2016 were $24.53 billion, $660 million or 3% higher than in 2015. In Business Insurance, earned premiums in 2016 increased by 1% over 2015. In Bond & Specialty Insurance, earned premiums in 2016 were comparable to 2015. In Personal Insurance, earned premiums in 2016 increased by 6% over 2015. Factors contributing to the changes in earned premiums in each segment in 2017 and 2016 compared with the respective prior year are discussed in more detail in the segment discussions that follow.
Net investment income in 2017 was $2.40 billion, $95 million or 4% higher than in 2016. Net investment income from fixed maturity investments in 2017 was $1.89 billion, $86 million lower than in 2016. The decrease primarily resulted from lower long-term reinvestment rates available in the market, partially offset by the impact of a slightly higher average level of fixed maturity investments. Net investment income from short-term securities in 2017 was $62 million, $33 million higher than in 2016, primarily due to higher short-term interest rates and a higher average level of short-term investments. Net investment income generated by non-fixed maturity investments in 2017 was $478 million, $148 million higher than in 2016, primarily due to higher returns from private equity limited partnerships.
The National Accounts market in Business Insurance is the primary source of the Company's fee-based business. Fee income is described in more detail in the Business Insurance discussion that follows.
Other revenues in all years presented included installment premium charges. Other revenues in 2017 also included revenues from Simply Business, which was acquired in August 2017. Other revenues in 2017 and 2016 also included gains related to the settlement of reinsurance disputes (discussed in more detail in note 16 of notes to the consolidated financial statements). Other revenues in 2016 also included proceeds from the favorable settlement of a claims-related legal matter.
Claims and claim adjustment expenses in 2017 were $17.47 billion, $2.40 billion or 16% higher than in 2016, primarily reflecting the impacts of (i) significantly higher catastrophe losses, (ii) higher volumes of insured exposures, (iii) loss cost trends, (iv) lower net favorable prior year reserve development, (v) higher non-catastrophe fire-related losses in Business Insurance and (vi) higher non-catastrophe weather-related losses in Personal Insurance. Catastrophe losses in 2017 primarily resulted from wildfires in California, Hurricanes Harvey, Irma and Maria, and several winter, wind and hail storms throughout the United States.
The Company's threshold for disclosing catastrophes is primarily determined at the reportable segment level. If a threshold for one segment or a combination thereof is exceeded and the other segments have losses from the same event, losses from the event are identified as catastrophe losses in the segment results and for the consolidated results of the Company. Additionally, an aggregate threshold is applied for International business across all reportable segments. The threshold for 2017 ranged from approximately $17 million to $30 million of losses before reinsurance and taxes.
The following table presents the amount of losses recorded by the Company for significant catastrophes that occurred in 2017, 2016 and 2015, the amount of net unfavorable (favorable) prior year reserve development recognized in 2017 and 2016 for catastrophes that occurred in 2016 and 2015, and the estimate of ultimate losses for those catastrophes at December 31, 2017, 2016 and 2015. For purposes of the table, a significant catastrophe is an event for which the Company estimates its ultimate losses will be $100 million or more after reinsurance and before taxes.
General and administrative expenses in 2017 were $4.17 billion, comparable with 2016. General and administrative expenses in 2016 were $4.15 billion, $60 million or 1% higher than in 2015. General and administrative expenses are discussed in more detail in the segment discussions that follow.
Interest expense in 2017, 2016 and 2015 was $369 million, $363 million and $373 million, respectively.
The Company's effective tax rate was 25%, 26% and 27% in 2017, 2016 and 2015, respectively. The effective tax rates in all years were lower than the statutory rate of 35% primarily due to the impact of tax-exempt investment income on the calculation of the Company's income tax provision. In addition, the effective tax rate in 2017 was increased by the net charge related to TCJA described above and was reduced by the impact of the resolution of prior year tax matters discussed above.
The loss and loss adjustment expense ratio of 67.2% in 2017 was 6.7 points higher than the loss and loss adjustment expense ratio of 60.5% in 2016. Catastrophe losses accounted for 7.6 points and 3.6 points of the 2017 and 2016 loss and loss adjustment expense ratios, respectively. Net favorable prior year reserve development in 2017 and 2016 provided 2.3 points and 3.2 points of benefit, respectively, to the loss and loss adjustment expense ratio. The loss and loss adjustment expense ratio excluding catastrophe losses and prior year reserve development ("underlying loss and loss adjustment expense ratio") in 2017 was 1.8 points higher than the 2016 ratio on the same basis, primarily reflecting (i) loss cost trends that modestly exceeded earned pricing in Business Insurance, (ii) higher non-catastrophe fire-related losses in Business Insurance and (iii) higher non-catastrophe weather-related losses in Personal Insurance.
The underwriting expense ratio of 30.7% in 2017 was 0.8 points lower than the underwriting expense ratio of 31.5% in 2016.
The loss and loss adjustment expense ratio of 60.5% in 2016 was 3.9 points higher than the loss and loss adjustment expense ratio of 56.6% in the same period of 2015. Catastrophe losses accounted for 3.6 points and 2.1 points of the 2016 and 2015 loss and loss adjustment expense ratios, respectively. Net favorable prior year reserve development in 2016 and 2015 provided 3.2 points and 3.9 points of benefit, respectively, to the loss and loss adjustment expense ratio. The underlying loss and loss adjustment expense ratio in 2016 was 1.7 points higher than the 2015 ratio on the same basis, primarily reflecting (i) higher loss estimates in the personal automobile product line for bodily injury liability
coverages and (ii) the impact of loss cost trends that modestly exceeded earned pricing in Business Insurance, partially offset by (iii) lower non-catastrophe fire-related losses and other loss activity in Business Insurance.
Earned premiums of $14.15 billion in 2017 were $291 million or 2% higher than in 2016. Earned premiums of $13.86 billion in 2016 were $157 million or 1% higher than in 2015. The increase in earned premiums in both 2017 and 2016 reflected increases in net written premiums over the preceding twelve months.
Other revenues in all years presented included installment premium charges. Other revenues in 2017 included revenues from Simply Business, which was acquired in August 2017. Other revenues in 2017 and 2016 also included gains related to the settlement of reinsurance disputes. Additionally, other revenues in 2016 included proceeds from the favorable settlement of a claims-related legal matter.
Income tax expense in 2017 was $448 million, $208 million or 32% lower than in 2016, primarily reflecting the impact of the $577 million decrease in income before income taxes in 2017 and the $15 million reduction in income tax expense resulting from the resolution of prior year tax matters. Income tax expense in 2016 was $656 million, $88 million or 12% lower than in 2015, primarily reflecting the $183 million decrease in income before income taxes in 2016.
The loss and loss adjustment expense ratio of 61.7% in 2016 was 1.8 points higher than the loss and loss adjustment expense ratio of 59.9% in 2015. Catastrophe losses in 2016 and 2015 accounted for 3.4 points and 1.8 points, respectively, of the loss and loss adjustment expense ratio. Net favorable prior year reserve development in 2016 and 2015 provided 3.1 points and 2.4 points of benefit, respectively, to the loss and loss adjustment expense ratio. The underlying loss and loss adjustment expense ratio in 2016 was 0.9 points higher than the 2015 ratio on the same basis.
The underwriting expense ratio of 32.4% in 2016 was 0.3 points higher than the underwriting expense ratio of 32.1% in 2015.
National Property and Other. Net written premiums of $1.69 billion in 2017 decreased by 5% from 2016. Business retention rates in declined from 2016. Renewal premium changes in 2017 remained positive and were higher than in 2016. New business premiums in 2017 decreased from 2016. Net written premiums of $1.78 billion in 2016 decreased by 1% from 2015. Business retention rates remained strong in 2016. Renewal premium changes in 2016 remained slightly positive but were lower than in 2015. New business premiums in 2016 decreased from 2015.
International. Net written premiums of $1.01 billion in 2017 increased by 6% over 2016, driven by the Company's European operations, including Lloyd's, as well as premium growth in Canada. Net written premiums of $955 million in 2016 decreased by 8% from 2015, primarily driven by the impacts of changes in foreign currency exchange rates and lower premium volume in the Company's European operations, including Lloyd's.
Segment income in 2016 was $712 million, $29 million or 4% higher than segment income of $683 million in 2015, primarily reflecting the pre-tax impact of (i) higher net favorable prior year reserve development, partially offset by (ii) lower net investment income. Net favorable prior year reserve development in 2016 and 2015 was $350 million and $281 million, respectively. Catastrophe losses in 2016 and 2015 were $6 million and $3 million, respectively. Partially offsetting this net pre-tax increase in segment income was a related increase in income tax expense.
Earned premiums in 2017 were $2.31 billion, $47 million or 2% higher than in 2016, primarily reflecting an increase in net written premiums over the preceding twelve months. Earned premiums of $2.26 billion in 2016 were comparable with 2015.
Net investment income in 2017 was $228 million, $11 million or 5% lower than in 2016. Net investment income in 2016 was $239 million, $15 million or 6% lower than in 2015. Included in Bond & Specialty Insurance are certain legal entities whose invested assets and related net investment income are reported exclusively in this segment and not allocated among all business segments. As a result, reported net investment income in Bond & Specialty Insurance reflects a significantly smaller proportion of allocated net investment income, including that from the Company's non-fixed maturity investments that experienced an increase in investment income in 2017 and 2016. Refer to the "Net Investment Income" section of the "Consolidated Results of Operations" discussion for a description of the factors contributing to the changes in the Company's consolidated net investment income in 2017 and 2016 compared with the respective prior years. In addition, refer to note 2 of notes to the consolidated financial statements for a discussion of the Company's net investment income allocation methodology.
Amortization of deferred acquisition costs in 2017 was $432 million, $11 million or 3% higher than in 2016, generally consistent with the increase in earned premiums. Amortization of deferred acquisition costs in 2016 was $421 million, $3 million or 1% higher than in 2015.
The loss and loss adjustment expense ratio of 38.6% in 2017 was 11.2 points higher than the loss and loss adjustment expense ratio of 27.4% in 2016. Net favorable prior year reserve development in 2017 and 2016 provided 6.1 points and 15.5 points of benefit, respectively, to the loss and loss adjustment expense ratio. Catastrophe losses in 2017 and 2016 accounted for 0.3 points of the loss and loss adjustment expense ratio in each year. The underlying loss and loss adjustment expense ratio in 2017 was 1.8 points higher than the 2016 ratio on the same basis, primarily reflecting the impact of a higher level of international surety losses.
The loss and loss adjustment expense ratio of 27.4% in 2016 was 3.9 points lower than the loss and loss adjustment expense ratio of 31.3% in 2015. Net favorable prior year reserve development in 2016 and 2015 provided 15.5 points and 12.4 points of benefit, respectively, to the loss and loss adjustment expense ratio. Catastrophe losses in 2016 and 2015 accounted for 0.3 points and 0.1 points, respectively, of the loss and loss adjustment expense ratio. The underlying loss and loss adjustment expense ratio in 2016 was 1.0 points lower than the 2015 ratio on the same basis.
The underwriting expense ratio of 38.3% in 2016 was 0.5 points higher than the underwriting expense ratio of 37.8% in 2015.
Bond & Specialty Insurance's gross and net written premiums were as follows:
Gross and net written premiums in 2017 increased by 5% and 4%, respectively, over 2016. Gross and net written premiums in 2016 were comparable with 2015.
Segment income in 2017 was $128 million, $389 million or 75% lower than segment income of $517 million in 2016, primarily reflecting the pre-tax impacts of (i) significantly higher catastrophe losses, partially offset by (ii) higher net investment income, (iii) higher underlying underwriting margins and (iv) net favorable prior year reserve development as compared to net unfavorable prior year reserve development in 2016. Catastrophe losses in 2017 and 2016 were $1.09 billion and $408 million, respectively. Net favorable prior year reserve development in 2017 was $13 million, compared with net unfavorable prior year reserve development of $3 million in 2016. The higher underlying underwriting margins primarily resulted from the impacts of (i) increased business volumes and (ii) earned pricing that modestly exceeded loss cost trends, partially offset by (iii) higher non-catastrophe weather-related losses. Partially offsetting this net pre-tax decrease in segment income was a related decrease in income tax expense. In addition, income tax expense in 2017 was reduced by $7 million as a result of the resolution of prior year tax matters.
Segment income in 2016 was $517 million, $415 million or 45% lower than segment income of $932 million in 2015, primarily reflecting the pre-tax impacts of (i) net unfavorable prior year reserve development as compared to net favorable prior year reserve development in 2015, (ii) lower underlying underwriting margins and (iii) higher catastrophe losses. Net unfavorable prior year reserve development in 2016 was $3 million, compared with net favorable prior year reserve development of $328 million in 2015. Catastrophe losses in 2016 and 2015 were $408 million and $266 million, respectively. The lower underlying underwriting margins primarily resulted from higher loss estimates in the Automobile product line for bodily injury liability coverages. Partially offsetting this net pre-tax decrease in segment income was a related decrease in income tax expense.
Claims and claim adjustment expenses in 2017 were $7.05 billion, $1.36 billion or 24% higher than in 2016, primarily reflecting the impacts of (i) significantly higher catastrophe losses, (ii) higher volumes of insured exposures, (iii) loss cost trends and (iv) higher non-catastrophe weather-related losses, partially offset by (v) net favorable prior year reserve development as compared with net unfavorable prior year reserve development in 2016. Claims and claim adjustment expenses in 2016 were $5.68 billion, $1.09 billion or 24% higher than in 2015, primarily reflecting (i) higher volumes of insured exposures, (ii) net unfavorable prior year reserve development as compared to net favorable prior year reserve development in 2015, (iii) higher catastrophe losses, (iv) higher loss estimates in the Automobile product line for bodily injury liability coverages and (v) the impact of loss cost trends.
Amortization of deferred acquisition costs in 2017 was $1.45 billion, $105 million or 8% higher than in 2016. Amortization of deferred acquisition costs in 2016 was $1.34 billion, $58 million or 5% higher than in 2015. The increases in both 2017 and 2016 were generally consistent with the increases in earned premiums.
General and administrative expenses in 2017 were $1.11 billion, $13 million or 1% lower than in 2016. General and administrative expenses of $1.12 billion in 2016 were comparable with 2015.
The income tax benefit in 2017 was $(44) million, compared with income tax expense of $192 million in 2016, primarily reflecting the impact of the $625 million decrease in income before income taxes in 2017, and the $7 million reduction in income tax expense resulting from the resolution of prior year tax matters. Income tax expense in 2016 was $192 million, $224 million or 54% lower than in 2015, primarily reflecting the impact of the $639 million decrease in income before income taxes in 2016. The level of income tax expense (benefit) in all years reflected the impact of tax-exempt investment income on the calculation of the Company's tax provision.
The combined ratio of 103.1% in 2017 was 7.3 points higher than the combined ratio of 95.8% in 2016.
The loss and loss adjustment expense ratio of 76.3% in 2017 was 8.8 points higher than the loss and loss adjustment expense ratio of 67.5% in 2016. Catastrophe losses accounted for 11.7 points and 4.9 points of the loss and loss adjustment expense ratios in 2017 and 2016, respectively. Net favorable prior year reserve development in 2017 provided 0.1 points of benefit to the loss and loss adjustment expense ratio. Net unfavorable prior year reserve development in 2016 had no impact on the loss and loss adjustment expense ratio. The underlying loss and loss adjustment expense ratio in 2017 was 2.1 points higher than the 2016 ratio on the same basis, primarily reflecting the impacts of (i) higher non-catastrophe weather-related losses, (ii) the tenure impact of higher levels of new business in recent years in the Automobile product line and (iii) a higher level of automobile business relative to homeowners and other business, partially offset by (iv) earned pricing that modestly exceeded loss cost trends.
The loss and loss adjustment expense ratio of 67.5% in 2016 was 9.4 points higher than the loss and loss adjustment expense ratio of 58.1% in 2015. Net unfavorable prior year reserve development in 2016 had no impact on the loss and loss adjustment expense ratio. Net favorable prior year reserve development provided 4.2 points of benefit to the loss and loss adjustment expense ratio in 2015. Catastrophe losses accounted for 4.9 points and 3.4 points of the loss and loss adjustment expense ratios in 2016 and 2015, respectively. The underlying loss and loss adjustment expense ratio in 2016 was 3.7 points higher than the 2015 ratio on the same basis, primarily reflecting (i) higher loss estimates in the Automobile product line for bodily injury liability coverages, (ii) the tenure impact of higher levels of new business in recent years in the Automobile product line and (iii) a higher level of automobile business relative to homeowners and other business.
Personal Insurance's domestic Agency business comprises business written through agents, brokers and other intermediaries.
Domestic Agency Automobile net written premiums in 2016 were 16% higher than in 2015. Business retention rates remained strong in 2016. Renewal premium changes in 2016 remained positive and were higher than in 2015. New business premiums in 2016 increased over 2015.
The Income (loss) for Interest Expense and Other in 2017 was $10 million higher than in 2016. The Income (loss) for Interest Expense and Other in 2016 was $11 million lower than in 2015. After-tax interest expense in 2017, 2016 and 2015 was $240 million, $236 million and $242 million, respectively.
The resolution of environmental exposures by the Company generally occurs through settlements with policyholders as opposed to claimants. Generally, the Company strives to extinguish any
obligations it may have under any policy issued to the policyholder for past, present and future environmental liabilities and extinguish any pending coverage litigation dispute with the policyholder. This form of settlement is commonly referred to as a "buy-back" of policies for future environmental liability. In addition, many of the agreements have also extinguished any insurance obligation which the Company may have for other claims, including, but not limited to, asbestos and other cumulative injury claims. The Company and its policyholders may also agree to settlements which extinguish any liability arising from known specified sites or claims. Where appropriate, these agreements also include indemnities and hold harmless provisions to protect the Company. The Company's general purpose in executing these agreements is to reduce the Company's potential environmental exposure and eliminate the risks presented by coverage litigation with the policyholder and related costs.
The duration of the Company's investigation and review of these claims and the time necessary to determine an appropriate estimate, if any, of the value of the claim to the Company vary significantly and are dependent upon a number of factors. These factors include, but are not limited to, the cooperation of the policyholder in providing claim information, the pace of underlying litigation or claim processes, the pace of coverage litigation between the policyholder and the Company and the willingness of the policyholder and the Company to negotiate, if appropriate, a resolution of any dispute pertaining to these claims. Because these factors vary from claim-to-claim and policyholder-by-policyholder, the Company cannot provide a meaningful average of the duration of an environmental claim. However, based upon the Company's experience in resolving these claims, the duration may vary from months to several years.
The Company continues to receive notices from policyholders tendering claims for the first time, frequently under policies issued prior to the mid-1980s. These policyholders continue to present smaller exposures, have fewer sites and are lower tier defendants. Further, in many instances, clean-up costs have been reduced because regulatory agencies are willing to accept risk-based site analyses and more efficient clean-up technologies. Over the past several years, the Company has experienced generally favorable trends in the number of new policyholders tendering environmental claims for the first time and in the number of pending declaratory judgment actions relating to environmental matters. However, the degree to which those favorable trends have continued has been less than anticipated. In addition, reserve development on existing environmental claims has been greater than anticipated,
driven by claims and legal developments in a limited number of jurisdictions. As a result of these factors, in 2017, 2016 and 2015, the Company increased its net environmental reserves by $65 million, $82 million and $72 million, respectively.
As a result of the processes and procedures discussed above, management believes that the reserves carried for asbestos and environmental claims are appropriately established based upon known facts, current law and management's judgment. However, the uncertainties surrounding the final resolution of these claims continue, and it is difficult to determine the ultimate exposure for asbestos and environmental claims and related litigation. As a result, these reserves are subject to revision as new information becomes available and as claims develop. The continuing uncertainties include, without limitation, the risks and lack of predictability inherent in complex litigation, any impact from the bankruptcy protection sought by various asbestos producers and other asbestos defendants, a further increase or decrease in the cost to resolve, and/or the number of, asbestos and environmental claims beyond that which is anticipated, the emergence of a greater number of asbestos claims than
The Company's invested assets at December 31, 2017 were $72.50 billion, of which 93% was invested in fixed maturity and short-term investments, 1% in equity securities, 1% in real estate investments and 5% in other investments. Because the primary purpose of the investment portfolio is to fund future claims payments, the Company employs a conservative investment philosophy. A significant majority of funds available for investment are deployed in a widely diversified portfolio of high quality, liquid, taxable U.S. government, tax-exempt U.S. municipal and taxable corporate and U.S. agency mortgage-backed bonds.
The carrying value of the Company's fixed maturity portfolio at December 31, 2017 was $62.69 billion. The Company closely monitors the duration of its fixed maturity investments, and investment purchases and sales are executed with the objective of having adequate funds available to satisfy the Company's insurance and debt obligations. The weighted average credit quality of the Company's fixed maturity portfolio, both including and excluding U.S. Treasury securities, was "Aa2" at both December 31, 2017 and 2016. Below investment grade securities represented 2.7% and 2.9% of the total fixed maturity investment portfolio at December 31, 2017 and 2016, respectively. The weighted average effective duration of fixed maturities and short-term securities was 4.0 (4.3 excluding short-term securities) at December 31, 2017 and 4.2 (4.5 excluding short-term securities) at December 31, 2016.
The Company's fixed maturity investment portfolio at December 31, 2017 and 2016 included $30.92 billion and $31.91 billion, respectively, of securities which are obligations of states, municipalities and political subdivisions (collectively referred to as the municipal bond portfolio). The municipal bond portfolio is diversified across the United States, the District of Columbia and Puerto Rico and includes general obligation and revenue bonds issued by states, cities, counties, school districts and similar issuers. Included in the municipal bond portfolio at December 31, 2017 and 2016 were $3.90 billion and $5.16 billion, respectively, of pre-refunded bonds, which are bonds for which states or municipalities have established irrevocable trusts, almost exclusively comprised of U.S. Treasury securities and obligations of U.S. government and government agencies and authorities. These trusts were created to fund the payment of principal and interest due under the bonds. The irrevocable trusts are verified as to their sufficiency by an independent verification agent of the underwriter, issuer or trustee. All of the Company's holdings of securities issued by Puerto Rico and related entities have been pre-refunded and therefore are defeased by U.S. Treasury securities.
(1)Rated using external rating agencies or by the Company when a public rating does not exist. The table includes $335 million of short-term securities which have the highest ratings issued by external rating agencies for short-term issuances. For purposes of this table, the short-term securities, which are rated "A-1+" and/or "P-1," are included as "Aaa" rated securities.
In addition to fixed maturities noted in the foregoing table, the Company has exposure totaling $153 million to private equity limited partnerships and real estate partnerships (both of which are included in other investments in the Company's consolidated balance sheet) whose primary investing focus is across Europe. The Company has unfunded commitments totaling $134 million to these partnerships. The Company has no non-redeemable preferred stock issued by companies in the Eurozone.
from credit losses as those losses are initially allocated to subordinated bondholders. The Company's investment strategy is to purchase CMO tranches that are expected to offer the most favorable return given the Company's assessment of associated risks. The Company does not purchase residual interests in CMOs. For more information regarding the Company's investments in residential mortgage-backed securities, see note 3 of notes to the consolidated financial statements.
The Company also invests in private equity limited partnerships, hedge funds and real estate partnerships. Also included in other investments are non-public common and preferred equities and derivatives. These asset classes have historically provided a higher return than fixed maturities but are subject to more volatility. At December 31, 2017 and 2016, the carrying value of the Company's other investments was $3.53 billion and $3.45 billion, respectively.
The Company meets its capital requirements to support its underwriting at Lloyd's using a combination of trust deposits and uncollateralized letters of credit. Securities with a fair value of approximately $37 million and $97 million held by a wholly-owned subsidiary at December 31, 2017 and 2016, respectively, and $33 million held by TRV at December 31, 2017, were pledged into Lloyd's trust accounts to provide a portion of the Lloyd's capital requirements. For more information regarding the Company's utilization of uncollateralized letters of credit, see "Liquidity and Capital Resources" herein.
The net unrealized investment gains that were included in shareholders' equity were as follows:
At December 31, 2017, the amount of gross unrealized losses for all fixed maturity and equity investments reported at fair value for which fair value was less than 80% of amortized cost for fixed maturity investments and cost for equity investments was not significant.
At December 31, 2017 and 2016, below investment grade securities comprised 2.7% and 2.9%, respectively, of the Company's fixed maturity investment portfolio. Included in below investment grade securities at December 31, 2017 were securities in an unrealized loss position that, in the aggregate, had an amortized cost of $313 million and a fair value of $305 million, resulting in a net pre-tax unrealized investment loss of $8 million. These securities in an unrealized loss position represented approximately 0.5% of the total amortized cost and 0.5% of the fair value of the fixed maturity portfolio at December 31, 2017 and accounted for 4.5% of the total gross pre-tax unrealized investment loss in the fixed maturity portfolio at December 31, 2017.
Following are the pre-tax realized losses on investments sold during the year ended December 31, 2017:
The Company actively monitors and evaluates changes in third-party models and, when necessary, calibrates the catastrophe risk model estimates delivered via its own proprietary modeling processes. The Company considers historical loss experience, recent events, underwriting practices, market share analyses, external scientific analysis and various other factors including non-modeled losses, to refine its proprietary view of catastrophe risk. These proprietary models are continually updated as new information and techniques emerge.
The threshold loss amounts in the tables above, which are based on the Company's in-force portfolio at December 31, 2017 and catastrophe reinsurance program at January 1, 2018, are net of reinsurance, after-tax and exclude unallocated claim adjustment expenses, which historically have been less than 10% of loss estimates. For further information regarding the Company's reinsurance, see "Item 1 - Reinsurance." The amounts for hurricanes reflect U.S. and Canadian exposures and include property exposures, property residual market exposures and an adjustment for certain non-property exposures. The hurricane loss amounts are based on the Company's catastrophe risk model estimates and include losses from the hurricane hazards of wind and storm surge. The amounts for earthquakes
reflect U.S. and Canadian property and workers' compensation exposures. The Company does not believe that the inclusion of hurricane or earthquake losses arising from other geographical areas or other exposures would materially change the estimated threshold loss amounts.
Severe weather events over the last two decades have underscored the unpredictability of future climate trends and created uncertainty regarding insurers' exposures to financial loss as a result of catastrophes and other weather-related events. For example, hurricane and storm surge activity have impacted areas further inland than previously experienced, and demographic changes have resulted in larger populations in coastal areas which historically have been subject to severe storms, thus expanding the Company's potential for losses from hurricanes. Additionally, both the frequency and severity of tornado and hail storms in the United States have been more volatile during the last decade. Accordingly, the Company may be subject to increased losses from catastrophes and other weather-related events. Demographic changes in areas prone to wildfires have also expanded the Company's potential for losses from wildfires. Additionally, the Company's catastrophe models may be less reliable due to the increased unpredictability in frequency and severity of severe weather events or other emerging trends in climate conditions.
• Increasingly unpredictable and severe weather conditions could result in increased frequency and severity of claims under policies issued by the Company. See "Risk Factors-Catastrophe losses could materially and adversely affect our results of operations, our financial position and/or liquidity, and could adversely impact our ratings, our ability to raise capital and the availability and cost of reinsurance" and "-Outlook-Underwriting Gain/Loss."
• Increased regulation adopted in response to potential changes in climate conditions may impact the Company and its customers. For example, state insurance regulation could impact the Company's ability to manage property exposures in areas vulnerable to significant climate driven losses. If the Company is unable to implement risk based pricing, modify policy terms or reduce exposures to the extent necessary to address rising losses related to catastrophes and smaller scale weather events (should those increased losses occur), its business may be adversely affected. See "Risk Factors-Catastrophe losses could materially and adversely affect our results of operations, our financial position and/or liquidity, and could adversely impact our ratings, our ability to raise capital and the availability and cost of reinsurance." In addition, climate change regulation could increase the Company's customers' costs of doing business. For example, insureds faced with carbon management regulatory requirements may have less available capital for investment in loss prevention and safety features which may, over time, increase loss exposures. Increased regulation may also result in reduced economic activity, which would decrease the amount of insurable assets and businesses.
• The full range of potential liability exposures related to changing climate conditions continues to evolve. Through the Company's Emerging Issues Committee and its Committee on Climate, Energy and the Environment, the Company works with its business units and corporate groups, as appropriate, to identify and try to assess climate change-related liability issues, which are continually evolving and often hard to fully evaluate. The Company regularly reviews emerging issues, including changing climate conditions, to consider potential changes to its modeling and the use of such modeling, as well as to help determine the need for new underwriting strategies, coverage modifications or new products. See "Risk Factors-The effects of emerging claim and coverage issues on our business are uncertain."
At December 31, 2017, the Company held $972 million of collateral in the form of letters of credit, funds and trust agreements held to fully or partially collateralize certain reinsurance recoverables.
Included in reinsurance recoverables are amounts related to structured settlements, which are annuities purchased from various life insurance companies to settle certain personal physical injury claims, of which workers' compensation claims comprise a significant portion. In cases where the Company did not receive a release from the claimant, the amount due from the life insurance company related to the structured settlement is included in the Company's consolidated balance sheet as a reinsurance recoverable and the related claim cost is included in the liability for claims and claim adjustment expense reserves, as the Company retains the contingent liability to the claimant. If it is expected that the life insurance company is not able to pay, the Company would recognize an impairment of the related reinsurance recoverable if, and to the extent, the purchased annuities are not covered by state guaranty associations. In the event that the life insurance company fails to make the required annuity payments, the Company would be required to make such payments. The following table presents the Company's top five groups by structured settlements at December 31, 2017 (in millions). Also included is the A.M. Best rating of the Company's predominant insurer from each insurer group at February 15, 2018:
(1)On November 30, 2017, CF Corporation acquired Fidelity & Guaranty Life and changed its name to FGL Holdings.
(2)On October 23, 2016, Genworth Financial (Genworth) announced that they have entered into a definitive agreement under which China Oceanwide Holdings Group Co., Ltd. (China Oceanwide) agreed to acquire all of the outstanding shares of Genworth. On March 7, 2017, Genworth stockholders adopted the merger agreement, and the acquisition is pending the receipt of required regulatory approvals. China Oceanwide is a privately held, family-owned international financial holding group headquartered in Beijing, China. On February 12, 2018, A.M. Best downgraded the financial strength rating of Genworth Life & Annuity Insurance Company to B+ (Good) from B++ (Good), and downgraded Genworth Life Insurance Company and Genworth Life Insurance Company of New York to B- (Fair) from B (Fair) and has maintained the under-review status of all ratings and revised the implications to developing from negative. The parties to the transaction agreed to extend the closing deadline for the transaction until April 1, 2018.
For a number of years, the Company's results have included significant amounts of net favorable prior year reserve development driven by better than expected loss experience. However, given the inherent uncertainty in estimating claims and claim adjustment expense reserves, loss experience could develop such that the Company recognizes higher or lower levels of favorable prior year reserve development, no favorable prior year reserve development or unfavorable prior year reserve development in future periods. In addition, the ongoing review of prior year claims and claim adjustment expense reserves, or other changes in current period circumstances, may result in the Company revising current year loss estimates upward or downward in future periods of the current year.
It is possible that changes in economic conditions could lead to higher inflation than the Company had anticipated, which could in turn lead to an increase in the Company's loss costs and the need to strengthen claims and claim adjustment expense reserves. These impacts of inflation on loss costs and claims and claim adjustment expense reserves could be more pronounced for those lines of business that require a relatively longer period of time to finalize and settle claims for a given accident year and, accordingly, are relatively more inflation sensitive. For a further discussion, see "Part I-Item 1A - Risk Factors-If actual claims exceed our claims and claim adjustment expense reserves, or if changes in the estimated level of claims and claim adjustment expense reserves are necessary, including as a result of, among other things, changes in the legal, regulatory and economic environments in which the Company operates, our financial results could be materially and adversely affected."
In Bond & Specialty Insurance, the Company expects that underlying underwriting margins and the underlying combined ratio for the first nine months of 2018 will be broadly consistent with the same period of 2017, and in the last quarter of 2018, the Company expects that underlying underwriting margins will be higher and the underlying combined ratio will be lower than in the same period of 2017.
Income Taxes. As a result of the decrease in the corporate federal income tax rate from 35% to 21% due to the enactment of the Tax Cuts and Jobs Act (TCJA) in December 2017, the Company's effective tax rate will decline in 2018. The Company expects its 2018 results of operations will benefit from the impact of that rate change. Under current GAAP reporting guidance, there is potential variability in the Company's effective tax rate due to the manner in which changes in corporate tax rates are reported on items reported in accumulated other comprehensive income (AOCI), particularly the tax related to unrealized gains and losses on fixed maturity securities. In February 2018, the FASB issued new accounting guidance to address the effects of the change in tax rates in the TCJA on items reported in AOCI; however, the new guidance is only applicable to changes resulting from the enactment of the TCJA and does not apply to future changes in tax laws and rates.
Investment Portfolio. The Company expects to continue to focus its investment strategy on maintaining a high-quality investment portfolio and a relatively short average effective duration. The weighted average effective duration of fixed maturities and short-term securities was 4.0 (4.3 excluding short-term securities) at December 31, 2017. From time to time, the Company enters into short positions in U.S. Treasury futures contracts to manage the duration of its fixed maturity portfolio. At December 31, 2017, the Company had $400 million notional value of open U.S. Treasury futures contracts. The Company continually evaluates its investment alternatives and mix. Currently, the majority of the Company's investments are comprised of a widely diversified portfolio of high-quality, liquid, taxable U.S. government, tax-exempt U.S. municipal and taxable corporate and U.S. agency mortgage-backed bonds.
Net investment income is a material contributor to the Company's results of operations. Based on the impacts of (i) the lower federal corporate income tax rate in 2018, (ii) slightly higher levels of fixed maturities and (iii) higher short-term investment yields, partially offset by the impact of (iv) expected lower reinvestment yields on fixed maturity investments, the Company expects that during 2018, after-tax net investment income from those portfolios will be approximately $25 million to $30 million higher on a quarterly basis as compared to the corresponding quarters of 2017. The impact of future market conditions on net investment income from the non-fixed maturity investment portfolio during 2018 is hard to predict. If general economic conditions and/or investment market conditions change during 2018, the Company could experience an increase or decrease in net investment income and/or significant realized investment gains or losses (including impairments).
The Company had a net pre-tax unrealized investment gain of $1.38 billion ($1.09 billion after-tax) in its fixed maturity investment portfolio at December 31, 2017. While the Company does not attempt to predict future interest rate movements, a rising interest rate environment would reduce the market value of fixed maturity investments and, therefore, reduce shareholders' equity, and a declining interest rate environment would have the opposite effects. The Company's investment portfolio has benefited from certain tax exemptions (primarily those related to interest from municipal bonds) and certain other tax laws, including, but not limited to, those governing dividends-received deductions and tax credits (such as foreign tax credits). Changes in these laws could adversely impact the value of the Company's investment portfolio. See "Changes in U.S. tax laws or in the tax laws of other jurisdictions in which we operate could adversely impact us" included in "Part I-Item 1A - Risk Factors."
In 2017, the Company had net pre-tax realized investment gains of $216 million, which were primarily driven by gains on sales of equity securities. Pursuant to updated FASB guidance and beginning January 1, 2018, the Company's equity securities, except those accounted for under the equity method of accounting, that have readily determinable fair value will be measured at fair value
with changes in fair value recognized as part of net realized investment gains in net income. At December 31, 2017, the carrying value of the Company's equity securities was $453 million, which included $13 million of net pre-tax unrealized investment gains. The Company currently expects that net pre-tax realized investment gains related to equity securities in 2018, if any, will be lower than in 2017.
Statements of Income for the years ended December 31, 2017, 2016 and 2015
Statements of Cash Flows for the years ended December 31, 2017, 2016 and 2015
Investments-Equity Method and Joint Ventures: Simplifying the Transition to the Equity Method of Accounting
In March 2016, the Financial Accounting Standards Board (FASB) issued updated guidance that eliminates the requirement to retroactively apply the equity method of accounting when an investment that was previously accounted for using another method of accounting becomes qualified to apply the equity method due to an increase in the level of ownership interest or degree of influence. If the investment was previously accounted for as an available-for-sale security, any related unrealized gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for the equity method is recognized through earnings. The updated guidance was effective for reporting periods beginning after December 15, 2016, and was applied prospectively. The adoption of this guidance did not have a material effect on the Company's results of operations, financial position or liquidity.
In March 2017, the FASB issued updated guidance to improve the presentation of net periodic pension cost and net periodic postretirement cost (net benefit costs). Net benefit costs comprise several components that reflect different aspects of an employer's financial arrangements as well as the cost of benefits provided to employees. The updated guidance requires that the employer service cost component be reported in the same lines as other employee compensation cost and that the other components (non-service costs) be presented separately from the service cost and outside of a subtotal of income from operations if one is presented. The updated guidance also allows only the service cost component to be eligible for capitalization in assets when applicable.
The Company adopted the updated guidance effective January 1, 2017. See note 14 which has been expanded to disclose the amount of service cost and non-service cost components of net periodic benefit cost and the line items in the consolidated statements of income in which such amounts are reported. The updated guidance with respect to only service costs being eligible for capitalization in assets was not applicable, as the Company capitalizes only commission and premium-related taxes in deferred acquisition costs.
In May 2017, the FASB issued updated guidance related to a change to the terms or conditions (modification) of a share-based payment award. The updated guidance provides that an entity should account for the effects of a modification unless the fair value and vesting conditions of the modified award and the classification of the modified award (equity or liability instrument) are the same as the original award immediately before the modification.
The Company adopted the updated guidance effective April 1, 2017. The adoption did not have an effect on the Company's results of operations, financial position or liquidity.
In May 2014, the FASB issued updated guidance to clarify the principles for recognizing revenue. While insurance contracts are not within the scope of this updated guidance, the Company's fee income related to providing claims and policy management services as well as claim and loss prevention
existing leases with an adjustment to equity as if the updated guidance had always been applied. Early adoption is permitted. The adoption of this guidance is not expected to have a material effect on the Company's results of operations, financial position or liquidity.
In June 2016, the FASB issued updated guidance for the accounting for credit losses for financial instruments. The updated guidance applies a new credit loss model (current expected credit losses or CECL) for determining credit-related impairments for financial instruments measured at amortized cost (e.g. reinsurance recoverables, including structured settlements that are recorded as part of reinsurance recoverables) and requires an entity to estimate the credit losses expected over the life of an exposure or pool of exposures. The estimate of expected credit losses should consider historical information, current information, as well as reasonable and supportable forecasts, including estimates of prepayments. The expected credit losses, and subsequent adjustments to such losses, will be recorded through an allowance account that is deducted from the amortized cost basis of the financial asset, with the net carrying value of the financial asset presented on the consolidated balance sheet at the amount expected to be collected.
The updated guidance is effective for reporting periods beginning after December 15, 2019 and is to be applied prospectively. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The adoption of this guidance is not expected to have a material effect on the Company's results of operations, financial position or liquidity.
On February 14, 2018, the FASB issued updated guidance that allows a reclassification of the stranded tax effects in accumulated other comprehensive income (AOCI) resulting from the Tax Cuts and Jobs Act of 2017 (TCJA). Current guidance requires the effect of a change in tax laws or rates on deferred tax balances to be reported in income from continuing operations in the accounting period that includes the period of enactment, even if the related income tax effects were originally charged or credited directly to AOCI. The amount of the reclassification would include the effect of the change in the U.S. federal corporate income tax rate on the gross deferred tax amounts and related valuation allowances, if any, at the date of the enactment of TCJA related to items in AOCI. The updated guidance is effective for reporting periods beginning after December 15, 2018 and is to be applied retrospectively to each period in which the effect of the TCJA related to items remaining in AOCI are recognized or at the beginning of the period of adoption. Early adoption is permitted.
The Company expects to adopt the updated guidance effective January 1, 2018. The adoption will not affect the Company's results of operations, financial position, or liquidity.
Investment income from fixed maturities is recognized based on the constant effective yield method which includes an adjustment for estimated principal pre-payments, if any. The effective yield used to determine amortization for fixed maturities subject to prepayment risk (e.g., asset-backed, loan-backed and structured securities) is recalculated and adjusted periodically based upon actual historical and/or projected future cash flows, which are obtained from a widely-accepted securities data provider. The adjustments to the yield for highly rated prepayable fixed maturities are accounted for using the retrospective method. The adjustments to the yield for non-highly rated prepayable fixed maturities are accounted for using the prospective method. Dividends on equity securities (including those with transfer restrictions) are recognized in income when declared. Rental income on real estate is recognized on a straight-line basis over the lease term. See the section titled: "Real Estate" in note 3 for further discussion. Investments in private equity limited partnerships, hedge funds, real estate partnerships and joint ventures are accounted for using the equity method of accounting, whereby the Company's share of the investee's earnings or losses in the fund is reported in net investment income.
Accrual of income is suspended on non-securitized fixed maturities that are in default, or on which it is likely that future payments will not be made as scheduled. Interest income on investments in
Net realized investment gains and losses are included as a component of pre-tax revenues based upon specific identification of the investments sold on the trade date. Included in net realized investment gains (losses) are other-than-temporary impairment losses on invested assets other than those investments accounted for using the equity method of accounting as described in the "Investment Impairments" section that follows.
Upon recognizing an other-than-temporary impairment, the new cost basis of the investment is the previous amortized cost basis less the other-than-temporary impairment recognized in net realized investment gains (losses). The new cost basis is not adjusted for any subsequent recoveries in fair value; however, for fixed maturity investments the difference between the new cost basis and the expected
cash flows is accreted on a quarterly basis to net investment income over the remaining expected life of the investment.
For non-structured fixed maturities (U.S. Treasury securities, obligations of U.S. government and government agencies and authorities, obligations of states, municipalities and political subdivisions, debt securities issued by foreign governments and certain corporate debt), the estimate of expected cash flows is determined by projecting a recovery value and a recovery time frame and assessing whether further principal and interest will be received. The determination of recovery value incorporates an issuer valuation assumption utilizing one or a combination of valuation methods as deemed appropriate by the Company. The Company determines the undiscounted recovery value by allocating the estimated value of the issuer to the Company's assessment of the priority of claims. The present value of the cash flows is determined by applying the effective yield of the security at the date of acquisition (or the most recent implied rate used to accrete the security if the implied rate has changed as a result of a previous impairment) and an estimated recovery time frame. Generally, that time frame for securities for which the issuer is in bankruptcy is 12 months. For securities for which the issuer is financially troubled but not in bankruptcy, that time frame is generally 24 months. Included in the present value calculation are expected principal and interest payments; however, for securities for which the issuer is classified as bankrupt or in default, the present value calculation assumes no interest payments and a single recovery amount.
The Company has, from time to time, engaged in securities lending activities from which it generates net investment income by lending certain of its investments to other institutions for short periods of time. Borrowers of these securities provide collateral equal to at least 102% of the market value of the loaned securities plus accrued interest. This collateral is held by a third-party custodian, and the Company has the right to access the collateral only in the event that the institution borrowing the Company's securities is in default under the lending agreement. Therefore, the Company does not
The Company performs a review, on at least an annual basis, of goodwill held by the reporting units which are the Company's three operating and reportable segments: Business Insurance; Bond & Specialty Insurance; and Personal Insurance. The Company estimates the fair value of its reporting units and compares it to their carrying value, including goodwill. If the carrying values of the reporting units were to exceed their fair value, the amount of the impairment would be calculated and goodwill adjusted accordingly.
Claims and claim adjustment expense reserves represent estimates for the ultimate cost of unpaid reported and unreported claims incurred and related expenses. The reserves are adjusted regularly based upon experience. Included in the claims and claim adjustment expense reserves in the consolidated balance sheets are reserves for long-term disability and annuity claim payments, primarily arising from workers' compensation insurance and workers' compensation excess insurance policies, that are discounted to the present value of estimated future payments.
The Company's non-U.S. insurance subsidiaries file financial statements prepared in accordance with the regulatory reporting requirements of their respective local jurisdiction.
Other revenues include revenues from premium installment charges, which are recognized as collected, revenues of noninsurance subsidiaries other than fee income and gains and losses on dispositions of assets and redemption of debt, and other miscellaneous revenues, including a gain recognized as a result of the settlement of a reinsurance dispute.
Compensation cost is measured based on the grant-date fair value of an award, utilizing the assumptions discussed in note 13. Compensation cost is recognized for financial reporting purposes over the period in which the employee is required to provide service in exchange for the award (generally the vesting period). In connection with certain share-based awards, participants are entitled to receive dividends during the vesting period, either in cash or dividend equivalent shares, commensurate with the dividends paid to common shareholders. Dividends and dividend equivalent
shares on awards that are expected to vest are recorded in retained earnings. Dividends paid on awards that are not expected to vest as part of the Company's forfeiture estimate are recorded as compensation expense.
•Select Accounts provides small businesses with property and casualty insurance products and services, including commercial multi-peril, workers' compensation, commercial automobile, general liability and commercial property.
•Middle Market provides mid-sized businesses with property and casualty insurance products and services, including workers' compensation, general liability, commercial multi-peril, commercial automobile and commercial property, as well as risk management, claims handling and other services. Middle Market generally provides these products to mid-sized businesses through Commercial Accounts, as well as to targeted industries through Construction, Technology, Public Sector Services and Oil & Gas, and additionally, provides mono-line umbrella and excess coverage insurance through Excess Casualty. Middle Market also provides insurance for goods in transit and movable objects, as well as builders' risk insurance, through Inland Marine; insurance for the marine transportation industry and related services, as well as other businesses involved in international trade, through Ocean Marine; and comprehensive breakdown for equipment, including property and business interruption, through Boiler & Machinery.
•National Accounts provides large companies with casualty insurance products and services, including workers' compensation, commercial automobile and general liability, generally utilizing loss-sensitive products, on both a bundled and unbundled basis. National Accounts also includes the Company's commercial residual market business, which primarily offers workers' compensation products and services to the involuntary market.
Business Insurance also includes Simply Business, as well as Business Insurance Other, which comprises the Special Liability Group (which manages the Company's asbestos and environmental liabilities) and the assumed reinsurance and certain other runoff operations.
The following tables summarize the components of the Company's revenues, income, net written premiums and total assets by reportable business segments.
(1)Segment revenues for reportable business segments exclude net realized investment gains. Segment income for reportable business segments equals net income excluding the after-tax impact of net realized investment gains and the impact of the Tax Cuts and Jobs Act of 2017 at enactment.
(1)The primary component of Interest Expense and Other was after-tax interest expense of $240 million, $236 million and $242 million in 2017, 2016 and 2015, respectively.
Pre-refunded bonds of $3.90 billion and $5.16 billion at December 31, 2017 and 2016, respectively, were bonds for which states or municipalities have established irrevocable trusts, almost exclusively comprised of U.S. Treasury securities and obligations of U.S. government and government agencies and authorities. These trusts were created to fund the payment of principal and interest due under the bonds.
The Company's fixed maturity investment portfolio at December 31, 2017 and 2016 included $2.41 billion and $1.71 billion, respectively, of residential mortgage-backed securities, which include pass-through securities and collateralized mortgage obligations (CMOs). Included in the totals at December 31, 2017 and 2016 were $804 million and $563 million, respectively, of GNMA, FNMA, FHLMC (excluding FHA project loans) and Canadian government guaranteed residential mortgage-backed pass-through securities classified as available for sale. Also included in those totals were residential CMOs classified as available for sale with a fair value of $1.61 billion and $1.15 billion at December 31, 2017 and 2016, respectively. Approximately 55% and 51% of the Company's CMO holdings at December 31, 2017 and 2016, respectively, were guaranteed by or fully collateralized by securities issued by GNMA, FNMA or FHLMC. The weighted average credit rating of the $717 million and $566 million of non-guaranteed CMO holdings at December 31, 2017 and 2016, respectively, was "A1" and "Baa2," respectively. The weighted average credit rating of all of the above securities was "Aa1" and "Aa2" at December 31, 2017 and 2016, respectively.
At December 31, 2017 and 2016, the Company held commercial mortgage-backed securities (CMBS, including FHA project loans) of $1.17 billion and $938 million, respectively, which are included in "All other corporate bonds" in the tables above. At December 31, 2017 and 2016, approximately $475 million and $290 million of these securities, respectively, or the loans backing such securities, contained guarantees by the U.S. government or a government-sponsored enterprise. The weighted average credit rating of the $693 million and $648 million of non-guaranteed securities at December 31, 2017 and 2016, respectively, was "Aaa" at both dates. The CMBS portfolio is supported by loans that are diversified across economic sectors and geographical areas. The weighted average credit rating of the CMBS portfolio was "Aaa" at both December 31, 2017 and 2016.
At December 31, 2017 and 2016, the Company had $304 million and $286 million, respectively, of securities on loan as part of a tri-party lending agreement.
At December 31, 2017 and 2016, the Company's insurance subsidiaries had $4.41 billion and $4.56 billion, respectively, of securities on deposit at financial institutions in certain states pursuant to the respective states' insurance regulatory requirements. Funds deposited with third parties to be used as collateral to secure various liabilities on behalf of insureds, cedants and other creditors had a fair value of $35 million at both December 31, 2017 and 2016. Other investments pledged as collateral securing outstanding letters of credit had a fair value of $1 million and $3 million at December 31, 2017 and 2016, respectively. In addition, the Company utilizes Lloyd's trust deposits, whereby owned securities with a fair value of approximately $37 million and $97 million held by a wholly-owned subsidiary at December 31, 2017 and 2016, respectively, and $33 million held by TRV at December 31, 2017, were pledged into Lloyd's trust accounts to provide a portion of the capital needed to support the Company's obligations at Lloyd's.
The Company's real estate investments include warehouses, office buildings and other commercial land and properties that are directly owned. The Company negotiates commercial leases with individual tenants through unrelated, licensed real estate brokers. Negotiated terms and conditions include, among others, rental rates, length of lease period and improvements to the premises to be provided by the landlord.
Future minimum rental income on operating leases relating to the Company's real estate properties is expected to be $90 million, $85 million, $70 million, $56 million and $44 million for 2018, 2019, 2020, 2021 and 2022, respectively, and $58 million for 2023 and thereafter.
The Company's short-term securities consist of Aaa-rated registered money market funds, U.S. Treasury securities, high-quality commercial paper (primarily A1/P1) and high-quality corporate securities purchased within a year to their maturity with a combined average of 71 days to maturity at December 31, 2017. The amortized cost of these securities, which totaled $4.90 billion and $4.87 billion at December 31, 2017 and 2016, respectively, approximated their fair value.
At December 31, 2017 and 2016, other than U.S. Treasury securities and obligations of U.S. government and government agencies and authorities, the Company was not exposed to any concentration of credit risk of a single issuer greater than 5% of the Company's shareholders' equity.
The total impact of net unrealized gains on investment securities was $1.11 billion after-tax at December 31, 2017, which included the $954 million reported in accumulated other comprehensive income shown above, as well as $158 million included in retained earnings that was part of the impact of enactment of the Tax Cuts and Jobs Act of 2017 recorded in earnings.
From time to time, the Company enters into U.S. Treasury note futures contracts to modify the effective duration of specific assets within the investment portfolio. U.S. Treasury futures contracts require a daily mark-to-market and settlement with the broker. At both December 31, 2017 and 2016, the Company had $400 million notional value of open U.S. Treasury futures contracts. Net realized investment losses related to U.S. Treasury futures contracts in 2017, 2016 and 2015 were not significant.
The Company also sells a small amount of U.S. equity index put option contracts that are settled for cash upon their expiration or when they are rolled over. Net realized investment losses related to these derivatives in 2017, 2016 and 2015 were not significant.
The Company holds investments in various publicly-traded securities which are reported in other investments. These investments include mutual funds and other small holdings. The $19 million and $17 million fair value of these investments at December 31, 2017 and 2016, respectively, was disclosed in Level 1. At December 31, 2017 and 2016, the Company held investments in non-public common and preferred equity securities, with fair value estimates of $38 million and $36 million, respectively, reported in other investments, where the fair value estimate is determined either internally or by an external fund manager based on recent filings, operating results, balance sheet stability, growth and other business and market sector fundamentals. Due to the significant unobservable inputs in these valuations, the Company includes the total fair value estimate for all of these investments at December 31, 2017 and 2016 in the amount disclosed in Level 3.
The Company utilized a pricing service and other market observable inputs to estimate fair value for approximately 97% and 99% of short-term securities at December 31, 2017 and 2016, respectively. A description of the process and inputs used by the pricing service to estimate fair value is discussed in the "Fixed Maturities" section above. Estimates of fair value for U.S. Treasury securities and money market funds are based on market quotations received from the pricing service and are disclosed in Level 1 of the hierarchy. The fair value of other short-term fixed maturity securities is estimated by the pricing service using observable market inputs and is disclosed in Level 2 of the hierarchy. For short-term securities where an estimate is not obtained from the pricing service, the carrying value approximates fair value and is included in Level 3 of the hierarchy.
The Company utilized a pricing service to estimate fair value for 100% of its debt, including commercial paper, at December 31, 2017 and 2016. The pricing service utilizes market quotations for debt that have quoted prices in active markets. Since fixed maturities other than U.S. Treasury securities generally do not trade on a daily basis, the fair value estimates are based on market observable inputs and disclosed in Level 2 of the hierarchy.
The Company had no material assets or liabilities that were measured at fair value on a non-recurring basis during the years ended December 31, 2017 and 2016.
insurance companies who agree to share these risks. The primary purpose of ceded reinsurance is to protect the Company, at a cost, from losses in excess of the amount it is prepared to accept and to protect the Company's capital. Reinsurance is placed on both a quota-share and excess-of-loss basis. Ceded reinsurance arrangements do not discharge the Company as the primary insurer, except for instances where the primary policy or policies have been novated, such as in certain structured settlement agreements.
Ceded premiums include the premiums paid for coverage provided by the Company's catastrophe bonds.
$200 million by December 31, 2020. The program excludes from participation the following types of insurance: Federal crop insurance, private mortgage insurance, financial guaranty insurance, medical malpractice insurance, health or life insurance, flood insurance, reinsurance, commercial automobile, professional liability (other than directors' and officers'), surety, burglary and theft, and farm-owners multi-peril. In the case of a war declared by Congress, only workers' compensation losses are covered by the program. All commercial property and casualty insurers licensed in the United States are generally required to participate in the program. Under the program, a participating insurer, in exchange for making terrorism insurance available, is entitled to be reimbursed by the Federal Government for 82% of subject losses in 2018, after an insurer deductible, subject to an annual cap. This reimbursement percentage will decrease over the remaining three-year life of the program to 80% of subject losses by December 31, 2020.
(1)Contract-based intangible assets subject to amortization are comprised of fair value adjustments on claims and claim adjustment expense reserves, reinsurance recoverables and other contract-related intangible assets. Customer-related intangible assets were not material as of December 31, 2016. Fair value adjustments recorded in connection with insurance acquisitions were based on management's estimate of nominal claims and claim adjustment expense reserves and reinsurance recoverables. The method used calculated a risk adjustment to a risk-free discounted reserve that would, if reserves ran off as expected, produce results that yielded the assumed cost-of-capital on the capital supporting the loss reserves. The fair value adjustments are reported as other intangible assets on the consolidated balance sheet, and the amounts measured in accordance with the acquirer's accounting policies for insurance contracts have been reported as part of the claims and claim adjustment expense reserves and reinsurance recoverables. The intangible assets are being recognized into income over the expected payment pattern. Because the time value of money and the risk adjustment (cost of capital) components of the intangible assets run off at different rates, the amount recognized in income may be a net benefit in some periods and a net expense in other periods.
The following table presents a reconciliation of beginning and ending property casualty reserve balances for claims and claim adjustment expenses:
(1)Amount represents acquired net claims and claim adjustment expense reserves of Travelers Participações em Seguros Brasil S.A. at October 1, 2015.
Reinsurance recoverables on unpaid losses at December 31, 2017 increased by $142 million over December 31, 2016, primarily reflecting the impacts of catastrophe losses and the asbestos reserve increase in the second half of 2017, partially offset by cash collections in 2017, including the settlement of certain disputes as discussed in more detail in note 16. Reinsurance recoverables on unpaid losses at December 31, 2016 decreased by $468 million from December 31, 2015, primarily reflecting the impact of cash collections in 2016, including the settlement of a reinsurance dispute which is discussed in more detail in note 16.
Business Insurance. Net favorable prior year reserve development in 2017 totaled $439 million, primarily driven by net favorable prior year reserve development in the segment's domestic operations due to better than expected loss experience in (i) the workers' compensation product line for multiple accident years, (ii) the general liability product line (excluding an increase to asbestos and environmental reserves) for both primary and excess coverages for multiple accident years and (iii) the commercial multi-peril product line for liability coverages for multiple accident years, partially offset by (iv) a $225 million increase to asbestos reserves, (v) the impact of higher than expected loss experience in the commercial automobile product line for recent accident years and (vi) a $65 million increase to environmental reserves. The net favorable prior year reserve development in the segment's domestic operations was partially offset by net unfavorable prior year reserve development in the segment's international operations in Europe primarily due to the U.K. Ministry of Justice's "Ogden" discount rate adjustment applied to lump sum bodily injury payouts.
Business Insurance. Net favorable prior year reserve development in 2016 totaled $424 million, primarily driven by better than expected loss experience in the Company's domestic operations in (i) the workers' compensation product line for multiple accident years and (ii) the general liability product line (excluding an increase to asbestos and environmental reserves), related to both primary and excess coverages for multiple accident years, partially offset by (iii) a $225 million increase to asbestos reserves and (iv) an $82 million increase to environmental reserves, as well as net favorable prior year reserve development in the segment's international operations in Europe.
Bond & Specialty Insurance. Net favorable prior year reserve development in 2016 totaled $350 million, primarily driven by better than expected loss experience in the Company's domestic operations in (i) the fidelity and surety product line for multiple accident years and (ii) the general liability product line for multiple accident years.
The claim development tables that follow present, by accident year, incurred and cumulative paid claims and allocated claim adjustment expense on a historical basis. This claim development information is presented on an undiscounted, net of reinsurance basis for ten years, or the number of years for which claims incurred typically remain outstanding if less than ten years. The claim development tables also provide the historical average annual percentage payout of incurred claims by age, net of reinsurance, as supplementary information (identified as unaudited in the tables below). For Personal Insurance-International-Canada, the claim development information reflects the acquisition of The Dominion of Canada General Insurance Company (Dominion) in November 2013 on a retrospective basis (includes Dominion data for years prior to the Company's acquisition of Dominion).
The incurred and paid amounts have been translated from the local currency to U.S. dollars using the December 31, 2017 spot rate for all years presented in the table above in order to isolate changes in foreign exchange rates from loss development.
Claims and claim adjustment expense reserves represent management's estimate of the ultimate liability for unpaid losses and loss adjustment expenses for claims that have been reported and claims that have been incurred but not yet reported as of the balance sheet date. Claims and claim adjustment expense reserves do not represent an exact calculation of the liability, but instead represent management estimates, primarily utilizing actuarial expertise and projection methods that develop estimates for the ultimate cost of claims and claim adjustment expenses. Because the establishment of claims and claims adjustment expense reserves is an inherently uncertain process involving estimates and judgment, currently estimated claims and claim adjustment expense reserves may change. The Company reflects changes to the reserves in the results of operations in the period the estimates are changed.
Detailed claim data is typically insufficient to produce a reliable indication of the initial estimate for ultimate claims and claim adjustment expenses for an accident year. As a result, the initial estimate for an accident year is generally based on an exposure-based method using either the loss ratio projection or the expected loss method. The loss ratio projection method, which is typically used for guaranteed-cost business, develops an initial estimate of ultimate claims and claim adjustment expenses for an accident year by multiplying earned premium for the accident year by a projected loss ratio. The projected loss ratio is determined by analyzing prior period experience, and adjusting for loss cost trends, rate level differences, mix of business changes and other known or observed factors influencing the accident year relative to prior accident years. The expected loss method, which is typically used for loss sensitive business, develops an initial estimate of ultimate claims and claim adjustment expenses for an accident year by analyzing exposures by account.
• The average value analysis combined with the reported claim development method assumes that average claim values are stable and predictable over time for a particular cohort of claims. It is typically limited to analysis at more granular levels, such as coverage or hazard/peril, where a more homogeneous subset of claims produce a more stable and fairly predictable average value. The reported claim development method is the same as the paid loss development method but uses changes in cumulative claim counts to produce estimates of ultimate claim counts rather than ultimate dollars. The resulting estimate of ultimate claim counts by cohort is multiplied by an average value per claim from an average value analysis to obtain estimated ultimate claims and claim adjustment expenses.
While these are the principal methods utilized, the Company's actuaries have available to them the full range of actuarial methods developed by the casualty actuarial profession. The Company's actuaries are also continually monitoring developments within the profession for advances in existing techniques or the creation of new techniques that might improve current and future estimates. Most actuarial methods assume that past patterns demonstrated in the data will repeat themselves in the future. For certain reserve components where this assumption may not hold, such as asbestos and environmental reserves, conventional actuarial methods are not utilized by the Company.
A claim file is created when the Company is notified of an actual demand for payment, notified of an event that may lead to a demand for payment or when it is determined that a demand for payment could possibly lead to a future demand for payment on another coverage on the same policy or on another policy. Claim files are generally created for a policy at the claimant by coverage level, depending on the particular facts and circumstances of the underlying event.
At December 31, 2017 and 2016, the Company's claims and claim adjustment expense reserves included $1.64 billion and $1.71 billion, respectively, for asbestos and environmental-related claims, net of reinsurance.
• a high level of litigation activity in certain jurisdictions involving individuals alleging serious asbestos-related illness, primarily involving mesothelioma claims;
mesothelioma, continue to target defendants who were not traditionally primary targets of asbestos litigation.
Net asbestos paid loss and loss expenses in 2017, 2016 and 2015 were $271 million, $708 million and $770 million, respectively. Net payments in 2016 included the $458 million net payment related to PPG Industries, Inc. Net payments in 2015 included the $502 million payment related to the settlement of asbestos direct action litigation. Approximately 4%, 69% and 69% of total net paid losses in 2017, 2016 and 2015, respectively, related to policyholders with whom the Company had entered into settlement agreements limiting the Company's liability.
Environmental Reserves. In establishing environmental reserves, the Company evaluates the exposure presented by each policyholder and the anticipated cost of resolution, if any. In the course of this analysis, the Company generally considers the probable liability, available coverage and relevant judicial interpretations. In addition, the Company considers the many variables presented, such as: the nature of the alleged activities of the policyholder at each site; the number of sites; the total number of potentially responsible parties at each site; the nature of the alleged environmental harm and the corresponding remedy at each site; the nature of government enforcement activities at each site; the ownership and general use of each site; the overall nature of the insurance relationship between the Company and the policyholder, including the role of any umbrella or excess insurance the Company
The Company continues to receive notices from policyholders tendering claims for the first time, frequently under policies issued prior to the mid-1980s. These policyholders continue to present smaller exposures, have fewer sites and are lower tier defendants. Further, in many instances, clean-up costs have been reduced because regulatory agencies are willing to accept risk-based site analyses and more efficient clean-up technologies. Over the past several years, the Company has experienced generally favorable trends in the number of new policyholders tendering environmental claims for the first time and in the number of pending declaratory judgment actions relating to environmental matters. However, the degree to which those favorable trends have continued has been less than anticipated. In addition, reserve development on existing environmental claims has been greater than anticipated, driven by claims and legal developments in a limited number of jurisdictions. As a result of these factors, in 2017, 2016 and 2015, the Company increased its net environmental reserves by $65 million, $82 million and $72 million, respectively.
Asbestos and Environmental Reserves. As a result of the processes and procedures discussed above, management believes that the reserves carried for asbestos and environmental claims are appropriately established based upon known facts, current law and management's judgment. However, the uncertainties surrounding the final resolution of these claims continue, and it is difficult to determine the ultimate exposure for asbestos and environmental claims and related litigation. As a result, these reserves are subject to revision as new information becomes available and as claims develop. The continuing uncertainties include, without limitation, the risks and lack of predictability inherent in complex litigation, any impact from the bankruptcy protection sought by various asbestos producers and other asbestos defendants, a further increase or decrease in the cost to resolve, and/or the number of, asbestos and environmental claims beyond that which is anticipated, the emergence of a greater number of asbestos claims than anticipated as a result of extended life expectancies resulting from medical advances and lifestyle improvements, the role of any umbrella or excess policies the Company has issued, the resolution or adjudication of disputes pertaining to the amount of available coverage for asbestos and environmental claims in a manner inconsistent with the Company's previous assessment of these claims, the number and outcome of direct actions against the Company, future developments pertaining to the Company's ability to recover reinsurance for asbestos and environmental claims and the unavailability of other insurance sources potentially available to policyholders, whether through exhaustion of policy limits or through the insolvency of other participating insurers. In addition, uncertainties arise from the insolvency or bankruptcy of policyholders and other defendants. It is also not possible to predict changes in the legal, regulatory and legislative environment and their impact on the future development of asbestos and environmental claims. This environment could be affected by changes in applicable legislation and future court and regulatory decisions and interpretations, including the outcome of legal challenges to legislative and/or judicial reforms establishing medical criteria for the pursuit of asbestos claims. It is also difficult to predict the ultimate outcome of complex coverage disputes until settlement negotiations near completion and significant legal questions are resolved or, failing settlement, until the dispute is
The Company has geographic exposure to catastrophe losses, which can be caused by a variety of events, including, among others, hurricanes, tornadoes and other windstorms, earthquakes, hail, wildfires, severe winter weather, floods, tsunamis, volcanic eruptions and other naturally-occurring events, such as solar flares. Catastrophes can also result from terrorist attacks and other intentionally destructive acts including those involving nuclear, biological, chemical and radiological events, cyber events, explosions and destruction of infrastructure. The incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophes are restricted to small geographic areas; however, hurricanes and earthquakes may produce significant damage in larger areas, especially those that are heavily populated. The Company generally seeks to mitigate its exposure to catastrophes through individual risk selection and the purchase of catastrophe reinsurance.
2017 Debt Redemption and Repayment. On June 2, 2017, the Company redeemed the remaining $107 million aggregate principal amount of its 6.25% Fixed-to-Floating Rate Junior Subordinated Debentures due 2067 at a price per debenture of 100% of the principal amount thereof, plus accrued and unpaid interest to the redemption date. On December 15, 2017, the Company's $450 million, 5.75% senior notes matured and were fully paid.
Junior Subordinated Debentures-The Company's three junior subordinated debenture instruments are all similar in nature to each other. Three separate business trusts issued preferred securities to investors and used the proceeds to purchase the Company's junior subordinated debentures. Interest on each of the instruments is paid semi-annually.
The Company's consolidated balance sheet includes the debt instruments acquired in a business acquisition, which were recorded at fair value as of the acquisition date. The resulting fair value adjustment is being amortized over the remaining life of the respective debt instruments using the effective-interest method. The amortization of the fair value adjustment reduced interest expense by $1 million and $2 million for the years ended December 31, 2017 and 2016, respectively.
The Company's Board of Directors has approved common share repurchase authorizations under which repurchases may be made from time to time in the open market, pursuant to pre-set trading plans meeting the requirements of Rule 10b5-1 under the Securities Exchange Act of 1934, in private transactions or otherwise. The authorizations do not have a stated expiration date. The timing and actual number of shares to be repurchased in the future will depend on a variety of factors, including the Company's financial position, earnings, share price, catastrophe losses, maintaining capital levels commensurate with the Company's desired ratings from independent rating agencies, funding of the Company's qualified pension plan, capital requirements of the Company's operating subsidiaries, legal requirements, regulatory constraints, other investment opportunities (including mergers and acquisitions and related financings), market conditions and other factors. In April 2017, the Board of Directors approved a share repurchase authorization that added an additional $5.0 billion of repurchase capacity. The following table summarizes repurchase activity in 2017 and remaining repurchase capacity at December 31, 2017.
The Company's Amended and Restated 2004 Stock Incentive Plan and the Amended and Restated 2014 Stock Incentive Plan provide settlement alternatives to employees in which the Company retains shares to cover payroll withholding taxes in connection with the vesting of restricted stock unit awards and performance share awards, and to cover the price of certain stock options that were exercised. During the years ended December 31, 2017 and 2016, the Company acquired $62 million and $72 million, respectively, of its common stock under these plans.
The Company's U.S. insurance subsidiaries, domiciled principally in the State of Connecticut, are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid by each insurance subsidiary to its respective parent company without prior approval of insurance regulatory authorities. A maximum of $2.66 billion is available by the end of 2018 for such dividends to the holding company, TRV, without prior approval of the Connecticut Insurance Department. The Company may choose to accelerate the timing within 2018 and/or increase the amount of dividends from its insurance subsidiaries in 2018, which could result in certain dividends being subject to approval by the Connecticut Insurance Department.
In addition to the regulatory restrictions on the availability of dividends that can be paid by the Company's U.S. insurance subsidiaries, the maximum amount of dividends that may be paid to the Company's shareholders is limited, to a lesser degree, by certain covenants contained in its line of credit agreement with a syndicate of financial institutions that require the Company to maintain a minimum consolidated net worth as described in note 8.
Statutory net income of the Company's domestic and international insurance subsidiaries was $2.30 billion, $3.20 billion and $3.80 billion for the years ended December 31, 2017, 2016 and 2015, respectively. Statutory capital and surplus of the Company's domestic and international insurance subsidiaries was $20.45 billion and $20.76 billion at December 31, 2017 and 2016, respectively.
The following table presents the changes in the Company's accumulated other comprehensive income (AOCI) for the years ended December 31, 2017, 2016 and 2015.
The following table presents the pre-tax components of the Company's other comprehensive income (loss) and the related income tax expense (benefit).
The following table presents the pre-tax and related income tax (expense) benefit components of the amounts reclassified from the Company's AOCI to the Company's consolidated statements of income.
The following table presents the components of income tax expense included in the amounts reported in the Company's consolidated financial statements:
If the Company determines that any of its deferred tax assets will not result in future tax benefits, a valuation allowance must be established for the portion of these assets that are not expected to be realized. The net change in the valuation allowance for deferred tax assets was an increase of $3 million in 2017 relating to the Company's consolidated Brazilian subsidiary. Based upon a review of the Company's anticipated future taxable income, and also including all other available evidence, both positive and negative, the Company's management concluded that it is more likely than not that the net deferred tax assets will be realized.
The Company recognized $41 million of tax expense resulting from deemed repatriation of foreign earnings as part of the net charge of $129 million to record the effect of TCJA at enactment during
The Company has recorded provisional amounts for the tax imposed on accumulated foreign earnings and partnership investments, as well as the amount due under the transition rule relating to the change in discounting of claims incurred, based on information available at December 31, 2017. As a result of the Company's normal U.S. income tax return preparation process, the Company expects taxes related to accumulated foreign earnings and partnerships to be adjusted as final earnings from foreign operations and partnership investments (Form K-1's) are received in 2018 for preparation of the Company's 2017 U.S. income tax return that will be filed in 2018. The amounts payable under the transition rules related to discounting have been estimated but are subject to change once the U.S. Treasury issues guidance sometime in 2018. Adjustments to temporary differences will result from the reduced income tax rate applied to the deferred taxes associated with these items. Provisional amounts may also be adjusted to the extent future clarifications of TCJA are provided.
The Company recognizes accrued interest and penalties, if any, related to unrecognized tax benefits in income taxes. During the years ended December 31, 2017, 2016 and 2015, the Company recognized approximately $(33) million, $31 million and $(32) million in interest, respectively. The Company had approximately $25 million and $57 million accrued for the payment of interest at December 31, 2017 and 2016, respectively.
The number of shares of the Company's common stock initially authorized for grant under the 2014 Incentive Plan was 10 million shares. In May 2017 and 2016, the Company's shareholders authorized an additional 2.5 million and 4.4 million shares of the Company's common stock, respectively, for grant under the 2014 Incentive Plan. The following are not counted towards the combined 16.9 million shares available and will be available for future grants under the 2014 Incentive Plan: (i) shares of common stock subject to awards that expire unexercised, that are forfeited, terminated or canceled, that are settled in cash or other forms of property, or otherwise do not result in the issuance of shares of common stock, in whole or in part; (ii) shares that are used to pay the exercise price of stock options and shares used to pay withholding taxes on awards generally; and (iii) shares purchased by the Company on the open market using cash option exercise proceeds; provided, however, that the increase in the number of shares of common stock available for grant pursuant to such market purchases shall not be greater than the number that could be repurchased at fair market value on the date of exercise of the stock option giving rise to such option proceeds. In addition, the 16.9 million shares authorized by shareholders for issuance under the 2014 Incentive Plan will be increased by any shares subject to awards under the 2004 Incentive Plan that were outstanding as of May 27, 2014 and subsequently expire, are forfeited, canceled, settled in cash or otherwise terminate without the issuance of shares.
Stock option awards granted to eligible officers and key employees have a ten-year term. All stock options are granted with an exercise price equal to the closing price of the Company's common stock on the date of grant. The stock options granted generally vest upon meeting certain years of service criteria. Except as the Compensation Committee of the Board of Directors may allow in the future, stock options cannot be sold or transferred by the participant. Stock options outstanding under the 2014 Incentive Plan and the 2004 Incentive Plan generally vest three years after grant date (cliff vest).
The Company issues restricted stock unit awards to eligible officers and key employees under the Equity Awards program established pursuant to the 2014 Incentive Plan. A restricted stock unit represents the right to receive a share of common stock. These restricted stock unit awards are granted at market price, generally vest three years from the date of grant, do not have voting rights and the underlying shares of common stock are not issued until the vesting criteria is satisfied. In addition, the Company's board of directors can be issued deferred stock units from (i) an annual award; (ii) deferred compensation (in lieu of cash retainer); and (iii) dividend equivalents earned on outstanding deferred compensation.
(3)Represents the current year change in estimated performance shares to reflect the attainment of performance goals for the awards that were granted in each of the years 2015 through 2017.
(4)95,953 shares of restricted common stock were also issued outside of the 2014 Incentive Plan in connection with the acquisition of Simply Business which remain unvested and are not included in this table. See note 9.
On February 6, 2018, the Company, under the 2014 Incentive Plan, granted 805,432 common stock awards in the form of restricted stock units, deferred stock units and performance share awards to participating officers, non-employee directors and other key employees. The restricted stock units and deferred stock units totaled 486,024 shares while the performance share awards totaled 319,408 shares. The fair value per share attributable to the common stock awards on the date of grant was $140.85.
At December 31, 2017, there was $143 million of total unrecognized compensation cost related to all nonvested share-based incentive compensation awards. This includes stock options, restricted and deferred stock units and performance shares granted under the 2014 Incentive Plan and the 2004 Incentive Plan and restricted common stock issued in connection with a 2017 business acquisition. The unrecognized compensation cost is expected to be recognized over a weighted-average period of 1.8 years. Cash received from the exercise of employee stock options under share-based compensation plans totaled $173 million and $332 million in 2017 and 2016, respectively. The tax benefit for tax deductions from employee stock options exercised during 2017 and 2016 totaled $31 million and $58 million, respectively.
For pension plans with an accumulated benefit obligation in excess of plan assets, the aggregate projected benefit obligation was $0.2 billion at both December 31, 2017 and 2016, and the aggregate accumulated benefit obligation was $0.2 billion at both December 31, 2017 and 2016. The fair value of plan assets for the above plans was $0.1 billion at both December 31, 2017 and 2016.
The following table indicates the line items in which the respective service costs and non-service costs are presented in the consolidated statements of income for the years ended December 31, 2017, 2016 and 2015.
This change did not affect the measurement of the Company's total benefit obligations as the change in the service cost and interest cost is completely offset in the actuarial (gain) loss reported for the period. The change reduced the service and interest cost components of net periodic benefit costs for 2016 by $6 million and $30 million, respectively, and resulted in an $0.08 increase in diluted net income per share for 2016. The weighted average discount rates that were used to measure service and interest costs during 2016 were 4.77% and 3.64%, respectively, for the domestic qualified pension plan, 4.53% and 3.47%, respectively, for the domestic nonqualified pension plan and 0.00% and 3.53%, respectively, for the domestic postretirement benefit plan. The discount rate associated with the service cost component of the domestic postretirement benefit plan is zero as it is a closed plan and all participants are fully vested. Under the Company's prior estimation approach, the weighted average discount rate for both the service and interest cost components would have been 4.50% for the domestic qualified pension plan, 4.37% for the domestic nonqualified pension plan and 4.35% for the domestic postretirement benefit plan. The Company accounted for this change as a change in estimate, and accordingly, recognized the effect prospectively beginning in 2016.
The discount rate assumption used to determine the benefit obligation is based on a yield-curve approach. Under this approach, individual spot rates from the yield curve of a hypothetical portfolio of
The Company's overall investment strategy for the qualified domestic pension plan is to achieve a mix of approximately 85% to 90% of investments for long-term growth and 10% to 15% for near-term benefit payments with a diversification of asset types, fund strategies and fund managers. The current target allocations for plan assets are 55% to 65% equity securities and 20% to 40% fixed income securities, with the remainder allocated to short-term securities. Equity securities primarily include investments in large, medium and small-cap companies primarily located in the United States. Fixed income securities include corporate bonds of companies from diversified industries, mortgage-backed securities, U.S. Treasury securities and debt securities issued by foreign governments.
The Company has a savings plan, The Travelers 401(k) Savings Plan (the Savings Plan), in which substantially all U.S. domestic Company employees are eligible to participate. Under the Savings Plan, the Company matches employee contributions up to 5% of eligible pay, with a maximum annual match of $6,500 which becomes 100% vested after three years of service. The Company's matching contribution is made in cash and invested according to the employee's current investment elections and can be reinvested into other investment options in accordance with the terms of the plan. The Company's non-U.S. employees participate in separate savings plans. The total expense related to all of the savings plans was $119 million, $114 million and $109 million for the years ended December 31, 2017, 2016 and 2015, respectively.
All common shares held by the Savings Plan are considered outstanding for basic and diluted EPS computations and dividends paid on all shares are charged to retained earnings.
On May 1, 2017, the Company agreed to a settlement of this dispute with the two remaining defendants, along with the settlement of several other disputes with these same parties. As a result of the settlement of all of these matters, the Company recorded an immaterial gain in "other revenues" in its consolidated statement of income for the three months ended June 30, 2017, and the reinsurance recoverable of $31 million in the Company's balance sheet was fully satisfied.
The following consolidating financial statements of the Company have been prepared pursuant to Rule 3-10 of Regulation S-X. These consolidating financial statements have been prepared from the Company's financial information on the same basis of accounting as the consolidated financial statements. The Travelers Companies, Inc. (excluding its subsidiaries, TRV) has fully and unconditionally guaranteed certain debt obligations of Travelers Property Casualty Corp. (TPC) and Travelers Insurance Group Holdings, Inc. (TIGHI), which totaled $700 million at December 31, 2017.
(1)Total other-than-temporary impairments (OTTI) for the year ended December 31, 2017, and the amounts comprising total OTTI that were recognized in net realized investment gains and in other comprehensive income (OCI), were as follows: