For the period 2013 through 2017, we are targeting an annual value creation ratio averaging 10 percent to 13 percent. At 14.5 percent for 2016, we exceeded the high end of that range. We were within that range for the three-year and five-year periods that ended in December 2016.
The 2016 value creation ratio improved by 11.1 percentage points, compared with 2015, and again included strong operating results as its primary contributor. The 2016 ratio improvement included 9.7 percentage points from a rise in market valuation for our equity securities investment portfolio. The 2015 value creation ratio was 9.2 percentage points lower than in 2014, driven by an 11.0 point reduction in the contribution from realized gains plus the change in unrealized gains from our investment portfolios in aggregate.
** Dividend declared to shareholders divided by beginning of year book value
Premium growth - We believe over any five-year period our agency relationships and initiatives can lead to a property casualty written premium growth rate that exceeds the industry average. The compound annual growth rate of our net written premiums was 8.1 percent over the five-year period 2012 through 2016, approximately double the 3.8 percent estimated growth rate for the property casualty insurance industry. The industry’s growth rate excludes its mortgage and financial guaranty lines of business.
Combined ratio - We believe our underwriting philosophy and initiatives can drive performance to achieve our underwriting profitability target of a GAAP combined ratio over any five-year period that consistently averages within the range of 95 percent to 100 percent. Our GAAP combined ratio averaged 94.3 percent over the five-year period 2012 through 2016, better than the performance target range. Performance as measured by the combined ratio is discussed in Consolidated Property Casualty Insurance Results. Our statutory combined ratio averaged 93.7 percent over the five-year period 2012 through 2016 compared with an estimated 99.1 percent for the property casualty industry. The industry’s ratio again excludes its mortgage and financial guaranty lines of business.
Investment income growth, on a pretax basis, had a compound annual growth rate of 2.5 percent over the five-year period 2012 through 2016 and 4.0 percent over the three-year period 2014 through 2016. It has grown every year since 2009, except for 2013 with its slight decrease of less than 1 percent.
The board of directors is committed to rewarding shareholders directly through cash dividends and share repurchase authorizations. Through 2016, the company has increased the annual cash dividend rate for 56 consecutive years, a record we believe is matched by only eight other publicly traded U.S. companies. In addition to regular dividends, excellent company performance provided the opportunity to further reward shareholders and was the main driver of a special dividend paid in December 2015. The board regularly evaluates relevant factors in dividend-related decisions, and the 2016 increase to the regular dividend reflected confidence in our strong capital, liquidity and financial flexibility, as well as progress through our initiatives to
Net income in 2016 decreased $43 million or 7 percent compared with 2015, driven by a decrease in property casualty underwriting income of $94 million after taxes, including $114 million from higher catastrophe losses. The 2016 decrease in property casualty underwriting income was partially offset by a $35 million increase in net realized investment gains after taxes and $17 million in investment income after taxes. Dividend income rose 7 percent in 2016 while interest income rose 3 percent, driving a net increase in pretax investment income of $23 million, or 4 percent. Our investment operation’s performance is discussed further in Investments Results.
Net income increased $109 million in 2015, compared with 2014, primarily due to a $130 million increase in property casualty underwriting income after taxes that included $28 million from lower catastrophe losses.
Property casualty net written premiums and earned premiums each grew 5 percent in 2016, reflecting average renewal price increases, a higher level of insured exposures and premium growth initiatives. Premium growth rates in 2016 were similar to 2015. Trends and related factors are discussed in Commercial Lines, Personal Lines and Excess and Surplus Lines Insurance Results, respectively.
Our property casualty insurance operations generated significant underwriting profits for each of the three years ending in 2016. The $144 million decrease in 2016, compared with 2015, included a $175 million increase in losses from natural catastrophe events. The $200 million increase in 2015, compared with 2014, included a $43 million decrease in losses from natural catastrophe events.
Our life insurance segment reported a $1 million profit in 2016 and a $2 million loss in 2015. We discuss results for the segment in Life Insurance Results. Most of this segment’s investment income is included in our investments segment results. In addition to investment income, realized investment gains from the life insurance investment portfolio are also included in our investments segment results.
plus pricing capabilities we are expanding through the use of technology and analytics. In addition to enhancing company efficiency, improving internal processes also supports the ability of the independent agencies that represent us to grow profitably by allowing them to serve clients faster and to more efficiently manage agency expenses.
Our view of the shareholder value we can create over the next five years relies largely on three assumptions - each highly dependent on the external environment. First, we anticipate our property casualty average insurance prices will increase in proportion to, or in excess of, our loss cost trends. Second, we assume that the economy can maintain a long-term growth track. Third, we assume that valuations of our marketable securities will vary within a typical range over time, based on historical trends. If those assumptions prove to be inaccurate, we may not be able to achieve our performance targets even if we accomplish our strategic objectives.
For some lines of business that we write, a considerable and uncertain amount of time can elapse between the occurrence, reporting and payment of insured claims. The amount we will actually have to pay for such claims also can be highly uncertain. This uncertainty, together with the size of our reserves, makes the loss and loss expense reserves our most significant estimate. Gross loss and loss expense reserves were $5.035 billion at year-end 2016 compared with $4.660 billion at year-end 2015.
affected geographic area and of available claims intelligence. Depending on the nature of the event, available claims intelligence could include surveys of field claims associates within the affected geographic area, feedback from a catastrophe claims team sent into the area, as well as data on claims reported as of the financial statement date. To determine whether an event is designated as a catastrophe, we generally use the catastrophe definition provided by Property Claims Service (PCS), a division of Insurance Services Office (ISO). PCS defines a catastrophe as an event that causes countrywide damage of $25 million or more in insured property losses and affects a significant number of policyholders and insureds.
Due to the uncertainties described above, our ultimate loss experience could prove better or worse than our carried reserves reflect. To the extent that reserves are inadequate and increased, the amount of the increase is a charge in the period that the deficiency is recognized, raising our loss and loss expense ratio and reducing earnings. To the extent that reserves are redundant and released, the amount of the release is a credit in the period that the redundancy is recognized, reducing our loss and loss expense ratio and increasing earnings.
Calendar year inflation. For long-tail and mid-tail business lines, calendar year inflation trends for future paid losses and paid DCCE do not vary significantly from a stable, long-term average. Our actuaries base reserve estimates derived from probabilistic trend family models on this assumption.
The application of our impairment policy resulted in other-than-temporary impairment (OTTI) charges that reduced our income before income taxes by $2 million in 2016, $52 million in 2015 and $24 million in 2014. OTTI losses represent noncash charges to income and are reported as realized investment losses.
Securities that have previously been other-than-temporarily impaired are evaluated based on their adjusted cost or amortized cost and further written down if deemed appropriate. We provide detailed information about securities fair valued in a continuous loss position at year-end 2016 in Item 7A, Application of Asset Impairment Policy.
Accounting Standards Codification (ASC) 820-10, Fair Value Measurements and Disclosures, defines fair value as the exit price or the amount that would be (1) received to sell an asset or (2) paid to transfer a liability in an orderly transaction between marketplace participants at the measurement date. When determining an exit price, we must, whenever possible, rely upon observable market data.
We have categorized our financial instruments, based on the priority of the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the financial instruments fall within different levels of the hierarchy, the categorization is based on the lowest level that is significant to the fair value measurement of the instrument. While we consider pricing data from outside services, we ultimately determine whether the data or inputs used by these outside services are observable or unobservable.
At December 31, 2016, total Level 3 assets were less than 1 percent of our investment portfolio measured at fair value. Financial assets that fall within the Level 3 hierarchy are valued based upon unobservable market inputs, normally because they are not actively traded on a public market. Pricing for each Level 3 security is based upon inputs that are market driven, including quotes from brokers or other external sources. We placed in the Level 3 hierarchy securities for which we were unable to obtain the pricing methodology or we could not consider the price provided as binding. Pricing for securities classified as Level 3 could not be corroborated by similar securities priced using observable inputs.
Key assumptions used in developing the 2016 net pension expense for our qualified plan were a 4.55 percent discount rate, a 7.25 percent expected return on plan assets and rates of compensation increases ranging from 2.75 percent to 3.25 percent.
In 2016, the net pension expense was $9 million. In 2017, we expect the net pension expense to be approximately $6 million.
Information about recent accounting pronouncements is provided in Item 8, Note 1 of the Consolidated Financial Statements.
Earned and net written premiums for our consolidated property casualty operations grew in 2016, reflecting average renewal price increases, a higher level of insured exposures and strategic initiatives for targeted growth. A key measure of property casualty profitability is underwriting profit or loss. Our 2016 underwriting profit of $242 million was $144 million less than in 2015, driven by a $175 million unfavorable effect from a higher amount of natural catastrophe losses, mostly caused by severe weather. The benefits of higher pricing, and our ongoing initiatives to improve pricing precision and loss experience related to claims and loss control practices, were largely responsible for the remainder of the change in 2016 underwriting profit compared with 2015. That improvement is discussed further below and includes prior accident year loss experience before catastrophes during 2016 that was slightly less favorable than in 2015.
The table below highlights property casualty results, with analysis and discussion in the sections that follow. That analysis and discussion includes sections by segment.
Premiums - Agency renewal written premiums rose $147 million in 2016 and were the primary contributor of growth in earned premiums and net written premiums that rose in each of our property casualty segments. The renewal premium increase was largely due to average renewal price increases and a higher level of insured exposures. Price increases with enhanced precision continue to benefit operating results.
New business written premiums produced through agencies increased $19 million in 2016, compared with 2015. Agents appointed during 2016 or 2015 produced a 2016 increase in standard lines new business of $38 million. Growth initiatives also favorably affect growth in subsequent years, particularly as newer agency relationships mature over time.
Our statutory combined ratio was 94.5 percent in 2016 compared with 90.6 percent in 2015 and 95.1 percent in 2014. The estimated statutory combined ratio for the property casualty industry, with the industry’s ratio excluding its mortgage and financial guaranty lines of business, was 100.7 percent in 2016, 98.3 percent in 2015 and 97.4 percent in 2014. The contribution of catastrophe losses to our statutory combined ratio was 7.5 percentage points in 2016, 3.7 percentage points in 2015 and 5.1 percentage points in 2014, compared with industry estimates of 4.9, 3.5 and 4.0 percentage points, respectively. Components of the combined ratio are discussed below.
Catastrophe loss trends are an important factor in assessing trends for overall underwriting results. Our 10-year historical annual average contribution of catastrophe losses to the combined ratio was 6.2 percentage points at December 31, 2016. Our five-year average was 6.1 percentage points.
For our commercial casualty line of business in 2016, we experienced a rising trend in paid losses and loss expenses that was more than we expected. As a result, we increased our actuarial best estimates of ultimate loss and loss expense ratios at the end of 2016, compared with year-end 2015. Net loss and loss expense reserves at December 31, 2016, for our commercial casualty line of business was $132 million higher than at year-end 2015. The IBNR portion of the reserve increase was $103 million.
Catastrophe loss trends, discussed above, accounted for some of the movement in current accident year loss and loss expense ratio for 2016, compared with 2015. Catastrophe losses added 7.7 percentage points in 2016, 4.1 points in 2015 and 5.7 points in 2014 to the respective consolidated property casualty current accident year loss and loss expense ratios in the table above.
Reserve development on prior accident years continued to net to a favorable amount in 2016, and was primarily
due to lower-than-anticipated loss emergence on known claims. We recognized $168 million of favorable development in 2016, compared with $184 million in 2015 and $98 million in 2014. Of the $16 million decrease in 2016, compared with 2015, $43 million was attributable to our commercial casualty line of business. Approximately 70 percent of our net favorable reserve development on prior accident years recognized during 2016 occurred in our commercial casualty, commercial property and workers’ compensation lines of business. In 2015, our commercial casualty and workers' compensation lines of business were responsible for approximately 85 percent of the favorable reserve development. As discussed in Liquidity and Capital Resources, Property Casualty Loss and Loss Expense Obligations and Reserves, Property Casualty Insurance Development of Estimated Reserves by Accident Year, commercial casualty and workers' compensation are considered long-tail lines with the potential for revisions inherent in estimating reserves. Favorable development recognized during 2014 was primarily from our commercial property and workers’ compensation lines of business. Development by accident year is further discussed in Property Casualty Insurance Development of Estimated Reserves by Accident Year.
In 2016, total large losses incurred decreased by $12 million, or 6 percent, net of reinsurance. The corresponding ratio decreased 0.5 percentage points. Our analysis of large losses incurred indicated no unexpected concentration of these losses and reserve increases by geographic region, policy inception, agency or field marketing territory. We believe the inherent volatility of aggregate loss experience for our portfolio of larger policies is greater than that of our portfolio of smaller policies, and we continue to monitor the volatility in addition to general inflationary trends in loss costs.
Discussions below of our property casualty insurance segments provide additional details about our results.
Premiums - Earned premiums and net written premiums rose in 2016, primarily due to a $76 million increase in renewal written premiums that continued to include a price increase for an average policy. New business written premiums in 2016 increased $7 million, or 2 percent, compared with 2015. The increase was driven by production from agencies appointed since the beginning of 2015, offsetting effects of a softening commercial insurance market.
Combined ratio - The 2016 combined ratio increased 5.6 percentage points compared with 2015, including a 4.0 percentage-point increase in the ratio for natural catastrophe losses. The 2016 ratio for current accident year losses and loss expenses before catastrophes increased by 0.7 percentage points, including 1.4 points from more current accident year losses of $1 million or more per claim, shown in the table below. Development on prior accident years’ loss and loss expense reserves before catastrophes during 2016 was 0.7 percentage points less favorable than in 2015, including 1.9 points from re-estimates of IBNR reserves for losses and loss expenses.
As discussed in Critical Accounting Estimates, Property Casualty Insurance Loss and Loss Expense Reserves, stable historical paid loss patterns are a key assumption used to make projections necessary for estimating IBNR
reserves. During 2016, we observed paid losses or re-estimates of case reserves emerging at levels higher than expected for commercial casualty, including a large umbrella liability claim for accident year 2007 and a large general liability claim for accident year 2012. Considering that new data at December 31, 2016, we estimated commercial casualty IBNR reserves for several older accident years at levels more likely to be adequate, compared with estimates at the end of 2015.
We continue to refine our use of predictive analytics tools to improve pricing precision as we further segment commercial lines policies, emphasizing identification and retention of policies we believe have relatively stronger price adequacy. These tools better align individual insurance policy pricing to risk attributes, providing our underwriters with enhanced abilities to target profitability and to discuss pricing impacts with agency personnel. We also continue to leverage our local relationships with agents through the efforts of our teams that work closely with them. We believe our field focus is unique and has several advantages, including providing us with quality intelligence on local market conditions. We seek to maintain appropriate pricing discipline for both new and renewal business as management continues to emphasize the importance of our agencies and underwriters assessing account quality to make careful decisions on a case-by-case basis whether to write or renew a policy. Premium rate credits may be used to retain renewals of quality business and to earn new business, but we do so selectively in order to avoid commercial accounts that we believe have insufficient profit margins.
In 2016, our commercial lines new business premiums written by our agencies increased $7 million, or 2 percent, compared with 2015. New business premium volume in recent years has been significantly influenced by new agency appointments. Agencies appointed since the beginning of 2015 produced commercial lines new business written premiums of $27 million, in aggregate, during 2016, up $17 million from what they produced during 2015. All other agencies contributed the remaining $345 million, down $10 million from the $355 million they produced in 2015.
Catastrophe losses, as discussed in Consolidated Property Casualty Insurance Results, explain some of the movement in current accident year loss and loss expense ratio for accident year 2016, compared with 2015. Catastrophe losses added 7.3 percentage points in 2016, 3.5 points in 2015 and 4.8 points in 2014 to the respective commercial lines current accident year loss and loss expense ratios in the table above.
The 59.3 percent ratio for current accident year loss and loss expenses before catastrophe losses for 2016 increased 0.7 percentage points compared with the 58.6 percent accident year 2015 ratio measured as of December 31, 2015. Higher commercial casualty IBNR reserves in 2016, noted above, contributed to the increase. Large losses, described below, and the corresponding ratios for new losses above $1 million, contributed a 1.4 percentage-point increase to the 2016 ratio. Those unfavorable contributions offset the favorable effects from initiatives, such as those to improve pricing precision and loss experience related to claims and loss control practices.
Commercial lines reserve development on prior accident years of $129 million in 2016 continued to net to a favorable amount, but provided a smaller benefit than the $154 million recognized in 2015. The $25 million net decrease in 2016 included $43 million from our commercial casualty line of business. Most of our commercial lines reserve net favorable development on prior accident years recognized during 2016 occurred in our commercial casualty, commercial property and workers’ compensation lines of business, with workers' compensation representing 53 percent. Favorable development recognized during 2015 was mostly from our commercial casualty and workers’ compensation lines of business. Favorable development recognized during 2014 was mostly from our workers’ compensation line of business. Development by accident year and other trends for commercial lines loss and loss expenses and the related ratios are further discussed in Liquidity and Capital Resources, Property Casualty Insurance Development of Estimated Reserves by Accident Year.
Net written premiums for the commercial lines industry in 2017 are projected to essentially match 2016, with the industry statutory combined ratio estimated at approximately 101 percent, excluding its mortgage and financial guaranty lines of business. Over the past several years, renewal and new business pricing has experienced significant competitive pressure, reinforcing the need for more pricing analytics and careful risk selection. While competition remains intense, industrywide commercial lines market pricing turned positive toward the end of 2011 and continued to firm for a period of time, according to several industry surveys. Average renewal pricing for our commercial lines insurance segment generally followed a similar trend. According to a variety of reports that focus on the commercial lines market, commercial lines pricing is expected to continue to soften during 2017. Despite challenging market conditions from strong competition, we believe we can manage our business and execute strategic initiatives to offset market pressures to some extent and profitably grow our commercial lines insurance segment.
Our personal lines statutory combined ratio was 100.8 percent in 2016, up from 100.0 percent in 2015 and 99.1 percent in 2014. By comparison, the estimated industry personal lines combined ratio was 102.6 percent in 2016, 99.6 percent in 2015 and 98.8 percent in 2014. Our concentration of business in areas affected by catastrophe events contributed to recent-year results that differed from the overall industry, an issue we are addressing in part through gradual geographic expansion. The contribution of catastrophe losses to our personal lines statutory combined ratio was 9.4 percentage points in 2016, 6.2 percentage points in 2015 and 7.8 percentage points in 2014, compared with industry estimates of 6.0, 4.8 and 5.5 percentage points, respectively.
Personal lines insurance is a strategic component of our overall relationship with most of our agencies and is an important component of our agencies’ relationships with their clients. We believe agents recommend our personal insurance products to their clients who seek to balance quality and price and who are attracted by our superior claims service and the benefits of our package approach. We also believe our continuing efforts to improve pricing precision are helping us attract and retain more of our agencies’ preferred business, while also obtaining higher rates for more thinly priced business. Our progress toward broader geographic diversification is reflected in part through premium growth trends. Personal lines earned premiums in our five highest volume states increased in aggregate by 4 percent in 2016, while premiums for the remaining states that include our newer areas of operation increased 8 percent in aggregate.
Other written premiums primarily consist of premiums that are ceded to reinsurers and that lower our net written premiums. Ceded premiums for 2016 essentially matched 2015.
The 63.0 percent ratio for current accident year loss and loss expenses before catastrophe losses for 2016 improved 1.9 percentage points compared with the 64.9 percent accident year 2015 ratio measured as of December 31, 2015. The improvement was largely due to a 2.4 percentage-point decrease in the ratio for current accident year losses of $1 million or more per claim, shown in the table below, that were primarily for homeowner claims and personal umbrella claims related to auto accidents.
Personal lines loss and loss expense reserve development on prior accident years recognized in 2016 was favorable by $4 million, in aggregate, compared with an unfavorable net amount of $5 million in 2015. The 2016 net favorable reserve development included an unfavorable $18 million for our personal auto line of business, primarily for accident years 2013 through 2015, favorable $8 million for our homeowner line business and the remainder was favorable for our other personal line of business. In 2016, personal auto included a refinement to reserves for loss expenses, transferring approximately $10 million of reserves to various lines of business in our commercial lines segment. For losses only, our 2016 personal auto prior accident year net reserve development was unfavorable by $25 million. The 2015 unfavorable development was driven by $15 million of unfavorable development for our personal auto line of business, including $10 million for accident year 2013. Our personal lines 2015 net unfavorable reserve development on prior accident years included $12 million of favorable development in our homeowner line of business. Favorable development recognized during 2015 and 2014 was primarily from our
Personal lines commission expense as a percent of earned premiums decreased in 2016 compared with 2015. The decrease reflected an unusually high 2015 ratio from changes in estimates related to allocations of deferred acquisition costs by segment. Other underwriting expenses as a percent of earned premiums rose in 2016.
The $13 million increase in 2016 renewal premiums reflected the opportunity to renew many policies for the first time as well as higher renewal pricing. Average renewal price increases were near the high end of the low-single-digit range during 2016, while 2015 was near the low end of the mid-single-digit range. We measure average changes in excess and surplus lines renewal pricing as the rate of change in renewal premium for the new policy period compared with the premium for the expiring policy period, assuming no change in the level of insured exposures or policy coverage between those periods for respective policies.
New business written premiums and other written premiums in 2016 were similar to amounts in 2015. Other written premiums are primarily premiums that are ceded to reinsurers and that lower our net written premiums.
Catastrophe losses, as discussed in Consolidated Property Casualty Insurance Results, explain some of the movement in current accident year loss and loss expense ratio for accident year 2016, compared with 2015. Catastrophe losses added 1.6 percentage points in 2016, 0.5 percentage points in 2015 and 1.8 percentage points in 2014, to the respective excess and surplus lines current accident year loss and loss expense ratios in the table above.
Excess and surplus lines reserve development on prior accident years continued to net to a favorable amount in 2016 as $34 million was recognized, compared with $35 million in 2015. Approximately two-thirds of the
We believe the loss and loss expense reserves for our excess and surplus lines business are adequate. The amount of outstanding reserves for our excess and surplus lines operation can be seen in a table in Liquidity and Capital Resources, Property Casualty Loss and Loss Expense Obligations and Reserves. One indication of how long it takes for most of the outstanding reserves to be settled is to measure outstanding reserves by accident year at different points in time. For accident year 2011 and all accident years prior to that, at December 31, 2011, we reported reserves for estimated unpaid losses and loss expenses of $77 million, net of reinsurance. At December 31, 2016, our estimate for the remaining unpaid losses and loss expenses that occurred in those accident years was approximately $4 million. The inherent uncertainty in estimating reserves is discussed in Liquidity and Capital Resources, Property Casualty Insurance Loss and Loss Expense Obligations and Reserves. Development trends by accident year are further discussed in Property Casualty Insurance Development of Estimated Reserves by Accident Year.
Earned premiums rose $19 million in 2016, primarily due to growth in our term life insurance business, as shown in the table below. Growth in 2015 was primarily due to term life insurance and universal life insurance.
Net death claims decreased slightly from 2015, and were below our mortality projections while remaining within our range of pricing expectations.
Underwriting expenses incurred, net of deferred acquisition costs, accounted for 23.6 percent of 2016 total benefits and expenses compared with 21.9 percent in 2015 and 21.6 percent in 2014. Expenses in 2016 increased 15 percent, more than the 9 percent growth in earned premiums, primarily due to increased operating expenses related to premium growth and technology initiatives. In 2015, the percentage increase for expenses was slightly less than growth earned premiums.
We recognize that assets under management, capital appreciation and investment income are integral to evaluation of the success of the life insurance segment because of the long duration of life products. On a basis that includes investment income and realized gains or losses from life insurance-related invested assets, our life insurance subsidiary reported net income of $48 million in 2016, compared with net income of $41 million in 2015 and $39 million in 2014. The life insurance subsidiary portfolio had after-tax net realized investment gains of $5 million in 2016, compared with less than $1 million in 2015 and $3 million in 2014. Realized investment gains and losses are discussed under Investments Results. We exclude most of our life insurance company investment income from investments segment results.
We view the life insurance market as having significant pockets of growth opportunities. The traditional life distribution system is in a state of mild disruption. The combination of low interest rates, new technology and historic low ownership rates provide us with ample room to grow our term focused life insurance book through our independent agency model.
Net realized investment gains and losses are made up of gains or losses from the disposal of securities, changes in the valuation of embedded derivatives within certain convertible securities and OTTI charges from impaired securities. The factors we consider when evaluating impairments are discussed in Critical Accounting Estimates, Asset Impairment.
As appropriate, we buy, hold or sell both fixed-maturity and equity securities on an ongoing basis to help achieve our portfolio objectives. We generally purchase fixed-maturity securities with the intention to hold until maturity. If they no longer meet our investment criteria, they are divested. Sales of fixed-maturity securities are usually due to a change in credit fundamentals. Pretax realized investment gains in the past three years largely were due to the sale of equity holdings.
$25 million in net realized gains from fixed-maturity security sales and calls.
The $70 million net realized investment gains and losses in 2015 were primarily due to $103 million in net realized gains from equity security sales and $18 million from fixed-maturity security sales and calls, partially offset by $52 million of OTTI charges for six securities.
Despite a rise in interest rates near the end of 2016, yields remain below both long-term market averages in general and our embedded portfolio yield specifically. For at least the near term, this is likely to continue to exert pressure on investment income growth.
We continue to focus on portfolio strategies to balance near-term income generation and long-term book value growth. In 2017, we expect to continue to allocate a portion of cash available for investment to equity securities, taking into consideration corporate liquidity and income requirements, as well as insurance department regulations and rating agency comments. We discuss our portfolio strategies in Item 1, Our Segments, Investments Segment.
We had $221 million of income tax expense in 2016 compared with $247 million in 2015 and $196 million in 2014. Our corporate effective tax rate for 2016 was 27.2 percent compared with 28.0 percent in 2015 and 27.2 percent in 2014.
The change in our effective tax rate was primarily due to changes in pretax income from underwriting results and realized investment gains and losses, with immaterial changes in the amount of permanent book-tax differences.
Historically, we have pursued a strategy of investing some portion of cash flow in tax-advantaged fixed-maturity and equity securities to minimize our overall tax liability and maximize after-tax earnings. See Item 1, Our Segments, Tax-Exempt Fixed Maturities, for further discussion on municipal bond purchases in our fixed-maturity investment portfolio. For our property casualty insurance subsidiaries, approximately 85 percent of interest from tax-advantaged fixed-maturity investments and approximately 60 percent of dividends from qualified equities are exempt from federal tax after applying proration from the 1986 Tax Reform Act. Our noninsurance companies own an immaterial amount of tax-advantaged fixed-maturity investments. For our noninsurance companies, the dividend received deduction exempts 70 percent of dividends from qualified equities. Our life insurance company does not own tax-advantaged, fixed maturity investments or equities subject to the dividend received deduction. Our effective tax rate reconciliation is found in Item 8, Note 11 of the Consolidated Financial Statements.
Dividends received from the subsidiary in 2016 were $28 million more than 2015, supported by strong property casualty insurance subsidiary net cash flow from operating activities. We expect 2017 parent company sources of cash flows to be similar to 2016. The majority of expenditures for the parent company have been consistent during the last three years, and we expect future expenditures to remain fairly stable. Share repurchases are discretionary, depending on cash availability and capital management decisions.
The parent company’s insurance subsidiary is largely the operations of the property casualty segments. The primary sources of cash inflows are collection of premiums, investment income, maturity of fixed-income securities and sale proceeds from investments. Property casualty insurance premiums generally are received before losses are paid under the policies purchased with those premiums. Cash outflows are primarily loss and loss expenses, commissions, salaries, taxes, operating expenses and investment purchases. Over the three-year period ended December 31, 2016, premium receipts and investment income have been more than sufficient to pay claims and operating expenses. Excess cash flows were partially used to pay dividends to the parent company. We are not aware of any known trends that would materially change historical cash flow results other than fluctuations in catastrophe claims and other large losses either individually or in aggregate.
Financial resources of the parent company also could be made available to our insurance subsidiaries, if circumstances required. This flexibility would include our ability to access the capital markets and short-term bank borrowings. We generally have minimized our reliance on debt financing although we may use the line of credit to fund short-term cash needs.
We provide details of our three long-term notes in Item 8, Note 8 of the Consolidated Financial Statements. None of the notes are encumbered by rating triggers. The total principal amount of our long-term debt at December 31, 2016, was $793 million and included:
The company’s senior debt is rated investment grade by independent rating firms. None of the four rating agencies made changes to our debt ratings in 2016. Our debt ratings at February 22, 2017, were: a- from A.M. Best, A from Fitch Ratings, A3 from Moody’s Investors Service and BBB+ from Standard & Poor’s.
Other invested assets - We may invest up to $27 million in private equity investments over the next four years.
At December 31, 2016, we had $777 million in cash and cash equivalents. During 2017, our insurance subsidiary can declare $469 million in dividends to our parent company without regulatory approval. That strong liquidity and our consistent cash flows give us the flexibility to meet current obligations and commitments while building value by prudently investing where we see potential for both current income and long-term return. Our cash provides adequate financial cushion when short-term operating results do not meet our objectives.
A long-term perspective governs our liquidity and capital resources decisions, with the goal of benefiting our policyholders, agents, shareholders and associates over time. Our underwriting philosophy and initiatives can drive performance to achieve our underwriting profitability target of a GAAP combined ratio over any five-year period that consistently averages within the range of 95 percent to 100 percent. Our GAAP combined ratio averaged 94.3 percent over the five-year period 2012 through 2016, resulting in strong underwriting profits.
We do not use any special-purpose financing vehicles or have any undisclosed off-balance-sheet arrangements (as that term is defined in applicable SEC rules) that are reasonably likely to have a current or future material effect on the company’s financial condition, results of operation, liquidity, capital expenditures or capital resources.
Our estimate of future gross property casualty loss and loss expense payments of $5.035 billion is lower than loss and loss expense reserves of $5.085 billion reported on our balance sheet at December 31, 2016. The $50 million difference is due to certain life and health loss reserves. Reserving practices are discussed in Critical Accounting Estimates, Property Casualty Insurance Loss and Loss Expense Reserves.
For the business lines in the commercial and personal lines insurance segments, and in total for the excess and surplus lines insurance segment, the following table details gross reserves among case, IBNR and loss expense reserves, net of salvage and subrogation. The $375 million increase in total gross reserves was primarily due to a $150 million increase in case loss reserves and a $187 million increase in IBNR loss reserves. Total gross reserves for our commercial casualty line of business rose $136 million, for our commercial auto line of business they rose $78 million, for our commercial property line of business they rose $77 million and for our personal auto line of business they rose $45 million.
The company established a reasonably likely range for net loss and loss expense reserves of $4.449 billion to $4.894 billion at year-end 2016, with the company carrying net reserves of $4.738 billion. The likely range was $4.125 billion to $4.507 billion at year-end 2015, with the company carrying net reserves of $4.379 billion. Our loss and loss expense reserves are not discounted for the time-value of money, but we have reduced the reserves by an estimate of the amount of salvage and subrogation payments we expect to recover.
Management’s best estimate of total loss and loss expense reserves as of year-end 2016 and 2015 was consistent with the corresponding actuarial best estimate.
We reconcile the beginning and ending balances of our reserves for loss and loss expenses at December 31, 2016, 2015 and 2014, in Item 8, Note 4 of the Consolidated Financial Statements. The reconciliation of our year-end 2015 reserve balance to net incurred losses one year later recognized $168 million of favorable reserve development.
Section B shows the cumulative net amount paid with respect to the previously recorded reserve as of the end of each succeeding year. For example, as of December 31, 2016, we paid $2.556 billion of loss and loss expenses in calendar years 2007 through 2016 for losses that occurred in accident years 2006 and prior. An estimated $341 million of losses remained unpaid as of year-end 2016 (net re-estimated reserves of $2.897 billion from Section C less cumulative net paid loss and loss expenses of $2.556 billion).
Section D, cumulative net reserve development, represents the aggregate change in the estimates for all years subsequent to the year the reserves were initially established. For example, reserves established at December 31, 2006, had developed favorably by $459 million over 10 years, net of reinsurance, which was reflected in income over the 10 years. The table shows favorable reserve development as a negative number. Favorable reserve development on prior accident years, which represents a negative expense, is favorable to income. The “One year later” line in the table shows the effects on income before income taxes in 2016, 2015 and 2014 of changes in estimates of the reserves for loss and loss expenses for all accident years. The effect was favorable to pretax income for those three years by $168 million, $184 million, and $98 million, respectively.
The following table shows net reserve changes at year-end 2016, 2015 and 2014 by property casualty segment and accident year:
Commercial auto - Loss emergence continued to develop unfavorably during calendar year 2016. This line of business has been troublesome for the industry as a whole in recent years. As part of the U.S. economic recession of a few years ago, slowing business activity influenced our estimates of reserves for ultimate losses and loss expenses during that period. As the economy slowly recovered, we believe we have been slow to recognize some of the higher loss cost effects in current accident year reserve estimates for at least part of that period. As claims that occurred during that period have become more mature, paid and reported loss cost trends resulted in us increasing our estimated ultimate losses. Initiatives to improve profitability of our commercial auto line of business are discussed in Commercial Lines Insurance Results.
Personal auto - Loss emergence continued to develop unfavorably during calendar year 2016. This line of business is subject to many of the same cost pressures related to the economic slowdown as commercial auto. Initiatives to improve profitability of our personal auto line of business are discussed in Personal Lines Insurance Results.
Our estimates of life, annuity and disability policyholder obligations reflect future estimated cash payments to be made to policyholders for future policy benefits, policyholders’ account balances and separate account liabilities. These estimates include death and disability income claims, policy surrenders, policy maturities, annuity payments, minimum guarantees on separate account products, commissions and premium taxes offset by expected future deposits and premiums on in-force contracts.
Our estimates of gross life, annuity and disability obligations do not reflect net recoveries from reinsurance agreements. Ceded life reinsurance receivables were $241 million at year-end 2016. As discussed in 2017 Reinsurance Programs, we purchase reinsurance to mitigate our life insurance risk exposure. At year-end 2016, ceded death benefits represented approximately 40.5 percent of our total gross policy face amounts in force.
These estimated cash outflows are undiscounted with respect to interest. As a result, the sum of the cash outflows for all years of $5.442 billion (total of life insurance obligations) exceeds the liabilities recorded in life policy and investment contract reserves and separate accounts for future policy benefits and claims of $3.411 billion (total of life insurance policy reserves and separate account policy reserves). Separate account policy reserves make up all but $10 million of separate accounts liabilities.
Reinsurance mitigates the risk of highly uncertain exposures and limits the maximum net loss that can arise from large risks or risks concentrated in areas of exposure. Management’s decisions about the appropriate structure of reinsurance protection and level of risk retention are affected by various factors, including changes in our underwriting practices, capacity to retain risks and reinsurance market conditions.
Primary components of the 2017 property and casualty reinsurance program are summarized below. The premium estimates below occurred near the beginning of each respective year, when direct written premiums that were subject to applicable reinsurance treaties were also estimated.
Property excess treaty - For 2017, we again purchased a property reinsurance treaty that provide an additional $25 million in protection for property losses. This treaty, along with the property per risk treaty, provides a total of $50 million of protection. The 2017 ceded premium estimate was approximately $6 million, essentially unchanged from the 2016 estimate.
Casualty per occurrence treaty - The casualty treaty provides capacity up to $25 million. Similar to the property treaty, it provides sufficient capacity to cover the vast majority of casualty accounts we insure and also includes protection for extra-contractual liability coverage losses. We retain the first $10 million of each loss. Losses between $10 million and $25 million are reinsured at 100 percent. The 2017 ceded premium estimate was $12 million, essentially unchanged from the 2016 estimate.
Casualty excess treaty - We purchase a casualty reinsurance treaty that provides an additional $45 million in protection for certain casualty losses. This treaty, along with the casualty per occurrence treaty, provides a total of $70 million of protection for workers’ compensation, extra-contractual liability coverage and clash coverage losses, which would apply when a single occurrence involves multiple policyholders of The Cincinnati Insurance Companies or multiple coverages for one insured. The 2017 ceded premium estimate was approximately $3 million, essentially unchanged from the 2016 estimate.
Property catastrophe treaty - To protect against catastrophic events such as wind and hail, hurricanes or earthquakes, we purchased property catastrophe reinsurance with a limit up to $600 million. Losses from the same occurrence can now be aggregated into one limit over a 120-hour period and applied to the treaty towards recovery. The treaty contains one reinstatement provision. The 2017 ceded premium estimate was $39 million, compared with a $41 million estimate for 2016. We retain the first $100 million of any loss, and a share of losses up to $600 million, as indicated below:
Individual risks with insured values in excess of $50 million, as identified in the policy, are handled through a different reinsurance mechanism. We typically reinsure property coverage for individual risks with insured values between $50 million and $85 million under an automatic facultative agreement. For risks with property values exceeding $85 million, we negotiate the purchase of facultative coverage on an individual certificate basis. For casualty coverage on individual risks with limits exceeding $25 million, facultative reinsurance coverage is placed on an individual certificate basis. For risks with casualty limits that are between $25 million and $27 million, we sometimes forego facultative reinsurance and retain an additional $2 million of loss exposure.
The Cincinnati Specialty Underwriters Insurance Company has separate property and casualty reinsurance treaties for 2017 through its parent, The Cincinnati Insurance Company. Primary components of the treaties include:
We also have catastrophe reinsurance coverage on our life insurance operations that reimburses us for covered net losses in excess of $9.5 million. Our recovery is capped at $75 million for losses involving our associates.
The following table shows our five largest life reinsurance receivable amounts by reinsurer at year-end 2016 and 2015. The A.M. Best insurer financial strength ratings are also shown.
Significant decline in investment income due to reduced or eliminated dividend payouts from a particular security or group of securities
Increased competition that could result in a significant reduction in the company’s premium volume
Restrict our ability to execute our business model, including the way we compensate agents
Deloitte & Touche LLP, our independent registered public accounting firm, audited the consolidated financial statements of Cincinnati Financial Corporation and subsidiaries for the year ended December 31, 2016. Deloitte & Touche LLP met with our audit committee to discuss the results of its examination. They have the opportunity to discuss the adequacy of internal controls and the quality of financial reporting without management present.
The company’s management assessed the effectiveness of the company’s internal control over financial reporting as of December 31, 2016, as required by Section 404 of the Sarbanes Oxley Act of 2002. Management’s assessment was based on the criteria established in the Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and was designed to provide reasonable assurance that the company maintained effective internal control over financial reporting as of December 31, 2016. The assessment led management to conclude that, as of December 31, 2016, the company’s internal control over financial reporting was effective based on those criteria.
We have audited the accompanying consolidated balance sheets of Cincinnati Financial Corporation and subsidiaries (the "Company") as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2016. Our audits also included the financial statement schedules listed in the Index at Item 15(c). We also have audited the Company's internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and financial statement schedules and an opinion on the Company's internal control over financial reporting based on our audits.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
The Cincinnati Insurance Company leads our insurance group that also includes two subsidiaries: The Cincinnati Casualty Company and The Cincinnati Indemnity Company. This group markets a broad range of standard market commercial and personal policies. The group focuses on delivery of quality customer service to our select group of 1,614 independent insurance agencies with 2,090 reporting locations across 41 states. In 2015, The Cincinnati Insurance Company began our reinsurance assumed operations, Cincinnati Re. Other subsidiaries of The Cincinnati Insurance Company include The Cincinnati Life Insurance Company, which markets life and disability income insurance and fixed annuities, and The Cincinnati Specialty Underwriters Insurance Company, which offers excess and surplus lines property casualty insurance products.
Included within our other invested assets are $31 million of life policy loans, $23 million of private equity investments and $27 million of real estate through direct property ownership and development projects in the United States for the year ended 2016. Life policy loans are carried at the receivable value. The private equity investments provide their financial statements to us and generally report investments on their balance sheets at fair value. We use the equity method of accounting for private equity investments.
For the purpose of ASC 825 disclosure, we estimate the fair value of our long-term senior notes on market pricing of similar debt instruments that are actively trading. We estimate the fair value of our note payable on the year-end outstanding balance because it is short term and tied to a variable interest rate. We estimate the fair value of liabilities for investment contracts and annuities using discounted cash flow calculations across a wide range of economic interest rate scenarios with a provision for our nonperformance risk. We estimate the fair value for policyholder loans on insurance contracts using a discounted cash flow model. Determination of fair value for structured settlements assumes the discount rates used to calculate the present value of expected payments are the risk-free spot rates plus an A3 rated bond spread for financial issuers at December 31, 2016, to account for nonperformance risk. See Note 3, Fair Value Measurements, for further details.
Premiums receivable are reviewed for impairment on a quarterly basis. We maintain an allowance for uncollectible premiums.
acquisition cost assumptions periodically to reflect actual experience, and we evaluate our deferred acquisition costs for recoverability.
Generally, investment income and realized investment gains and losses of the separate accounts accrue directly to the contract holder, and we do not include them in the consolidated statements of income. Revenues and expenses related to separate accounts consist of contractual fees and mortality, surrender and expense risk charges. Also, each separate account BOLI includes a negotiated capital gain and loss sharing arrangement between the company and the bank. A percentage of each separate account’s realized capital gain and loss representing contract fees and assessments accrues to us and is transferred from the separate account to our general account and is recognized as revenue or expense. We record as revenues separate account investment management fees in fee revenues of the consolidated statements of income.
Premiums that we cede are deferred and recorded as earned premiums on a pro rata basis over the terms of the contracts. We estimate loss amounts recoverable from our reinsurers based on the reinsurance policy terms.
Net income per common share is based on the weighted average number of common shares outstanding during each of the respective years. We calculate net income per common share (diluted) assuming the exercise or conversion of share-based awards using the treasury stock method.
We grant qualified and nonqualified share-based compensation under authorized plans. The stock options generally vest on a graded scale over three years following the date of grant and are exercisable over 10-year periods.
There were no subsequent events requiring adjustment to the consolidated financial statements or disclosure.
In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810) - Amendments to the Consolidation Analysis. ASU 2015-02 makes amendments to the current consolidation guidance, focusing mainly on the investment management industry; however, entities across all industries may be impacted. The effective date of ASU 2015-02 was for interim and annual reporting periods beginning after December 15, 2015. The company adopted this ASU and it did not have a material impact on our company’s consolidated financial position, cash flows or results of operations.
classification and measurement of investments in equity securities and the presentation of certain fair value changes for financial liabilities measured at fair value. The effective date of ASU 2016-01 is for interim and annual reporting periods beginning after December 15, 2017. The ASU has not yet been adopted. Management is currently evaluating the impact on our company’s consolidated financial position, cash flows and results of operations.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The main provision of ASU 2016-02 requires the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. The effective date of ASU 2016-02 is for interim and annual reporting periods beginning after December 15, 2018. The ASU has not yet been adopted. Management is currently evaluating the impact on our company’s consolidated financial position, cash flows and results of operations.
In March 2016, the FASB issued ASU 2016-07, Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting. ASU 2016-07 eliminates the requirement to retroactively adjust an investment, results of operations, and retained earnings once an investment qualifies for use of the equity method. It requires the equity method investor to add the cost of acquiring the additional interest in the investee to the current basis of the investor's previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting without retroactive adjustment. The effective date of ASU 2016-07 is for interim and annual reporting periods beginning after December 15, 2016. The ASU has not yet been adopted; however, it will not have a material impact on our company's consolidated financial position, cash flows or results of operations.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 amends previous guidance on the impairment of financial instruments by adding an impairment model that allows an entity to recognize expected credit losses as an allowance rather than impairing as they are incurred. The new guidance is intended to reduce complexity of credit impairment models and result in a more timely recognition of expected credit losses. The effective date of ASU 2016-13 is for interim and annual reporting periods beginning after December 15, 2019. The ASU has not yet been adopted. Management is currently evaluating the impact on our company’s consolidated financial position, cash flows and results of operations.
The net unrealized investment gains in our fixed-maturity portfolio at December 31, 2016, are primarily the result of the continued low interest rate environment that increased the fair value of our fixed-maturity portfolio. Our commercial mortgage-backed securities had an average rating of Aa1/AA at December 31, 2016 and 2015. The seven largest net unrealized investment gains in our common stock portfolio are from JP Morgan Chase & Co. (NYSE:JPM), Exxon Mobil Corporation (NYSE:XOM), Honeywell International Incorporated (NYSE:HON), BlackRock Inc. (NYSE:BLK), Microsoft Corporation (Nasdaq:MFST), Johnson and Johnson (NYSE:JNJ), and The Procter & Gamble Company (NYSE:PG), which had a combined gross unrealized gain of $698 million. At December 31, 2016, JP Morgan Chase & Co. was our largest single equity holding with a fair value of 3.8 percent of our publicly traded common equities portfolio and 1.3 percent of the total investment portfolio.
At December 31, 2016, fixed-maturity investments with amortized cost of $70 million and fair value of $72 million were on deposit with various states in compliance with regulatory requirements. At December 31, 2015,
The following table provides investment income, realized investment gains and losses, and the change in unrealized investment gains and losses:
The fair value hierarchy gives the highest priority to quoted prices with readily available independent data in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable market inputs (Level 3). When various inputs for measurement fall within different levels of the fair value hierarchy, the lowest observable input that has a significant impact on fair value measurement is used. Our valuation techniques have not changed from those used at December 31, 2015, and ultimately management determines fair value. Financial instruments reported at fair value in our consolidated financial statements are categorized based upon the following characteristics or inputs to the valuation techniques:
Each financial instrument that was deemed to have significant unobservable inputs when determining valuation is identified in the following tables by security type with a summary of changes in fair value for the years ended December 31, 2016 and 2015. Total Level 3 assets continue to be less than 1 percent of financial assets measured at fair value in the consolidated balance sheets. Assets presented in the table below were valued based primarily on broker/dealer quotes for which there is a lack of transparency as to inputs used to develop the valuations. Transfers into Level 3 included situations where a fair value quote was not provided by the company's nationally recognized pricing vendor and as a result the price was stale or had been replaced with a broker quote where the inputs had not been corroborated to be market observable resulting in the security being classified as Level 3. Transfers out of Level 3 included situations where a broker quote was used in the prior period and a fair value quote
became available from the company's pricing vendor in the current period. The quantitative detail of these unobservable inputs is neither provided nor reasonably available to us.
Fair values for deferred annuities were calculated based upon internally developed models because active markets and observable inputs do not exist. To determine the fair value, we made the following significant assumptions: (1) the discount rates used to calculate the present value of expected payments are the risk-free spot rates plus an A3 rated bond spread for financial issuers at December 31, 2016 and 2015, to account for nonperformance risk; (2) the rate of interest credited to policyholders is the portfolio net earned interest rate less a spread for expenses and profit; and (3) additional lapses occur when the credited interest rate is exceeded by an assumed competitor credited rate, which is a function of the risk-free rate of the economic scenario being modeled.
Fair values for structured settlements were calculated based on internally developed models which assume the discount rates used to calculate the present value of expected payments are the risk-free spot rates plus an A3 rated bond spread for financial issuers at December 31, 2016 and 2015, to account for nonperformance risk. The structured settlements were classified as Level 2 as an active market does not exist, but fair value is based on observable inputs.
for commercial umbrella coverage improved slightly better than expected. Therefore, estimated ultimate losses were lowered. Our commercial auto line experienced $31 million of adverse development due to higher loss cost effects in recent accident years, resulting in an increase of our reserve estimate for claims that have not yet been settled. We believe we were slow to recognize some of the higher loss cost effects.
During 2014, we experienced $98 million of favorable development on prior accident years including $57 million of favorable development in commercial lines, $12 million of favorable development in personal lines and
$29 million of favorable development in excess and surplus lines. Favorable development in 2014 was $49 million less than in 2013, largely due to the change in prior accident years before catastrophes. We recognized favorable reserve development of $51 million for the workers’ compensation line, $34 million for the commercial property line and $14 million for the homeowner line, due to reduced uncertainty of prior accident year loss and loss expense for these lines. Our commercial casualty line experienced $5 million of adverse development due to an increase in its paid loss and loss expenses for cumulative accident years three or more years old, resulting in an increase recognized in estimates for IBNR losses and loss expenses for all prior accident years in total compared to 2013 and 2012. Our commercial auto line developed unfavorably by $39 million during 2014 due to higher loss cost effects in recent accident years, resulting in an increase of our reserve estimate for claims that have not yet been settled.
We believe our exposure to asbestos and environmental claims is limited, largely because our reinsurance retention was $500,000 or below prior to 1987. We also were predominantly a personal lines company in the 1960s and 1970s. During the 1980s and early 1990s, commercial lines grew as a percentage of our overall business and our exposure to asbestos and environmental claims grew accordingly. Over that period, we included an asbestos and environmental exclusion in almost all policies or endorsed the exclusion to the policies. We have not engaged in any mergers or acquisitions through which such a liability could have been assumed. We continue to monitor our claims for evidence of material exposure to other mass tort classes such as silicosis, but we have found no such credible evidence to date.
The following table provides a reconciliation of the property casualty incurred losses and allocated loss adjustment expenses (ALAE) development and paid losses and ALAE development information at December 31, 2016.
For all lines of business, the claim counts reported are primarily measured by insurance coverages that are triggered when a loss occurs and a reserve is established. For this purpose, coverages are defined as unique
The following table shows the average annual percentage payout of incurred losses for the homeowner line of business:
$225 million and an additional $50 million accordion feature. Our unsecured revolving credit facility has a term of five years that expires May 13, 2019. We had no compensating balance requirements on short-term debt for either 2016 or 2015. At December 31, 2016, $20 million was drawn on the line of credit. At December 31, 2015,
$35 million was drawn on the line of credit. The interest rate charged on our borrowings on this credit agreement ranged from 1.31 percent to 1.49 percent during 2016 and ranged from 1.07 percent to 1.19 percent during 2015.
Declared cash dividends per share were $1.92, $2.30 and $1.76 for the years ended December 31, 2016, 2015 and 2014, respectively.
Our insurance subsidiary declared dividends to the parent company of $475 million in 2016, $447 million in 2015 and $400 million in 2014. State regulatory requirements restrict the dividends insurance subsidiaries can pay. Dividends must be paid within 30 days of declaration. Generally, the most our insurance subsidiary can pay without prior regulatory approval is the greater of 10 percent of statutory capital and surplus or 100 percent of statutory net income for the prior calendar year. Dividends exceeding these limitations may be paid only with approval of the insurance department of the domiciliary state. During 2017, the total that our insurance subsidiary, which is the parent of all other insurance subsidiaries, may declare in dividends is approximately $469 million.
The table below includes our net written consolidated property casualty insurance premiums on assumed and ceded business:
Our consolidated statements of income include earned consolidated property casualty insurance premiums on
Deferred tax assets are reduced by a valuation allowance when management believes it is more likely than not that some, or all, of the deferred tax assets will not be realized. After considering all positive and negative evidence of taxable income in the carryback and carryforward periods as permitted by law, we believe it is more likely than not that all of the deferred tax asset will be realized. As a result, we have no valuation allowance as of December 31, 2016 and 2015.
As a result of positions either taken in our 2013 through 2015 federal tax returns filed with the IRS or expected to be taken in the 2016 filing, we believe it is more likely than not that our tax liability will be sustained upon examination by the IRS. We therefore carry no amount for unrecognized tax benefits for the years ended 2013 through 2016.
The statute of limitations for federal tax purposes has closed for tax years 2012 and earlier. There are no federal returns under examination and we have not been notified of any upcoming IRS examinations.
In addition to our IRS filings, we file income tax returns with immaterial amounts in various state jurisdictions. The statute of limitations for state income tax purposes has closed for tax years 2012 and earlier. There are no state income returns under examination and we have not been notified of any upcoming state examinations.
The current sources of dilution of our common shares are certain equity-based awards as discussed in Note 17, Share-Based Associate Compensation Plans. The above table includes the number of anti-dilutive share-based awards at year-end 2016, 2015 and 2014. We did not include these share-based awards in the computation of net income per common share (diluted) because their exercise would have anti-dilutive effects.
Excluding cash, during 2016 we held approximately 83 percent of our pension portfolio in domestic common equity investments. The remainder of the portfolio consisted of 10 percent in states, municipalities and taxable political subdivisions fixed-maturity investments and 7 percent in domestic corporate fixed-maturity investments. Our common equity portfolio consisted of 22 percent in the information technology sector, 20 percent in the financial sector, 14 percent in the healthcare sector, 10 percent in the consumer staples sector, 10 percent in the consumer discretionary sector and 10 percent in the industrial sector at year-end 2016. No additional sectors accounted for 10 percent or more of our common equity portfolio balance at year-end 2016.
Investments in securities are valued based on the fair value hierarchy outlined in Note 3, Fair Value Measurements. The pension plan did not have any liabilities carried at fair value during the years ended December 31, 2016 and 2015. There have been no transfers between Level 1 and Level 2 for the years ended December 31, 2016 and 2015. The following table shows the fair value hierarchy for those assets measured at fair value on a recurring basis at December 31, 2016 and 2015. Excluded from the table below is cash on hand of $11 million and $21 million at December 31, 2016 and 2015, respectively.
In the ordinary course of conducting business, the company and its subsidiaries are named as defendants in various legal proceedings. Most of these proceedings are claims litigation involving the company's insurance subsidiaries in which the company is either defending or providing indemnity for third-party claims brought against insureds or litigating first-party coverage claims. The company accounts for such activity through the establishment of unpaid loss and loss expense reserves. We believe that the ultimate liability, if any, with respect to such ordinary-course claims litigation, after consideration of provisions made for potential losses and costs of defense, is immaterial to our consolidated financial condition, results of operations and cash flows.
As of December 31, 2016, we had $26 million of unrecognized total compensation cost related to nonvested stock options and restricted stock unit awards. That cost will be recognized over a weighted-average period of 1.8 years.
Expected volatility is based on our stock price over a historical period that approximates the expected term.
Service-based restricted stock units granted to associates are valued at fair value of the shares on the date of grant less the present value of the dividends that holders of restricted stock units do not receive on the shares underlying the restricted stock units during the vesting period. Service-based restricted stock units generally cliff vest three years after the date of grant. During 2016, we also granted restricted stock units which vest on a
We have performance-based awards that vest on the first day of March after a three-calendar-year performance period. These awards vest according to the level of three-year total shareholder return achieved compared with a peer group over a three-year performance period with payouts ranging from 0 to 200 percent for awards granted in 2014, 2015 and 2016. Three-year total shareholder return is calculated by using annualized total return of a stock to an investor due to capital gain appreciation plus reinvestment of all dividends.
For the three-year performance period ended December 31, 2016, our total shareholder returned exceeded five of our nine peers. We expect payout of these shares at the target level to occur in March of 2017. During 2016, we issued 25,461 shares of performance-based restricted stock units at the threshold-level performance hurdle for the three-year performance period ended December 31, 2015, as our total shareholder return exceeded four of
Expected volatility is based on each company's historical volatility using daily stock price observations.
Other revenues are primarily finance income and, beginning in 2015, earned premiums of Cincinnati Re.
Income or loss before income taxes for each segment is reported based on the nature of that business area’s operations: