When looking at our longer-term objectives, we see three primary performance drivers for our value creation ratio:
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 95.1 percent over the five-year period 2014 through 2018, near the more favorable end of the performance target range. Performance as measured by the combined ratio is discussed in Consolidated Property Casualty Insurance Results. Our statutory combined ratio averaged 94.7 percent over the five-year period 2014 through 2018, compared with an estimated 99.9 percent for the property casualty industry, with 2018 representing industry data reported through the first nine months of 2018. The industry’s ratio again excludes its mortgage and financial guaranty lines of business.
Investment contribution - We believe our investment philosophy and initiatives can drive investment income growth and lead to a total return on our equity investment portfolio over a five-year period that exceeds the five-year total return of the S&P 500 Index.
Investment income growth, on a pretax basis, had a compound annual growth rate of 3.2 percent over the five-year period 2014 through 2018.
Over the five years ended December 31, 2018, our equity portfolio compound annual total return was 8.4 percent compared with a compound annual total return of 8.5 percent for the Index. Our equity portfolio favors larger-capitalization, high-quality, dividend growing stocks with a slight value orientation. In recent years, returns for this type of stocks have generally lagged the broader market. For the year 2018, our annual equity portfolio total return was negative 3.3 percent, compared with negative 4.2 percent for the Index.
Total investments decreased by 2 percent during 2018 on a fair value basis, with a decrease in our securities portfolio valuation that offset a 4 percent increase in its cost basis. Entering 2019, we believe the portfolio continues to be well diversified and is well positioned to withstand short-term fluctuations. We discuss our investment strategy in Item 1, Investments Segment, and results for the segment in Investments Results. Total assets rose less than 1 percent. Shareholders’ equity decreased by 5 percent and book value per share decreased by 4 percent, for reasons discussed in the preceding Executive Summary.
The amount of our debt obligations increased by $9 million in 2018, compared with 2017. Our 9.5 percent ratio of debt to total capital (debt plus shareholders’ equity) at year-end 2018 increased by 0.5 percentage points compared with the prior-year ratio.
Our property casualty insurance operations generated underwriting profits for each of the three years ending in 2018. The $58 million improvement in 2018, compared with 2017, included a $7 million increase in losses from natural catastrophe events and and $48 million more benefit from net favorable reserve development on prior accident years. The $114 million decrease in 2017, compared with 2016, included a $4 million increase in losses from natural catastrophe events and less benefit from net favorable reserve development on prior accident years.
We measure property casualty underwriting profitability primarily by the combined ratio. Our combined ratio measures the percentage of each earned premium dollar spent on claims plus all expenses related to our property casualty operations, all on a pretax basis. A lower ratio indicates more favorable results and better underlying performance. A ratio below 100 percent represents an underwriting profit. Initiatives to improve our combined ratio are discussed in Item 1, Our Business and Our Strategy, Strategic Initiatives. In 2018, 2017 and 2016, favorable development on reserves for claims that occurred in prior accident years helped offset other incurred losses and loss expenses. Reserve development is discussed further in Property Casualty Loss and Loss Expense Obligations and Reserves. Losses from weather-related catastrophes are another important item influencing the combined ratio and are discussed along with other factors in Financial Results for our property casualty business and related segments.
Our life insurance segment reported an $8 million profit in 2018 and a $1 million loss in 2017. 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, investment gains from the life insurance investment portfolio are also included in our investments segment results.
Drive premium growth - Implementation of these initiatives is intended to further penetrate each market we serve through our independent agencies. Strategies aimed at specific market opportunities, along with service enhancements, can help our agents grow and increase our share of their business. Premium growth initiatives also include expansion of Cincinnati Re. Diversified growth also may reduce variability of losses from weather-related catastrophes.
We establish loss and loss expense reserves for our property casualty insurance business as balance sheet liabilities. Unpaid loss and loss expenses are the estimated amounts necessary to pay for and settle all outstanding insured claims, including incurred but not reported (IBNR) claims. These reserves account for unpaid loss and loss expenses as of a financial statement date.
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. 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.
The application of our impairment policy resulted in other-than-temporary impairment (OTTI) charges that reduced our income before income taxes by $5 million in 2018, $9 million in 2017 and $2 million in 2016. OTTI losses represent noncash charges to income and are reported as investment losses.
Our internal investment portfolio managers monitor their assigned portfolios. If a fixed-maturity security is valued below amortized cost, the portfolio managers undertake additional reviews. Such declines often occur in conjunction with events taking place in the overall economy and market, combined with events specific to the industry or operations of the issuing organization. Managers review quantitative measurements such as a declining trend in fair value, the extent of the fair value decline and the length of time the value of the security has been depressed, as well as qualitative measures such as pending events, credit ratings and issuer liquidity. We are even more proactive
when these declines in valuation are greater than might be anticipated when viewed in the context of overall economic and market conditions. We provide information about valuations of our invested assets in Item 8, Note 2 of the Consolidated Financial Statements.
All fixed-maturity securities valued below 100 percent of amortized cost are reported to the asset impairment committee for evaluation. When evaluating for OTTI, the committee considers the company’s intent and ability to retain a security for a period adequate to recover its cost.
Fixed-security 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 fixed-maturity securities fair valued in a continuous loss position at year-end 2018 in Item 7A, Application of Asset Impairment Policy.
At December 31, 2018, 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 benefit obligation at year-end 2018 for our qualified plan were a 4.34 percent discount rate and rates of compensation increases ranging from 2.25 percent to 3.25 percent. To determine the discount rate, a theoretical settlement portfolio of high-quality, rated corporate bonds was chosen to provide payments approximately matching the plan’s projected benefit payments. A single interest rate was determined, resulting in a discounted value of the plan’s benefit payments that equates to the market value of the selected bonds. The discount rate is reflective of current market interest rate conditions and our plan's liability characteristics.
Key assumptions used in developing the 2018 net pension expense for our qualified plan were a 3.73 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 2018, the net pension expense was $5 million. In 2019, we expect the net pension expense to be approximately $3 million.
The fair value of the plan assets exceeded the accumulated benefit obligation by $21 million and $23 million at year-end 2018 and 2017, respectively. The fair value of the plan assets equaled the projected plan benefit obligation at year-end 2018 and was $6 million less than the projected plan benefit obligation at year-end 2017, respectively. Market conditions and interest rates significantly affect future assets and liabilities of the pension plan.
We measure profit or loss for our commercial lines, personal lines, excess and surplus lines and life insurance segments based upon underwriting results (profit or loss), which represent net earned premium less loss and loss expenses, or contract holders’ benefits incurred, and underwriting expenses on a pretax basis. We also evaluate results for our consolidated property casualty insurance operations. That is the total of our standard market segments (commercial lines and personal lines), our excess and surplus lines insurance segment and our reinsurance assumed operations. For analysis of our consolidated property casualty insurance results, it is important to include our reinsurance assumed operations earned premiums, loss and loss expenses and also underwriting expenses reported as Other. Underwriting results and segment pretax operating income are not substitutes for net income determined in accordance with GAAP.
Premiums - Agency renewal written premiums rose $160 million in 2018 and represented approximately 80 percent of the 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.
Combined ratio - The 2018 combined ratio improved by 1.1 percentage points compared with 2017, including a 0.1 percentage-point decrease in the ratio for natural catastrophe losses. The 2018 ratio for current accident year losses and loss expenses before catastrophes increased by 0.4 percentage points, in part due to an increase in commercial lines large losses for new losses above $1 million described below, and partially offset what we believe are improvements to some of our loss experience due to recent-year initiatives to improve pricing precision and claims and loss control practices. The remainder of the 2018 combined ratio decrease included 1.2 percentage-points more benefit in the ratio for prior accident year losses and loss expenses before catastrophes. We further discuss ratios related to reserve development in the sections that follow the Catastrophe Losses Incurred table below.
Most of the incurred losses and loss expenses shown in the consolidated property casualty insurance results three-year highlights table are for the respective current accident years, with reserve development on prior accident years shown separately. Since less than half of our consolidated property casualty current accident year incurred losses and loss expenses represents net paid amounts, the majority represents reserves for our estimate of ultimate losses and loss expenses. These reserves develop over time, and we re-estimate previously reported reserves as we learn more about the development of the related claims. The table below illustrates that development. For example, the 68.9 percent accident year 2017 loss and loss expense ratio reported as of December 31, 2017, developed favorably by 1.3 percentage points to 67.6 percent due to claims settling for less than previously estimated, or due to updated reserve estimates for unpaid claims, as of December 31, 2018. Accident years 2017 and 2016 have both developed favorably, as indicated by the progression over time for the ratios in the table.
Catastrophe loss trends, discussed above, accounted for some of the movement in the current accident year loss and loss expense ratio for 2018, compared with 2017. Catastrophe losses added 7.4 percentage points in 2018, 7.8 points in 2017 and 7.7 points in 2016 to the respective consolidated property casualty current accident year loss and loss expense ratios in the table above.
Consolidated property casualty commission expenses rose $45 million, or 5 percent, in 2018, with profit-sharing commissions for agencies increasing by $4 million. The 2018 ratio of commission expenses as a percent of earned premiums increased by 0.2 percentage points, compared with 2017. The 2018 ratio for other underwriting expenses decreased by 0.4 percentage-points compared with 2017, as earned premiums rose at a faster pace than other underwriting expenses. During 2018, we continued to carefully manage expenses while also making strategic investments that include enhancement of underwriting expertise.
For only those commercial lines policies that did expire and were then renewed during 2018, we estimate that the average price increase was near the low end of the mid-single-digit range, slightly higher than full-year 2017. During 2018, we continued to further segment our commercial lines policies, emphasizing identification and retention of policies we believed had relatively stronger price adequacy. Conversely, we continued to seek more aggressive renewal terms and conditions on policies we believed had relatively weaker pricing, in turn retaining fewer of those policies.
In 2018, our commercial lines new business premiums written by our agencies increased $20 million, or 5 percent, compared with 2017. New business premium volume in recent years has been significantly influenced by new agency appointments. Agencies appointed since the beginning of 2017 produced commercial lines new business written premiums of $40 million, in aggregate, during 2018, up $25 million from what they produced during 2017. All other agencies contributed the remaining $377 million, down $5 million from the $382 million they produced in 2017.
Loss and loss expenses include both net paid losses and reserve changes for unpaid losses as well as the associated loss expenses. Most of the incurred losses and loss expenses shown in the commercial lines insurance segment three-year highlights table are for the respective current accident years, with reserve development on prior accident years shown separately. Since less than half of our commercial lines insurance segment current accident year incurred losses and loss expenses represents net paid amounts, the majority represents reserves for our estimate of ultimate losses and loss expenses. These reserves develop over time, and we re-estimate previously reported reserves as we learn more about the development of the related claims. The table below illustrates that development. For example, the 66.8 percent accident year 2017 loss and loss expense ratio reported as of December 31, 2017, developed favorably by 2.2 percentage points to 64.6 percent due to claims settling for less than previously estimated, or due to updates to reserve estimates for unpaid claims, as of December 31, 2018. Accident years 2017 and 2016 for the commercial lines insurance segment have both developed favorably, as indicated by the progression over time of the ratios in the table.
Catastrophe losses, as discussed in Consolidated Property Casualty Insurance Results, explain some of the movement in the current accident year loss and loss expense ratio for accident year 2018, compared with 2017. Catastrophe losses added 6.5 percentage points in 2018, 5.7 points in 2017 and 7.3 points in 2016 to the respective commercial lines current accident year loss and loss expense ratios in the table above.
Commercial lines reserve development on prior accident years of $157 million in 2018 continued to net to a favorable amount and provided a larger benefit than the $73 million recognized in 2017. The $84 million net increase in 2018 included $58 million from our commercial casualty line of business. Most of our commercial lines net favorable reserve development on prior accident years recognized during 2018 occurred in our commercial casualty, commercial property and workers’ compensation lines of business. Favorable development recognized during 2017 was mostly from our commercial property and workers’ compensation lines of business. Favorable development recognized during 2016 was mostly from our commercial casualty, commercial property and workers’ compensation lines 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.
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.
Commercial lines commission expenses as a percent of earned premiums increased in 2018, compared with 2017, reflecting an increase in the ratio for agency commissions other than profit-sharing. The ratio for 2017 decreased slightly compared with 2016, reflecting a decrease in the ratio for agency commissions other than profit-sharing. In 2018, other underwriting expenses as a percent of earned premiums decreased compared with 2017, as earned premiums rose at a faster pace than other underwriting expenses. In 2017, the ratio rose, compared with 2016 as strategic investments that include enhancement of underwriting expertise offset the favorable effects of higher earned premiums and ongoing expense management efforts.
We intend to keep marketing our products to a broad range of business classes with a package approach, while also continuing to improve our pricing precision and further segmenting among commercial lines policies. We intend to maintain our underwriting selectivity and carefully manage our rate levels as well as our programs that seek to accurately match exposures with appropriate premiums. We will continue to evaluate each risk individually and to make decisions about rates, the use of three-year commercial policies and other policy conditions on a case-by-case basis, even in lines and classes of business that are under competitive pressure. For our commercial auto line of business, we will continue to improve premium rate classification and the use of other rating variables in risk selection and pricing. We believe that our initiatives to improve pricing precision and lower loss costs will continue to benefit commercial lines profitability during 2019, and that recent-year premium growth initiatives will continue to grow commercial lines premiums at a healthy pace.
Personal auto, representing 46 percent of 2018 earned premiums for our personal lines insurance segment, was the only major line of business in that segment with a 2018 total loss and loss expense ratio significantly higher than we desired. During 2018, our personal auto policies experienced estimated premium rate increases averaging in the high-single-digit range. We believe the rate increases and other actions to improve pricing precision and reduce loss costs will improve future profitability.
Our personal lines statutory combined ratio was 101.2 percent in 2018, compared with 102.4 percent in 2017 and 100.8 percent in 2016. The contribution of catastrophe losses to our personal lines statutory combined ratio was 9.4 percentage points in 2018, 10.9 percentage points in 2017 and 9.4 percentage points in 2016.
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 1 percent in 2018, while premiums for the remaining states, including our newer areas of operation, increased 14 percent in aggregate.
Personal lines new business written premiums grew $4 million, or 2 percent, during 2018, compared with 2017. That growth was driven by policies from high net worth clients of our agencies. Personal lines new business written premiums from our high net worth policies totaled approximately $71 million for 2018, compared with approximately $58 million for 2017, an increase of $13 million. New business written premiums for the part of our personal lines segment we sometimes refer to as middle market business decreased $9 million in 2018, reflecting underwriting discipline. Some of what we report as new business came from accounts that were not new to our agents. We believe our agents’ seasoned accounts tend to be priced more accurately than business that may be less familiar to them.
Other written premiums primarily consist of premiums that are ceded to reinsurers and lower our net written premiums. An increase in ceded premiums reduced net written premium growth by $2 million for 2018, compared with 2017.
Loss and loss expenses include both net paid losses and reserve changes for unpaid losses as well as the associated loss expenses. Most of the incurred losses and loss expenses shown in the personal lines insurance segment three-year highlights table are for the respective current accident years, with reserve development on prior accident years shown separately. Since approximately two-thirds of our personal lines current accident year incurred losses and loss expenses represent net paid amounts, the remaining one-third represents reserves for our estimate of ultimate losses and loss expenses. These reserves develop over time, and we re-estimate previously reported reserves as we learn more about the development of the related claims. The table below illustrates that development. For example, the 75.2 percent accident year 2017 loss and loss expense ratio reported as of December 31, 2017, developed unfavorably by 0.8 percentage points to 76.0 percent due to claims settling for more than previously estimated, or due to updated reserve estimates for unpaid claims, as of December 31, 2018. Accident year 2016 for the personal lines insurance segment developed favorably during 2017 and then developed unfavorably by a relatively small amount during 2018, as indicated by the progression over time for the ratios in the table.
Catastrophe losses, as discussed in Consolidated Property Casualty Insurance Results, explain much of the movement in the current accident year loss and loss expense ratio for accident year 2018, compared with accident year 2017. Catastrophe losses added 9.1 percentage points in 2018, 11.2 points in 2017 and 9.7 points in 2016 to the respective personal lines current accident year loss and loss expense ratios in the table above. Personal lines catastrophe losses for 2018 resulted in a ratio below our 11.4 percent 10-year annual average for personal lines that included 22.8 percent for 2011. Our personal lines catastrophe loss ratios for 2018 and 2016 reflect an average closer to our 10.4 percent average over the same 10-year period, excluding the unusually high ratio for 2011. Personal lines catastrophe losses are inherently volatile, as discussed above and in Consolidated Property Casualty Insurance Results.
Our high net worth initiative, along with various other actions to improve performance in our personal lines insurance segment, is discussed in greater detail in Personal Lines Insurance Results and also in Item 1, Our Business and Our Strategy, Strategic Initiatives and Our Segments, Personal Lines Insurance Segment. Our personal lines pricing trends need to exceed loss trends to improve personal lines insurance segment profitability, thereby helping to achieve our corporate performance objectives.
Premiums - Earned premiums and net written premiums continued to grow during 2018, driven by higher renewal written premiums that included average renewal estimated price increases in the low-single-digit range. New business written premiums grew 3 percent in 2018, reflecting a highly competitive market.
New business written premiums rose $2 million, as additional marketing efforts offset the effects of a highly competitive market, particularly for larger policies. Other written premiums in 2018 reduced net written premium growth by $2 million more than in 2017. Other written premiums are primarily premiums that are ceded to reinsurers and lower our net written premiums.
Catastrophe losses, as discussed in Consolidated Property Casualty Insurance Results, explain some of the movement in the current accident year loss and loss expense ratio for accident year 2017, compared with 2016. Catastrophe losses added 1.1 percentage points in 2018, 1.1 percentage points in 2017 and 1.6 percentage points in 2016 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 2018 as $24 million was recognized, compared with $29 million in 2017. Approximately three-fourths of the 2018 favorable development was for accident years 2017, 2016 or 2015, in aggregate, and was primarily due to lower-than-anticipated loss emergence on known claims.
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, using Item 8, Note 4 of the Consolidated Financial Statements. For example, for accident years 2013, 2012 and 2011, in aggregate, after subtracting cumulative paid amounts from incurred amounts at December 31, 2013, reserves for estimated unpaid losses, plus the portion of loss expenses known as ALAE, equaled $129 million. For those same accident years, at December 31, 2018, the reserve estimate for the remaining unpaid amount equaled $11 million. The inherent uncertainty in estimating reserves is discussed in
In 2018, total large losses incurred of $4 million, net of reinsurance, matched 2017. The ratio for 2018 large losses as a percent of earned premiums decreased by 0.2 percentage points. That ratio for 2017 increased by 0.5 points, compared with 2016. Our analysis indicated no unexpected concentration of these losses and reserve increases by risk category, 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.
Profitability - The life insurance segment frequently reports only a small profit or loss because most of its investment income is included in the investments segment results. We include only investment income credited to contract holders (interest assumed in life insurance policy reserve calculations) in life insurance segment results. The segment reported a $8 million profit in 2018, following a loss of $1 million in 2017 and a profit of $1 million in 2016. It has averaged a profit of less than $1 million over the past five years.
Over the past several years, we have worked to maintain a portfolio of simple, yet competitive, products primarily under the LifeHorizons banner. Our product development efforts emphasize death benefit protection and guarantees. Distribution expansion within our property casualty insurance agencies remains a high priority. Our 35 life field marketing representatives work in partnership with our 142 property casualty field marketing representatives. Approximately 59 percent of our term and other life insurance product premiums were generated through our property casualty insurance agency relationships.
Underwriting expenses incurred, net of deferred acquisition costs, accounted for 21.9 percent of 2018 total benefits and expenses compared with 23.9 percent in 2017 and 23.6 percent in 2016. Expenses in 2018 decreased 5 percent, compared with 8 percent growth in earned premiums. Expenses decreased in 2018 due to the impact of unlocking of actuarial assumptions for our universal life insurance contracts. In 2017, the percentage increase for expenses was 2 percentage points more than growth in earned premiums.
Principle-based reserves had a noticeable impact on our statutory operating results and we look forward to the positive statutory results accelerating into 2019. Such results will allow us more options with respect to capital management.
We continue to view the new tax environment as very favorable. We look forward to competing in 2019, and beyond, on a more level playing field from a tax perspective, in what is still a very competitive term market.
Interest rates and regulatory action are the biggest sources of risk for our segment of the life insurance industry. The volatility in bond yields in the fourth quarter of 2018 highlight this risk. If rates revert to lower levels and remain there, companies will be motivated to look for higher premium to offset lower investment income. From a regulatory standpoint, there is a risk of overly aggressive suitability rules creeping over into the life insurance domain from the current focus on annuities. Such activity could be a significant headwind to future life insurance sales.
Investment income - Pretax investment income grew $10 million, or 2 percent, in 2018, primarily due to an increase from dividends. Dividend income reflected rising dividend rates and net purchases of equity securities from available funds. Interest income for 2018 matched 2017, as net purchases of fixed-maturity securities offset the continuing effects on bond yields of the low interest rate environment. Pretax investment income rose 2 percent in 2017, reflecting increases in both dividend income and interest income. Average yields in the investment income table below are based on the average invested asset and cash amounts indicated in the table using fixed-maturity securities valued at amortized cost and all other securities at fair value.
Interest income of $445 million in 2018 matched 2017. The average fixed-maturity pretax yield declined by approximately 17 basis points but was offset by a larger average fixed-maturity portfolio that rose 4 percent on an amortized cost basis. Interest income increased 1 percent in 2017 when that yield declined by approximately 18 basis points while the portfolio rose 5 percent on an amortized cost basis.
We discussed our portfolio strategies in Item 1, Investments Segment. We discuss risks related to our investment income and our fixed-maturity and equity investment portfolios in Item 7a, Quantitative and Qualitative Disclosures About Market Risk.
Investment gains and losses are recognized on the sales of investments, for certain changes in fair values of securities even though we continue to hold the securities or as otherwise required by GAAP. New accounting requirements adopted in 2018 resulted in reporting, through net income, the change in fair value for equity securities still held, as disclosed in Note 1, Summary of Significant Accounting Policies, and Note 2, Investments. Net investment gains and losses included $404 million of losses in 2018, from the recognition of fair value changes of equity securities still held that prior to 2018 would have been reported in other comprehensive income instead of net income. Change in unrealized gains or losses for fixed-maturity securities are included as a component of other comprehensive income (OCI). Accounting requirements for OTTI charges for the fixed-maturity portfolio are disclosed in Item 8, Note 1, Summary of Significant Accounting Policies. The factors we consider when evaluating impairments are also discussed in Critical Accounting Estimates, Asset Impairment.
Bond prices were under pressure in 2018 as interest rates rose and corporate credit spreads widened. While in recent quarters we have been able to purchase fixed income securities at yields exceeding the average of the existing portfolio, we continue to experience redemptions of higher coupon bonds purchased during and shortly after the financial crisis that we cannot replace in the current market with similar quality and coupon levels.
We continue to focus on portfolio strategies to balance near-term income generation and long-term book value growth. In 2019, 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.
Total revenues in 2018 for our Other operations increased, compared with 2017, primarily due to earned premiums of Cincinnati Re, our reinsurance assumed operation. Other also includes noninvestment operations of the parent company and its commercial leasing and financial services subsidiary, CFC Investment Company. Total expenses for Other also increased in 2018, primarily due to losses and loss expenses and underwriting expenses from Cincinnati Re.
Other loss in the table below represents losses before income taxes. For each year shown, Other loss was largely driven by interest expense from debt of the parent company. Net results of Cincinnati Re were an underwriting loss of approximately $8 million in 2018 and an underwriting loss of approximately $20 million in 2017, reflecting significant amounts of natural catastrophe losses, following a 2016 underwriting profit of approximately $8 million.
The change in our effective tax rate between years is largely driven by the significant non-recurring income tax benefit recorded during 2017 as a result of enactment of the Tax Cuts and Jobs Act (the “Tax Act”) on December 22, 2017. The 2017 effective tax rate was reduced as a result of the revaluation of our net deferred tax liability to account for the decrease in the federal tax rate from 35 percent to 21 percent. In addition, as a result of adoption of ASU 2016-01 in 2018, the change in our effective tax rate was impacted due to large net unrealized losses included in 2018 income versus only net realized gains included in income for the prior-year periods. Finally, our change in the effective tax rate for the current year included a reduction of 19.9 percent as a result of Internal Revenue Service (“IRS”) approved changes to our tax accounting methods, primarily related to the valuation of our tax base unpaid losses.
The Tax Act, which took effect on January 1, 2018, lowered the U.S. corporate income tax rate from a top marginal rate of 35 percent to a flat rate of 21 percent and changed the amount of dividends received deduction and proration. For tax years after 2017, for our property casualty insurance subsidiaries, approximately 75 percent of interest from tax-advantaged, fixed-maturity investments and approximately 40 percent of dividends from qualified equities are exempt from federal tax after applying proration. For our noninsurance companies, the dividend received deduction exempts 50 percent of dividends from qualified equities.
Our effective tax rate reconciliation is found in Item 8, Note 11 of the Consolidated Financial Statements.
At December 31, 2018, the parent company had $2.478 billion in cash and marketable securities, providing strong liquidity to fund cash outflows, as needed. The payment of dividends to shareholders is largely based upon receiving subsidiary dividends. Alternatively, we could sell investments or use our line of credit to support the dividend payment.
The parent company’s primary sources of cash inflows are dividends from our insurance subsidiary, investment income and sale proceeds from investments. The parent company’s cash outflows are primarily interest and principal payments on long- and short-term debt, dividends to shareholders, common stock repurchases and general operating expenses. The table below shows a summary, by the direct cash flow method, of the major sources and uses of cash flow of the parent company.
Dividends received from the subsidiary in 2018 were $35 million more than 2017 while shareholder’s dividend payments decreased by $64 million, largely as a result of a special dividend declared and paid in 2017. We expect 2019 parent company sources of cash flow to be similar to 2018. Use of liquidity for share repurchases are discretionary depending on cash availability and capital management decisions. The majority of expenditures for the parent company have been fairly consistent during the last three years, and we expect future expenditures to remain consistent except for the acquisition of MSP Underwriting Limited (MSP) as disclosed in Item 8, Note 1 of the Consolidated Financial Statements. We entered into a foreign exchange forward contract that provides for an economic hedge for the agreed upon purchase price. The acquisition transaction is expected to close during the first quarter of 2019.
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, 2018, 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.
Cash in excess of operating requirements is invested in fixed-maturity and equity securities. Cash generated from investment income provides an important investment contribution to cash flow and liquidity. The sale of investments could provide an additional source of liquidity at either the parent company or insurance subsidiary level, if required. In addition to possible sales of investments, proceeds of call or maturities of fixed-maturity securities also can provide liquidity. During the five-year period beginning in 2019, fair value of $3.504 billion, or 32.8 percent, of our fixed-maturity portfolio is scheduled to mature. At December 31, 2018, we had $5.742 billion of common stock securities, with $2.233 billion, or 38.9 percent, held by the parent company.
At December 31, 2018, we had a $225 million line of credit with commercial banks, with $32 million borrowed. That line of credit had a $24 million balance at December 31, 2017. During 2018, we borrowed a net $8 million as part of routine cash management. That line of credit was due to expire on May 13, 2019. Effective February 4, 2019, we amended our unsecured revolving line of credit to $300 million with an accordion feature giving us the option to double that amount under the same terms and conditions. The agreement was extended for five years, amending the expiration to February 4, 2024, with the option of two one-year extensions. Terms and conditions are similar to the former agreement except the net worth covenant has been eliminated and debt-to-total capital maximum is now 35 percent.
Dividends to shareholders - The ability of our company to continue paying cash dividends is subject to factors the board of directors deem relevant. While the board and management believe there is merit to sustaining the company’s long record of dividend increases, our first priority is the company’s financial strength. Over the past 10 years, the company has paid an average of 73 percent of net income as dividends. Through 2018, the board had increased our cash dividend for 58 consecutive years. The board decision in February 2019 to increase the dividend demonstrated confidence in the company’s strong capital, liquidity, financial flexibility and initiatives to grow earnings.
At December 31, 2018, we estimated our future contractual obligations as follows:
At December 31, 2018, we believe our most significant other commitments were:
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 95.1 percent over the five-year period 2014 through 2018, resulting in strong underwriting profits.
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 $427 million increase in total gross reserves was primarily due to a $180 million increase in case loss reserves and a $174 million increase in IBNR loss reserves. Total gross reserves for our commercial casualty line of business rose $161 million, for Cincinnati Re they rose $71 million, for our homeowner line of business they rose $65 million and for our commercial auto line of business they rose $50 million.
We carried $89 million of net loss and loss expense reserves for asbestos and environmental claims and $44 million of reserves for mold claims at year-end 2018, compared with $84 million and $45 million, respectively, for such claims at year-end 2017. The asbestos and environmental claims amounts for each respective year constituted 1.6 percent and 1.7 percent of total net loss and loss expense reserves at these year-end dates.
Reserving data for asbestos and environmental claims has characteristics that limit the usefulness of the methods and models used to analyze loss and loss expense reserves for other claims. Specifically, asbestos and environmental loss and loss expenses for different accident years do not emerge independently of one another as loss development and Bornhuetter-Ferguson methods assume. In addition, asbestos and environmental loss and loss expense data available to date did not reflect a well-defined tail, greatly complicating the identification of an appropriate probabilistic trend family model. At year-end 2018, we used a weighted average of a paid survival ratio method and report year method to estimate reserves for IBNR asbestos and environmental claims. Our exposure to such claims is limited; we believe a weighted average of both methods produces a sufficient level of reserves.
The ranges reflect our assessment of the most likely unpaid loss and loss expenses at year-end 2018 and 2017. However, actual unpaid loss and loss expenses could nonetheless fall outside of the indicated ranges.
Overall favorable development for consolidated property casualty reserves of $167 million in 2018 illustrated the potential for revisions inherent in estimating reserves, especially for long-tail lines such as commercial casualty and workers’ compensation. As noted in Critical Accounting Estimates, Key Assumptions Loss Reserving, our models predict that actual loss and loss expense emergence will differ from projections, and we do not attempt to monitor or identify such normal variations. The table in Property Casualty Loss and Loss Expense Obligations and Reserves shows reserves by segment and lines of business and the components of gross reserves among case, IBNR and loss expense reserves.
Workers’ compensation - We continue to see favorable reserve development, for all prior accident years in aggregate. During 2018, the trend for estimated payments to be made in future calendar years was stable compared to 2017. However, we continue to monitor this line closely, as a sudden increase in trend for future payments has a highly leveraged effect.
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. Further, these estimates are based on mortality, morbidity and lapse assumptions reflective of our recent experience and expectations of future payment obligations.
Our estimates of gross life, annuity and disability obligations do not reflect net recoveries from reinsurance agreements. Ceded life reinsurance receivables were $240 million at year-end 2018. As discussed in 2018 Reinsurance Programs, we purchase reinsurance to mitigate our life insurance risk exposure. At year-end 2018, ceded death benefits represented approximately 36.8 percent of our total gross policy face amounts in force.
A single large loss or an unexpected rise in claims severity or frequency due to a catastrophic event is a risk to the company's liquidity and financial strength. In an effort to control such losses, we limit marketing property casualty insurance in specific geographic areas and monitor our exposure in certain coastal regions. An example of this is the reduction in recent years of our homeowner policies in the southeastern U.S. coastal region. Loss exposures in that area had been identified as a major contributor to our catastrophe probable maximum loss estimates shown in the table below. Those estimates were subsequently reduced, in large part due to less exposure from southeastern U.S. homeowner policies. We also continually review aggregate exposures to huge disasters and purchase reinsurance protection to cover these exposures. For business other than Cincinnati Re, we use the Risk Management Solutions (RMS) and Applied Insurance Research (AIR) models to evaluate exposures to a once-in-a-100-year and a once-in-a-250-year event to help determine appropriate reinsurance coverage programs. In conjunction with these activities, we also continue to evaluate information provided by our reinsurance broker. Examples include deterministic modeling of probable maximum loss contribution from growth in new geographic territories.
To help determine appropriate reinsurance coverage for hurricane, earthquake and tornado/hail exposures, for business other than Cincinnati Re we use the RMS and AIR models to estimate the probable maximum loss from a single event or multiple events occurring in a one-year period. The models are proprietary in nature, and the vendors that provide them periodically update the models, sometimes resulting in significant changes to their estimate of probable maximum loss. As of the end of 2018, both models indicated that a hurricane event represents our largest amount of exposure to losses. The table below summarizes estimated probabilities and the corresponding probable maximum loss from a single hurricane event occurring in a one-year period, for business other than Cincinnati Re, and indicates the effect of such losses on consolidated shareholders’ equity at December 31, 2018. Net losses are net of reinsurance and income taxes, assuming a 21 percent federal tax rate, and assume our 2019 reinsurance programs apply.
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 2019 ceded premium estimate was $12 million, essentially unchanged from the 2018 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 2019 ceded premium estimate was approximately $3 million, essentially unchanged from the 2018 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 2019 ceded premium estimate was $43 million, essentially unchanged from the 2018 estimate. We retain the first $100 million of any loss, and a share of losses up to $600 million, as indicated below:
Beginning in 2013 we added an alternative reinsurance structure to protect against certain catastrophic events, and a similar structure is in place for 2017 through 2019. For certain exposures in the United States, we arranged for the purchase of collateralized reinsurance funded through the issuance of collateralized risk-linked securities, known as catastrophe bonds with Skyline Re Ltd ("Skyline"). The catastrophe bond arrangements generally provide reinsurance coverage for specific types of losses in specific geographic locations. They are generally designed to supplement coverage provided under the property catastrophe treaty. Effective January 2017, we have a catastrophe bond arrangement providing up to $200 million in earthquake reinsurance protection or $80 million in severe convective storm coverage or various combinations of those coverages. It expires in January 2020 and meets the requirements to be accounted for as reinsurance in accordance with the guidance for reinsurance contracts. The earthquake coverage is countrywide, excluding California, and the severe convective storm coverage territory is also countrywide, excluding Florida. The storm coverage provides loss recovery when storm losses for all events in aggregate exceed $190 million, after an $8 million deductible per event.
After reinsurance, and before any applicable benefit from our catastrophe bond, our maximum exposure to a catastrophic event that causes $600 million in covered losses in 2019 would be $125 million, matching our retention for 2018. The largest catastrophe loss event in our history occurred during 2011 from a May 20-27 storm system that included a tornado in Joplin, Missouri, and also significant losses from hail in the Dayton, Ohio, area. Our losses from that storm were estimated at December 31, 2017, to be $226 million before reinsurance.
The Cincinnati Specialty Underwriters Insurance Company has separate property and casualty reinsurance treaties for 2018 through its parent, The Cincinnati Insurance Company. Primary components of the treaties include:
Casualty treaties - The casualty treaty is written on an excess of loss basis and provide limits up to $6 million, which is adequate capacity for the risk profile we insure. A second treaty layer of $5 million excess of $6 million is written to provide coverage for extra contractual obligations or clash exposures. The maximum retention for any one casualty loss is $1 million by Cincinnati Specialty Underwriters. Losses between $1 million and $6 million are reinsured at 100 percent by The Cincinnati Insurance Company.
We also have catastrophe reinsurance coverage on our life insurance operations that reimburses us for covered net losses in excess of $12 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 2018 and 2017. The A.M. Best insurer financial strength ratings are also shown.
The fact that the consummation of the transaction to acquire MSP Underwriting Ltd. and its subsidiaries is subject to closing conditions, one or more of which may not be satisfied, or that the transaction is not consummated for any other reason
Our inability to integrate MSP and its subsidiaries into our on-going operations, or disruptions to our on-going operations due to such integration
Inability to obtain adequate ceded reinsurance on acceptable terms, amount of reinsurance coverage purchased, financial strength of reinsurers and the potential for nonpayment or delay in payment by reinsurers
Events or actions, including unauthorized intentional circumvention of controls, that reduce the company’s future ability to maintain effective internal control over financial reporting under the Sarbanes-Oxley Act of 2002
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, 2018. 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, 2018, 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, 2018. The assessment led management to conclude that, as of December 31, 2018, the company’s internal control over financial reporting was effective based on those criteria.
The Company’s management is responsible for these financial statements, 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 an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
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 1,757 independent insurance agencies with 2,344 reporting locations across 42 states. Other subsidiaries of The Cincinnati Insurance Company include The Cincinnati Life Insurance Company, which markets life insurance and fixed annuities, and The Cincinnati Specialty Underwriters Insurance Company, which offers excess and surplus lines property casualty insurance products. The Cincinnati Insurance Company also conducts the business of our reinsurance assumed operations, Cincinnati ReSM.
Impairment charges for fixed maturities are recorded for other-than-temporary declines in value if fair value is below amortized cost and, in the asset impairment committee’s judgment, the fair value is not expected to be recouped within a designated recovery period. Our invested asset impairment policy also states that fixed maturities below their amortized cost that the company (1) intends to sell or (2) more likely than not will be required to sell before recovery of their amortized cost basis are deemed to be other-than-temporarily impaired (OTTI). The amortized cost of any such securities is reduced to fair value as the new cost basis, and a realized loss is recorded in the period in which it is recognized. When these two criteria are not met, and the company believes that full collection of interest and/or principal is not likely, we determine the net present value of future cash flows by using the effective interest rate implicit in the security at the date of acquisition as the discount rate and compare that amount with the amortized cost and fair value of the security. The difference between the net present value of the expected future cash flows and amortized cost of the security is considered a credit loss and recognized as a realized loss in the period in which it occurred. The difference between the fair value and the net present value of the cash flows of the security, the noncredit loss, is recognized in other comprehensive income as an unrealized loss. We had no fixed-maturity securities with a noncredit loss for the years ended 2018, 2017 and 2016.
Included within our other invested assets were $33 million and $31 million of life policy loans, $60 million and $35 million of private equity investments and $30 million and $37 million of real estate through direct property ownership and development projects in the United States at December 31, 2018 and 2017, respectively. 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 and real estate development investments.
We establish a liability for traditional long-duration contracts as we receive premiums. The amount of this liability is the present value of future expenses and benefits less the present value of future net premiums. Net premium is the portion of gross premium required to provide for all expenses and benefits. We estimate future expenses and benefits and net premium using assumptions for expected expenses, mortality, morbidity, withdrawal rates and
investment income. We include a provision for deviation, meaning we allow for some uncertainty in making our assumptions. We establish our assumptions when the contract is issued, and we generally maintain those assumptions for the life of the contract. We use both our own experience and industry experience, adjusted for historical trends, in arriving at our assumptions for expected mortality, morbidity and withdrawal rates. We use our own experience and historical trends for setting our assumption for expected expenses. We base our assumption for expected investment income on our own experience, adjusted for current and future economic conditions.
We carry the assets of separate account BOLIs at fair value. The liabilities on separate account BOLIs primarily are the contract holders’ claims to the related assets and are carried at an amount equal to the contract holders’ account value. At December 31, 2018, the current fair value of the contract holders’ account value exceeded the current fair value of the BOLI invested assets and cash by approximately $3 million. At December 31, 2017, the current fair value of the BOLI invested assets and cash exceeded the current fair value of the contract holders' account value by approximately $29 million. If the BOLI projected fair value were to fall below the value we guaranteed, a liability would be established with a corresponding charge to the company’s earnings.
We calculate deferred income tax liabilities and assets using tax rates in effect when temporary differences in the consolidated financial statement income and taxable income are expected to reverse. We recognize deferred income taxes for numerous temporary differences between our taxable income and consolidated financial statement income and other changes in shareholders’ equity. Such temporary differences relate primarily to unrealized gains and losses on investments and differences in the recognition of deferred acquisition costs, unearned premiums, insurance reserves and basis differences in the carrying value of investments held. We charge deferred income taxes associated with balances that impact other comprehensive income, such as unrealized appreciation and depreciation of fixed-maturity investments, to shareholders’ equity in accumulated other comprehensive income (AOCI). We charge deferred taxes associated with other differences to income.
We sponsor a defined benefit pension plan that was modified during 2008. We closed entry into the pension plan, and only participants 40 years of age or older could elect to remain in the plan. Our pension expense is based on certain actuarial assumptions and also is composed of several components that are determined using the projected unit credit actuarial cost method. Refer to Note 13, Employee Retirement Benefits, for more information about our defined benefit pension plan.
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. We grant service-based restricted stock units that cliff vest three years after the date of grant as well as service-based restricted stock units that vest ratably over the three-year vesting term. We also grant performance-based restricted stock units that vest if certain market conditions are attained. In 2018, the CFC compensation committee approved share-based awards including incentive stock options, nonqualified stock options, service-based restricted and performance-based restricted stock units. See Note 17, Share-Based Associate Compensation Plans, for further details.
Related to the pending acquisition of MSP Underwriting Limited, on January 3, 2019, the company entered into a foreign exchange forward contract, which provides for an economic hedge between the agreed upon purchase price in GBP and currency fluctuations between the U.S. dollar and GBP during the period from that date through February 28, 2019. The acquisition is expected to close during the first quarter of 2019.
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers. ASU 2014-09 requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. Insurance contracts do not fall within the scope of this ASU. The effective date of ASU 2014-09 was for interim and annual reporting periods beginning after December 15, 2017. The company adopted this ASU effective January 1, 2018, and it did not have a material impact on the company's consolidated financial position, cash flows or results of operations.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 revised the accounting related to the 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 was for interim and annual reporting periods beginning after December 15, 2017. The company adopted this ASU on January 1, 2018, and applied it on a modified retrospective basis without prior period amounts restated. As a result of the adoption, $2.503 billion of after-tax unrealized gains on equity securities was reclassified on January 1, 2018, from accumulated other comprehensive income to retained earnings. Results of operations were impacted as changes in fair value of equity securities are now reported in net income instead of reported in other comprehensive income. As a result of the adoption of this ASU, for the year ended December 31, 2018, the net investment loss of $402 million in the consolidated statements of income included a decrease of $404 million from the fair value change of equity securities.
In March 2017, the FASB issued ASU 2017-07, Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Postretirement Benefit Costs. ASU 2017-07 provides guidance on how to present the components of net periodic benefit costs in the income statement for pension plans and other post-retirement benefit plans and allows only the service cost component of net benefit cost to be eligible for capitalization when applicable. The effective date of ASU 2017-07 is for interim and annual reporting periods beginning after December 15, 2017. The company adopted this ASU effective January 1, 2018, and disclosed the line items used in the statements of income to present the service and non-service components of net periodic benefit costs in Note 13, Employee Retirement Benefits, to these consolidated financial statements. The adoption did not have a material impact on our company's consolidated financial position, cash flows or results of operations.
In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting. ASU 2017-09 clarifies when to account for a change to the terms or conditions of a share based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The effective date of ASU 2017-09 was for interim and annual reporting periods, beginning after December 15, 2017, and was applied prospectively. The company adopted this ASU effective January 1, 2018, and it did 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. In November 2018, the FASB issued ASU 2018-19, Codification Improvements to Topic 326. ASU 2018-19 makes narrow-scope amendments to certain aspects of the credit losses standard. These ASU's have 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 2017, the FASB issued ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. ASU 2017-08 amends guidance on the amortization period of premiums on certain purchased callable debt securities. The amendments shorten the amortization period of premiums on certain purchased callable debt securities to the earliest call date. The amendments should be applied on a modified retrospective basis through a cumulative-effect adjustment to beginning retained earnings. The effective date of ASU 2017-08 is for interim and annual reporting periods beginning after December 15, 2018. The ASU has not yet been adopted; however, it is not expected to have a material impact on our company's consolidated financial position, cash flows or results of operations.
In June 2018, the FASB issued ASU 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. ASU 2018-07 expands the scope of Topic 718, Compensation - Stock Compensation, which currently only includes share-based payments issued to employees, to include share-based payments issued to nonemployees for the acquisition of goods and services. The effective date of ASU 2018-07 is for interim and annual reporting periods beginning after December 15, 2018. The ASU has not yet been adopted; however, it is not expected to have a material impact on our company's consolidated financial position, cash flows or results of operations.
In August 2018, the FASB issued ASU 2018-12, Financial Services - Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts. ASU 2018-12 is intended to improve the timeliness of recognizing changes in the liability for future policy benefits and modify the rate used to discount future cash flows. The ASU will simplify and improve the accounting for certain market-based options or guarantees associated with deposit or account balance contracts, simplify amortization of deferred acquisition costs while improving and expanding required disclosures. The effective date of ASU 2018-12 is for interim and annual reporting periods beginning after December 15, 2020. 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 following table provides cost or amortized cost, gross unrealized gains, gross unrealized losses and fair value for our fixed-maturity and equity securities:
For the years ended December 31, 2018, 2017 and 2016, there were no credit losses on fixed-maturity securities for which a portion of OTTI has been recognized in other comprehensive income.
During 2018, we other-than-temporarily impaired one security. At December 31, 2018, 400 fixed-maturity investments with a total unrealized loss of $58 million had been in an unrealized loss position for 12 months or more. Of that total, no fixed-maturity investments had fair values below 70 percent of amortized cost.
During 2016, we other-than-temporarily impaired four securities. At December 31, 2016, 32 fixed-maturity investments with a total unrealized loss of $11 million had been in an unrealized loss position for 12 months or more. Of that total, no fixed-maturity investments had fair values below 70 percent of amortized cost. There were no equity security investments in an unrealized loss position for 12 months or more as of December 31, 2016.
The following tables illustrate the fair value hierarchy for those assets measured at fair value on a recurring basis at December 31, 2018 and 2017. We do not have any liabilities carried at fair value. There were no transfers between Level 1 and Level 2.
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, 2018 and 2017. 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 without observable inputs or data that could not be corroborated by our pricing vendors in the prior period and significant observable inputs were identified in the current period.
Fair value of the note payable was determined based upon the outstanding balance at December 31, 2018 and 2017, because it is short term and tied to a variable interest rate. Fair value of the long-term debt was determined under the fair value measurements and disclosure accounting rules based on market pricing of similar debt instruments that are actively trading. We determine fair value for our debt the same way that we value corporate fixed maturities in our investment portfolio. Fair value can vary with macroeconomic conditions. Regardless of the fluctuations in fair value, the outstanding principal amount of our long-term debt is $793 million at both December 31, 2018 and 2017. None of the long-term debt is encumbered by rating triggers. The note payable and long-term debt were classified as Level 2 as an active market does not exist, but fair value is determined based on observable inputs.
The following table shows the fair value of our life policy loans, included in other invested assets:
Recorded reserves for the deferred annuities were $787 million and $835 million at December 31, 2018 and 2017, respectively. Recorded reserves for the structured settlements were $156 million and $161 million at December 31, 2018 and 2017, respectively.
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, 2018 and 2017, 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.
Our reserving process takes into account known facts and interpretations of circumstances and factors including the type of claim, policy provisions pertaining to each claim, potential subrogation or salvage recoverable, large loss activity and trends, new business activity, judicial decisions, economic conditions, changes in law and regulation and product and underwriting changes. There have been no significant changes in methodologies and assumptions used in calculating loss and loss expense reserves for all years presented. There were no material additional premiums or return premiums accrued for as a result of prior-year effects.
$47 million for both the commercial property line and commercial casualty line due to reduced uncertainty of prior accident year loss and loss expense for these lines. This illustrates the potential for revisions inherent in estimating reserves, especially for long-tail lines such as workers’ compensation.
During 2017, we experienced $119 million of favorable development on prior accident years including $73 million of favorable development in commercial lines, $14 million of favorable development in personal lines, $29 million of favorable development in excess and surplus lines and $3 million of favorable development in our reinsurance assumed operations. We recognized favorable development of $54 million for the workers' compensation line,
$33 million for the commercial property line and $30 million for the other commercial lines due to reduced uncertainty of prior accident year loss and loss expense for these lines. We recognized unfavorable reserve development of $33 million for the commercial auto line 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. Commercial casualty developed unfavorably by $11 million due to paid losses or re-estimates of case reserves at higher than expected levels.
During 2016, we experienced $168 million of favorable development on prior accident years including $129 million of favorable development in commercial lines, $4 million of favorable development in personal lines, $34 million of favorable development in excess and surplus lines and $1 million of favorable development in our reinsurance assumed operations. We recognized favorable development of $69 million for the workers’ compensation line, $29 million for the commercial property line, $20 million for the commercial casualty line and $42 million for the other commercial lines due to reduced uncertainty of prior accident year loss and loss expense for these lines. We recognized unfavorable reserve development of $31 million for the commercial auto line and $18 million for the personal auto line. Both lines developed unfavorable 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.
In the following tables, commercial casualty and workers' compensation each disclose 10 accident years of loss and ALAE reserves and cumulative number of reported claims. Commercial auto, commercial property, personal auto and homeowner each disclose five accident years of loss and ALAE reserves and cumulative number of reported claims as each of these lines have five year cumulative average annual percentage payouts of approximately 95 percent or higher. The excess and surplus lines began operations in 2008 with earned premiums and loss and ALAE reserves being immaterial prior to 2011. Accordingly, we disclosed eight accident years of loss and ALAE reserves and cumulative number of reported claims for the excess and surplus lines, and will disclose additional accident years in subsequent annual filings, not to exceed 10 years.
The unrecognized tax benefit liability is carried in other liabilities in the consolidated balance sheets. Included in the unrecognized tax benefit liability as of December 31, 2018 is $34 million, if recognized, would affect the effective tax rate. Although no interest and penalties currently are accrued, if incurred, they would be recognized as a component of income tax expense. When the IRS processes our income tax return filing for the 2018 tax year, it is possible that a decrease for the full amount of our $34 million of unrecognized tax benefits, all of which relates to our property-casualty tax base insurance claims and reserve deduction, may be necessary within the coming year.
We sponsor a defined contribution plan (401(k) plan) with matching company contributions totaling $18 million,
To determine the discount rate for each plan, a theoretical settlement portfolio of high-quality rated corporate bonds was chosen to provide payments approximately matching the plan’s projected benefit payments. A single interest rate for each plan was determined resulting in a discounted value of the plan's benefit payments that equates to the market value of the selected bonds. The discount rate is reflective of current market interest rate conditions and our plan's liability characteristics. Based on this analysis, we increased the rate from the prior year by 0.61 percentage points for the qualified pension plan and by 0.64 percentage points for the SERP. Compensation increase assumptions reflect anticipated rates of inflation, real return on wage growth and merit and promotional increases. The mortality assumption is updated annually to reflect the updated scale. The RP-2014 Employee Mortality Tables and RP-2014 Annuitant Mortality Tables for males and females projected generationally with Scale MP-2018, Scale MP-2017 and Scale MP-2016 were used for the years 2018, 2017 and 2016, respectively. The updated mortality table did not have a significant impact on our consolidated financial statements as our qualified plan assumes the majority of benefits will be paid in the form of lump sums.
Service costs and non-service costs (benefit) are allocated in the same proportion primarily to underwriting, acquisition and insurance expenses line item with the remainder allocated to the insurance losses and contract holders' benefits line item on the consolidated statements of income for 2018, 2017 and 2016.
Four equity compensation plans currently permit us to grant various types of equity awards. We currently grant incentive stock options, nonqualified stock options, service-based restricted stock units and performance-based restricted stock units to associates, including some with market-based performance objectives under our shareholder-approved plans. We also have a Holiday Stock Plan that permits annual awards of one share of common stock to each full-time associate for each full calendar year of service up to a maximum of 10 shares. One of our equity compensation plans permits us to grant stock to our outside directors as a component of their annual compensation. We used treasury shares for share-based compensation award issues or exercises during 2018 and 2017.
$9 million, and $8 million for the years ended December 31, 2018, 2017 and 2016, respectively. Options exercised during the years ended December 31, 2018, 2017 and 2016, had intrinsic value of $15 million, $19 million and $25 million, respectively. Intrinsic value is the market price less the exercise price. Options vested during the years ended December 31, 2018, 2017 and 2016, had total intrinsic value of $6 million, $8 million and $11 million, respectively.
As of December 31, 2018, we had $30 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 1.7 years.
Cash received from the exercise of options was $9 million, $13 million and $21 million for the years ended December 31, 2018, 2017 and 2016, respectively. We acquired 69,649, 96,030 and 186,097 shares totaling
$5 million, $7 million and $13 million, respectively, from associates in consideration for option exercises during 2018, 2017 and 2016. The weighted-average remaining contractual life for options expected to vest as of December 31, 2018, was 8.62 years.
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. We also grant restricted stock units which vest on a three year ratable vesting schedule. Service-based restricted stock units vested during the year had an intrinsic value of $24 million for 2018 and $23 million for the years 2017 and 2016.
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 2018, 2017 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, 2018, our total shareholder return exceeded four of our nine peers. We expect payout of these shares at the threshold level to occur in March of 2019. During 2018, we issued 80,666 shares of performance-based restricted stock units at the target-level performance hurdle for the three-year performance period ended December 31, 2017, as our total shareholder return exceeded five of nine peers in our 2015 peer group. We issued 87,228 shares of performance-based restricted stock units during 2017 at the target-level performance hurdle for the three-year performance period ended December 31, 2016, as we achieved a three-year total shareholder return that exceeded five of nine peers in our 2014 peer group. Performance-based awards vested during the year had an intrinsic value of $6 million, $7 million and $6 million for the years ended December 31, 2018, 2017 and 2016, respectively.
Dividend yield has been modeled assuming dividends are reinvested in additional shares of the issuing entity on the ex-dividend date during the performance period.
Below is a summary of service-based and performance-based share information, assuming a target payout for performance-based shares, for the year 2018:
The sum of the quarterly reported per share amounts may not equal the full year as each is computed independently. Revenues including investment gains and losses, which are integral to our financial results over the long term, may cause this value to fluctuate substantially because we have substantial discretion in the timing of investment sales. Also, applicable accounting standards require us to recognize gains and losses from certain changes in fair values of securities and embedded derivatives without actual realization of those gains and losses.