Management’s Discussion and Analysis of Financial Condition and Results of Operations addresses the financial condition of the Corporation as of December 31, 2012 compared with December 31, 2011 and the results of operations for each of the three years in the period ended December 31, 2012. This discussion should be read in conjunction with the consolidated financial statements and related notes and the other information contained in this report.
global political, economic and market conditions, particularly in the jurisdictions in which we operate and/or invest, including:
the impact of legislative, regulatory, judicial and similar developments on our business, including those relating to insurance industry reform, terrorism, catastrophes, the financial markets, solvency standards, capital requirements, accounting guidance and taxation;
Operating income was $1.4 billion in 2012, $1.5 billion in 2011 and $1.9 billion in 2010. The modestly lower operating income in 2012 compared with that in 2011 was due primarily to lower property and casualty investment income. The underwriting income of our property and casualty insurance business was similar in both years. The lower operating income in 2011 compared with that in 2010 was due to substantially lower underwriting income, attributable in large part to a higher impact of catastrophes. Property and casualty investment income was flat in 2011 compared with that in 2010. Management uses operating income, a non-GAAP financial measure, among other measures, to evaluate its performance because the realization of investment gains and losses in any period could be discretionary as to timing and can fluctuate significantly, which could distort the analysis of operating trends.
Total net premiums written increased by 1% in 2012 and 5% in 2011. The effect of foreign currency translation on total net premium growth was slightly negative in 2012 compared to a slightly positive impact in 2011. Net premiums written in the United States increased by 2% in both 2012 and 2011. Net premiums written outside the United States decreased by 3% in 2012 and increased by 11% in 2011. When measured in local currencies, such premiums grew slightly in 2012 and grew significantly in 2011. In both years, premium growth both inside and outside the United States was limited by our emphasis on underwriting discipline in a highly competitive market and our focus on rate adequacy and profitability for both renewal and new business.
Net premiums written in the United States increased in 2012 as a result of growth in our personal and commercial insurance segments. Net premiums written in the United States for our specialty insurance segment, of which the predominant component is our professional liability insurance business, decreased in 2012. Growth in our personal insurance business was attributable to new business, strong retention of existing business as well as higher rates and insured exposures upon renewal. While the pricing environment was positive during 2012 in the commercial and professional liability classes, continuing a trend that began during 2011, the positive trend had a more significant impact on growth in our commercial insurance business. Premium growth in our professional liability business remained constrained in 2012 by the continuing effects of the economic downturn and our focus on rate adequacy and profitability in what remains a highly competitive marketplace.
Overall, average renewal rates in 2012 in the United States were up significantly in both our commercial and professional liability business in comparison to expiring rates. Average renewal rates in 2011 were up modestly in our commercial business but were down slightly in our professional liability business. The amounts of coverage purchased or the insured exposures, both of which are bases upon which we calculate the premiums we charge, remained generally flat in both years compared to the respective prior year. We continued to retain a high percentage of our existing business in our commercial and professional liability classes in both years, but renewal retention levels in 2012 were lower than those in 2011, as we continued to seek renewal rate increases in most of these classes, and take underwriting actions to improve profitability, particularly in some of the professional liability classes. In both years, the overall level of new business was down for these components of our business, reflecting the competitive market as well as our underwriting discipline.
In 2011, net premiums written outside the United States grew in all segments of the business, due in part to the positive impact of foreign currency translation. Particularly strong growth occurred in our personal insurance business outside the United States in 2011.
Average renewal rates for our personal insurance business outside the United States were close to flat in 2012 and 2011. We continued to retain a high percentage of our customers and new business was also positive in both years, but more so in 2011.
The highly competitive market conditions worldwide are likely to continue in 2013. We expect that the positive pricing environment in the United States, which began in 2011 and continued throughout 2012, will continue into 2013. Outside the United States, we expect that the slightly positive pricing environment will continue in 2013. In addition, while there have been signs over the last two years that areas of the global economy have been improving, the improvement has been inconsistent across geographies and industries. If there is sustained improvement in the economy, it should result in a positive impact on premiums, although there is typically a lag between the recovery and any resulting growth in premiums. We expect our net written premiums will be modestly higher in 2013 compared with 2012, assuming average foreign currency to U.S. dollar exchange rates in 2013 remain similar to 2012 year-end levels.
The reinsurance assumed business has been in runoff since the sale of our ongoing reinsurance assumed business in December 2005.
The most significant component of our ceded reinsurance program is property reinsurance. We purchase two main types of property reinsurance: catastrophe and property per risk.
The catastrophe bond arrangements provide reinsurance coverage for specific types of losses in specific geographic locations. They are generally designed to supplement coverage provided under the North American catastrophe treaty. We currently have two catastrophe bond arrangements in effect. We have a $475 million reinsurance arrangement, a portion of which expires in March 2014 and the remainder in March 2015, that provides coverage for our exposure to homeowners and commercial losses related to certain hurricane, earthquake, severe thunderstorm and winter storm loss events in twelve states in the northeastern United States and the District of Columbia. We also have a $150 million reinsurance arrangement that expires in March 2016 that provides coverage for homeowners-related hurricane and severe thunderstorm losses in eight states along the southern U.S. coastline.
For the indicated catastrophic events in the northeastern United States, the combination of the North American catastrophe treaty, the supplemental catastrophe reinsurance and the $475 million catastrophe bond arrangement provides additional coverage of approximately 65% of losses (net of recoveries from other available reinsurance) between $1.65 billion and $3.65 billion.
After stabilizing in 2011, reinsurance rates for property risks increased in 2012 due in large part to the significant catastrophe losses incurred worldwide by the insurance industry in 2011. Nevertheless, based on changes in coverage we made upon renewal of the major components of our program, the overall cost of our property reinsurance program was modestly lower in 2012 than in 2011, excluding the reinstatement premium costs associated with Storm Sandy. We do not expect the changes we made to our property reinsurance program during 2012 to have a material effect on the Corporation’s results of operations, financial condition or liquidity.
Statutory accounting principles applicable to property and casualty insurance companies differ in certain respects from generally accepted accounting principles (GAAP). Under statutory accounting principles, policy acquisition and other underwriting expenses are recognized immediately, not at the time premiums are earned. Management uses underwriting results determined in accordance with GAAP, among other measures, to assess the overall performance of our underwriting operations. To convert statutory underwriting results to a GAAP basis, certain policy acquisition expenses are deferred and amortized over the period in which the related premiums are earned. Underwriting income determined in accordance with GAAP is defined as premiums earned less losses and loss expenses incurred and GAAP underwriting expenses incurred.
An accident year is the calendar year in which a loss is incurred or, in the case of claims-made policies, the calendar year in which a loss is reported. The total losses and loss expenses incurred for a particular calendar year include current accident year losses and loss expenses as well as any increases or decreases to our estimates of losses and loss expenses that occurred in all prior accident years, which we refer to as prior year loss development.
Underwriting results were profitable in 2012 and 2011 and highly profitable in 2010. The combined loss and expense ratio for our overall property and casualty business was as follows:
The loss ratio in 2012 was similar to 2011, as a lower amount of favorable prior year loss development and a slightly higher impact of catastrophes in 2012 were offset by a decrease in the current accident year loss ratio excluding catastrophes. The loss ratio was higher in 2011 compared with 2010 due to a higher impact of catastrophes and a modest increase in the current accident year loss ratio excluding catastrophes.
Our estimated net losses from Storm Sandy were $829 million and we incurred $53 million of reinsurance reinstatement premium costs related to the storm. Our estimated gross losses from Storm Sandy were about $1.1 billion, with almost all of the losses from property claims, both commercial and homeowners, and only a modest impact from automobile and other claims. Our net losses of $829 million were lower than the gross amount due primarily to our traditional property catastrophe treaty and, to a much lesser extent, per risk and quota share reinsurance treaties as well as facultative reinsurance placed on an individual risk basis. While it is possible that our estimate of ultimate gross losses related to Storm Sandy could change in the future, we do not expect that any such change would have a material effect on the Corporation’s consolidated financial condition or liquidity, due to the substantial amount of remaining reinsurance available for this event under a combination of the catastrophe treaty and other components of our property reinsurance program.
respectively, of the combined ratio. In 2012, most of the impact of catastrophes was due to Storm Sandy, but there were also catastrophe losses related to other events, including several severe hail and wind storms in the United States. A significant portion of the catastrophe losses in 2011 related to flooding in Australia as well as tornadoes and other storms in the United States, including losses of about $300 million related to Hurricane Irene. A significant portion of the catastrophe losses in 2010 related to numerous storms in the United States and, to a lesser extent, an earthquake in Chile.
Net premiums written from personal insurance, which represented 35% of our premiums written in 2012, increased by 4% in both 2012 and 2011 compared with the respective prior year. Net premiums written for the classes of business within the personal insurance segment were as follows:
Growth in net premiums written in our personal insurance business in 2012 occurred both inside and outside the United States, due in large part to new business, strong retention of existing business as well as higher rates and higher insured exposures upon renewal. In 2012, growth was more significant in the United States than growth outside the United States, which reflected the negative impact of foreign currency translation. Overall growth in net premiums written in our personal insurance business in 2011 was driven by growth outside the United States across all components of this business, due in large part to new business and, to a lesser extent, the positive impact of foreign currency translation. Personal automobile premiums increased slightly in 2012 and substantially in 2011 compared to the respective preceding year. Premium growth for personal automobile business in the United States, which remained a highly competitive marketplace, was modest in both years. Growth for personal automobile business written outside the United States was near flat in 2012, as the negative impact of foreign currency translation offset the new business growth in select locations, compared with strong growth in 2011. Premiums written outside the United States represented approximately 40% of our net premiums written in 2012 for the automobile class worldwide, with a substantial portion written in Brazil. Premiums from our homeowners business increased modestly in both years, with growth occurring both inside and outside the United States. Growth both inside and outside the United States in 2012 reflected higher renewal rates as well as increases in coverage on existing policies. In 2011, growth both inside and outside the United States was due primarily to new business and, to a lesser extent, increases in coverage on existing policies. Premiums from our other personal business, which includes accident and health, excess liability and yacht coverages, increased significantly in 2012 after increasing slightly in 2011. In
Homeowners results were profitable in 2012, breakeven in 2011 and highly profitable in 2010. The more profitable results in 2012 compared with 2011 were due to a lower current accident year loss ratio excluding catastrophes, due in part to lower non-catastrophe weather-related losses. The less profitable results in 2011 compared with 2010 were due in large part to a higher impact of catastrophes, as well as a higher impact of non-catastrophe weather-related losses. The impact of catastrophes accounted for 21.0 percentage points of the combined loss and expense ratio for this class in 2012 compared with 20.6 percentage points in 2011 and 15.6 percentage points in 2010.
In 2012, premium growth in our commercial insurance business was driven by an increase in business written in the United States. Net premiums written outside the United States decreased modestly in 2012 compared with 2011, due in part to the negative impact of foreign currency translation. Overall, premium growth for our commercial insurance business reflected improved pricing. Premium growth was limited in several classes of business, however, by a market that remained highly competitive and offered only limited attractive new business opportunities. The positive overall rate environment, which began in 2011, continued throughout 2012, particularly in the United States. Improvement in the rate environment outside the United States has generally been slower and continued to lag the United States. Average renewal rates in the United States were up significantly in 2012, with increases occurring in all major classes of our business. Average renewal rates outside the United States increased only slightly in 2012. Retention levels of our existing policyholders remained strong in 2012, but were down from those in 2011, both inside and outside the United States. The decline in retention was largely due to both our effort to increase rates and our non-renewal of some underperforming accounts and some property business in catastrophe exposed areas. The average renewal exposure change was close to flat in 2012, both inside and outside the United States. The amount of new business was down in 2012 compared with 2011, both inside and outside the United States, as we continued to maintain our underwriting discipline and our focus on obtaining adequate rates in the competitive market.
Results for our casualty business were profitable in each of the past three years, particularly in 2011. Results for the automobile component of our casualty business were near breakeven in 2012 compared with profitable results in 2011 and 2010. Automobile results were more profitable in 2011 compared with 2012 and 2010 mainly due to a higher amount of favorable prior year loss development. Results for the primary liability component of this business were unprofitable in 2012. Results for this component were profitable in 2011 and 2010, but more so in 2011. Primary liability results deteriorated in 2012 compared with 2011 and 2010 partly due to an increase in the frequency of large reported losses, many of which related to prior accident years. Conversely, results in 2011 benefited from a significant amount of favorable prior year loss development. Results for the excess liability component were increasingly profitable in each of the past three years. Excess liability results in all three years benefited from substantial favorable prior year loss development mainly due to lower than expected claim severity. Results for our casualty business were adversely affected in the last three years by incurred losses related to toxic waste claims and asbestos claims. Our analysis of these exposures resulted in increases in the estimate of our ultimate liabilities. Such losses represented 3.4 percentage points of the combined ratio for this business in 2012, 4.0 percentage points in 2011 and 2.7 percentage points in 2010.
Net premiums written in our surety business declined significantly in 2012 and increased only slightly in 2011 compared to the respective prior year. In both years, net premiums written in the United States decreased, due to the effects of the weak economic conditions that resulted in fewer contracts requiring a surety bond being awarded to our existing customers that operate in the construction industry. Net written premiums written outside the United States increased in both years.
Our specialty insurance business produced profitable underwriting results in 2012 and highly profitable results in 2011 and 2010. The combined loss and expense ratios for the classes of business within specialty insurance were as follows:
Our professional liability business produced profitable results in 2012 and highly profitable results in 2011 and 2010. The less profitable results in 2012 compared with 2011 and 2010 were due to a higher current accident year combined ratio and to a lower amount of favorable prior year loss development, particularly outside the United States. The fiduciary liability class produced highly profitable results in each of the past three years. Results for the directors and officers liability class were also highly
profitable in all three years, but more so in 2011 and 2010. Results for both the fiduciary liability and directors and officers liability classes reflected favorable prior year loss development in each of the past three years. For the fidelity class, results were unprofitable in 2012. Results for this class were profitable in 2011 and 2010, but more so in 2010. The less profitable results in each successive year reflected increased large loss activity resulting from alleged third party and insured-employee criminal activity. Results for the employment practices liability class were highly unprofitable in 2012 compared with near breakeven results in 2011 and highly profitable results in 2010. The less profitable results in 2012 and 2011 in this class were due to deterioration in the current accident year loss ratio relative to the respective prior year. Results in 2012 also reflected unfavorable prior year loss development, while results in 2010 benefited from favorable prior year loss development. Employment practices liability claims have been more numerous and protracted in recent years due primarily to the effect of the economic downturn and higher unemployment levels during that time. Our errors and omissions liability business produced highly unprofitable results in each of the past three years, reflecting unfavorable prior year loss development and generally elevated claim frequency levels in recent years, particularly outside the United States.
Our surety business produced highly profitable results in each of the past three years due to favorable loss experience. Our surety business tends to be characterized by losses that are infrequent but have the potential to be highly severe. When losses occur, they are sometimes mitigated by recovery rights to the customer’s assets, contract payments, collateral and bankruptcy recoveries.
As this business is in runoff, net premiums written from our reinsurance assumed business were not significant during the past three years. Reinsurance assumed results were profitable in each of the past three years. Results in each year benefited from favorable prior year loss development.
The September 11, 2001 attack changed the way the property and casualty insurance industry views catastrophic risk. That tragic event demonstrated that numerous classes of business we write are subject to terrorism related catastrophic risks in addition to the catastrophic risks related to natural occurrences. This, together with the limited availability of terrorism reinsurance, required us to change how we identify and evaluate risk accumulations. We have licensed a terrorism model that provides loss estimates under numerous event scenarios.
As a precondition to recovery under TRIA, insurance companies with direct commercial insurance exposure in the United States for TRIA lines of business are required to make insurance for covered acts of terrorism available under their policies. In the event of an act of terrorism, each insurer has a separate deductible that it must meet before federal assistance becomes available. The deductible is based on a percentage of direct U.S. earned premiums for the covered lines of business in the previous calendar year. For 2013, that deductible is 20% of direct premiums earned in 2012 for these lines of business. For losses above the deductible, the federal government will pay for 85% of covered losses, while the insurer retains 15%. There is a combined annual aggregate limit for the federal government and all insurers of $100 billion. If acts of terrorism result in covered losses exceeding the $100 billion annual limit, insurers are not liable for additional losses. While we expect the provisions of TRIA will mitigate our exposure in the event of a large-scale terrorist attack, our deductible is substantial, approximating $1.0 billion in 2013.
Given the inherent complexity of the loss reserving process and the potential variability of the assumptions used, the actual emergence of losses could vary, perhaps substantially, from the estimate of losses included in our financial statements, particularly in those instances where settlements do not occur until well into the future. Our net loss reserves at December 31, 2012 were $22.0 billion. Therefore, a relatively small percentage change in the estimate of net loss reserves would have a material effect on the Corporation’s results of operations.
Short tail classes consist principally of homeowners, commercial property and marine business. For these classes, claims are generally reported and settled shortly after the loss occurs and the claims usually relate to tangible property. Consequently, the estimation of loss reserves for these classes is less complex.
Our actuaries perform a comprehensive review of loss reserves for each of the numerous classes of business we write at least once a year. The timing of such review varies by class of business and, for some classes, the jurisdiction in which the policy was written. The review process takes into consideration the variety of trends that impact the ultimate settlement of claims in each particular class of business. Additionally, each quarter our actuaries review the emergence of paid and reported losses relative to expectations and, as necessary, conduct reserve reviews for particular classes of business.
The loss reserve estimation process relies on the basic assumption that past experience, adjusted for the effects of current developments and likely trends, is an appropriate basis for predicting future outcomes. As part of that process, our actuaries use a variety of actuarial methods that analyze experience, trends and other relevant factors. The principal standard actuarial methods used by our actuaries in the loss reserve reviews include loss development factor methods, expected loss ratio methods, Bornheutter-Ferguson methods and frequency/severity methods.
changes in the inflation rate for goods and services related to covered damages such as medical care and home repair costs,
changes in the judicial interpretation of policy provisions relating to the determination of coverage,
changes in the general attitude of juries in the determination of liability and damages,
The following discussion includes disclosure of possible variation from current estimates of loss reserves due to a change in certain key assumptions for particular classes of business. These impacts are estimated individually, without consideration for any correlation among such assumptions or among lines of business. Therefore, it would be inappropriate to take the amounts and add them together in an attempt to estimate volatility for our loss reserves in total. We believe that the estimated variation in reserves detailed below is a reasonable estimate of the possible variation that may occur in the future. However, if such variation did occur, it would likely occur over a period of several years and therefore
its impact on the Corporation’s results of operations would be spread over the same period. It is important to note, however, that there is the potential for future variation greater than the amounts discussed below.
Reserves for the professional liability classes other than fidelity were $6.7 billion, net of reinsurance, at December 31, 2012. Based on a review of our loss experience, if the loss development factor for each accident year changed such that the cumulative loss development factor for the most recent accident year changed by 10%, we estimate that the net reserves for professional liability classes other than fidelity would change by approximately $650 million, in either direction. This degree of change in the reported loss development pattern is within the historical variation around the averages in our data.
Reserves for commercial excess liability (excluding asbestos and toxic waste claims) were $3.1 billion, net of reinsurance, at December 31, 2012. These reserves are included within commercial casualty. Based on a review of our loss experience, if the loss development factor for each accident year changed such that the cumulative loss development factor for the most recent accident year changed by 20%, we estimate that the net reserves for commercial excess liability would change by approximately $375 million, in either direction. This degree of change in the reported loss development pattern is within the historical variation around the averages in our data.
We believe that the loss reserves carried at December 31, 2012 for asbestos and toxic waste claims were adequate. However, given the judicial decisions and legislative actions that have broadened the scope of coverage and expanded theories of liability in the past and the possibilities of similar interpretations in the future, it is possible that our estimate of loss reserves relating to these exposures may increase in future periods as new information becomes available and as claims develop.
Asbestos Reserves. Asbestos remains the most significant and difficult mass tort for the insurance industry in terms of claims volume and dollar exposure. Asbestos claims relate primarily to bodily injuries asserted by those who came in contact with asbestos or products containing asbestos. Tort theory affecting asbestos litigation has evolved over the years. Early court cases established the “continuous trigger” theory with respect to insurance coverage. Under this theory, insurance coverage is deemed to be triggered from the time a claimant is first exposed to asbestos until the manifestation of
A number of key jurisdictions have adopted venue reform that requires plaintiffs to have a connection to the jurisdiction in order to file a complaint.
A number of jurisdictions have passed or are considering legislation that will require fuller disclosure by plaintiffs of amounts received from asbestos bankruptcy trusts.
financial resources of traditional asbestos defendants have been depleted, plaintiffs are targeting these viable peripheral parties with greater frequency and, in many cases, for large awards.
In establishing our asbestos reserves, we evaluate the exposure presented by each insured. As part of this evaluation, we consider a variety of factors including: the available insurance coverage; limits and deductibles; the jurisdictions involved; the number of claimants; the disease mix exhibited by the claimants; the past settlement values of similar claims; the potential role of other insurance, particularly underlying coverage below our excess liability policies; potential bankruptcy impact; relevant judicial interpretations; and applicable coverage defenses, including asbestos exclusions.
The following table presents the number of policyholders for whom we have open asbestos case reserves and the related net loss reserves at December 31, 2012 as well as the net losses paid during 2012 by component.
the impact of the exhaustion of primary limits and the resulting increase in claims on excess liability policies we have issued;
Most PRPs named to date are parties who have been generators, transporters, past or present landowners or past or present site operators. These PRPs had proper government authorization in many instances. However, relative fault has not been a factor in establishing liability. While the volume of new claims is significantly reduced from the activity in the 1980s, PRPs continue to tender claims to insurers on newly identified hazardous waste sites. Insurance policies issued to PRPs were not intended to cover claims arising from gradual pollution. Since 1986, most policies have specifically excluded such exposures.
At December 31, 2012, $195 million of the net toxic waste loss reserves were IBNR reserves.
Reinsurance Recoverable. Reinsurance recoverable is the estimated amount recoverable from reinsurers related to the losses we have incurred. At December 31, 2012, reinsurance recoverable included $163 million recoverable with respect to paid losses and loss expenses, which is included in other assets, and $1.9 billion recoverable on unpaid losses and loss expenses, including reinsurance losses incurred but not reported. Approximately $275 million of reinsurance recoverable on unpaid losses and loss expenses at December 31, 2012 related to losses associated with Storm Sandy. None of the reinsurance recoverable on unpaid losses and loss expenses is currently due for collection.
A reconciliation of our beginning and ending loss reserves, net of reinsurance, for the three years ended December 31, 2012 is as follows:
The net favorable development of $614 million in 2012 was due to various factors: The most significant factors were:
We experienced overall favorable development of about $200 million in the professional liability classes other than fidelity. This favorable development was driven by the directors and officers liability and fiduciary liability classes, partially offset by adverse development in the errors and omissions liability and employment practices liability classes. Overall, the reported loss activity was less than expected, with aggregate favorable emergence from accident years 2008 and prior partly offset by some adverse emergence in the more recent accident years. This development was recognized as one among many factors in the determination of loss reserves at December 31, 2012. Among other important factors were the continued uncertainty from the crisis in the financial markets and its aftermath, the effects of the ensuing economic downturn and other recent industry litigation dynamics, as well as the reversal in 2012 of the previous general downward trend in prices.
We experienced favorable development of about $125 million in the aggregate in the personal and commercial property classes, mostly related to the 2007 through 2011 accident years. The severity and frequency of late developing property claims that emerged during 2012 were lower than expected, including those related to catastrophes, and the development of existing case reserves was more favorable than expected. Because the incidence of large property losses is subject to a considerable element of fortuity, reserve estimates for these claims are based on an
analysis of past loss experience on average over a period of years. As a result, this factor had a relatively modest effect on our determination of carried property loss reserves at December 31, 2012.
We experienced unfavorable development of about $60 million in the fidelity class due to higher than expected reported loss emergence, related mostly to accident years 2008 through 2010. Loss reserve estimates at the end of 2011 included an expectation of less prior year loss activity than actually occurred in 2012. This activity was driven by case developments on a relatively small number of claims related to the recent economic and financial environment. This continued adverse development was reflected in the determination of carried fidelity loss reserves at December 31, 2012.
We experienced favorable development of about $45 million in the runoff of our reinsurance assumed business due primarily to better than expected reported loss activity from cedants.
We experienced favorable development of about $40 million in the personal automobile business due primarily to lower than expected frequency of prior period claims. This factor was reflected in our determination of carried loss reserves for this business at December 31, 2012.
The net favorable development of $767 million in 2011 was also due to various factors. The most significant factors were:
We experienced unfavorable development of about $70 million in the fidelity class due to higher than expected reported loss emergence, related to the 2010 accident year and, to a lesser extent, the 2009 accident year.
The net favorable development of $746 million in 2010 was also due to various factors. The most significant factors were:
We experienced overall favorable development of about $315 million in the professional liability classes other than fidelity, including about $190 million from our business outside the United States. The most significant amount of favorable development occurred in the directors and officers liability class, particularly from our business outside the United States, with additional favorable development in the fiduciary liability and employment practices liability classes, partially offset by adverse development in the errors and omissions liability class. The aggregate reported loss activity related to accident years 2007 and prior was less than expected, reflecting a favorable business climate, lower policy limits and better terms and conditions.
We experienced favorable development of about $110 million in the aggregate in the personal and commercial property classes, primarily related to the 2008 and 2009 accident years. The severity and frequency of late developing property claims that emerged during 2010 were lower than expected.
In Item 1 of this report, we present an analysis of our consolidated loss reserve development on a calendar year basis for each of the ten years prior to 2012. The variability in reserve development over the ten year period illustrates the uncertainty of the loss reserving process. Conditions and trends that have affected reserve development in the past will not necessarily recur in the future. It is not appropriate to extrapolate future favorable or unfavorable reserve development based on amounts experienced in prior years.
Our U.S. property and casualty subsidiaries are required to file annual statements with insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities. These annual statements include an analysis of loss reserves, referred to as Schedule P, that presents accident year loss development information by line of business for the nine years prior to 2012. It is our intention to post the Schedule P for our combined U.S. property and casualty subsidiaries on our website as soon as it becomes available.
The effective tax rate on our investment income was 18.8% in 2012 compared with 19.0% in 2011 and 19.1% in 2010. The effective tax rate fluctuates as the proportion of tax exempt investment income relative to total investment income changes from period to period.
If both investment yields and average foreign currency to U.S. dollar exchange rates are similar in 2013 to 2012 year-end levels, property and casualty investment income after taxes for 2013 is expected to decline. This expected decline results from the effect of investing funds from securities that matured in 2012 in securities with yields lower than the yields of the maturing securities, and the expectation that this pattern will continue in 2013. The expected decline includes the positive impact of a slightly higher amount of average invested assets estimated to be held during 2013, based on expectations of cash flows during the year.
Corporate and other produced a loss before taxes of $237 million in 2012 compared with losses of $246 million and $220 million in 2011 and 2010, respectively. The lower loss in 2012 compared to 2011 was primarily due to lower interest expense resulting from the repayment of $400 million of outstanding notes upon maturity in November 2011. The higher loss in 2011 compared to 2010 was primarily due to lower investment income in 2011. Investment income in 2010 included a $20 million special dividend received on an equity security investment.
In determining whether fixed maturities are other than temporarily impaired, we are required to recognize an other-than-temporary impairment loss when we conclude that we have the intent to sell or it is more likely than not that we will be required to sell an impaired fixed maturity before the security recovers to its amortized cost value or it is likely we will not recover the entire amortized cost value of an impaired security. If we have the intent to sell or it is more likely than not that we will be required to sell an impaired fixed maturity before the security recovers to its amortized cost value, the security is written down to fair value and the entire amount of the writedown is included in net income as a realized investment loss. For all other impaired fixed maturities, when the impairment is determined to be other than temporary, the impairment loss is separated into the amount representing the credit loss and the amount representing the loss related to all other factors. The amount of the impairment loss that represents the credit loss is included in net income as a realized investment loss and the amount of the impairment loss that relates to all other factors is included in other comprehensive income.
Information related to investment securities in an unrealized loss position at December 31, 2012 and 2011 is included in Note (3)(b) of the Notes to Consolidated Financial Statements.
On January 31, 2013, the Board of Directors authorized the repurchase of up to $1.3 billion of Chubb’s common stock which replaced the January 2012 authorization. The authorization has no expiration date. We expect to complete the repurchase of shares under this authorization by the end of January 2014, subject to market conditions and other factors.
Our strong underwriting and investment results generated substantial operating cash flows in 2012. In 2012, cash provided by the property and casualty subsidiaries’ operating activities increased approximately $370 million compared to 2011 primarily as a result of higher premium collections and lower loss payments. In 2012, cash provided by the property and casualty subsidiaries’ operating activities exceeded the cash used for financing activities (primarily the payment of dividends to Chubb) by approximately $650 million. In 2012, dividends paid to Chubb by the property and casualty subsidiaries decreased by $940 million compared to 2011. In 2011 and 2010, our underwriting and investment results also generated substantial operating cash flows. In 2011, cash provided by the property and casualty subsidiaries’ operating activities declined compared to 2010 primarily as a result of higher loss payments partially offset by higher premium collections. In 2011, the cash used by the property and casualty subsidiaries for financing activities (primarily the payment of dividends to Chubb) exceeded the cash provided by operating activities by approximately $650 million. In 2011, dividends paid to Chubb by the property and casualty subsidiaries increased by $500 million compared to 2010. In 2010, the cash provided by the property and casualty subsidiaries’ operating activities exceeded the cash used for financing activities (primarily the payment of dividends to Chubb) by approximately $250 million.
The Corporation does not have any off-balance sheet arrangements that are reasonably likely to have a material effect on the Corporation’s financial condition, results of operations, liquidity or capital resources, other than as disclosed in Note (13) of the Notes to Consolidated Financial Statements.
The main objectives in managing our investment portfolios are to maximize after-tax investment income and total investment return while managing credit risk and interest rate risk in order to ensure that funds will be available to meet our insurance obligations. Investment strategies are developed based on many factors including underwriting results and our resulting tax position, regulatory requirements, fluctuations in interest rates and consideration of other market risks. Investment decisions are centrally managed by investment professionals based on guidelines established by management and approved by the boards of directors of Chubb and its respective operating companies.
Our investment portfolio primarily comprises high quality bonds, principally tax exempt securities, corporate bonds, mortgage-backed securities and U.S. Treasury securities, as well as foreign government and corporate bonds that support our operations outside the United States. The portfolio also includes equity securities, primarily publicly traded common stocks, and other invested assets, primarily private equity limited partnerships, all of which are held with the primary objective of capital appreciation.
The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels as follows:
Fair values of long term debt issued by Chubb are determined by management, utilizing prices obtained from a third party, nationally recognized pricing service.
In 2012, the liability related to our pension and other postretirement plans increased, primarily as a result of actuarial losses attributable to the decline in the discount rates used to value our pension and other postretirement obligations, partially offset by an increase in the fair value of the assets held by our pension and other postretirement benefit plans in excess of the expected return on plan assets. Postretirement benefits costs not recognized in net income increased by $45 million, which was reflected in other comprehensive income, net of applicable deferred income taxes.
The liability related to our pension and other postretirement benefit plans increased in 2011, primarily as a result of actuarial losses attributable to a decline in the discount rates used to value our pension and other postretirement obligations, and lower than expected return on plan assets. In 2010, the liability related to our pension and other postretirement benefit plans decreased. Postretirement benefit costs not recognized in net income increased by $329 million in 2011 and decreased by $20 million in 2010, which were reflected in other comprehensive income, net of applicable deferred income taxes.
Employee benefits are discussed further in Note (11) of the Notes to Consolidated Financial Statements.
Consolidated financial statements of the Corporation at December 31, 2012 and 2011 and for each of the three years in the period ended December 31, 2012 and the report thereon of our independent registered public accounting firm, and the Corporation’s unaudited quarterly financial data for the two-year period ended December 31, 2012 are listed in Item 15(a) of this report.