We evaluate the performance of our insurance segments using industry financial measurements determined under SAP and certain measures determined under GAAP. We evaluate our investment operations segment based on investment returns of assets managed. Financial information about our segments for 2018 is set forth in this Item 7 and in Note 17 to our consolidated financial statements included in Item 8 of this Form 10-K.
While our improved 2018 results were driven primarily by personal lines, our commercial lines grew and made progress towards underwriting profitability. In 2017, we announced our intention to exit all of our specialty business, and by the end of 2018, this work was largely complete. As a result, we are now an organization focused on writing personal auto and homeowners, small and middle market commercial, farm and ranch and workers’ compensation insurance.
To succeed, we must have a culture that enables us to move quickly and effectively, with our agents and customers at the forefront. We have worked to build a culture that encourages openness, candor, transparency, creativity and challenge - on a foundation of trust and respect. State Auto associates are encouraged to act like owners by participating, asking questions, challenging assumptions and proposing solutions. Our culture also includes a shared commitment to the communities in which we live and work. Our success will be measured not only in our business performance, but in the difference we are able to make in our communities.
The following highlights significant factors that impacted 2018 results as compared to 2017 and 2016:
•Net investment losses were $49.7 million in 2018 compared to net investment gains of $65.1 million and $36.5 million in 2017 and 2016, respectively. Net investment losses in 2018 were impacted by $57.4 million of unrealized losses from equity securities and other invested assets due to the adoption of ASU 2016-01 on January 1, 2018, which requires changes in fair value for equity securities and other invested assets still held to be reported through net income. Net realized gains for 2018 declined compared to 2017 and 2016 due to (i) fewer sales transactions and (ii) the impact of the adoption of ASU 2016-01. Net realized gains in 2017 were impacted by (i) net realized gains of $18.5 million from the sale of our U.S. small-cap equity portfolio and (ii) sales within our U.S. large-cap equity portfolio. The proceeds from the sale of our U.S. small-cap equity portfolio were reinvested in U.S. small-cap focused mutual and exchange traded funds. Net realized gains in 2016 were impacted by the recognition of a $12.0 million gain from the redemption of a limited partnership investment in international equities.
In October 2016, we launched State Auto Connect for our personal auto and homeowners products in five states. State Auto Connect is a fully digital quote and issue platform that incorporates advanced data analytics and updated pricing models, enabling us to offer new products and coverages. The platform enables our agents to submit, quote, bind, issue and bill policies through a completely digital and integrated platform. We continued the rollout of State Auto Connect throughout 2017 and 2018. The final state rollout was completed in January 2019.
The SAP catastrophe loss ratio for the year ended December 31, 2018 was 7.2%, compared to 7.5% in 2017 and 8.4% in 2016 (Tables 1 - 3). During 2018, catastrophe losses were primarily related to wind and hail storms with approximately one-third of the losses in the states of Texas and Colorado. During 2017, we were primarily impacted by (i) Hurricanes Harvey and Irma and (ii) widespread storms that affected the Ohio Valley region, South Carolina, Texas, Mississippi and Georgia. The 2016 results were impacted by (i) storms in Texas, primarily wind and hail, (ii) Hurricane Matthew, and (iii) wildfires in Tennessee.
The SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2018 was 52.2%, compared to 57.7% in 2017 and 58.2% in 2016. (Tables 1 - 3). The SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2018 improved 5.5 points when compared to 2017 (Tables 1 - 2).
The homeowners SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2018 improved 0.4 points when compared to 2017 (Tables 1 - 2) primarily attributable to favorable development of prior accident year losses of 2.9 points compared to adverse development of 0.7 points 2017. Partially offsetting the 2018 improvement was a 3.2 point increase in the 2018 current accident year ratio when compared to 2017. The 2018 ratio reflects an increase in non-catastrophe weather when compared to 2017.
The SAP catastrophe loss and ALAE ratio for the year ended December 31, 2018 was 4.6% compared to 5.9% and 5.4% in 2017 and 2016, respectively (Tables 4 - 6). Weather-related catastrophe events for the year ended December 31, 2018 were less severe than catastrophe events impacting our 2017 and 2016 results. The 2017 commercial insurance segment's cat loss and ALAE ratios were impacted by the same events described in the preceding personal insurance segment discussion.
The commercial insurance segment SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2018 was 49.0% compared to 50.9% and 58.5% in 2017 and 2016, respectively (Tables 4 - 6). The 1.9 point improvement in the 2018 ratio compared to 2017 (Tables 4 - 5) was due to (i) a 1.4 point improvement in the current accident year ratio when compared to 2017 and (ii) greater favorable development of 10.1 points in 2018 compared to 9.6 points in 2017. The 7.6 point improvement in the 2017 ratio compared to 2016 (Tables 5 - 6) was primarily driven by (i) greater favorable development of prior accident year losses compared to the same 2016 period, and (ii) pricing, underwriting and claims improvements implemented throughout the last three years, including improved risk classification, rate increases and reductions in claims leakage.
The small commercial package SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2018 increased 1.0 points compared to 2017 (Tables 4 -5) driven by less favorable development of prior accident year losses of 7.9 points compared to 9.0 points in 2017. The 2017 small commercial package ratio improved 3.2 points when compared to the same 2016 period primarily driven by greater favorable development of prior accident year losses compared to 2016.
The middle market commercial SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2018 increased 5.5 points compared to 2017 (Tables 4 - 5). The increase in the non-catastrophe loss and ALAE ratio was driven by an increase in current accident year losses of 8.6 points, partially offset by greater favorable development of prior accident year losses of 10.6 points compared to 7.5 points in 2017. The 2018 ratio was impacted by (i) elevated claim frequency, (ii) an increase in weather-related claims, and (iii) large fire losses when compared to 2017. The 2017 middle market commercial ratio improved 9.5 points compared to 2016 (Tables 5 - 6) primarily driven by greater favorable development of prior accident year losses compared to 2016. The 2017 favorable development was attributable to lower than anticipated liability severity from accident years 2014 and 2015.
The workers’ compensation SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2018 improved 8.9 points compared to 2017 (Tables 4 - 5) primarily driven by greater favorable development of prior accident year losses of 14.7 points compared to 10.0 points in 2017. The 2018 favorable development of prior accident year losses occurred primarily within accident years 2015, 2016, and 2017. Additionally, the 2018 current accident year ratio improved 4.2 points when compared to 2017 reflecting better experience. The 2017 workers’ compensation ratio improved 5.8 points compared to 2016 (Tables 5 - 6) primarily driven by greater favorable development of prior accident year losses compared to 2016. The 2017 favorable development occurred primarily within accident years 2015 and 2016. While lower than anticipated severity accounted for the majority of the development, lower than expected frequency contributed as well.
The farm and ranch SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2018 improved 14.7 points compared to 2017 (Tables 4 - 5) driven by improvement in the current accident year ratio of 10.9 points compared to 2017. The 2018 current accident year loss ratio reflects lower severity compared to 2017 which was impacted by an elevated level of large fire losses. The 2018 ratio improvement was also impacted by greater favorable development of prior accident year losses of 6.0 points compared to 2.2 points in 2017. The 2017 farm and ranch ratio increased 17.1 points compared to 2016 (Tables 5 - 6) primarily driven by large fire losses.
The following table sets forth certain key performance indicators for our specialty insurance segment for the years ended December 31, 2018, 2017 and 2016:
We have exited the specialty of business, either through a series of renewal rights transactions or by placing lines of business into run-off, which will result in the elimination of the specialty insurance segment and its related underwriting results from the State Auto Group. We stopped writing specialty business on a net basis in 2018, and as a result, in 2019, the specialty insurance segment will no longer be a reportable segment. However, exposure to the risks underlying this business will continue as the premiums are earned through mid-2019.
As a result of our decision to exit specialty business, the specialty insurance segment's net written premiums for the year ended December 31, 2018 decreased compared to the same 2017 and 2016 periods (Tables 7 - 9).
Net written premiums for the year ended December 31, 2017 decreased 19.3% compared to 2016 (Tables 8 - 9). The change was primarily driven by (i) our third quarter 2016 decision to exit program business and (ii) a decline in E&S property net written premiums due to our 2017 decision to exit E&S property business and continued competitiveness within the catastrophe-exposed property market. These decreases were partially offset by new business growth in E&S casualty, primarily driven by increased production from our umbrella and gas & propane distribution underwriting teams.
As earned premiums for the specialty insurance segment continues to run-off, the related loss and LAE ratios will reflect increasing volatility. The SAP catastrophe loss and ALAE ratio for 2018 was 1.4% compared to 22.5% and 3.1% in 2017 and 2016, respectively (Tables 7 - 9). The 2017 SAP cat loss and ALAE ratio reflects the impact of Hurricane’s Harvey and Irma, which added 21.2 points, or $50.6 million, to the cat loss ratio. The 2016 SAP cat loss ratio reflects the impact of Hurricane Matthew which added 2.4 points, or $5.9 million, to the cat loss ratio.
Losses and loss expenses for a calendar year represent the combined estimated ultimate liability for claims occurring in the current calendar year along with any change in the estimated ultimate liability for claims occurring in prior years. The following table sets forth the provision for losses and loss expenses for those claims occurring in the current and prior years, along with the GAAP loss and LAE ratio for the years ended December 31, 2018, 2017 and 2016:
As shown above, the impact on 2018 loss and loss expenses attributable to prior years was $80.2 million, or favorable development in the estimated ultimate liability for prior years’ claims.
The following table sets forth a tabular presentation of the development of the ultimate liability of prior accident years by line of business for the years ended December 31, 2018, 2017 and 2016:
For further information, see the discussion below and the "Personal Insurance Segment", "Commercial Insurance Segment" and "Specialty Insurance Segment" sections of “Results of Operations - Insurance Segments” included in this Item 7
•The personal insurance segment non-catastrophe loss and ALAE reserves contributed $1.6 million of the favorable development, driven by personal auto which contributed $4.4 million of favorable development, primarily due to lower than anticipated bodily injury severity from the prior two accident years. This was partially offset by homeowners and other personal, which contributed $1.5 million and $1.3 million of adverse development, respectively.
The following table sets forth a tabular presentation of the favorable development by accident year for the year ended December 31, 2016:
•The personal insurance segment non-catastrophe loss and ALAE reserves contributed $9.0 million of the adverse development, driven by personal auto which contributed $7.9 million of adverse development, primarily due to higher than anticipated bodily injury severity from the prior two accident years.
•The commercial insurance segment non-catastrophe loss and ALAE reserves contributed $5.1 million of favorable development, primarily driven by workers’ compensation, other commercial, and farm & ranch, which contributed $4.2 million, $1.8 million, and $1.7 million respectively. Favorable development in these lines was driven by lower than anticipated severity emerging from multiple accident years. The favorable development was partially offset by adverse development in commercial auto of $3.6 million, which was driven by higher than anticipated bodily injury severity from the prior two accident years.
The risks and uncertainties inherent in our estimates include, but are not limited to, actual settlement experience different from historical data trends, changes in business and economic conditions, court decisions creating unanticipated liabilities, ongoing interpretation of policy provisions by the courts, inconsistent decisions in lawsuits regarding coverage and additional information discovered before settlement of claims. Our results of operations and financial condition would be impacted, perhaps significantly, in the future if the ultimate payments required to settle claims vary from the liability currently recorded. For a discussion of our reserving methodologies, see “Critical Accounting Policies - Losses and Loss Expenses Payable” included in this Item 7.
We have investment policy guidelines with respect to purchasing fixed maturity investments for our insurance subsidiaries which preclude purchases of bonds that are rated below investment grade by a recognized rating service. Our fixed maturity portfolio is composed of high quality, investment grade issues, comprised mostly of debt issues rated A, or higher. We obtain investment ratings from nationally recognized ratings agencies. If there is a split rating, we assign the lowest rating obtained. At December 31, 2018, there was one fixed maturity investment rated below investment grade in our available-for-sale investment portfolio. This security is rated below investment grade due to a rating downgrade subsequent to the purchase of the security.
At December 31, 2018, our investments in fixed maturities, equity securities and certain other invested assets are carried at fair value. The unrealized holding gains or losses of our available-for-sale fixed maturities, net of applicable deferred taxes, are included as a separate component of stockholders’ equity as accumulated other comprehensive income and as such are not included in the determination of net income.
At December 31, 2018, our equity portfolio consisted of approximately 42 different large-cap stocks and 16 mutual and exchange traded funds. The largest single fund holding was 22.2% of the equity portfolio based on fair value and the top ten positions accounted for 72.6% of the equity portfolio. At December 31, 2017, our equity portfolio consisted of approximately 42 different large-cap stocks and 15 mutual and exchange traded funds. The largest single fund holding was 20.2% of the equity portfolio based on fair value and the top ten positions accounted for 71.1% of the equity portfolio. During the fourth quarter of 2017, we sold our externally-managed small-cap holdings and reinvested the proceeds into small-cap focused mutual funds and ETFs.
Our primary market risk exposures are to changes in market prices for equity securities and changes in interest rates and credit ratings for fixed maturity securities. Our fixed maturity securities are subject to interest rate risk whereby the value of the securities varies as market interest rates change. We manage this risk by closely monitoring the duration of the fixed maturity portfolio. The duration of the fixed maturity portfolio was approximately 4.23 and 4.23 as of December 31, 2018 and 2017, respectively. The following table sets forth our interest rate risk and the effects of a parallel change in interest rates on the fair value of the available-for-sale fixed maturity portfolio at December 31, 2018:
We believe that the fixed maturity portfolio’s exposure to credit risk is minimal as approximately 65.8% of the bonds we own are rated AA or better. We do not intend to change our investment policy or the quality of our fixed maturity investments. The fixed maturity portfolio is managed in a laddered-maturity style and considers business mix and liability payout patterns to ensure adequate cash flow to meet claims as they are presented. We also manage liquidity risk by maintaining sufficient cash balances, owning some agency and U.S. Treasury securities at all times, purchasing bonds of major issuers, and purchasing bonds that are part of a medium or large issue. The fixed maturity portfolio does not have any direct exposure to either exchange rate risk or commodity risk. We do not rely on the use of derivative financial instruments. We categorize our fixed maturities as available-for-sale in order to provide us greater flexibility in managing our portfolio. We do not maintain a trading portfolio.
There are no mortgage backed securities in our fixed maturity portfolio which may be labeled sub-prime mortgage backed securities. We invest only in mortgage backed securities issued by a federal agency or that are U.S. Government guaranteed. Specifically, at December 31, 2018, approximately $771.9 million, or 35.7%, of our fixed maturity available-for-sale investment portfolio was in either GNMA pools, which are guaranteed by the full faith and credit of the U.S. Government, or FNMA or Freddie Mac pools.
The following table sets forth the credit ratings of our municipal securities based on ratings by nationally recognized rating agencies at December 31, 2018:
At December 31, 2018, our large-cap equity portfolio had a weighted beta of 0.98 using the S&P 500 Index as the benchmark. At December 31, 2018, our mutual and exchange traded funds portfolio had a weighted beta of 0.99 using the S&P 500 Index and the CRSP US Small Cap Index as benchmarks. Beta estimates the degree the portfolio’s price will fluctuate based on a given movement in the market index. The following tables set forth what changes might occur in the value of the large-cap equity portfolio and the mutual fund and ETF portfolio given a change in the respective index at December 31, 2018:
The above analysis is limited in that it does not take into account any actions that might be taken by us in response to these changes. As a result, the actual impact of a change in equity market prices and the resulting equity values may differ significantly from what is shown in the table. By investing in mostly large-cap issues we hope to limit liquidity risk in the equity portfolio. The U.S. large-cap equity portfolio does not have any direct exposure to exchange rate risk since we do not directly hold any foreign stocks. We constantly monitor the equity portfolio holdings for any credit risk issues that may arise. We do not invest in any commodity futures or commodity oriented mutual funds.
The following table sets forth the components of net investment income for the years ended December 31, 2018, 2017 and 2016:
The following table sets forth realized gains (losses) and the proceeds received on sale for our investment portfolio for the years ended December 31, 2018, 2017 and 2016:
Net realized gains decreased $57.4 million in 2018 when compared to 2017, while net realized gains for 2017 increased $28.6 million when compared to 2016. Net realized gains for 2018 declined compared to 2017 and 2016 due to (i) fewer sales transactions and (ii) the impact of the adoption of ASU 2016-01. Net realized gains in 2017 were impacted by (i) realized gains of $18.5 million from the sale of our U.S. small-cap equity portfolio and (ii) sales within our U.S. large-cap equity portfolio. The proceeds from the sale of our U.S. small-cap equity portfolio were reinvested in U.S. small-cap focused mutual and exchange traded funds. During the fourth quarter of 2016, we redeemed a limited partnership investment in international equities that had been classified as other invested assets. The redemption proceeds were reinvested in an international equity mutual fund classified as an equity security. We recognized a gain of $12.0 million on the redemption. Out of the total proceeds related to this redemption and reinvestment, $44.0 million was non-cash and therefore excluded from net cash used in investing activities in the consolidated statements of cash flows.
When a fixed maturity security has been determined to have an other-than-temporary decline in fair value, the impairment charge is separated into an amount representing the credit loss, which is recognized in earnings, and the amount related to non-credit factors, which is recognized in accumulated other comprehensive income. See “Critical Accounting Policies - Investments” included in this Item 7 for OTTI impairment indicators. Future increases or decreases in fair value, if not other-than-temporary, are included in accumulated other comprehensive income (loss). We recognized $2.3 million of OTTI on our fixed maturity portfolio during 2016. We did not recognize any impairments on our fixed maturity portfolio during 2018 or 2017.
Based upon our review of our investment portfolio at December 31, 2018, we determined that there were no individual investments with an unrealized holding loss that had a fair value significantly below cost continually for more than one year. The following table sets forth detailed information on our available-for-sale investment portfolio by lot at fair value for our gross unrealized holding gains (losses) at December 31, 2018:
For the year ended December 31, 2018, the federal income tax expense was $0.1 million compared to an income tax expense of $52.8 million for 2017 and an income tax benefit of $0.4 million for 2016. Our effective tax rate for 2018 was 0.5% compared with 150.7% in 2017 and (2.3%) in 2016. The change in our effective tax rate in 2018 when compared to 2017 was primarily due to the revaluation of our net deferred tax asset as a result of the enactment of the TCJA in 2017. The revaluation of our deferred tax asset resulted in a provisional deferred tax charge of $43.5 million in 2017.
Our insurance subsidiaries must have adequate liquidity to ensure that their cash obligations are met. However, as discussed below, the STFC Pooled Companies do not have the day-to-day liquidity concerns normally associated with an insurance company due to their participation in, and the terms of, the Pooling Arrangement. In addition, State Auto P&C’s $100.0 million open line of credit with the Federal Home Loan Bank of Cincinnati (the “FHLB”) is available for general corporate purposes such as funding liquidity needs. See “Liquidity and Capital Resources - Borrowing Arrangements included in this Item 7.
We maintain a portion of our investment portfolio in relatively short-term and highly liquid investments to ensure the immediate availability of funds to pay claims and expenses. At December 31, 2018 and 2017, we had $59.8 million and $91.5 million, respectively, in cash and cash equivalents, and $2,523.3 million and $2,614.1 million, respectively, of total investments. Our available-for-sale fixed maturities included $8.9 million and $9.3 million, respectively, of securities on deposit with insurance regulators, as required by law, at December 31, 2018 and 2017. In addition, substantially all of our fixed maturity and equity securities are traded on public markets. For a further discussion regarding investments, see “Results of Operations - Investments Operations Segment” included in this Item 7.
State Auto P&C has an Open Line of Credit Commitment (the "OLC") with the FHLB that provides State Auto P&C with a $100.0 million one-year open line of credit available for general corporate purposes. Draws under the OLC are to be funded at a daily variable rate advance with a term of no more than 180 days with interest payable monthly. All advances under the OLC are to be fully secured by a pledge of specific investment securities of State Auto P&C. As of December 31, 2018, no advances had been made under the OLC.
State Auto P&C has outstanding two term loans with the FHLB in the principal amounts of $21.5 million and $85.0 million, respectively (the “2016 FHLB Loan” and "2018 FHLB Loan", respectively). The 2016 FHLB Loan is a five-year term loan, but may be prepaid after three years with no prepayment penalty. The 2016 FHLB Loan provides for interest-only payments during its term, with principal due in full at maturity. The interest rate is fixed over the term of the loan at 1.73%. The 2018 FHLB Loan is a 15-year loan and provides for interest-only payments during its term, with principal due in full at maturity. The interest rate is fixed over the term of the loan at 3.96%. Prepayment of the 2018 FHLB Loan would require a prepayment fee. The 2018 FHLB Loan refinanced a prior loan from the FHLB. State Auto P&C incurred a $0.4 million prepayment fee which is included in interest expense in the condensed consolidated statements of income for the year ended December 31, 2018.
State Auto Financial’s Delaware business trust subsidiary (the “Capital Trust”) has outstanding $15.0 million liquidation amount of capital securities, due 2033. In connection with the Capital Trust’s issuance of the capital securities and the related purchase by State Auto Financial of all of the Capital Trust’s common securities (liquidation amount of $0.5 million), State Auto Financial has issued to the Capital Trust $15.5 million aggregate principal amount of unsecured Floating Rate Junior Subordinated Debt Securities due 2033 (the “Subordinated Debentures”). The sole assets of the Capital Trust are the Subordinated Debentures and any interest accrued thereon. Interest on the Capital Trust’s capital and common securities is payable quarterly at a rate equal to the three-month LIBOR rate plus 4.20%, adjusted quarterly. The applicable interest rates for December 31, 2018 and 2017 were 6.94% and 5.68%, respectively.
The following table sets forth our notes payable at December 31, 2018:
Related to our notes payable, our primary market risk exposure is to the change in interest rates and our credit rating. For a discussion regarding our credit ratings see “Liquidity and Capital Resources - Credit and Financial Strength Ratings” included in this Item 7. Based upon the notes payable carrying value at December 31, 2018, we had $15.2 million notes payable with variable interest and $85.3 million and $21.5 million of notes payable with interest fixed at 3.96% and 1.73%, respectively, which equated to approximately 12.5% variable interest debt and 87.5% fixed interest debt. Our decision to obtain fixed versus variable interest rate debt is influenced primarily by the following factors: (a) current market interest rates; (b) anticipated future market interest rates; (c) availability of fixed versus variable interest instruments; and (d) our currently existing notes payable fixed and variable interest rate position. See our contractual obligations table included in “Liquidity and Capital Resources -Contractual Obligations” included in this Item 7.
As of July 1, 2018, the State Auto Group renewed the casualty excess of loss reinsurance agreement. Under this reinsurance agreement, the State Auto Group is responsible for the first $3.0 million of losses that involve workers' compensation, auto liability, other liability and umbrella liability policies. This reinsurance agreement provides coverage up to $10.0 million, except for commercial umbrella policies which are covered for limits up to $15.0 million. E&S casualty and programs risks are not subject to this casualty excess of loss reinsurance agreement.
Also, certain unusual claim situations involving extra contractual obligations, excess of policy limits, LAE coverage and multiple policy or coverage loss occurrences arising from bodily injury liability, property damage, uninsured motorist and personal injury protection are covered by a Clash reinsurance agreement that provides for $30.0 million of coverage in excess of $10.0 million retention for each loss occurrence. This Clash reinsurance coverage sits above the $7.0 million excess of $3.0 million arrangement. Policies underwritten by the E&S casualty and programs units are not subject to this casualty excess of loss reinsurance agreement.
Effective March 1, 2018, the State Auto Group entered into a quota share agreement (the "Oil & Gas Quota Share") covering its gas & propane distribution book of business. The Oil & Gas Quota Share expires February 28, 2019. In accordance with this agreement, the State Auto Group ceded to external reinsurers (i) 100% of unearned premiums for this book of business as of the effective date and (ii) 100% of new and renewal policies issued on or after the effective date. In addition, the State Auto Group will receive a minimum ceding commission of 23.0% on premiums ceded under the Oil & Gas Quota Share.
The rates for all of our treaty reinsurance agreements are negotiated annually.
State Auto P&C, Milbank and SA Ohio are subject to regulations and restrictions under which payment of dividends from statutory surplus can be made to State Auto Financial during the year without prior approval of regulatory authorities. Under the insurance regulations of Iowa and Ohio (the states of domicile), the maximum amount of dividends that we may pay out of earned surplus to shareholders within a twelve month period without prior approval of the Department is limited to the greater of 10% of the most recent year-end policyholders’ surplus or net income for the twelve month period ending the 31st day of December of the previous year-end. Pursuant to these rules, $87.2 million is available for payment to State Auto Financial from its insurance subsidiaries in 2019 without prior approval. State Auto Financial received dividends from its insurance subsidiaries in the amount of $10.0 million, $15.0 million and $10.0 million in 2018, 2017 and 2016.
Loss reserves are management’s best estimates (“MBE”) at a given point in time of what we expect to pay to settle all claims incurred as of that date based on known facts, circumstances and historical trends. Loss reserves at the individual claim level are established on either a case reserve basis or formula reserve basis depending on the type and circumstances of the loss. The case reserve amounts are determined by claims adjusters based on our reserving practices, which take into account the type of risk, the circumstances surrounding each claim and applicable policy provisions. The formula reserves are based on historical data for similar claims with provision for changes caused by inflation. Case reserves and formula reserves are reviewed on a regular basis, and as new data becomes available, estimates are updated resulting in adjustments to loss reserves. Generally, reported losses initially reserved on a formula basis and not settled after six months are case reserved at that time. The process for calculating the IBNR component of the loss reserve is to develop an estimate of the ultimate losses and loss expenses incurred, and subtract all amounts already paid or held as case or formula reserves.
The determination of ultimate losses and loss expenses integrates information and analysis provided by several disciplines within our Company, including claims, actuarial and accounting. This assessment requires considerable judgment in understanding how claims mature, which lines of business are the most volatile, and how trends change over time. Loss reserves represent an estimate at a given point in time based on many variables including historical and statistical information, inflation, legal developments, storm loss estimates and economic conditions. Although we consider many different sources of information, as well as a number of actuarial methodologies to estimate our loss reserves, there is no single method for determining the exact ultimate liability.
Long-Tail Business: For long-tail business, a material portion of claims may not be settled within five years. Reserve estimates for long-tail business use the same methods listed above along with several other methods as determined by the actuary. For example, premium-based methods may be used in developing ultimate loss estimates, including the Expected Loss Ratio and Bornhuetter-Ferguson methods described below.
The estimated cumulative impact that this additional, unexpected 5% increase in the loss cost trend would have on our results of operations over the lifetime of the underlying claims in workers’ compensation is an increase of $111.7 million on reserves, or a $88.2 million reduction to net income, assuming a tax rate of 21%. Inflation changes have much more impact on the longer tail commercial lines like workers’ compensation, and much less impact on the shorter tail personal lines.
The following tables set forth the net losses and loss expenses payable by major line of business at December 31, 2018 and 2017:
Pension and postretirement benefit obligations are long-term in nature and require management’s judgment in estimating the factors used to determine these amounts. We review these factors annually, including the discount rate and expected long-term rate of return on plan assets. Because these obligations are based on estimates which could change, the ultimate benefit obligation could be different from the amount estimated.
The accumulated benefit obligation (“ABO”) of a defined benefit pension plan represents the actuarial present value of benefits attributed by the pension benefit formula to employee service rendered prior to the measurement date and based on current and past compensation levels, while the projected benefit obligation (“PBO”) is the ABO plus a factor for future compensation levels. The ABO, which considers current compensation levels only, provides information about the obligation an employer would have if the plan were discontinued at the measurement date. At December 31, 2018, our ABO and PBO was $406.5 million and $428.1 million, respectively. At December 31, 2018, STFC’s defined benefit pension plan’s fair value of the assets was $381.6 million, which resulted in an underfunded status within our balance sheet of $46.5 million. On a cash flow basis, we target an annual contribution level that meets at least the targeted normal cost plus any shortfall amortizations of the plan, as defined by ERISA. Currently, we expect to make a cash contribution to the pension plan up to $15.0 million in 2019.
See Note 11, “Pension and Postretirement Benefit Plans,” to our consolidated financial statements included in Item 8 of this Form 10-K for further disclosures regarding our benefit plans.
For 2018, we recognized federal income tax benefit of $0.1 million compared to a federal income tax expense of $52.8 million for 2017 and federal income tax benefit of $0.4 million for 2016. Income taxes for the year ended 2017 reflect provisional deferred tax expense of $43.5 million attributable to the revaluation of our deferred tax assets and liabilities as a result of the enactment of the TCJA. Income taxes for the year ended 2016 reflect the impact of a correction of prior period deferred tax expense related to expired stock options. As a result of the correction, deferred federal income tax expense and additional paid-in-capital were reduced by $1.6 million, respectively.
In computing taxable income, property and casualty insurers are required to discount their unpaid loss reserves. TCJA changed the prescribed interest rates to rates based on corporate bond yield curves, required the use of IRS-prescribed claims payment patterns and extended the applicable time periods for the claims payment patterns. These changes were effective for tax years beginning after 2017 and were subject to a transition rule that spreads the additional tax payment from the amount determined by applying these changes over the subsequent eight years beginning in 2018. The pre-tax provisional change in discounted loss reserves attributable to the TCJA changes to loss reserve discounting was determined to be $50.9 million at December 31, 2017. As a result of changes to the IRS Code, deferred tax assets were increased by that amount, with an offsetting deferred tax liability. The deferred tax liability will be amortized over a period of eight years beginning in 2018. This item is a taxable temporary difference and has no direct impact on total tax expense for 2017 and future years.
See Note 10, “Federal Income Taxes,” to our consolidated financial statements included in Item 8 of this Form 10-K for further disclosures regarding our income tax matters.
The Company’s insurance subsidiaries, domiciled in Ohio and Iowa, are required to prepare statutory basis financial statements in accordance with the accounting practices prescribed or permitted by the insurance departments of the states of domicile. Prescribed statutory accounting practices are those practices that are incorporated directly or by reference in state laws, regulations, and general administrative rules applicable to all insurance enterprises domiciled in a particular state. The Ohio and Iowa Departments of Insurance require insurers domiciled in their respective states to prepare statutory financial statements in accordance with National Association of Insurance Commissioners’ (“NAIC”) statutory accounting practices. Permitted statutory accounting practices are those practices that differ either from state-prescribed statutory accounting practices or NAIC statutory accounting practices. The Company’s insurance subsidiaries do not apply any statutory accounting
The Company views gross unrealized losses on fixed maturities as being temporary since it is its assessment that these securities will recover in the near term, allowing the Company to realize the anticipated long-term economic value. The Company regularly monitors its investments that have fair values less than cost or amortized cost for signs of other-than-temporary impairment, an assessment that requires significant management judgment regarding the evidence known. Such judgments could change in the future as more information becomes known, which could negatively impact the amounts reported. Among the factors that management considers for fixed maturity securities are the financial condition of the issuer, including receipt of scheduled principal and interest cash flows, and intent to sell, including if it is more likely than not that the Company will be required to sell the investments before recovery. When a fixed maturity security has been determined to have an other-than-temporary impairment, the impairment charge is separated into an amount representing the credit loss, which is recognized in earnings as a realized loss and the amount related to non-credit factors, which is recognized in other comprehensive income. Future increases or decreases in fair value, if not other-than-temporary, are included in other comprehensive income.
The following table sets forth net deferred acquisition costs for the years ended December 31, 2018, 2017 and 2016:
In January 2016, the FASB issued ASU-2016-01 to improve certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Specifically the guidance (i) requires equity investments, including equity securities and limited partnership interests, that are not accounted for under the equity method of accounting or result in consolidation to be measured at fair value with changes in fair value recognized in earnings, (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminates the requirement to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost, (iv) requires the use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) requires an entity to present separately in other comprehensive income the portion of the total change in fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option, (vi) requires separate presentation of financial assets and liabilities by measurement category and form on the balance sheet or the notes to the financial statements, and (vii) clarifies that the need for a valuation allowance on a deferred tax asset related to an available for sale security should be evaluated with other deferred tax assets. The guidance was effective beginning January 1, 2018. The adoption of this guidance resulted in the recognition of $60.8 million of net unrealized gains (net of tax) as a cumulative effect adjustment that increased retained earnings as of January 1, 2018 and decreased accumulated other comprehensive income (“AOCI”) by the same amount. Changes in the fair value of equity securities and other invested assets previously identified as available-for-sale are reported in "net investment (loss) gain" in the condensed consolidated statements of income. At December 31, 2017, equity securities and other invested assets were classified as available-for-sale on the Company's balance sheet; however, upon adoption, the guidance eliminated the available-for-sale balance sheet classification for equity securities and other invested assets.
In June 2016, the FASB issued ASU 2016-13 that amended previous guidance on the impairment of financial instruments by adding an impairment model that requires 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 measurement of credit losses for available-for-sale debt securities measured at fair value is not affected except that credit losses recognized are limited to the amount by which fair value is below amortized cost and the carrying value adjustment is recognized as an allowance rather than impairing as they are incurred. The guidance is effective beginning January 1, 2020 and the Company is currently evaluating the impact on its results of operations and consolidated financial position.
Based on this assessment, management determined that the impact of the error was not material to the consolidated financial position, statements of income or cash flows as presented in the Company’s quarterly and annual financial statements that have been previously filed in the Company’s Quarterly Reports on Form 10-Q and Annual Reports on Form 10-K. As a result, amendment of such reports is not required. However, management concluded during the first quarter that the cumulative correction of the error could have a material effect to the Company's current year consolidated financial statements. Accordingly, the Company revised the previously issued annual and interim consolidated financial statements for 2017 and annual financial statements for 2016 in this Form 10-K to correct the reported DAC asset balance as well as other immaterial out of period operating adjustments previously identified. As periods prior to 2016 were impacted by the error, retained earnings as of January 1, 2016 was decreased by $5.9 million to recognize the cumulative net of tax impact of the correction of the error as of that date.
As a result, the Company's balance sheet has been revised to reverse the impact of pooling these items by increasing the reported pension and postretirement benefits liability and reducing reported stockholders' equity by recording additional unrecognized actuarial losses and prior service costs within accumulated other comprehensive income at each reported balance sheet date. For these adjustments, associated deferred tax benefits have been established at each reported balance sheet date. For the year ended December 31, 2017, an additional deferred income tax expense of $7.1 million was recorded to reflect an adjustment to deferred taxes for the reduction of the corporate income tax rate in connection with the TCJA. Related earnings and book value per share amounts have been revised accordingly. These adjustments are not material to the Company’s previously issued financial statements.
The following tables set forth the Company’s gross unrealized losses and fair value on its investments by lot, aggregated by investment category and length of time for individual securities that have been in a continuous unrealized loss position at December 31, 2018 and 2017:
At December 31, 2018, State Auto P&C had fixed maturity securities, with a carrying value of approximately $106.5 million, that were pledged as collateral for the FHLB Loan (as defined in Note 9). In accordance with the terms of the FHLB Loan, State Auto P&C retains all rights regarding these securities, which are included in the “U.S. government agencies mortgage-backed securities” classification of the Company’s fixed maturity securities portfolio.
At December 31, 2018, State Auto P&C had fixed maturities with fair values of approximately $20.3 million pledged as collateral for the performance obligations under its reinsurance agreement with Home State County Mutual Insurance Company ("Home State") as defined in Note 7. In accordance with the terms of the trust agreement, State Auto P&C retains all rights regarding these securities, which are included in the “U.S. government agencies mortgage-backed securities” classification of the Company’s fixed maturity securities portfolio.
Fixed maturities with fair values of approximately $8.9 million and $9.3 million were on deposit with insurance regulators as required by law at December 31, 2018 and 2017, respectively.
The following table sets forth the realized and unrealized holding gains (losses) on the Company’s investment portfolio for the years ended December 31, 2018, 2017 and 2016:
•Level 3 includes unobservable inputs which reflect the reporting entity’s estimates of the assumptions that market participants would use in pricing the asset or liability (including assumptions about risk).
The following tables set forth the Company’s investments within the fair value hierarchy at December 31, 2018 and 2017:
For assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3), the following table sets forth a reconciliation of the beginning and ending balance for 2017, separately for each major category of assets. This security was sold during the second quarter of 2017.
Included in notes payable are the FHLB Loans (as defined in Note 9) and Subordinated Debentures. The Company estimates the fair value of the FHLB Loans by discounting cash flows using a borrowing rate currently available to the Company for a loan with similar terms. The FHLB Loans have been placed in Level 3 of the fair value hierarchy. The carrying amount of the Subordinated Debentures approximates its fair value as the interest rate adjusts quarterly and has been disclosed in Level 3.
The following table sets forth the activity in the liability for losses and loss expenses for the years ended December 31:
Unallocated loss adjustment expenses and catastrophe reserves contributed $3.2 million and $2.0 million, respectively of favorable development in 2017. Favorable development of prior accident years' non-catastrophe loss and ALAE reserves was primarily driven by $44.0 million of favorable development in the commercial insurance segment. Favorable development in these lines was driven by lower than anticipated severity emerging from multiple accident years. The personal insurance segment non-catastrophe loss and ALAE reserves accounted for $1.6 million of the favorable development in 2017. Personal auto contributed $4.4 million of favorable development primarily driven by lower than anticipated severity emerging from accident years 2015 and 2016. Slightly offsetting the favorable development was adverse development in homeowners and other personal of $1.5 million and $1.3 million, respectively. Homeowners adverse development was primarily from accident year 2016. Adverse development in other personal was driven by higher than anticipated severity emerging from accident years 2015 and 2016. The specialty insurance segment non-catastrophe loss and ALAE reserves accounted for $4.2 million of adverse development, primarily driven by E&S property with adverse development of $3.0 million. E&S property adverse development was driven by higher than anticipated severity for liability coverages on business in run-off.
The above information is provided for each of the Company’s reportable insurance segments and then is further disaggregated between short and long-tail where "tail" refers to the time period between the occurrence of a loss and the ultimate settlement of the claims. See Note 17 for discussion of the Company’s reportable segments.
Long-Tail Business: For long-tail business, a material portion of claims may not be settled within five years. Reserve estimates for long-tail business use the same methods listed above along with several other methods as determined by the actuary. For example, premium-based methods may be used in developing ultimate loss estimates, including the Expected Loss Ratio and Bornhuetter-Ferguson methods as described in the "Losses and Loss Expenses Payable" section of "Critical Accounting Policies" included in Item 7 of this Form10-K.
The change in incurred losses and loss adjustment expenses for prior accident years was due to lower than expected emergence in the workers’ compensation product. The unanticipated emergence in the workers’ compensation product was driven by lower than expected severity, primarily attributable to accident years 2015 - 2017.
Effective March 1, 2018, the State Auto Group entered into a quota share agreement ("Oil & Gas Quota Share") covering its gas & propane distribution book of business. The Oil & Gas Quota Share expires February 28, 2019. In accordance with this agreement, the State Auto Group ceded to external reinsurers (i) 100% of unearned premiums for this book of business as of the effective date and (ii) 100% of new and renewal policies issued on or after the effective date. In addition, the State Auto Group will receive a minimum ceding commission of 23.0% on premiums ceded under the agreement. On March 1, 2018, the Company ceded unearned premiums of $9.7 million to the reinsurers under the terms of this agreement.
The following table sets forth the effect of the Company’s external reinsurance on its income statements for the years ended December 31, 2018, 2017 and 2016, prior to the reinsurance transaction with State Auto Mutual under the Pooling Arrangement, as discussed in Note 8a:
The following table sets forth the reinsurance transactions on the Company’s balance sheets for the Pooling Arrangement between the STFC Pooled Companies and State Auto Mutual at December 31, 2018 and 2017:
Pursuant to the Pooling Arrangement, State Auto Mutual receives all premiums and pays all losses and expenses associated with the insurance business produced by the pool participants and then settles the intercompany balances generated by these transactions with the participating companies on a quarterly basis within 60 days following each quarter end. No interest is paid on this balance. When settling the intercompany balances, State Auto Mutual provides the pool participants with full credit for the premiums written and net losses paid during the quarter and retains all receivable amounts from insureds and agents and reinsurance recoverable on paid losses from unaffiliated reinsurers. Any receivable amounts that are ultimately deemed to be uncollectible are charged-off by State Auto Mutual and allocated to the pool members on the basis of pool participation. As a result, the Company has an off-balance sheet credit risk related to the balances due to State Auto Mutual from insurers, agents and reinsurers, which are offset by the unearned premium from the respective policies. The Company’s share of the premium balances due to State Auto Mutual from agents and insureds at December 31, 2018 and 2017 is approximately $347.8 million and $323.1 million, respectively.
Under these agreements, the Company earned interest of $4.9 million for each of the three years ended December 31, 2018, 2017 and 2016, respectively. See Note 4 for the notes receivable fair value discussion.
Stateco provides State Auto Mutual and its affiliates investment management services. Investment management income is recognized quarterly based on a percentage of the average fair value of investable assets and the equity portfolio performance of each company managed. Revenue related to these services amounted to $2.0 million, $2.0 million and $1.9 million in 2018, 2017 and 2016, respectively, and is included in other income (affiliates) on the consolidated statements of income.
On March 22, 2018, State Auto P&C entered into an Open Line of Credit Commitment (the "OLC") with the FHLB. The OLC provides State Auto P&C with a $100.0 million one-year open line of credit available for general corporate purposes. Draws under the OLC are to be funded at a daily variable rate advance with a term of no more than 180 days with interest payable monthly. All advances under the OLC are to be fully secured by a pledge of specific investment securities of State Auto P&C. As of December 31, 2018, no advances had been made under the OLC.
At December 31, 2018, the tax benefit of the net operating loss (“NOL”) carryforward was $15.1 million. The NOL carryforwards do not begin to expire until 2032 and will not fully expire until 2036.
At December 31, 2018, the Company carried no balance for uncertain tax positions. The Company had no accrual for the payment of interest and penalties at December 31, 2018 or 2017.
The following table sets forth information regarding the pension and postretirement benefit plans’ change in benefit obligation, plan assets and funded status at December 31, 2018 and 2017:
The following table sets forth the amounts included in accumulated other comprehensive (loss) income that has not been recognized in net periodic cost at December 31, 2018 and 2017:
The following table sets forth the Company’s share of amortization expected to be recognized as a component of net periodic cost for the year ending December 31, 2019:
The following table sets forth the weighted average assumptions used to determine the benefit plans’ obligations at December 31, 2018 and 2017:
The assumed health care cost trend rates have a significant effect on the amounts reported for the postretirement plan. The following table sets forth the effects of a one percentage point change in assumed health care cost trend rates for the year ended December 31, 2018:
See Note 4 for the valuation methods used by the Company for each type of financial instrument the plans hold that are carried at fair value. There were no transfers between level categorizations during the years ended December 31, 2018 and 2017.
Included in the pension plan’s investments is two international funds (“the funds”) that invests in equity securities of foreign issuers and are managed by third party investment managers. The funds had a fair value of $32.7 million and $41.0 million at December 31, 2018 and 2017, respectively, which was determined using the funds' net asset value. In accordance with Accounting Standard Codification 820-10, since these investments are measured at fair value using the net asset value per share practical expedient they have not been classified in the table below.
The following tables set forth the plan’s investments within the fair value hierarchy at December 31, 2018 and 2017:
12. Other Comprehensive (Loss) Income and Accumulated Other Comprehensive (Loss) Income
The Company maintains share-based compensation plans for key employees and outside, or non-employee, directors. Effective May 4, 2017, the share-based compensation plan for key employees is the State Auto Financial Corporation 2017 Long-Term Incentive Plan (the “2017 LTIP”). The 2017 LTIP replaced the State Auto Financial Corporation 2009 Equity Compensation Plan (the “2009 Equity Plan”). The stock-based compensation plan for outside directors is the Outside Directors Restricted Share Unit Plan (the “RSU Plan”).
The Company’s share-based compensation plans authorize the granting of various equity-based incentives including performance stock awards, performance unit awards, restricted stock, and other stock based awards to employees and non-employee directors and agents. The expense for these equity-based incentives is based on their fair value at the date of grant and amortized over their vesting period.
The Company has reserved 2.4 million common shares under the 2017 LTIP. As of December 31, 2018, a total of 1.9 million common shares are available for issuance under the 2017 LTIP. The 2017 LTIP provides that (i) the maximum value of performance stock awards or performance unit awards settled in cash that may be granted in any calendar year is equal to the excess of the number of awards multiplied by the fair market value of the company’s common shares on the applicable payment or settlement date of the award multiplied by 5 and (ii) the maximum number of common shares subject to awards of performance stock and performance units that may be granted in any calendar year to any one individual is 250,000 shares. The 2017 LTIP automatically terminates on May 4, 2027.
Generally, service-based and performance-based equity awards are expensed pro-rata over their respective vesting periods based on the market value of the awards at the time of grant. Performance-based equity awards that contain variable vesting criteria are expensed based on management’s expectation of the percentage of the award that will ultimately be earned. These estimates can change periodically throughout the measurement period.
As of December 31, 2018, there was $6.4 million of total unrecognized compensation cost related to performance unit awards. The remaining cost is expected to be recognized over a period of 1.57 years.
The following table sets forth the Company’s total activity and related information for service-based restricted stock award activity for the years ended December 31, 2018, 2017 and 2016:
In accordance with the terms of the 2009 Equity Plan, stock options were granted at an option price not less than the fair market value of the common shares at the date of grant and that nonqualified stock options may be granted at any price determined by the Compensation Committee of the Board of Directors. Options granted generally vest over a three-year period, with one-third of the options vesting on each anniversary of the grant date, and must be exercised no later than ten years from the date of grant.
The fair value of each stock option is estimated on the date of grant using the Black-Scholes closed-form pricing model. The pricing model requires assumptions such as the expected life of the option and expected volatility of the Company’s stock over the expected life of the option, which significantly impacts the assumed fair value. The Company uses historical data to determine these assumptions and if these assumptions change significantly for future grants, share-based compensation expense will fluctuate in future periods.
The following tables present the weighted-average assumptions used in the option pricing model for options granted to employees during 2016. The expected life of the options for employees represents the period of time the options are expected to be outstanding and is based on historical trends. For non-employees the expected life of the option approximates the remaining contractual term of the option. The expected stock price volatility is based on the historical volatility of the Company’s stock for a period approximating the expected life and the expected dividend yield is based on the Company’s most recent period’s dividend payout. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant and has a term approximating the expected life of the option.
The fair value of share-based awards granted to employees was estimated at the date of grant using the Black-Scholes option-pricing model. The following table sets forth the weighted average fair values and related assumptions for options granted for the year ended December 31, 2016:
The following table sets forth the Company’s stock option activity and related information for the years ended December 31, 2018, 2017 and 2016:
Aggregate intrinsic value for total options outstanding at December 31, 2018 was $15.8 million. Aggregate intrinsic value for total options exercisable at December 31, 2018 was $15.2 million.
During 2018 and 2017, common shares valued at approximately $110,256 and $106,581, respectively, were distributed by the Company under the RSU Plan.
The personal insurance segment primarily provides personal automobile and homeowners to the personal insurance market. The commercial insurance segment primarily provides commercial automobile, commercial multi-peril, fire & allied, general liability, workers’ compensation insurance covering small-to-medium sized commercial exposures in the commercial insurance market. In addition, the commercial insurance segment provides farm & ranch insurance. The specialty insurance segment provides commercial coverages that require specialized product underwriting, claims handling or risk management services through a distribution channel of retail agents and wholesale brokers, which may include program administrators and other specialty sources.
The following tables set forth quarterly financial data for 2018 and 2017:
In accordance with the Contingencies Topic of the Financial Accounting Standards Board’s Accounting Standards Codification, the Company accrues for a litigation-related liability when it is probable that such a liability has been incurred and the amount can be reasonably estimated. The Company reviews all litigation on an ongoing basis when making accrual and disclosure decisions. For certain legal proceedings, the Company cannot reasonably estimate losses or a range of loss, if any, particularly for proceedings that are in their early stages of development or where the plaintiffs seek indeterminate damages. Various factors, including, but not limited to, the outcome of potentially lengthy discovery and the resolution of important factual questions, may need to be determined before probability can be established or before a loss or range of loss can be reasonably estimated. If the loss contingency in question is not both probable and reasonably estimable, the Company does not establish an accrual and the matter will continue to be monitored for any developments that would make the loss contingency both probable and reasonably estimable. Based on currently available information known to the Company, it believes that its reserves for litigation-related liabilities are reasonable. However, in the event that a legal proceeding results in a substantial judgment against, or settlement by, the Company, there can be no assurance that any resulting liability or financial commitment would not have a material adverse effect on the financial condition, results of operations or cash flows of the consolidated financial statements of the Company.