(1)The combined ratio is a commonly used financial measure of property and casualty underwriting performance. A combined ratio below 100.0 percent generally indicates a profitable book of business.
(2)On August 20, 2018, a special dividend of $3.00 per share was paid to shareholders.
•property and casualty insurance, which includes commercial lines insurance, personal lines insurance and assumed reinsurance; and
•life insurance, which includes deferred and immediate annuities, universal life products and traditional life (primarily single premium whole life) insurance products.
For 2020, approximately 50.4 percent of our property and casualty premiums were written in Texas, California, Iowa, Missouri and New Jersey.
The spread of the COVID-19 virus, beginning in mid-March 2020, caused significant financial market volatility, economic uncertainty and interruptions to normal business activities. The COVID-19 pandemic has had a profound impact on day-to-day life, financial markets and the economy in the United States. The Company, in response to the challenges presented by the COVID-19 pandemic, activated its pre-existing business continuity plans to respond to a pandemic in mid-March 2020. With the exception of our essential services employees, UFG has dispatched its staff to work remotely for the safety, health and well-being of our employees. We are fully operational, but have limited some non-essential travel. Our essential services employees are following recommended health and safety policies. We are and will continue to monitor the state and federal responses to the pandemic and, when appropriate, will adjust our operations in response. We have a return to workplace plan for our employees. The plan will be implemented at the appropriate time and in a way that is designed to ensure the health and safety of our employees.
We anticipate that the larger impact on our financial condition and results of operations will likely result from developments in the economy as a whole and the effect on financial markets and the investments we hold in our investment portfolio, premiums and demand for our products, and our ability to collect premiums or any requirement to return premiums to policyholders. We believe our current liquidity position is sufficient to maintain our current operations and we have the ability to draw on our credit facility if needed. See "Credit Facilities" in Part II, Item 8, Note 14 "Debt" for more information. We implemented state-mandated and optional payment leniency programs for our policyholders, all of which have expired as of December 31, 2020. As of December 31, 2020, we did not see a significant impact to cash flows or allowance for doubtful accounts as a result of these programs. During the fourth quarter of 2020, management did not repurchase any shares of stock, and the share repurchase program has been suspended since mid-March 2020. Also, the Company maintained the payment of quarterly cash dividends during 2020, with fourth quarter of 2020 marking the 211th consecutive quarter of paying dividends since March 1968.
We evaluate goodwill and other intangible assets for impairment at least on an annual basis or whenever events or changes in circumstances indicate that it is more likely than not that the carrying amount of goodwill and other intangible assets may exceed their implied fair value. Goodwill is evaluated at the reporting unit level, for which we have one reporting unit level. Any impairment is charged to operations in the period that the impairment is
identified. During the third quarter of 2020, we completed our annual quantitative analysis of goodwill. As a result of the quantitative analysis, we impaired the remaining balance of our goodwill of $15.1 million as of September 30, 2020 based on the following factors: (i) disruptions in the equity markets, specifically for property and casualty insurance companies, as a result of the COVID-19 pandemic and due to recent weather related catastrophes; (ii) recent elevated commercial auto loss ratios; and (iii) the fair value of our stock trading significantly below book value. The Company used a weighting of the income and market approaches to determine the fair value of the reporting unit.
The decline in certain sectors of the equity markets in 2020 due to the COVID-19 pandemic did have a material impact on the fair value of our investments in equity securities and limited liability partnerships. The Company's investment philosophy, objectives, approach and program have not changed as a result of the COVID-19 pandemic. In 2020 the decrease in the fair value of equity securities from December 31, 2019 was $6.9 million.
The Company has a highly rated fixed maturity portfolio, with low credit risk. The Company recognized an unrealized gain of $35.8 million, net of tax, in 2020 on its available-for-sale fixed maturity portfolio.
In 2019, the increase in net income from continuing operations compared to 2018 was primarily due to an increase in the value of our investments in equity securities from strong increases in equity markets and an increase in net premiums earned, from rate increases, offset by an increase in losses and loss settlement expenses from an increase in severity of commercial auto and auto liability losses, reserve strengthening in our Gulf Coast Region and an increase in catastrophe losses.
Assumed premiums written increased $6.5 million in 2020 as compared to 2019 due to growth of our assumed book by the addition of new programs and cedant premium growth.
In 2020, we exceeded our catastrophe reinsurance retention level of $20.0 million with the August Midwest derecho, causing widespread storms and high winds. The August Midwest derecho was a full retention loss, with losses in excess of our stated reinsurance retention of $20.0 million. Total losses from this storm were $101.8 million with $81.8 million of reinsurance recoveries. In 2019 and 2018, we did not exceed our catastrophe reinsurance retention level of $20.0 million per event.
The following table represents the primary reinsurers we utilize and their financial strength ratings as of December 31, 2020:
(1)Primary reinsurers participating in the property and casualty excess of loss programs.
Refer to Part II, Item 8, Note 4 "Reinsurance" for further discussion of our reinsurance programs.
5.9 points. The increase was primarily driven by an increase in the severity of losses in commercial auto line of
conditions, including the effects of inflation. All of these factors influence our estimates of required reserves and for long-tail lines these factors can change over the course of the settlement of the claim. However, there is no precise method for evaluating the specific dollar impact of any individual factor on the development of reserves.
Our reserving philosophy is to reserve claims to their ultimate expected loss amount as soon as practicable after information about a claim becomes available. This approach tends to produce, on average, cautiously pessimistic case reserves, which we expect to result in some level of favorable development over the course of settlement.
The property and casualty insurance business experienced $17.7 million of favorable development in our net reserves for prior accident years for the twelve-month period ended December 31, 2020. Four lines contributed the majority of favorable development with the largest contribution coming from workers' compensation which had $25.4 million favorable development followed by commercial fire and allied lines which had $10.7 million favorable development. The two other lines which experienced favorable development were fidelity and surety with $2.1 million favorable development and personal automobile with $1.9 million favorable development. The favorable development for workers' compensation was primarily from reductions in reserves for reported claims which were more than sufficient to offset paid loss. Reductions in reserves for IBNR claims also contributed favorable development in addition to loss adjustment expense ("LAE") where reductions in reserves more than sufficient to offset payments. Commercial fire and allied lines developed favorably because reductions in reserves for reported claims combined with reductions in reserves for IBNR claims were more than sufficient to offset paid loss; LAE also contributed favorable development with reductions in reserves more than sufficient to offset payments. Fidelity and surety loss developed favorably because a reduction in reserves for IBNR claims was more than sufficient to offset both paid loss and increases in reserves for reported claims. The personal automobile line of business developed favorably because reductions of reserves for reported claims combined with reductions of reserves for IBNR claims were more than sufficient to offset paid loss; LAE also contributed favorable development with reductions in reserves more than sufficient to offset payments. Much of the favorable development was offset by unfavorable development from three lines with the largest contribution coming from commercial liability which experienced $12.8 million unfavorable development. The two other lines which experienced unfavorable development were reinsurance assumed with $6.4 million unfavorable development and commercial automobile with $4.0 million unfavorable development. The commercial liability line of business experienced unfavorable development due to paid loss which was greater than reductions in reserves for unpaid loss; LAE developed favorably and partially offset the unfavorable loss development. The unfavorable development for the reinsurance assumed line of business was due to paid loss which was greater than reductions in reserves for unpaid loss. The commercial automobile line of business experienced unfavorable development because paid loss was greater than reductions in reserves for unpaid loss, but a portion of the unfavorable loss development was offset by favorable development from LAE where payments were more than offset by reductions of reserves for unpaid loss adjustment expense. On an all lines combined basis, favorable development is attributable to LAE which continues to benefit from additional litigation management efforts. The lines of business not mentioned individually above contributed an additional combined total of $0.8 million of favorable development.
The property and casualty insurance business experienced $5.3 million of favorable development in our net reserves for prior accident years for the year ended December 31, 2019. Four lines contributed favorable development with the largest contribution coming from workers' compensation, which had $37.3 million favorable development. The three other lines that experienced favorable development were fidelity and surety with $3.1 million favorable development, commercial fire and allied lines with $2.3 million favorable development, and personal automobile with $1.2 million favorable development. The favorable development for workers' compensation was primarily from reductions in reserves for reported claims which were more than sufficient to offset paid loss; LAE also contributed favorable development with reductions in reserves more than sufficient to offset payments. Fidelity and surety loss developed favorably because reductions in claim reserves and salvage recoveries were more than sufficient to offset loss payments. Commercial fire and allied lines developed favorably due to paid LAE where reductions in reserves
Reserve development amounts can vary significantly from year-to-year depending on a number of factors, including the number of claims settled and the settlement terms, and are subject to reallocation between accident years and lines of business.
In recent years, we began to use our loss control department more extensively in an attempt to return this line of business to a higher level of profitability. For example, our loss control department has representatives who make multiple visits each year to businesses and job sites to ensure safety. We also do not renew accounts that no longer meet our underwriting or pricing guidelines. We avoid accounts that have become too underpriced for the risk.
As a result of our acquisition of Mercer Insurance Group, Inc. in 2011, we added construction defect exposure in the states of California, Nevada and Arizona. Mercer Insurance Group, Inc. has been writing in these states for more than 20 years. In order to minimize our exposure to construction defect claims in this region, we continually review the coverage we offer and our pricing models. In an effort to limit our exposure from residential multi-unit buildings, we started including condominium and townhouse construction policy exclusions in 2012 for our
contracting policies in this region. For the majority of our residential contractors we limit the size of any tracts the contractor is working on to 25 homes or less and do not include a continuous trigger with our designated work exclusion. In a majority of the policies in our small service, repair and remodel contractors program, we have a favorable new residential construction exclusion. We also apply strict guidelines when additional insured forms are required and changed our underwriting guidelines to limit our exposure to large, multi-party construction defect claims.
The net loss ratio improved 7.6 percentage points in 2020 compared to 2019. In both years, the loss ratio was at an elevated level due to the severity of losses from social inflation of bodily injury claims from prior accident years. In 2020, the improvement was from less prior accident year reserve strengthening than in 2019.
Our personal lines consist primarily of fire and allied lines (including homeowners) and automobile lines. The net loss ratio deteriorated 58.0 percentage points in 2020 compared to 2019. The deterioration is primarily attributable to our personal fire and allied line of business due to an increase in catastrophe losses. Also, net premiums earned decreased due to the renewal rights agreement for our personal lines business we entered into in May 2020, providing our independent insurance agents with the opportunity to transfer their personal lines policies to Nationwide Mutual Insurance Company beginning in the third quarter of 2020.
Our assumed reinsurance is the business we choose to write by participating in programs insuring insurance companies. The net loss ratio deteriorated 32.0 percentage points in 2020 compared to 2019. The deterioration is attributable to strengthening reserves for incurred but not reported claim events.
The sale of our discontinued operations closed on March 30, 2018, and therefore income was only earned in the first quarter of 2018. For the year ended December 31, 2018, our discontinued operations had a loss before income taxes of $1.3 million.
We reported a federal income tax benefit on a consolidated basis of $56.8 million or 33.5 percent of pre-tax loss in 2020. In 2019, federal income tax expense on a consolidated basis was $2.1 million or 12.2 percent of pre-tax income and federal income tax benefit on a consolidated basis of $3.3 million or 13.5 percent of pre-tax income in 2018.
Our effective tax rate was impacted by the The Tax Cuts and Jobs Act of 2017 (the "Tax Act"), which was enacted on December 22, 2017. The Tax Act significantly revised the U.S. corporate income tax laws including lowering the U.S. federal corporate tax rate from 35 percent to 21 percent effective January 1, 2018. Our effective federal tax rate varied from the statutory federal income tax expense rate in each year, due primarily to the impact of the provisions of the CARES Act.
Domestic and global capital markets weathered truly unprecedented adversity in 2020. The year began with projections for steady GDP growth and expectations of continued strength in labor and housing markets. In response, risk investors were rewarded as financial assets priced higher into February. By late February, however, the global economy could no longer ignore the health and economic risks posed by the novel coronavirus, COVID-19.
Overall, the current investment environment is challenging with the U.S. equity market seeing stretched valuations only encountered a handful of times in history. Fixed income markets face a near zero-rate environment with no sign of relief on the horizon. We believe the global economy is in the process of recovering from recession. While successful vaccine developments have given us a line of sight to what many are predicting to be a strong second half of 2021, the long-term economic damage caused by COVID-19 has yet to be fully understood. With an increase in debt during the pandemic, companies around the globe are relying on an imminent recovery so as to avoid an avalanche of defaults. Our investment program is defensive in nature and designed to outperform during periods of market uncertainty.
The Company's assets are invested to preserve capital and maximize after-tax returns while maintaining an appropriate balance of risk. The return on our portfolio is an important component of overall financial results, but
quality and safety of principal is the highest priority of our investment program. Our general investment philosophy is to purchase financial instruments with the expectation that we will hold them to their maturity. However, active management of our portfolio is considered necessary to appropriately manage risk, achieve portfolio objectives and maximize investment income as market conditions change.
Each of our insurance company subsidiaries develops an appropriate investment strategy that aligns with its business needs and supports United Fire's strategic plan and risk appetite. The portfolio is structured so as to be in compliance with state insurance laws that prescribe the quality, concentration and type of investments that may be made by insurance companies.
The composition of our investment portfolio at December 31, 2020 is presented at carrying value in the following table:
At December 31, 2020, we classified $1.8 billion, or 100.0 percent, of our fixed maturities portfolio as available-for-sale, compared to $1.7 billion, or 99.1 percent, at December 31, 2019. Available-for-sale fixed maturity securities are carried at fair value, with changes in fair value recognized as a component of accumulated other comprehensive income in stockholders' equity. We record fixed maturity trading securities, primarily convertible redeemable preferred debt securities, and equity securities at fair value, with any changes in fair value recognized in earnings.
As of December 31, 2020 and 2019, we did not have direct exposure to investments in subprime mortgages or other credit enhancement vehicles.
Our investment portfolio is invested primarily in fixed maturity securities whose fair value is susceptible to market risk, specifically interest rate changes. Duration is a measurement used to quantify our inherent interest rate risk and analyze our ability to match our invested assets to our reserve liabilities. If our invested assets and reserve liabilities have similar durations, then any change in interest rates will have an equal effect on these accounts. The primary purpose for matching invested assets and reserve liabilities is liquidity. With appropriate matching, our investments will mature when cash is needed, preventing the need to liquidate other assets prematurely. Mismatches in the duration of assets and liabilities can cause significant fluctuations in our results of operations.
The weighted average effective duration of our portfolio of fixed maturity securities was 3.4 years at December 31, 2020 compared to 4.2 years at December 31, 2019.
The amortized cost and fair value of available-for-sale and trading fixed maturity securities at December 31, 2020, by contractual maturity, are shown in the following table. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Asset-backed securities, mortgage-backed securities and collateralized mortgage obligations may be subject to prepayment risk and are therefore not categorized by contractual maturity.
We invest the premiums received from our policyholders in order to generate investment income, which is an important component of our revenues and profitability. The amount of investment income that we are able to generate is affected by many factors, some of which are beyond our control. Some of these factors are volatility in the financial markets, economic growth, inflation, changes in interest rates, world political conditions, terrorist attacks or threats of terrorism, adverse events affecting other companies in our industry or the industries in which we invest and other unpredictable national or world events. Net investment income decreased 34.3 percent in 2020, compared with the same period of 2019 and was primarily due to the change in the fair value of our investments in
Changes in unrealized gains and losses on available-for-sale fixed maturity securities do not affect net income and earnings per share but do impact comprehensive income, stockholders' equity and book value per share. We believe that any unrealized losses on our available-for-sale fixed-maturity securities at December 31, 2020 are temporary based upon our current analysis of the issuers of the securities that we hold and current market conditions. We invest in high quality assets to provide protection from future credit quality issues. Non-credit related unrealized gains and losses are recognized as a component of other comprehensive income and represent other market movements that are not credit related, for example interest rate changes. We have no intent to sell, and it is more likely than not that we will not be required to sell, these securities until the fair value recovers to at least equal our cost basis or the securities mature.
In 2020, our investment income, net of investment expenses, decreased $20.7 million to $39.7 million as compared to 2019, primarily due to the change in the fair value of our investments in limited liability partnerships, a decrease in interest on fixed maturities and interest on cash and cash equivalents due to declining interest rates.
(1)Represents the change in value of our interests in limited liability partnerships that are recorded on the equity method of accounting.
The following table details our annualized yield on average invested assets from continuing operations for 2020 and 2019, and both continuing and discontinued operations for 2018, which is based on our invested assets (including money market accounts) at the beginning and end of the year divided by net investment income:
As of December 31, 2020, net unrealized investment gains, after tax, totaled $83.1 million compared to unrealized gains of $47.3 million and unrealized losses of $9.3 million as of December 31, 2019 and 2018, respectively. The increase in net unrealized investment gains in 2020 was primarily the result of an increase in the value of the fixed maturity portfolio due to lower interest rates during 2020.
The amounts set forth in the following table detail the impact of hypothetical interest rate changes on the fair value of fixed maturity securities held at December 31, 2020. The sensitivity analysis measures the change in fair values arising from immediate changes in selected interest rate scenarios. We employed hypothetical parallel shifts in the yield curve of plus or minus 100 and 200 basis points in the simulations. Additionally, based upon the yield curve shifts, we employ estimates of prepayment speeds for mortgage-related products and the likelihood of call or put options being exercised within the simulations.
Credit risk is the willingness and ability of a borrower to repay on time and in full any principal and interest due to the lender. Losses related to credit risk are realized through the income statement and have a direct impact on the earnings of UFG. Given the vast majority of our holdings are fixed income maturity securities, we view credit risk as our primary investment risk. Our internal Investment Department has developed and maintains a rigorous underwriting process to analyze and measure the expected frequency and severity of loss (i.e., credit quality) for government, agency, municipal, structured security, and corporate bond issuers. The objective is to maintain the appropriate balance of risk in our portfolio, consistent with our Investment Policy Statement and conservative investment style, and ensure the portfolio is compensated appropriately for the credit risk it holds. We do have within our municipal bond holdings a small number of securities whose ratings were enhanced by third-party insurance for the payment of principal and interest in the event of an issuer default. Of the insured municipal securities in our investment portfolio, 99.5 percent and 99.6 percent were rated "A" or above, and 95.8 percent and 95.6 percent were rated "AA" or above at December 31, 2020 and 2019, respectively, without the benefit of insurance. Due to the underlying financial strength of the issuers of the securities, we believe that the loss of insurance would not have a material impact on our operations, financial position, or liquidity.
We have no direct exposure in any of the guarantors of our investments. Our largest indirect exposure with a single guarantor totaled $9.7 million or 21.0 percent of our insured municipal securities at December 31, 2020, as compared to $11.7 million or 24.2 percent at December 31, 2019. Our five largest indirect exposures to financial guarantors accounted for 81.5 percent and 81.2 percent of our insured municipal securities at December 31, 2020 and 2019, respectively.
Liquidity measures our ability to generate sufficient cash flows to meet our short- and long-term cash obligations. Our cash inflows are primarily a result of the receipt of premiums, reinsurance recoveries, sales or maturities of investments, and investment income. Cash provided from these sources is used to fund the payment of losses and loss settlement expenses, the purchase of investments, operating expenses, dividends, pension plan contributions, and in recent years, common stock repurchases.
The following table displays a summary of cash sources and uses in 2020, 2019 and 2018 from continuing and discontinued operations:
In the Consolidated Statement of Cash Flows, cash flows from discontinued operations are shown in separate lines in each of the operating, investing and financing sections of the Cash Flow Statement. Our cash flows from continuing operations were sufficient to meet our current liquidity needs for the full-year periods ended December 31, 2020, 2019 and 2018 and we anticipate they will be sufficient to meet our future liquidity needs. We also have the ability to draw on our credit facility if needed. See Note 14 "Debt" for more information. During 2020, the Company implemented state-mandated and optional payment leniency programs for our policyholders as a result of the COVID-19 pandemic. As of December 31, 2020, we did not see a significant impact to cash flows or an increase in our allowance for doubtful accounts as a result of these programs. These payment modifications did not have a material impact on our financial condition, liquidity or capital position.
Net cash flows provided by operating activities totaled $41.4 million, $93.8 million and $110.1 million in 2020, 2019 and 2018, respectively. Our cash flows from operating activities were sufficient to meet our liquidity needs for 2020, 2019 and 2018.
In addition to investment income, possible sales of investments and proceeds from calls or maturities of fixed maturity securities also can provide liquidity. During the next five years, $0.5 billion, or 26.6 percent of our fixed maturity portfolio will mature.
Our cash outflows for investment purchases from continuing operations totaled $450.2 million in 2020, compared to $274.7 million and $540.4 million for the same period in 2019 and 2018, respectively. Our cash outflows for investment purchases from discontinued operations totaled $15.4 million in 2018.
Dividends paid to shareholders totaled $28.5 million, $32.7 million and $105.4 million in 2020, 2019 and 2018, respectively. The increase in dividends paid to shareholders in 2018 was primarily due to a special cash dividend of $3.00 per share paid to shareholders on August 20, 2018. Our practice has been to pay quarterly cash dividends, which we have paid every quarter since March 1968.
During 2020, 2019 and 2018, pursuant to authorization by our Board of Directors, we repurchased 70,467, 258,756, and 120,372 shares of our common stock, respectively, which used cash totaling $2.7 million in 2020, $11.7 million in 2019 and $5.4 million in 2018. At December 31, 2020, we were authorized to purchase an additional 1,786,977 shares of our common stock under our share repurchase program, which expires in August 2022.
Information specific to our credit facilities is incorporated by reference from Note 14 "Debt" contained in Part II, Item 8. As of December 31, 2020, we were in compliance with two of three financial covenants of the Credit Agreement (the “Credit Agreement”) with Wells Fargo Bank, National Association ("Wells Fargo"), as
UFG sold an aggregate $50.0 million of notes due 2040 to the Note Purchasers. One note with a principal amount of $35.0 million was issued to Federated Mutual and one note with a principal amount of $15.0 million was issued to Federated Life.
We offer our agents a profit-sharing plan as an incentive for them to place high-quality property and casualty insurance business with us. Based on business produced by the agencies in 2020, property and casualty agencies expect to receive profit-sharing payments of $15.4 million in 2021.
We estimate the pension contribution for 2021 in accordance with the Pension Protection Act of 2006 (the "Act"). Contributions for future years are dependent on a number of factors, including actual performance versus assumptions made at the time of the actuarial valuations and maintaining certain funding levels relative to regulatory requirements. Contributions in 2021, and in future years, are expected to be at least equal to the IRS minimum required contribution in accordance with the Act.
These partnerships are included in our other long term investments on the Consolidated Balance Sheets with a current fair value of $69.3 million, or 3.2% of our total invested assets, at December 31, 2020.
In general, investment securities are exposed to various risks, such as interest rate risk, credit risk, and overall market volatility risk. Therefore, it is reasonably possible that changes in the fair value of our investment securities that are reported at fair value will occur in the near term and such changes could materially affect the amounts reported in the Consolidated Financial Statements. Also, it is reasonably possible that changes in the value of our investments in trading securities and limited liability partnerships could occur in the future and such changes could materially affect our results of operations as reported in our Consolidated Financial Statements.
The following table illustrates the hypothetical impact on the premium deficiency charge recorded for the quarter ended December 31, 2020, of reasonably likely changes in the assumed loss and loss settlement expense ratios utilized for purposes of this calculation. The entire impact of these changes would be recognized through income as other underwriting expenses. The following table illustrates the impact of potential changes in the expected loss and loss settlement expense ratios for all lines of business on the premium deficiency charge. The base amount indicated below is the actual premium deficiency charge recorded as an offset against the DAC asset established as of the quarter ended December 31, 2020:
Actual future results could differ materially from our assumptions used to calculate the recorded DAC asset. Changes in our assumed loss and loss settlement expense ratios in the future would impact the amount of deferred
Reserves for losses and loss settlement expenses are reported using our best estimate of ultimate liability for claims that occurred prior to the end of any given reporting period, but have not yet been paid. Before credit for reinsurance recoverables, these reserves were $1,578.1 million and $1,421.8 million at December 31, 2020 and 2019, respectively. We purchase reinsurance to mitigate the impact of large losses and catastrophic events. Loss and loss settlement expense reserves ceded to reinsurers were $131.8 million for 2020 and $68.5 million for 2019. Our reserves, before credit for reinsurance recoverables, by line of business as of December 31, 2020, were as follows:
construction defect coverage are reported 10 years or more after the policy period, and the workers' compensation coverage provided by our policies pays unlimited medical benefits for the duration of the claimant's injury up to the lifetime of the claimant. In addition, final settlement of certain claims can be delayed for years due to litigation or other reasons. Reserves for these claims require us to estimate future costs, including the effect of judicial actions, litigation trends and medical cost inflation, among others. Reserve development can occur over time as conditions and circumstances change many years after the policy was issued and/or the loss occurred.
of business. The specific projection methods used to establish point estimates vary depending on what is deemed most appropriate for a particular line of business and year. Results of these methods are usually averaged together to provide a final point estimate. Given that there are several inputs depending on the line of business, the methods may be averaged and modified based on changes known to management or trends in the market. IBNR estimates are derived by subtracting reported loss from the final point estimate loss.
Reserves for assumed reinsurance are established using methods and techniques identical to those used for direct lines of business. The additional delay inherent in assumed reinsurance reporting is considered in our reserving process and payment is not problematic. Assumed reinsurance, like every independent line of business, has unique reporting and payment patterns that are reviewed as part of the reserve estimation process.
There are three distinct types of reserves ceded to reinsurers: (1) reported claim reserves, (2) loss IBNR, and (3) LAE IBNR. Ceded reserves for reported claims are calculated by subtracting the primary retention from the claim value established by our claim adjuster. Ceded loss IBNR originates from our boiler and machinery business which is 100 percent reinsured and from the Midwest August derecho catastrophe. For this business ceded loss IBNR is equal to direct loss IBNR. Boiler and machinery business is included in our commercial fire and allied line of business. We will cede some LAE expenses when we cede loss. Our ceded LAE IBNR is estimated based on our ceded unpaid loss reserves and the general relation, by line of business, between LAE and loss. Our primary retention was $2.0 million for 2012 through 2015 and increased to $2.5 million for 2016 through 2020.
As an example, if our loss and loss settlement expense reserves of $1,578.1 million as of December 31, 2020, is 10.0 percent inadequate, we would experience a reduction in future pre-tax earnings of up to $157.8 million. This reduction could be recorded in one year or multiple years, depending on when we identify the deficiency. The deficiency would also affect our financial position in that our equity would be reduced by an amount equivalent to the reduction in net income. Any deficiency that would be recognized in our loss and loss settlement expense reserves usually does not have a material effect on our liquidity because the claims have not been paid. Conversely, if our estimates of ultimate unpaid loss and loss settlement expense reserves prove to be redundant, our future earnings and financial position would be improved. We believe our reserving philosophy, coupled with what we believe to be aggressive and successful claims management and loss settlement practices, has resulted in year-to-year redundancies in reserves. We believe our approach produces recorded reserves that are reasonable as to their relative position within a range of reasonable reserves from year-to-year.
In 2020, we did not change the key method through which we develop our assumptions on which we based our reserving calculations. In estimating our 2020 loss and loss settlement expense reserves, we did not anticipate future events or conditions that were inconsistent with past development patterns.
Our reserve for other liability claims at December 31, 2020, was $652.3 million and consisted of 5,895 claims, compared with $600.0 million, consisting of 6,461 claims at December 31, 2019. Of the $652.3 million total reserve for other liability claims, $154.9 million is identified as defense costs and $37.0 million is identified as general overhead required in the settlement of claims.
Included in the other liability line of business are gross reserves for construction defect losses and loss settlement expenses. Construction defect is a liability allegation relating to defective work performed in the construction of structures such as commercial buildings, apartments, condominiums, single family dwellings or other housing, as well as the sale of defective building materials. These claims seek recovery due to damage caused by alleged deficient construction techniques or workmanship. At December 31, 2020, we had $73.6 million in construction defect loss and loss settlement expense reserves, excluding IBNR reserves that are calculated for the overall other liability commercial line, which consisted of 3,983 claims. At December 31, 2019, our reserves, excluding IBNR reserves, totaled $60.4 million, which consisted of 3,439 claims. The reporting of such claims can be delayed, as the statute of limitations can be up to 10 years. Court decisions in recent years have expanded insurers' exposure to construction defect claims. As a result, claims may be reported more than 10 years after a project has been completed, as litigation can proceed for several years before an insurance company is identified as a potential contributor. Claims have also emerged from parties claiming additional insured status on policies issued to other parties, such as contractors seeking coverage from a subcontractor's policy.
Included in the other liability and assumed reinsurance lines of business are reserves for asbestos and other environmental losses and loss settlement expenses. At December 31, 2020 and 2019, we had $2.5 million and $3.1 million, respectively, in direct and assumed asbestos and environmental loss reserves. The estimation of loss reserves for environmental claims and claims related to long-term exposure to asbestos and other substances is one of the most difficult aspects of establishing reserves, especially given the inherent uncertainties surrounding such claims. Although we record our best estimate of loss and loss settlement expense reserves, the ultimate amounts paid upon settlement of such claims may be more or less than the amount of the reserves, because of the significant uncertainties involved and the likelihood that these uncertainties will not be resolved for many years.
The factors contributing to our year-to-year redundancy include: establishing reserves at their ultimate expected loss amount as soon as practicable after information becomes available, which produces, on average, cautiously pessimistic case reserves; using claims negotiation to control the size of settlements; assuming that we have liability for all claims, even though the issue of liability may, in some cases, be resolved in our favor; promoting claims management services to encourage return-to-work programs; case management by nurses for serious injuries and management of medical provider services and billings; and using programs and services to help prevent fraud and to assist in favorably resolving cases.
The following table details the pre-tax impact on our property and casualty insurance business' financial results and financial condition of reasonably likely reserve development. Our lines of business that have historically been most susceptible to significant volatility in reserve development have been shown separately and utilize hypothetical levels of volatility of 5.0 percent and 10.0 percent. Our other, less volatile, lines of business have been aggregated and utilize hypothetical levels of volatility of 3.0 percent and 5.0 percent.
In addition, for the post-retirement benefit plan, a 100 basis point decrease in the medical trend rate would decrease the post-retirement benefit obligation at December 31, 2020, by $4.5 million, while a 100 basis point increase in the medical trend rate would increase the benefit obligation at December 31, 2020, by $5.5 million.
A 100 basis point decrease in our estimated long-term rate of return on pension plan assets would increase the benefit expense for the year ended December 31, 2020, by $2.5 million, while a 100 basis point increase in the rate would decrease benefit expense by $2.5 million, for the same period.
For the post-retirement benefit plan, a 100 basis point increase in our estimated medical trend rate would increase the benefit expense for the year ended December 31, 2020, by $0.6 million, while a 100 basis point decrease in the rate would decrease benefit expense by $0.5 million, for the same period.
As described in Part II, Item 8, Note 15 "Intangible Assets," the Company performed a quantitative impairment analysis on its one reporting unit and recognized an impairment charge of $15.1 million for the year ended December 31, 2020. The Company tests goodwill for impairment annually, during the third quarter, or more frequently if events or changes in circumstances indicate that goodwill might be impaired. An impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value. The Company used a weighting of the income and market approaches to determine the fair value of the reporting unit. The impairment was based on the following factors: (i) disruptions in the equity markets, specifically for property and casualty insurance companies, as a result of the COVID-19 pandemic and due to the current year weather related catastrophes; and (ii) the fair value of our stock trading significantly below book value.
Information specific to accounting standards that we adopted in 2020 or pending accounting standards that we expect to adopt in the future is incorporated by reference from Note 1 "Summary of Significant Accounting Policies" contained in Part II, Item 8, "Financial Statements and Supplementary Data."
(2)The change in liability for underfunded employee benefit plans is net of income taxes.
United Fire Group, Inc. ("UFG", "United Fire", the "Registrant", the "Company", "we", "us", or "our") and its consolidated subsidiaries and affiliates are engaged in the business of writing property and casualty insurance through a network of independent agencies. Our insurance company subsidiaries are licensed as a property and casualty insurer in 49 states, plus the District of Columbia.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The financial statement categories that are most dependent on management estimates and assumptions include: investments; deferred policy acquisition costs; reinsurance receivables and recoverables; goodwill impairment; losses and loss settlement expenses; and pension and post-retirement benefit obligations.
To establish loss and loss settlement expense reserves, we make estimates and assumptions about the future development of claims. Actual results could differ materially from those estimates, which are subjective, complex and inherently uncertain. When we establish and adjust reserves, we do so given our knowledge at the time of the circumstances and facts of known claims. To the extent that we have overestimated or underestimated our loss and loss settlement expense reserves, we adjust the reserves in the period in which such adjustment is determined.
Our whole life and term insurance (i.e., traditional business) premiums are reported as earned when due and benefits and expenses are associated with premium income in order to result in the recognition of profits over the lives of the related contracts. Income annuities with life contingencies (single premium immediate annuities and supplementary contracts) have premium recorded and any related expense charge fees recorded as income and expense when the contract is issued. On universal life and deferred annuity policies (i.e., non-traditional business), income and expenses are reported when charged and credited to policyholder account balances in order to result in recognition of profits over the lives of the related contracts. We accomplish this by means of a provision for future policy benefits and the deferral and subsequent amortization of policy acquisition costs.
In 2020, 2019, and 2018, we made cash payments for income taxes of $138, $1,575 and $29,071, respectively. In 2020, we did not receive a federal tax refund. We received federal tax refunds of $5,401 and $1,503 in 2019 and 2018, respectively, which resulted from the utilization of our net operating losses and net capital loss carryforwards and carrybacks. We made no interest payments in 2020, 2019 and 2018. These payments exclude interest credited to policyholders' accounts.
Depreciation expense totaled $5,947, $10,482 and $4,455 for 2020, 2019 and 2018, respectively.
The Company executed a private placement debt transaction on December 15, 2020 between United Fire & Casualty Company ("UF&C"), and Federated Mutual Insurance Company, a mutual insurance company domiciled in Minnesota ("Federated Mutual"), and Federated Life Insurance Company, an insurance company domiciled in Minnesota ("Federated Life” and, together with Federated Mutual, the "Note Purchasers").
Interest payments under the surplus notes will be paid quarterly on March 15, June 15, September 15 and December 15 of each year (each such date, an "Interest Payment Date"). The interest rate will equal the rate that corresponds to the A.M. Best Co. (or its successor’s) financial strength rating for members of the United Fire & Casualty Pooled Group as of the applicable Interest Payment Date. As of December 31, 2020, interest totaled $133 and is included in accrued expenses and other liabilities in the Consolidated Balance Sheets and as an expense in other underwriting expenses in the Consolidated Statements of Income and Comprehensive Income. Payment of interest is subject to approval by the Iowa Insurance Division.
The Company performs a quarterly review of its tax positions and makes a determination whether it is more likely than not that the tax position will be sustained upon examination. If, based on this review, it appears not more likely than not that the position will be sustained, the Company will calculate any unrecognized tax benefits and calculate any interest and penalties. At December 31, 2020, 2019, and 2018 the Company did not recognize any liability for unrecognized tax benefits. In addition, we have not accrued for interest and penalties related to unrecognized tax
We file a consolidated federal income tax return. We also file income tax returns in various state jurisdictions. We are no longer subject to federal or state income tax examination for years before 2017.
The Company and certain related parties are equity investors in one investment in which the Company determined is a variable interest entity ("VIE") as a result of participation in the risks and rewards of the VIE based on the objectives and strategies of the VIE. The VIE is a limited liability company that primarily invests in commercial real estate. The Company and certain related parties are not the primary beneficiary largely due to their inability to influence management or direct the activities that most significantly impact the VIE's economic performance. Based on these facts and circumstances, the Company has a variable interest in the VIE, but has not consolidated the VIE's financial results as it is not the primary beneficiary. The Company's investment is reported in other long-term investments in the Consolidated Balance Sheets and accounted for under the equity method of accounting. The fair value of the VIE at December 31, 2020 was $3.3 million and there are no future funding commitments.
An allowance for mortgage loan losses is established based on historical loss information of the collective pool of the Company's commercial mortgage loan investments which have similar risk characteristics. To calculate the allowance for mortgage loan losses, the Company starts with historical loan experience to predict the future expected losses and then layers on a market-linked adjustment. On a quarterly basis, quantitative credit risk metrics, including for example, cash- flows, rent rolls and financial statements are reviewed for each loan to determine if it is
For reinsurance receivables, the Company's model estimates expected credit loss by multiplying the exposure at default by both the probability of default and loss given default ("LGD"). The LGD is estimated by the rating of the Company, historical relationship with UFG, existence of letters of credit and known regulation the Company may be held accountable for. The ultimate LGD percentage is estimated after considering Moody’s experience with unsecured year 1 bond recovery rates from 1983-2017. The allowance calculated as of December 31, 2020 is recorded through the line "Reinsurance receivables and recoverables" in the Consolidated Balance Sheets and through the line "Other underwriting expenses" in the Consolidated Statements of Income and Other Comprehensive Income. As of December 31, 2020, the Company had a credit loss allowance for reinsurance receivables of $190.
With respect to premiums receivable, the Company utilizes an aging method to estimate credit losses. An allowance for doubtful accounts is based on a periodic evaluation of the aging and collectability of amounts due from agents and policyholders. "Premiums receivable" are presented in the Consolidated Balance Sheets net of an estimated allowance for doubtful accounts and recorded through "Other underwriting expenses" in the Consolidated Statements of Income and Comprehensive Income.
Comprehensive income includes all changes in stockholders' equity during a period except those resulting from investments by and dividends to stockholders.
Subsequent to the completion of the financial statements as of December 31, 2020, the Company made the decision to change the post-retirement benefit plan to a voluntary plan funded exclusively by participants, commencing at the start of 2023. The impact of this decision will be reflected in the financial statements subsequent to December 31, 2020. As of December 31, 2020, the post-retirement benefit obligation was $31,666. This benefit obligation, along with the unrecognized prior service costs, will be released into the Consolidated Statement of Income and Other Comprehensive Income over the next two years. See Note 8 "Employee Benefits" for more information.
In August 2018, the FASB issued guidance to align the requirements for capitalizing implementation costs incurred in a cloud computing hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The guidance requires the Company to determine which implementation costs to capitalize as an asset related to the service contract and which costs to expense. The new guidance was effective for annual and interim periods beginning after December 15, 2019. The Company adopted the new guidance as of January 1, 2020. The adoption did not have a significant impact on the Company's financial position or results of operations.
In June 2016, the FASB issued new guidance on the measurement of credit losses for most financial instruments. The new guidance replaces the incurred loss model for recognizing credit losses with an expected loss model for instruments measured at amortized cost and requires allowances to be recorded for available-for-sale debt securities rather than reduce the carrying amount. These allowances are remeasured each reporting period. The new guidance was effective for annual periods beginning after December 15, 2019 and interim periods within those years. The new guidance impacted the Company's impairment model related to our available-for-sale fixed-maturity portfolio, reinsurance receivables and mortgage loans. The Company has performed a run of the credit loss models as of January 1, 2020. These models resulted in an immaterial expected credit loss at January 1, 2020. Prior to the adoption of the new guidance, the Company utilized an aging method to estimate credit losses on premiums receivable. This aging method is permitted under the new guidance. The Company adopted the new guidance
prospectively as of January 1, 2020 recording a cumulative effect adjustment to opening retained earnings of $30. This cumulative effect adjustment is an allowance related to the Company's reinsurance receivables. The adoption of the new guidance did not have a material impact on the Company's financial position and results of operations.
In December 2019, the FASB issued new guidance which simplifies the accounting for income taxes by removing certain exceptions to income tax accounting. The amendments also improve consistent application of and simplify GAAP for other areas of income tax accounting. The new guidance clarifies and amends existing guidance, including removing certain requirements that an entity evaluate when a step-up in the tax basis of goodwill should be considered part of the business combination in which the book goodwill was originally recognized, when it should be considered a separate transaction and requiring an entity to reflect the effect of an enacted change in tax laws or rates in the annual effective tax rate computation in the interim period that includes the enactment date. The new guidance is effective for annual periods beginning after December 15, 2020. The Company adopted the new guidance as of January 1, 2021. The adoption of the new guidance will modify existing disclosures but will not have an impact on the Company’s financial position and results of operations.
Net realized gains (losses) on disposition of investments are computed using the specific identification method and are included in the computation of net income. A summary of net realized investment gains (losses) for 2020, 2019 and 2018, is as follows:
The proceeds and gross realized gains (losses) on the sale of available-for-sale fixed maturity securities from continuing operations for 2020, 2019 and 2018, are as follows:
There were no proceeds and gross realized gains (losses) on the sale of available-for-sale fixed maturity securities from discontinued operations for 2020, 2019 and 2018.
An allowance for credit losses is recorded based on a number of factors including the current economic conditions, management's expectations of future economic conditions and performance indicators, such as market value vs. amortized cost, investment spreads widening or contracting, rating actions, payment and default history. The following table contains a rollforward of the allowance for credit losses for available-for-sale fixed maturity securities at December 31, 2020:
The unrealized losses on our investments in available-for-sale fixed maturities were the result of interest rate movements. We have no intent to sell, and it is more likely than not that we will not be required to sell, these securities until the fair value recovers to at least equal our cost basis or the securities mature.
•Level 1: Valuations are based on unadjusted quoted prices in active markets for identical financial instruments that we have the ability to access.
•Level 3: Valuations are based on pricing or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement of the financial instrument. Such inputs may reflect management's own assumptions about the assumptions a market participant would use in pricing the financial instrument.
The mortgage loan portfolio consists entirely of commercial mortgage loans. The fair value of our mortgage loans is determined by modeling performed by our third party fund manager based on the stated principal and coupon payments provided for in the loan agreements. These cash flows are then discounted using an appropriate risk-adjusted discount rate to determine the security's fair value.
Our other long-term investments consist primarily of our interests in limited liability partnerships that are recorded on the equity method of accounting. The fair value of the partnerships is obtained from the fund managers, which is based on the fair value of the underlying investments held in the partnerships. In management's opinion, these values represent a reasonable estimate of fair value. We have not adjusted the net asset value provided by the fund managers.
A summary of the carrying value and estimated fair value of our financial instruments from at December 31, 2020 and 2019 is as follows:
The following tables present the categorization for our financial instruments measured at fair value on a recurring basis. The tables include financial instruments at December 31, 2020 and 2019:
At least annually, we review the methodologies and assumptions used by our valuation service providers and verify that they are reasonable and representative of the fair value of the underlying securities held in the investment portfolio. We validate the prices obtained from independent pricing services and brokers prior to their use for reporting purposes by evaluating their reasonableness on a monthly basis. In addition, on a quarterly basis, we also test all securities in the portfolio and independently corroborate the valuations obtained from our third-party valuation service providers. Quarterly, we also perform deep dive analysis of the pricing method used by our third-party valuation service provider by selecting a random sample of securities by asset class and reviewing methodologies. In our opinion, the pricing obtained at December 31, 2020 and 2019 was reasonable.
Securities categorized as Level 3 include holdings in certain private placement fixed maturity and equity securities for which an active market does not currently exist. The fair value of our Level 3 private placement securities is determined by management relying on pricing received from our independent pricing services and brokers consistent with the process to estimate fair value for Level 2 securities. However, securities are categorized as Level 3 if these quotes cannot be corroborated by other market observable data due to the unobservable nature of the brokers’
valuation processes. The following table provides a quantitative information about our Level 3 securities at December 31, 2020.
(1) Unrealized gains are recorded as a component of comprehensive income.
amounts which we believe will not be collected according to the contractual terms of the respective loan agreement. As of December 31, 2020, the Company had an allowance for mortgage loan losses of $76, summarized in the following rollforward:
In 2020, we renewed our participation in all of our assumed programs. Loss and loss settlement expenses ceded increased in 2020 as compared to 2019, primarily due to the August Midwest derecho, the recovery of the all lines aggregate program and increase in severity of commercial property and workers' compensation losses.
In 2018, we renewed our participation in all of our assumed programs.
We have several programs that provide reinsurance coverage. This reinsurance coverage limits the risk of loss that we retain by reinsuring direct risks in excess of our retention limits. The following table provides a summary of our primary reinsurance programs. Retention amounts reflect the accumulated retentions and co-participation of all layers within a program. For 2020, there was an all lines annual aggregate excess of loss program with variable retention of 6.37 percent of gross net earned premium with a minimum retention of $58.5 million and a maximum of $71.5 million. Our all lines aggregate recovery is also limited to $30.0 million and 75.0 percent of the program was placed. For 2020, the Company recovered the maximum of $22.5 million from the all lines annual aggregate excess of loss program. For 2019, there was an all lines annual aggregate excess of loss program with a variable retention of 6.66 percent of gross net earned premium with a minimum retention of $58.5 million and a maximum of $71.5 million. Our all lines aggregate recovery is also limited to a maximum of $30.0 million. For 2018, there was an all lines annual aggregate excess of loss program with a variable retention of 6.78 percent of gross net earned premium with a minimum retention of $58.5 million and a maximum of $71.5 million. Our all lines aggregate recovery is also limited to a maximum of $30.0 million. For 2019 and 2018, the Company did not have any recoveries from the all lines annual aggregate loss program.
The ceding of insurance did not legally discharge United Life from primary liability under its policies. United Life must pay the loss if the reinsurer fails to meet its obligations. United Life periodically monitored the financial condition of their reinsurers to confirm that they were financially stable and had strong credit ratings. We believe that all of the reinsurers were in an acceptable financial condition.
Generally, we base reserves for each claim on the estimated ultimate exposure for that claim. We believe that it is appropriate and reasonable to establish a best estimate for reserves within a range of reasonable estimates, especially when we are reserving for claims for bodily injury, disabilities and similar claims, for which settlements and verdicts can vary widely. Our reserving philosophy may result in favorable reserve development in future years that will decrease losses and loss settlement expenses for prior year claims in the year of adjustment. We realize that this
The significant drivers of the favorable reserve development in 2020 were workers' compensation which had $25,428 favorable development followed by commercial fire and allied lines which had $10,655 favorable development, fidelity and surety with $2,068 favorable development and personal automobile with $1,851 favorable development. The favorable development for workers' compensation was primarily from reductions in reserves for reported claims which were more than sufficient to offset paid loss. Reductions in reserves for IBNR claims also contributed favorable development in addition to LAE where reductions in reserves more than sufficient to offset payments. Commercial fire and allied lines developed favorably because reductions in reserves for reported claims combined with reductions in reserves for IBNR claims were more than sufficient to offset paid loss. LAE also contributed favorable development with reductions in reserves more than sufficient to offset payments. Fidelity and surety loss developed favorably because a reduction in reserves for IBNR claims was more than sufficient to offset both paid loss and increases in reserves for reported claims. The personal automobile line of business developed favorably because reductions of reserves for reported claims combined with reductions of reserves for IBNR claims were more than sufficient to offset paid loss. LAE also contributed favorable development with reductions in reserves more than sufficient to offset payments. Much of the favorable development was offset by unfavorable development from three lines with the largest contribution coming from commercial liability with $12,845, reinsurance assumed with $5,972 and commercial automobile with $4,024. The commercial liability line of business experienced unfavorable development due to paid loss which was greater than reductions in reserves for unpaid loss. LAE developed favorably and partially offset the unfavorable loss development. The unfavorable development for reinsurance assumed was due to paid loss which was greater than reductions in reserves for unpaid loss. The commercial automobile line of business experienced unfavorable development because paid loss was greater than reductions in reserves for unpaid loss, but a portion of the unfavorable loss development was offset by favorable development from LAE where payments were more than offset by reductions of reserves for unpaid loss adjustment expense. On an all lines combined basis, favorable development is attributable to LAE which continues to benefit from additional litigation management efforts.
The significant drivers of the favorable reserve development in 2019 were our workers' compensation partially offset by unfavorable development primarily for commercial liability and commercial automobile. Workers' compensation favorable development was primarily from reserve reductions for both reported claims and loss IBNR which were more than sufficient to offset paid loss with additional favorable development coming from LAE, where the reduction in LAE reserves was more than sufficient to offset paid LAE. The other lines with relatively small contributions to development, either favorable or unfavorable, generally experienced favorable development for LAE. Commercial liability unfavorable development was primarily from paid loss which exceeded reserve reductions for both reported claims and loss IBNR; additional unfavorable development came from LAE where paid LAE exceeded reductions of LAE reserves. Commercial liability and commercial automobile continue to be adversely affected by reserve strengthening for both reported claims and loss IBNR in response to an increase in severity of claims. Commercial liability continues to receive umbrella claims which flow in from commercial automobile.
additional favorable development coming from LAE where the LAE IBNR reduction was more than sufficient to offset paid LAE which continues to benefit from additional litigation management efforts when compared to prior years. Reinsurance assumed favorable development is attributable reductions in reserves for both reported claims and loss IBNR as we reviewed our book of business and released excess reserves during 2018. Commercial automobile favorable development was driven by LAE where LAE IBNR reductions were more than sufficient to offset paid LAE. Fidelity and surety favorable development is attributable reductions in reserves for both reported claims and loss IBNR which were more than sufficient to offset paid loss. Commercial liability adverse development is attributable to reserve strengthening for both reported claims and loss IBNR primarily in response to an increase in umbrella auto related claims while LAE developed favorably with reductions of LAE IBNR more than sufficient to offset paid LAE.
Statutory capital and surplus in regards to policyholders at December 31, 2020, 2019 and 2018 and statutory net income (loss) for the years then ended are as follows:
(1)The 2018 Life, accident and health business only includes results prior to the closing of the sale of United Life Insurance Company, which closed on March 30, 2018. Prior to the closing of the sale, United Fire & Casualty Company owned United Life Insurance Company, accordingly, the property and casualty statutory capital and surplus includes life, accident and health statutory capital and surplus, and therefore represents our total consolidated statutory capital and surplus.
We paid dividends to our common shareholders of $28,526, $32,662 and $105,408 in 2020, 2019 and 2018, respectively. Payments of any future dividends and the amounts of such dividends, however, will depend upon factors such as net income, financial condition, capital requirements, and general business conditions. We will only pay dividends if declared by our Board of Directors, out of funds legally available, and subject to any other restrictions that may be applicable to us.
In 2020, 2019 and 2018, United Fire & Casualty Company received dividends from its wholly owned subsidiaries of $62,400, $6,300 and $8,500, respectively. In 2020, 2019 and 2018, United Fire & Casualty Company paid dividends
to United Fire Group, Inc. totaling $4,000, $57,000 and $105,000, respectively. These intercompany dividend payments are eliminated for reporting in our Consolidated Financial Statements.
We are directed by the state insurance departments' solvency regulations to calculate a required minimum level of statutory capital and surplus based on insurance risk factors. The risk-based capital results are used by the NAIC and state insurance departments to identify companies that merit regulatory attention or the initiation of regulatory action. United Fire & Casualty Company and its property and casualty insurance subsidiaries and affiliates had statutory capital and surplus in regards to policyholders well in excess of their required levels at December 31, 2020.
We offer various benefits to our employees including a noncontributory defined benefit pension plan, an employee/retiree health and dental benefit plan.
In December 2020, the Company made the decision to amend the noncontributory defined benefit pension plan. The Company plans to amend the pension plan by discontinuing the noncontributory defined benefit pension plan and put in place a noncontributory cash balance pension plan effective July 1, 2021. All benefits under the noncontributory defined benefit pension plan will stop accruing on June 30, 2021.
Subsequent to the completion of the financial statements as of December 31, 2020, the Company made the decision to change the post-retirement benefit plan to a voluntary plan funded exclusively by participants, commencing at the start of 2023. The impact of this decision will be reflected in the financial statements subsequent to December 31, 2020. As of December 31, 2020, the post-retirement benefit obligation was $31,666. This benefit obligation, along with the unrecognized prior service costs, will be released into the Consolidated Statement of Income and Other Comprehensive Income over the next two years.
The investments held by the pension plan at December 31, 2020 include the following asset categories:
•Equity securities, which may include various types of stock, such as large-cap, mid-cap, small-cap, and international stocks;
•Pooled separate accounts, which includes two separate funds, a core plus bond separate account and a real estate separate account;
•An arbitrage fund, which is a fund that takes advantage of price discrepancies, primarily equity securities, for the same asset in different markets;
•A group annuity contract that is administered by United Life, a former subsidiary of United Fire; and
As of December 31, 2020, we had six external investment managers that are allowed to exercise investment discretion, subject to limitations, if any, established by the investment/retirement committee. We utilize multiple
The following is a summary of the pension plan's actual and target asset allocations at December 31, 2020 and 2019 by asset category:
The investment return expectations for the pension plan are used to develop the asset allocation based on the specific needs of the pension plan. Accordingly, equity securities comprise the largest portion of our pension plan assets, as they yield the highest rate of return. The United Life annuity, which is the fifth largest asset category and was originally written by our former life insurance subsidiary in 1976, provides a guaranteed rate of return. The interest rate on the group annuity contract is determined annually.
recent trading activity of the underlying security in the financial markets. These securities represent various taxable bonds held by the pension plan. These securities categorized as Level 2 are valued in the same manner as described in Note 3 "Fair Value of Financial Instruments" and have the same controls in place.
The pension plan invests in two pooled separate account funds, a core plus bond separate account fund and a U.S. property separate account fund. Investments in the core plus bond separate account fund are stated at fair value as provided by the administrator of the fund based on the fair value of the underlying assets owned by the fund. The fair value measurement is classified within Level 2 of the fair value hierarchy. The fair value of the investments in the U.S. property separate account fund is provided by the administrator of the fund based on the net asset value of the fund. The net asset value is based on the fair value of the underlying properties included in the fund. The fair value of the underlying properties are based on property appraisals conducted by an independent third party. The fair value measurement is classified within Level 3 of the fair value hierarchy. We have not adjusted the net asset value provided by the custodian for either fund.
The following tables present the categorization of the pension plan's assets measured at fair value on a recurring basis at December 31, 2020 and 2019:
The fair value of fixed maturity securities categorized as Level 2 is determined by management based on fair value information reported in the custodial statements, which is derived from recent trading activity of the underlying security in the financial markets. These securities represent various taxable bonds held by the pension plan. These securities categorized as Level 2 are valued in the same manner as described in Part II, Item 8, Note 3 "Fair Value of Financial Instruments" and have the same controls in place.
The Society of Actuaries ("SOA") is an actuarial organization that periodically reviews mortality data and publishes mortality tables and improvement scales. In October 2019, the SOA released the Pri-2012 mortality tables for private sector retirement plans in the United States. The mortality assumptions are based on the Pri-2012 white collar base rate mortality projected generationally using the Principal Mortality Improvement Scale ("Principal 2016-10"). The Principal 2016-10 scale is based on latest mortality improvement scale, the MP-2020 model issued by the SOA with a few user-selected assumptions: 10- year convergence period on age and cohort and long-term rate assumptions using sex-distinct and age based rated developed from Social Security Trustee Reports. We have reviewed these updated tables and have updated the mortality assumptions based on this information and also based on research provided by our external actuaries. We will continue to monitor mortality assumptions and make changes as appropriate to reflect additional research and our resulting best estimate of future mortality rates.
(1)For the pension plan, the benefit obligation is the projected benefit obligation. For the post-retirement benefit plan, the benefit obligation is the accumulated post-retirement benefit obligation.
Our accumulated pension benefit obligation was $271,515 and $226,196 at December 31, 2020 and 2019, respectively.
The components of the net periodic benefit cost for our pension and post-retirement benefit plans are as follows:
The United Fire Group, Inc. 2008 Stock Plan (the "2008 Stock Plan") authorized the issuance of restricted and unrestricted stock awards, stock appreciation rights, incentive stock options, and non-qualified stock options for up to 1,900,000 shares of United Fire common stock to employees. In May 2014, the Registrant's shareholders approved an additional 1,500,000 shares of United Fire common stock issuable at any time and from time to time pursuant to the 2008 Stock Plan, among other amendments, and renamed such plan as the United Fire Group, Inc. Stock Plan (as amended, the "Stock Plan"). At December 31, 2020, there were 700,680 authorized shares remaining available for future issuance. The Stock Plan is administered by the Board of Directors, which determines those employees who will receive awards, when awards will be granted, and the terms and conditions of the awards. The Board of Directors may also take any action it deems necessary and appropriate for the administration of the Stock Plan. Pursuant to the Stock Plan, the Board of Directors may, at its sole discretion, grant awards to our employees who are in positions of substantial responsibility with United Fire.
Options granted pursuant to the Stock Plan are granted to buy shares of United Fire's common stock at the market value of the stock on the date of grant. Options granted prior to March 2017 vest and are exercisable in installments of 20.0 percent of the number of shares covered by the option award each year from the grant date, unless the Board of Directors authorizes the acceleration of vesting. Options granted after March 2017 vest and are exercisable in installments of 33.3 percent of the number of shares covered by the option award each year from the grant date, unless the Board of Directors authorizes the acceleration of vesting. To the extent not exercised, vested option awards accumulate and are exercisable by the awardee, in whole or in part, in any subsequent year included in the option period, but not later than 10 years from the grant date. Restricted and unrestricted stock awards granted pursuant to the Stock Plan are granted at the market value of our common stock on the date of the grant. Restricted stock awards fully vest after 3 years or 5 years from the date of issuance, unless accelerated upon the approval of the Board of Directors, at which time United Fire common stock will be issued to the awardee. All awards are generally granted free of charge to the eligible employees of United Fire as designated by the Board of Directors.
The United Fire Group, Inc. Non-Employee Director Stock Plan (formerly known as the 2005 Non-Qualified Non- Employee Director Stock Option and Restricted Stock Plan) (the "Director Stock Plan") authorizes the issuance of restricted stock awards and non-qualified stock options to purchase shares of UFG's common stock to non-employee directors. On May 20, 2020, the Company’s shareholders approved amendments to the Director Stock Plan, previously approved by the Company’s Board of Directors, to (i) increase the number of shares available for future awards under the Director Stock Plan from 300,000 to 450,000, (ii) extend the expiration date of the Director Stock Plan from December 31, 2020 to December 31, 2029, (iii) allow for the grant of awards of restricted stock units, and (iv) rename the Director Stock Plan as the "United Fire Group, Inc. Non-Employee Director Stock Plan." At December 31, 2020, we had 160,135 authorized shares available for future issuance.
restricted stock (other than those terms and conditions set forth in the plan) and the number of shares of common stock to be issued pursuant to an option agreement or restricted stock agreement (subject to limits set forth in the plan). The Board of Directors may also take any action it deems necessary and appropriate for the administration of the Director Stock Plan.
The activity in the Director Stock Plan is displayed in the following table:
As of December 31, 2020, we had $4,095 in stock-based compensation expense that has yet to be recognized through our results of operations. We expect this compensation to be recognized in subsequent years according to the following table, except with respect to awards that are accelerated by the Board of Directors, in which case we will recognize any remaining compensation expense in the period in which the awards are accelerated.
The following table summarizes information regarding the stock options outstanding and exercisable at December 31, 2020:
Our personal lines consist primarily of automobile and fire and allied lines coverage, including homeowners.
In May 2020, the Company entered into a renewal rights agreement for our personal lines business, providing our
independent insurance agents with the opportunity to transfer their personal lines policies to Nationwide Mutual
Insurance Company beginning in the third quarter of 2020, subject to the receipt of applicable regulatory approvals.
(1)The sum of the quarterly reported amounts may not equal the full year, as each is computed independently.
The Company determines if a contract contains a lease at inception of the contract by reviewing the facts and circumstances of the contract to determine if a lease is present. The Company has operating leases relating to office space, vehicles, computer equipment, and office equipment, which are recorded as a lease obligation liability disclosed in the "Accrued expenses and other liabilities" line on the Consolidated Balance Sheets and as a lease right-of-use asset disclosed in the "Other assets" line on the Consolidated Balance Sheets. The lease right-of-use asset represents the Company's right to use each underlying asset for the lease term and the lease obligation liability represents the Company's obligation over the lease term. As an accounting policy election, we have elected the practical expedient on not separating lease components from non-lease components to each major asset class.
The Company executed a private placement debt transaction on December 15, 2020 between UF&C, and Federated Mutual and Federated Life.
Interest payments under the surplus notes will be paid quarterly on March 15, June 15, September 15 and December 15 of each year (each such date, an "Interest Payment Date"). The interest rate will equal the rate that corresponds to the A.M. Best Co. (or its successor’s) financial strength rating for members of the United Fire & Casualty Pooled Group as of the applicable Interest Payment Date, as set forth in the table below. As of December 31, 2020, interest expense totaled $133. Payment of interest is subject to approval by the Iowa Insurance Division.
The Credit Agreement includes customary events of default, including default in payments of principals, default in payment of other indebtedness, change of control and voluntary and involuntary insolvency proceedings, the occurrence of which would allow the Lenders to accelerate payment of all amounts outstanding thereunder and terminate any further commitments to lend.
Prior to February 2, 2020, the Company had a credit agreement (the "Previous Credit Agreement") which it entered into on February 2, 2016. The Company, as borrower, entered into the Previous Credit Agreement with the lenders from time to time party thereto and KeyBank National Association ("Key Bank"), as administrative agent, swingline lender and letter of credit issuer. The Previous Credit Agreement provided for a $50,000 four-year unsecured revolving credit facility that included a $20,000 letter of credit subfacility and a swingline subfacility in the amount up to $5,000. The Previous Credit Agreement allowed the Company to increase the aggregate amount of the commitments thereunder by up to $100,000.
The carrying value of our goodwill was zero at December 31, 2020 and $15,091 at December 31, 2019, respectively. During the third quarter of 2020, we completed our annual quantitative analysis of goodwill. As a result of the quantitative analysis, we impaired the remaining balance of our goodwill of $15,091 as of September 30, 2020 based on the following factors: (i) disruptions in the equity markets, specifically for property and casualty insurance companies, as a result of the COVID-19 pandemic and due to recent weather related catastrophes; (ii) recent elevated commercial auto loss ratios; and (iii) the fair value of our stock trading significantly below book value. The Company used a weighting of the income and market approaches to determine the fair value of the reporting unit.
UFG agreed to provide services to Kuvare through a transition services agreement ("TSA"). The TSA included, among other considerations, accounting management, human resources, legal and information technology services, from the closing date for up to 24 months. The TSA ended as scheduled on March 30, 2020. The Company received a total of $1,019 as part of the TSA.
Description of the Matter As described in Note 15 to the consolidated financial statements, the Company performed a quantitative impairment analysis on its one reporting unit and recognized an impairment charge of $15.1 million for the year ended December 31, 2020. Management tests goodwill for impairment annually, during the third quarter, or more frequently if events or changes in circumstances indicate that goodwill might be impaired. An impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value. The Company used a weighting of the income and market approaches to determine the fair value of the reporting unit.
How We Addressed the Matter in Our Audit We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the quantitative goodwill impairment analysis, including, among others, the controls over management's review of the valuation model and the significant assumptions used.
To test the estimated fair value of the reporting unit, we, with the support of our valuation specialists, performed audit procedures that included, among others, assessing methodologies, the weighting of those methodologies, and testing the significant assumptions discussed above. We tested the significant assumptions by comparing them to current and forecasted industry and economic trends, historical results, analyst reports, forecasted peer company information obtained from publicly available sources and developing an independent range of estimates and comparing that to the calculations performed by management. We also evaluated management’s selection of market multiples by comparing them to publicly available data on comparable public companies.