Three buildings, two in Springfield, Missouri and the other in Glenmont, New York, which are used by our Property and Casualty segment.
* This includes the Company’s provisional impact of the recent U.S. Tax Cut and Jobs Act (“Tax Reform”) of $206.4 million, which may be adjusted for the current and future periods, possibly materially, due to, among other things, further refinement of the Company’s calculations, changes in interpretations and assumptions the Company has made, tax guidance that may be issued and actions the Company may take as a result of Tax Reform. Excluding the impact of Tax Reform, the Company’s 2017 net income would have been $287.3 million and net earnings per basic and diluted share of $10.68 and $10.65, respectively. For a discussion of the impact of the recently adopted legislation, see Item 8, Financial Statements and Supplementary Data, Notes to the Consolidated Financial Statements, Note 14, Income Taxes.
Certain statements made in this report include forward-looking statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements generally are indicated by words such as “expects,” “intends,” “anticipates,” “plans,” “believes,” “estimates,” “will” or words of similar meaning; and include, without limitation, statements regarding the outlook of our business and expected financial performance. These forward-looking statements are subject to changes and uncertainties which are, in many instances, beyond our control and have been made based upon our assumptions, expectations and beliefs concerning future developments and their potential effect upon us. There can be no assurance that future developments will be in accordance with our expectations, or that the effect of future developments on us will be as anticipated. It is not a matter of corporate policy for us to make specific projections relating to future earnings, and we do not endorse any projections regarding future performance made by others. Additionally, we do not publicly update or revise forward-looking statements based on the outcome of various foreseeable or unforeseeable events. Forward-looking statements are not guarantees of future performance and involve various risks and uncertainties. There are certain important factors that could cause actual results to differ, possibly materially, from expectations or estimates reflected in such forward-looking statements, including without limitations risks, uncertainties and other factors discussed in Item 1A, Risk Factors and elsewhere in this report. Management’s discussion and analysis (“MD&A”) of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included in Item 8, Financial Statements and Supplementary Data.
Our business has been and will continue to be influenced by a number of industry-wide, segment or product-specific trends and conditions. In our discussion below, we first outline the broad macro-economic or industry trends (General Trends) that we expect to impact our overall business. Second, we discuss certain segment-specific trends we believe may impact individual segments or specific products within these segments.
Changing Regulatory Environment: The insurance industry is primarily regulated at the state level, although some life and annuity products and services are also subject to U.S. federal regulation. We are regularly subjected to additional or changing regulation that requires us to update systems, change product structure, increase the amount of reporting or adopt changes to distribution. These changes may increase the capital requirements for us and the industry, increase operating costs, change our operating practices and change our ability to provide products with pricing attractive to the marketplace.
Increased Challenges of Talent Attraction and Retention: Attracting qualified individuals and retaining existing employees is a challenge for all employers. Businesses have become extremely competitive in the talent marketplace, and with the increasing impact of social media (particularly sites like LinkedIn) it is easier than ever for companies to find individuals with needed job skills and lure them away from their current positions. As a result, the ability to distinguish American National as the employer of choice grows increasingly important. Providing the right mix of benefits and opportunities is the best approach to attracting and retaining employees. Expanding our use of technology and social media will enhance our employer brand and educate candidates on why they want to work for us. Evolving acquisition strategies to target the diversity of today’s workforce will continue to grow our candidate base. Succession planning and the identification/development of high potential employees creates career paths designed to retain our best and brightest. Increasing our talent development efforts ensures the growth of skill sets and the ability to promote from within.
Most of the major provisions of the Patient Protection and Affordable Care Act, and a reconciliation measure, the Health Care and Education Reconciliation Act of 2010 (collectively, “the Healthcare Acts”), phased in effective January 1, 2014. The Healthcare Acts mandated broad changes in the delivery of health care benefits that have impacted our business model including our relationships with current and future customers, producers, and health care providers, as well as our products, services and processes. As a result, the Healthcare Acts generated new opportunities in the limited benefit and supplemental product markets. In recent years, we built a portfolio of such products to be sold in the worksite market as well as to individuals. We had some success with the individual products in 2015 and 2016 although these products were restricted somewhat in 2016 and 2017 due to regulatory changes. We are now expanding our presence in the worksite market to generate new opportunities in the broker market, as well as developing and implementing a captive sales force. The future of the Healthcare Acts remains questionable and subject to change. We continue to monitor possible changes and maintain a wait and see attitude, allowing us to be opportunistic to new markets.
We expect our Managing General Underwriter (“MGU”) business to remain stable during 2017. We generally retain only 10% of the MGU premium and risk. The majority of the revenue generated from this business is fee income included in “Other income” of the Health segment’s operating results.
We offer our personal and commercial property and casualty lines of business primarily through captive agents. We favor a balanced, focused and collaborative approach to both growth and profitability through the development of successful agencies.
Annuity Reserving-Reserves for payout annuities with more than insignificant amounts of mortality risk are calculated in accordance with the applicable accounting guidance for limited pay insurance contracts. Benefit and maintenance expense reserves are calculated by using assumptions reflecting our expectations of future costs, including an appropriate margin for adverse deviation. These assumptions are locked-in at issue and generally reflect pricing assumptions from that period. If the resulting reserve would otherwise cause profits to be recognized at the issue date, additional reserves are recorded. The resulting recognition of profits would be gradual over the expected life of the contract.
Future lapse rates will remain reasonably consistent with our current expectations;
Future interest spreads will remain reasonably consistent with our current expectations.
Premium Deficiency Reserves-Deficiency reserves are established when the expected future claim payments and expenses for a classification of policies are in excess of the expected premiums for these policies. The determination of a deficiency reserve takes into consideration the likelihood of premium rate increases, the timing of these increases, and the expected benefit utilization patterns. We have established premium deficiency reserves for portions of the major medical business and the long-term care business that are in run-off. The assumptions and methods used to determine the deficiency reserves are reviewed periodically for reasonableness, and the reserve amount is monitored against emerging losses.
IBNR-IBNR reserves are estimated based on many variables including: historical statistical information, inflation, legal environment, economic conditions, trends in claim severity and frequency as well as other factors affecting the adequacy of claim reserves. Loss and premium data is aggregated by exposure class and by accident year. IBNR reserves are estimated by projecting ultimate losses on each class of business and subtracting paid losses and case reserves. Our overall reserve practice provides for ongoing claims evaluation and adjustment based on the development of related data and other relevant information pertaining to claims. Adjustments in aggregate reserves, if any, are included in the results of operations of the period during which such adjustments are made.
We believe we conservatively reflect the potential uncertainty generated by volatility in our loss development profiles when selecting loss development factor patterns for each line of business. See Note 12, Liability for Unpaid Claims and Claim Adjustment Expenses, of the Notes to the Consolidated Financial Statements for additional information.
Premium Deficiency Reserve-Deficiency reserves are recorded when the expected claims payments and policy maintenance costs for a product line exceed the expected premiums for that product line. The estimation of a deficiency reserve considers the current profitability of a product line using anticipated claims, CAE, and policy maintenance costs. The assumptions and methods used to determine the need for deficiency reserves are reviewed periodically for reasonableness. There were no reserves of this type at December 31, 2017 and December 31, 2016, respectively.
The loss ratio selections and development profiles are developed primarily using our historical claims and loss experience. These development patterns reflect prior inflation rates, and could be impacted by future changes in inflation rates, particularly those relating to medical care costs, automobile repair parts and building or home material costs. These assumptions have not been modified from the preceding periods and are consistent with historical loss reserve development patterns.
The analysis of our credit insurance lines of business quantifies the estimated impact on gross loss reserves of a reasonably likely scenario of varying the ratio applied to the earned premium to determine the IBNR reserves at December 31, 2017. IBNR reserving methodology for this line of business focuses primarily on the use of a ratio applied to the unearned premium for each credit insurance product. The selected ratios are based on historical loss and claim data. In our analysis, we varied this ratio by +/- 5% across all credit insurance products combined. The results of our analysis show an increase or decrease in gross reserves across all accident years combined of approximately $12.1 million.
Management believes our reserves at December 31, 2017 are adequate. New information, regulation, events or circumstances unknown at the original valuation date, however, may result in future development resulting in ultimate losses being significantly greater or less than the recorded reserves at December 31, 2017.
We had a DAC asset of approximately $1.37 billion and $1.29 billion at December 31, 2017 and 2016, respectively. See Note 10, Deferred Policy Acquisition Costs, of the Notes to the Consolidated Financial Statements for additional details.
The Company has frozen each of its defined benefit pension plans. Our pension and postretirement benefit obligations and related costs covering our employees are estimated using actuarial concepts in accordance with the relevant accounting guidance. The discount rate and the expected return on plan assets are important elements of expense and/or liability measurements. Each year, these key assumptions are reevaluated to determine whether they reflect the best estimates for the current period. Changes in the methodology used to determine the best estimates are made when facts or circumstances change. Other assumptions involve demographic factors such as retirement age, mortality and turnover. The expected long-term rate of return on plan assets is determined using the building-block method which is described further in Item 8, Financial Statements and Supplementary Data, Notes to Consolidated Financial Statements, Note 2, Summary of Significant Accounting Policies and Practices, Pension and Postretirement Benefit Plans. In 2017, the Company commenced a one-time window offering to terminated, vested participants of our qualified defined benefit pension plans. The offer allowed participants to take a lump sum or annuity payout which was funded from pension plan assets. See Item 8, Financial Statements and Supplementary Data, Notes to Consolidated Financial Statements, Note 18, Pension and Postretirement Benefits for additional details.
Our effective tax rate is based on income, non-taxable and non-deductible items, statutory tax rates and tax credits. Also, management’s best estimate of future events and their impact is included in our accounting estimates. Certain changes or future events, such as changes in tax legislation, and completion of tax audits could have an impact on our estimates and effective tax rate. Audit periods remain open for review until the statute of limitations has passed.
The federal government enacted the Tax Cuts and Jobs Act (“Tax Reform”) on December 22, 2017. Tax Reform makes broad and complex changes to federal corporate tax law that we expect will have a significant impact on our provision for taxes. Most notably, Tax Reform reduced the corporate income tax rate from 35% to 21%. Other provisions affecting corporations include, but are not limited to, changes to the deductibility of interest expense, limitations on certain deductions for executive compensation and the repeal of the corporate Alternative Minimum Tax. In addition, there are several changes that are specific to insurance companies, namely changes to the proration formula used to determine the amount of dividends eligible for the dividends-received deduction, changes to the calculation of tax reserves associated with policyholder liabilities and modified discounting rules for tax reserves of our property and casualty companies. In its entirety, Tax Reform will result in changes to our overall tax obligations following the effective date of the legislation which is January 1, 2018.
Subsequent to enactment, the Securities Exchange Commission introduced Staff Accounting Bulletin No. 118 (“SAB 118”) to provide guidance on accounting for the effects of Tax Reform. SAB 118 provides guidance on accounting for the effects of the U.S. Tax Reform where our determinations are incomplete but we are able to determine a reasonable estimate. A final determination is required to be made within a measurement period not to extend beyond one year from the enactment of Tax Reform. We have recorded a provisional benefit of $206.4 million in our 2017 financial statements in accordance with the guidance in SAB 118. As a result of Tax Reform, we have remeasured our existing deferred tax balances at the new 21% corporate income tax rate. Additionally, we have made a reasonable estimate to evaluate the impact of Tax Reform on our 2017 financial statements, including evaluating the impact of changes in calculating income tax reserves for both our life and property and casualty insurance products. These provisional amounts may be adjusted for current and future periods, possibly materially, due to among other things, further refinement of our calculations, changes in our interpretations and assumptions, tax guidance that may be issued and action we may take as a result of Tax Reform.
Aside from the above, the income tax effects of Tax Reform in its entirety are currently being analyzed. We will continue to evaluate Tax Reform and adjust our provisional amounts as needed. We expect to complete our detailed analysis no later than the fourth quarter of 2018. Additionally, we expect that we will record the effect of additional aspects of Tax Reform in 2018 as those aspects become effective.
A positive amount of net change indicates less expense was deferred than amortized and represents an increase to expenses in the period indicated.
Earnings increased during 2017 compared to 2016 primarily due to higher realized investment earnings and a decrease in policyholder benefits. Earnings decreased during 2016 compared to 2015 reflecting the net impact of the change in estimate which resulted in a net decrease in earnings of $3.7 million.
Premiums increased during 2017 compared to 2016 and 2016 compared to 2015 primarily due to continued growth in renewal premium on traditional life products.
Commissions increased during 2017 compared to 2016 which was commensurate with the increase in all life sales. Commissions increased during 2016 compared to 2015 primarily due to an increase in universal life policy sales.
Reinsurance is used in the credit life business primarily to provide producers of credit-related insurance products the opportunity to participate in the underwriting risk through producer-owned captive reinsurance companies often domiciled outside of the United States. A majority of the treaties entered into by our Credit Insurance Division are written on a 100% coinsurance basis with benefit limits of $100,000 on credit life. We have entered into funds withheld reinsurance treaties, which provide for cessions to the reinsurer on a written basis.
For 2017, the companies to whom we have ceded reinsurance for the Life segment are shown below (in thousands, except percentages):
Annuity premium and deposit amounts received are shown below (in thousands):
The interest margin earned on fixed deferred annuities interest decreased by $3.3 million for 2017 compared to 2016 due to a decrease in fixed investment yields, and decreased $21.3 million for 2016 compared to 2015 due to a decrease in assets, as measured by account value.
The S&P 500 Index increased by approximately 19.4% and 9.5% in 2017 and 2016, respectively. This change in index performance led to an increase in option return of $54.3 million during 2017 compared to 2016, and $33.5 million during 2016 compared to 2015 in the related equity-indexed annuities. Interest margin is highly correlated with asset base as large changes in interest credited are offset by option return. The increase in asset base in 2017 compared to 2016 was offset by a decrease in fixed investment yields causing a decrease in interest spread.
Earned premiums decreased during 2017 compared to 2016 primarily due to the non-renewal of the above referenced group health plan partially offset by an increase in MGU and credit accident and health premiums. MGU premiums increased due to the onboarding of new performing groups by several MGUs. Credit accident and health premiums increased primarily due to the addition of new producers writing credit monthly pay business. Earned premiums decreased during 2016 compared to 2015, primarily due to a decline in Medicare Supplement and MGU premiums. Medicare Supplement earned premiums decreased due to lapses that were greater than new sales, compounded by the continuing shift in sales from comprehensive higher premium plans to the lower premium high deductible plan. MGU premiums decreased due to the removal of lesser performing groups by several MGUs. Since the MGU policy counts include 100% reinsured certificates, the increase does not always translate into corresponding increases in premiums.
Total in-force policies decreased during 2017 compared to 2016 in all blocks of business except for Medicare Supplement and MGU. Although credit accident and health premiums increased, policy counts, which do not include monthly pay business, decreased due to a decrease in the traditional single premium business. Although supplemental insurance sales increased during 2017 compared to 2016, the termination of two large groups with low coverage amounts produced a net decrease in supplemental insurance policy counts. Group health in-force policies decreased during 2017 compared to 2016, primarily due to the exclusion of certain AD&D coverages. All other in-force policies decreased during 2017 compared to 2016 due to the lapsation of older policies. During 2016 compared to 2015 in-force policies decreased in all blocks of health business, except for group and MGU. Since the MGU policy counts include 100% reinsured certificates, the increase does not always translate into corresponding increases in premiums.
Claims incurred decreased during 2017 compared to 2016 due to the non-renewal of a group health plan, the change in estimate during third quarter of 2016 decreasing the ceded MGU claim reserves, and the continued shrinkage of the closed medical expense block.
Commissions increased during 2017 compared to 2016 due to the correlated sales in credit accident and health and the MGU line of business. Commissions decreased during 2016 compared to 2015 primarily due to the decrease in premiums.
For 2017, the companies to which we have ceded reinsurance for the Health segment are shown below (in thousands, except percentages):
Property and Casualty earnings increased during 2017 compared to 2016, primarily due to increased net premiums earned coupled with an improvement in the loss ratio. Property and Casualty earnings decreased during 2016 compared to 2015, as continued premium growth and the favorable results in our commercial lines were outpaced by the increase in losses attributable to personal auto claims and higher catastrophe losses.
Net premiums written and earned increased for all major lines of business during 2017 compared to 2016. The largest increases were in the personal automobile and other commercial lines of business. Net premiums written and earned increased during 2016 compared to 2015 for all major lines of business.
Operating expenses increased during 2017 compared to 2016, and 2016 compared to 2015 as a result of costs related to growth initiatives.
Homeowners: Net premiums written and earned increased during 2017 compared to 2016 and 2016 compared to 2015 primarily due to increased sales to renters. The loss and combined ratios increased during 2017 compared to 2016 and 2016 compared to 2015 due to an increase in catastrophe losses.
Other Personal: These products include coverages for individuals seeking to protect their personal property and liability not covered within their home and auto policies such as coverages for watercraft, recreational vehicles, motorcycle and personal umbrella. The loss and combined ratios increased during 2017 compared to 2016 due to increased claims for rental-owners along with several large umbrella claims. The loss ratio decreased during 2016 compared to 2015 primarily due to certain personal umbrella claim re-designations from personal lines to commercial lines.
Commercial Automobile: Net premiums written and earned increased during 2017 compared to 2016, primarily due to increased sales as well as improved rate adequacy. The loss and combined ratios decreased during 2017 compared to 2016 primarily due to a decrease in the average severity of losses. Net premiums written and earned increased during 2016 compared to 2015, due to an increase in direct written premiums coupled with a decrease in ceded premiums. The loss ratio decreased during 2016 compared to 2015, primarily due to a decrease in average severity of losses.
(1) The Corporate Program covers all non-credit property and casualty business, subject to certain limits, and is not specific to the Company or any of its subsidiaries, or any state or region. The program does cover the Mortgage Security Insurance (MSI) and Guaranteed Auto Protection (GAP) business written by the Credit Insurance Division.
Each per-event coverage above includes one automatic reinstatement except for a 12.5% portion of the Corporate Program (12.5% of $35 million to $500 million). The automatic reinstatement requires us to pay additional reinsurance premium for any losses into each reinsurance layer. The reinstatement premium is prorated by the percentage of actual loss to the coverage, with the exception of losses from $35 million to $100 million, which reflect a 50% reduction on the prorated amount, and the losses from $17.5 million to $35 million, in which a 70% portion is free for the first limit and reflects a 50% reduction on the second limit. The 12.5% placement of non-reinstateable coverage reduces the amount of reinstatement premium we are obligated to pay. We purchase a Catastrophe Aggregate reinsurance coverage that provides for $30 million of limit excess of $90 million of aggregated catastrophe losses. Qualifying losses include amounts of retained losses below $10 million on Property Claims Services (PCS) declared catastrophe events and internally declared catastrophe events exceeding $5 million. The Catastrophe Aggregate reinsurance coverage has been placed at 100.0% for 2018 and does not include a reinstatement.
A Stretch & Aggregate cover is purchased which consists of a $35 million annual limit available either wholly or in part across two layers. The first layer is 8.75% of $400 million excess of $100 million on an occurrence basis. The second layer provides aggregate protection where subject loss is $35 million excess of $5 million of each catastrophe. Recoveries follow satisfaction of a $45 million annual aggregate deductible. This cover was placed on July 1, 2017, and remains in place until June 30, 2018. American National expects to place the cover again on July 1, 2018.
We use multiple reinsurers with each reinsurer absorbing part of the overall risk ceded. The primary reinsurers in the 2017 programs and the coverage each provides are shown in the following table:
Mortgage Loans- We invest in commercial mortgage loans that are diversified by property-type and geography. Generally, mortgage loans are secured by first liens on income-producing real estate with a loan-to-value ratio of up to 75%. Mortgage loans are carried at outstanding principal balances, adjusted for any unamortized premium or discount, deferred fees or expenses, and net of allowances. The weighted average coupon yield on the principal funded for mortgage loans was 4.7% at December 31, 2017 and 2016, respectively.
Net investment income increased $105.8 million during 2017 compared to 2016 primarily due to an increase in realized and unrealized gains of equity-indexed options as a result of increases in the S&P 500 and an increase in mortgage loan income. Equity-indexed options are recorded at fair value with changes in fair value recorded as investment income.
The net change in the unrealized gains on fixed maturity securities between December 31, 2017 and December 31, 2016 is primarily attributable to the decrease in benchmark ten-year interest rates which were 2.41% and 2.45% respectively. The Company does not currently intend to sell nor does it expect to be required to sell any of the securities in an unrealized loss position.
We have notes payable relating to borrowings by real estate joint ventures that we consolidate into our financial statements that are not part of our capital resources. The lenders for the notes payable have no recourse against us in the event of default by the joint ventures. Therefore, the liability we have for these notes payable is limited to our investment in the respective ventures, which totaled $28.4 million and $31.8 million at December 31, 2017 and 2016, respectively.
The changes in our capital resources are summarized below (in thousands):
Statutory capital and surplus is the capital of our insurance companies reported in accordance with accounting practices prescribed or permitted by the applicable state insurance departments. RBC is calculated using formulas applied to certain financial balances and activities that consider, among other things, investment risks related to the type and quality of investments, insurance risks associated with products and liabilities, interest rate risks and general business risks. Insurance companies that do not maintain capital and surplus at a level of at least 200% of the authorized control level RBC are required to take certain actions. At December 31, 2017 and December 31, 2016, American National Insurance Company’s statutory capital and surplus was $3,293,474,000 and $2,985,909,000, respectively. American National Insurance Company and each of its insurance subsidiaries had statutory capital and surplus at December 31, 2017 and December 31, 2016, substantially above 200% of the authorized control level.
Consolidated Statements of Operations for the years ended December 31, 2017, 2016, and 2015
Consolidated Statements of Comprehensive Income for the years ended December 31, 2017, 2016, and 2015
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 28, 2018 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated statements of financial position of the Company as of December 31, 2017 and 2016, the related consolidated statements of operations, comprehensive income, changes in equity, and cash flows for each of the years in the three-year period ended December 31, 2017, and the related notes and financial statement schedules I to V (collectively, the consolidated financial statements), and our report dated February 28, 2018 expressed an unqualified opinion on those consolidated financial statements.
Investment securities - Bonds classified as held-to-maturity are carried at amortized cost. Bonds classified as available-for-sale are carried at fair value. Equity securities are classified as available-for-sale and carried at fair value. After-tax net unrealized gains or losses on available-for-sale securities are reflected in equity as a component of “Accumulated Other Comprehensive Income” (“AOCI”).
Real Estate Joint Ventures and Other Limited Partnership Interests in which the Company has more than a minor interest or influence over the investee’s operations, but it does not have a controlling interest and is not the primary beneficiary, are accounted for using the equity method. These investments are reported as “Investments in unconsolidated affiliates” in the consolidated statements of financial position. For certain joint ventures, American National records its share of earnings using a lag methodology of one to three months when timely financial information is not available and the contractual right does not exist to receive such financial information. In addition to the investees’ impairment analysis of its underlying investments, American National routinely evaluates its investments in those investees for impairments. American National considers financial and other information provided by the investee, other known information and inherent risks in the underlying investments, as well as future capital commitments, in determining whether impairment has occurred. When an impairment is deemed to have occurred at the joint venture level, American National recognizes its share as an adjustment to “Equity in earnings of unconsolidated affiliates” to record the investment at its fair value. When an impairment results from American National’s separate analysis, an adjustment is made through “Net realized investment gains” to record the investment at its fair value.
All fixed maturity securities with unrealized losses are assessed to determine if the creditworthiness of any of those securities has deteriorated to a point where its carrying value will not be realized at maturity. For fixed maturity securities at December 31, 2017, the unrealized losses on fixed maturity securities that were not other-than-temporarily impaired were the result of credit spread widening. There were no delinquent coupon payments attributed to these securities at December 31, 2017.
Derivative instruments are purchased to hedge against future interest rate increases in liabilities indexed to market rates, and are recorded in the consolidated statements of financial position at fair value net of collateral provided by counterparties. The change in fair value of derivative assets and liabilities is reported in the consolidated statements of operations as “Net investment income” and “Interest credited to policyholders’ account balances,” respectively. American National does not apply hedge accounting treatment to its derivative instruments. The Company uses derivative instruments to hedge our business risk and holds collateral to offset exposure from its counterparties. Unrestricted collateral that supports credit risk is reported in the consolidated statements of financial position as an offset to “Other invested assets” with an associated payable to “Other liabilities” for excess collateral.
Cash and cash equivalents include cash on-hand and in banks, as well as amounts invested in money market funds and are reported as “Cash and cash equivalents” in the consolidated statements of financial position.
Separate account assets and liabilities are funds that are held separate from the general assets and liabilities of American National and that represent the investments of variable insurance product contract holders, who bear the investment risk of such funds. Investment income and investment gains and losses from these separate funds accrue to the benefit of the contract holders. Separate accounts are established in conformity with insurance laws and are not chargeable with liabilities that arise from any other business of American National. American National reports separately, as assets and liabilities, investments held in separate accounts and liabilities of the separate accounts if (i) such separate accounts are legally recognized; (ii) assets supporting the contract liabilities are legally insulated from American National’s general account liabilities; (iii) investments are directed by the contract holder; and (iv) all investment performance, net of contract fees and assessments, is passed through to the contract holder. The assets of these accounts are carried at fair value. Deposits, net investment income and realized investment gains and losses for these accounts are excluded from revenues, and related liability increases are excluded from benefits and expenses in the consolidated financial statements.
Participating business comprised approximately 5.5% of the life insurance in-force at December 31, 2017 and 17.1% of life premiums in 2017. Of the total participating business, 76.1% was written by Farm Family Life Insurance Company (“Farm Family Life”), which has since been merged with American National Insurance Company of New York.
For this participating business, profits earned on participating business are reserved for the payment of dividends to policyholders, except for the stockholders’ share of profits on participating policies, which is limited to the greater of 10% of the profit on participating business, or 50 cents per thousand dollars of the face amount of participating life insurance in-force. Participating policyholders’ interest includes the accumulated net income from participating policies reserved for payment to such policyholders in the form of dividends (less net income allocated to stockholders as indicated above) as well as a pro rata portion of unrealized investment gains (losses), net of tax.
The effects of tax legislation are recognized in the period of enactment. The effects of the U.S. Tax Cut and Jobs Act (“Tax Reform”) were reflected in the 2017 financial statements as reasonably estimated provisional amounts based on available information subject to interpretation in accordance with the SEC’s Staff Accounting Bulletin No. 118 (“SAB 118”). SAB 118 provides guidance on accounting for the effects of the Tax Reform where our determinations are incomplete but we are able to determine a reasonable estimate. A final determination is required to be made within a measurement period not to extend beyond one year from the enactment date. The provisional amount is primarily associated with the estimated remeasurement of net deferred tax liabilities arising from a lower U.S. Corporate tax rate. See Item 8. Financial Statements and Supplementary Data, Notes to Consolidated Financial Statements, Note 14, Income Taxes for further discussion.
Future Adoption of New Accounting Standards- The FASB issued the following accounting guidance relevant to American National:
In March 2017, the FASB issued guidance on the presentation of net periodic pension and postretirement benefit costs. The guidance requires the service cost component to be reported in the same line item as other compensation costs. All other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside of income from operations. The standard is effective for annual periods, including interim periods within those annual periods beginning after December 15, 2017. The Company plans to adopt the standard effective January 1, 2018. This guidance is to presentation only and will not have an impact to the Company’s results of operations or financial position.
Actual maturities differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Residential and commercial mortgage-backed securities, which are not due at a single maturity, have been allocated to their respective categories based on the year of final contractual maturity.
The Company’s total investment in and equity in earnings of unconsolidated affiliates, of which substantially all are LLC’s or LLP’s, were comprised of the following (in thousands):
The Company’s use of derivative instruments exposes it to credit risk in the event of non-performance by the counterparties. The Company has a policy of only dealing with counterparties we believe are credit worthy and obtaining sufficient collateral where appropriate, as a means of mitigating the financial loss from defaults. The non-performance risk is the net counterparty exposure based on the fair value of the open contracts, less collateral held. The Company maintains master netting agreements with its current active trading partners. As such, a right of offset has been applied to collateral that supports credit risk and has been recorded in the consolidated statements of financial position as an offset to “Other invested assets” with an associated payable to “Other liabilities” for excess collateral.
Embedded Derivative- The amounts reported within policyholder contract deposits include equity linked interest crediting rates based on the S&P 500 index within index annuities and indexed life. The following unobservable inputs are used for measuring the fair value of the embedded derivatives associated with the policyholder contract liabilities:
Mortality rate assumptions vary by age and by gender based on company and industry experience. Decreases to the assumed mortality rates increase the fair value of the liabilities as more policyholders earn crediting interest. Increases to the assumed mortality rates decrease the fair value as higher decrements reduce the potential for future interest credits.
Policy loans-The carrying value of policy loans is the outstanding balance plus any accrued interest. Due to the collateralized nature of policy loans such that they cannot be separated from the policy contracts, the unpredictable timing of repayments and the fact that settlement is at outstanding value, American National believes the carrying value of policy loans approximates fair value.
Investment contracts -The carrying value of investment contracts is equivalent to the accrued account balance. The accrued account balance consists of deposits, net of withdrawals, plus or minus interest credited, fees and charges assessed and other adjustments. American National believes that the carrying value of investment contracts approximates fair value because the majority of these contracts’ interest rates reset at anniversary.
Future policy benefit liabilities for disabled lives are estimated using the present value of benefits method and experience assumptions as to claim terminations, expenses and interest. The interest rate used in establishing such liabilities range from 3.0% to 6.0%.
The liability for unpaid claims and claim adjustment expenses (“claims”) for accident and health, and property and casualty insurance is included in “Policy and contract claims” in the consolidated statements of financial position and is the amount estimated for incurred but not reported (“IBNR”) claims and claims that have been reported but not settled. Liability for unpaid claims are estimated based upon American National’s historical experience and actuarial assumptions that consider the effects of current developments, anticipated trends and risk management programs, less anticipated salvage and subrogation. The effects of the changes are included in the consolidated results of operations in the period in which the changes occur. The time value of money is not taken into account for the purposes of calculating the liability for unpaid claims. There have been no significant changes in methodologies or assumptions used to calculate the liability for unpaid claims and claim adjustment expenses.
The net and gross reserve calculations have shown favorable development as a result of favorable loss emergence compared to what was implied by the loss development patterns used in the original estimation of losses in prior years. Estimates for ultimate incurred claims attributable to insured events of prior years decreased by approximately $77,296,000 in 2017 and decreased by approximately $36,788,000 in 2016 and $22,830,000 in 2015. This was a reflection of lower-than-anticipated losses in 2017 related to accident years prior to 2017 in the workers compensation, auto and business owner and commercial package policy lines of business, and lower-than-anticipated losses in the auto and multi-peril lines of business in 2016 and 2015.
For short-duration health insurance claims, the total of IBNR plus expected development on reported claims included in the liability for unpaid claims and claim adjustment expenses at December 31, 2017 was $26,030,000.
For most credit property and casualty products, IBNR liability is calculated as a percentage of pro rata unearned premium, with the specific percentage for a given product line determined by a completion factor method. For a large subset of GAP waiver and collateral protection insurance business, IBNR liability is the average monthly paid loss over the preceding 12 months.
The expected development on reported claims is the sum of a pay-to-current reserve and a future reserve. The pay-to-current reserve is calculated for each open claim having a monthly indemnity and contains the monies required to pay the open claim from the last payment date to the current valuation date. The future reserve is calculated by assigning to each open claim a fixed reserve amount based on the historical average severity. For debt cancellation products and involuntary unemployment insurance this reserve is calculated using published valuation tables.
Auto Liability- Consists of personal and commercial auto. Claims and claim adjustment expenses are shown below (in thousands):
Non-Auto Liability- Consists of workers’ compensation and other liability occurrence. Claims and claim adjustment expenses are shown below (in thousands):
Short Tail Property- Consists of auto physical damage, fire, rental owners, standard fire policy, country estates, inland marine and watercraft. This line of business has substantially all claims settled and paid in less than two years. Claims and claim adjustment expenses are shown below (in thousands):
The following table is supplementary information. 10 year average annual percentage payout of incurred claims is shown below:
For the Property and Casualty segment, American National retains the first $500,000 of loss per workers’ compensation risk and $1.5 million of loss per non-workers’ compensation risk. Workers’ compensation reinsurance coverage for losses between $500,000 and $1 million follows satisfaction of a $2 million annual aggregate deductible. Reinsurance covers up to $6 million of property and liability losses per risk. Additional excess property per risk coverage is purchased to cover risks up to $20 million, and excess casualty clash coverage is purchased to cover losses up to $60 million. Excess casualty clash covers losses incurred as a result of one casualty event involving multiple policies, excess policy limits, and extra contractual obligations. Facultative reinsurance is purchased for individual risks attaching at $20 million, as needed. Corporate catastrophe coverage is in place for losses up to $500 million. American National retains the first $17.5 million of each catastrophe. Catastrophe aggregate reinsurance coverage is also purchased. This coverage is provided by two contracts. The first contract provides for $30 million of coverage after $90 million of aggregated catastrophe losses has been reached. The first $10 million of each catastrophe loss contributes to the $90 million aggregation of losses. The second aggregate contract is the Stretch & Aggregate cover. It consists of a $35 million annual limit available either wholly or in part across two layers. The first layer is 8.75% of $400 million excess of $100 million on an occurrence basis. The second layer provides aggregate protection with subject loss of $35 million excess of $5 million of each catastrophe. Recoveries follow satisfaction of a $45 million annual aggregate deductible. This cover was placed on July 1, 2017. American National expects to place the cover again on July 1, 2018.
On December 22, 2017, the Tax Cuts and Jobs Act (“Tax Reform”) was enacted. Tax Reform includes numerous changes to existing federal income tax law, including a permanent reduction in the federal corporate income tax rate from 35% to 21%. We have recorded a provisional benefit of $206.4 million in our 2017 financial statements. As a result of the enactment of Tax Reform, we remeasured our existing deferred tax balances at the new 21% corporate income tax rate. Additionally, we have made a reasonable estimate to evaluate the impact of Tax Reform on our 2017 financial statements, including evaluating the impact of changes in calculating income tax reserves for both our life and property and casualty insurance products. Pursuant to Staff Accounting Bulletin No. 118 (“SAB 118”) this provisional tax benefit is a reasonable estimate which may be adjusted for current and future periods, possibly materially, due to among other things, further refinement of our calculations, changes in interpretations and assumptions we have made, tax guidance that may be issued and action we may take as a result of Tax Reform.
American National made income tax payments of $33,640,000, $33,367,000 and $80,759,000 during 2017, 2016, and 2015, respectively.
American National’s federal income tax returns for years 2014 to 2016 are subject to examination by the Internal Revenue Service. The years 2005 to 2009 have been closed by the Internal Revenue Service and we have received $10.8 million in refunds related to those years. In the opinion of management, all prior year deficiencies have been paid or adequate provisions have been made for any tax deficiencies that may be upheld. No provision for penalties or interest were established during 2017 relating to a dispute with the Internal Revenue Service. Management does not believe there are any uncertain tax benefits that could be recognized within the next twelve months that would decrease American National’s effective tax rate.
RSU awards allow the recipient of the awards to settle the vested RSUs in either shares of American National’s common stock, cash or a combination of both. RSUs granted vest after a one-year or three-year graded vesting requirement or over a shorter period as a result of death, disability or retirement after age 65.
* This includes the Company’s provisional impact of Tax Reform of $206.4 million, which may be adjusted for the current and future periods, possibly materially, due to, among other things, further refinement of the Company’s calculations, changes in interpretations and assumptions the Company has made, tax guidance that may be issued and actions the Company may take as a result of Tax Reform. Excluding the impact of Tax Reform, the Company’s 2017 net income would have been $287.3 million and net earnings per basic and diluted share of $10.68 and $10.65, respectively
Risk Based Capital (“RBC”) is a measure insurance regulators use to evaluate the capital adequacy of American National Insurance Company and its insurance subsidiaries. RBC is calculated using formulas applied to certain financial balances and activities that consider, among other things, investment risks related to the type and quality of investments, insurance risks associated with products and liabilities, interest rate risks and general business risks. Insurance companies that do not maintain capital and surplus at a level at least 200% of the authorized control level RBC are required to take certain actions. At December 31, 2017 and 2016, American National Insurance Company’s statutory capital and surplus was $3,293,474,000 and $2,985,909,000, respectively. American National Insurance Company and each of its insurance subsidiaries had statutory capital and surplus at December 31, 2017 and 2016, substantially above 200% of the authorized control level.
Statutory accounting differs from GAAP primarily by charging policy acquisition costs to expense as incurred, establishing future policy benefit liabilities using different actuarial assumptions, and valuing securities on a different basis. In addition, certain assets are not admitted under statutory accounting principles and are charged directly to surplus.
American National County Mutual Insurance Company (“County Mutual”) is a mutual insurance company owned by its policyholders. American National has a management agreement that effectively gives it control of County Mutual. As a result, County Mutual is included in the consolidated financial statements of American National. Policyholder interests in the financial position of County Mutual are reflected as noncontrolling interest of $6,750,000 at December 31, 2017 and 2016.
American National Insurance Company and its subsidiaries exercise control or ownership of various joint ventures, resulting in their consolidation into American National’s consolidated financial statements. The interests of the other partners in the consolidated joint ventures are shown as noncontrolling interests of $2,262,000 and $2,567,000 at December 31, 2017 and 2016, respectively.
The estimated actuarial loss for the plan that will be amortized out of AOCI into the net periodic benefit cost over the next fiscal year is $9,646,000. Amounts recognized as a component of AOCI that have not been recognized as a component of the combined net periodic benefit cost of the defined benefit pension plans, are shown below (in thousands):
American National and its subsidiaries lease insurance sales office space in various cities. The remaining long-term lease commitments at December 31, 2017 were approximately $4,877,000.
American National had aggregate commitments at December 31, 2017, to purchase, expand or improve real estate, to fund fixed interest rate mortgage loans, and to purchase other invested assets of $852,615,000 of which $639,750,000 is expected to be funded in 2018 with the remainder funded in 2019 and beyond.
American National has a $100,000,000 short-term variable rate borrowing facility containing a $55,000,000 sub-feature for the issuance of letters of credit. Borrowings under the facility are at the discretion of the lender and would be used only for funding working capital requirements. The combination of borrowings and outstanding letters of credit cannot exceed $100,000,000 at any time. As of December 31, 2017 and 2016, the outstanding letters of credit were $4,586,000 and $9,473,000, respectively, and there were no borrowings on this facility. This facility expires on October 31, 2018. American National expects it will be able to be renewed on substantially equivalent terms upon expiration.
American National has guaranteed bank loans for customers of a third-party marketing operation. The bank loans are used to fund premium payments on life insurance policies issued by American National. The loans are secured by the cash values of the life insurance policies. If the customer were to default on a bank loan, American National would be obligated to pay off the loan. As the cash values of the life insurance policies always equal or exceed the balance of the loans, management does not foresee any loss on these guarantees. The total amount of the guarantees outstanding as of December 31, 2017, was approximately $206,376,000, while the total cash value of the related life insurance policies was approximately $209,683,000.
Mortgage Loans to Gal-Tex Hotel Corporation (“Gal-Tex”): American National holds a first mortgage loan originated in 1999, with an interest rate of 7.25% and final maturity date of April 1, 2019 issued to a subsidiary of Gal-Tex, which is collateralized by a hotel property in San Antonio, Texas. This loan is current as to principal and interest payments.