Three buildings in League City, Texas which are used by our Life, Health, and Corporate and Other segments.
Five buildings, four in Springfield, Missouri and the other in Glenmont, New York, which are used by our Property and Casualty segment.
The Corporate and Other segment acts as the owner of all of the invested assets of the Company. The investment income from the invested assets is allocated to the insurance segments in accordance with the assets allocated to each insurance segment. Earnings of the Corporate and Other segment are derived from income related to invested assets not allocated to the insurance segments and from our non-insurance businesses. All realized investment gains and losses, which includes other-than-temporary impairments (“OTTI”), are recorded in this segment.
Interest Rates: The low-interest rate environment is a challenge for life insurers as the spreads on deposit-type contracts remain narrow, especially as interest rates have approached minimum crediting rates. Low market interest rates reduce the spreads between the amounts we credit to fixed annuity and individual life policyholders and the amounts we earn on the investments that support these obligations. Our ALM Committee actively manages the profitability of our in-force blocks. In previous years, we reduced the guaranteed minimum crediting rates on new fixed annuity contracts, which has afforded us the flexibility to respond to the unusually low-interest rate environment. In previous years, we also reduced crediting rates on in-force contracts, where permitted to do so. These actions help mitigate the adverse impact of low interest rates on the profitability of these products, although sales volume may be negatively impacted as a result. We also maintain assets with various maturities to support product liabilities and ensure liquidity. A gradual increase in longer-term interest rates relative to short-term rates generally will have a favorable effect on the profitability of our products. Rapidly rising interest rates could result in reduced persistency of our spread-based products, if contract holders shift assets into higher yielding investments. We believe our ability to react quickly to the changing marketplace will help us manage this risk.
Importance of Operating Efficiencies: The volatile economic environment and costs associated with greater regulation create a further need for operating efficiencies. We manage our cost base while maintaining our commitment to provide superior customer service to policyholders and agents. Investments in technology are coordinated through a disciplined project management process. We anticipate continually improving our use of technology to enhance our policyholders’ and agents’ experience and increase efficiency of our employees.
Our expanded use of technology, particularly our new recruiting-marketing platform combined with greater use of social media, is intended to enhance our employer brand and educate candidates on why they should work for us. Our ongoing efforts to develop a diverse and inclusive workforce not only strengthens the engagement of our current employee population but helps make us an attractive employer where differing insights and opinions are valued. Valuing different perspectives and the impact of broader employee influence on how decisions are made, are two areas for the company to focus on for successful retention. Providing for robust career development opportunities and effective succession planning is expected to be another important part of our retention efforts.
We offer our personal and commercial property and casualty lines of business primarily through exclusive agents. We favor a balanced, focused and collaborative approach to both growth and profitability through the development of successful agencies.
Case Reserves-Reserves for reported losses are determined on either a judgment or a formula basis, depending on the timing and type of the loss. The formula reserve is a fixed amount for each claim of a given type based on historical paid loss data for similar claims with a provision for claim inflation. Judgment reserve amounts replace initial formula reserves and are set for each loss based on facts and circumstances of each case and the expectation of damages. We regularly monitor the adequacy of reserves on a case-by-case basis and change the amount of such reserves as necessary.
No significant prospective changes in laws that would significantly affect future payouts.
For non-credit lines of business, future inflation rates could vary from our assumption of relatively stable rates. Unexpected changes in future inflation rates could impact our financial position and liquidity, and we measure the sensitivity of our reserve levels to unexpected changes in inflation. The impacts of future inflation for a 1.0% decrease and 3.0% increase over the implied inflation rate in the December 31, 2018 gross loss reserve balance are as follows (amounts in thousands):
It is not appropriate to aggregate the impacts shown in our sensitivity analysis, as our lines of business are not directly correlated. The variations are not meant to be a “best-case” or “worst-case” scenario, and it is possible that future variations will be more or less than the amounts in the sensitivity analysis. While these are possible scenarios based on the information available to us at this time, we do not believe the reader should consider our sensitivity analysis an actual reserve range.
Management believes our reserves at December 31, 2018 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, 2018.
We had a DAC asset of approximately $1.50 billion and $1.37 billion at December 31, 2018 and 2017, respectively. See Note 10, Deferred Policy Acquisition Costs, of the Notes to the Consolidated Financial Statements for additional details.
Some of our reinsurance contracts contain clauses that allow us to terminate the participation with reinsurers whose ratings are downgraded. Information used in our risk assessment is comprised of industry ratings, recent news and reports, and a limited review of financial statements. We also may require reinsurers not licensed in our state of domicile or with whom we have limited experience, to provide letters of credit, trust agreements, or cash advances to fund their share of reserves.
Our effective tax rate is based on income at statutory tax rates, adjusted for non-taxable and non-deductible items, and tax credits. Management’s best estimate of future events and their impact is included in our effective tax rate. 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.
Subsequent to enactment, the Securities Exchange Commission introduced Staff Accounting Bulletin No. 118 (“SAB 118”). SAB 118 provides guidance on accounting for the effects of the Tax Reform where our determinations were incomplete but we were 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. In 2017, we recorded a provisional tax benefit of $206.4 million in accordance with the guidance in SAB 118. As a result of Tax Reform, we remeasured our existing deferred tax balances to the new 21% corporate income tax rate. Additionally, we made a reasonable estimate to evaluate the impact of Tax Reform on our 2017 financial statements. There were no adjustments in 2018 to the provisional tax benefit we recorded in 2017.
Earnings decreased during the year ended December 31, 2018 compared to 2017 primarily due to the inclusion of net unrealized losses on equity securities in income as required by new accounting guidance. The earnings for the year ended December 31, 2018 were also impacted by a reduced interest margin resulting from a decrease in the S&P 500 index on equity-indexed products in our Annuity segment as well as losses impacting our homeowners, commercial auto and GAP lines of business in our Property and Casualty segment. Earnings increased during 2017 compared to 2016 primarily due to an increase in net investment income and realized investment gains. The increase in net investment income was attributable to increased income on mortgage loans. The increase in realized investment gains was attributable to an increase in the sale of bonds, equity securities, and certain real estate holdings.
The Company converted the valuation of its universal life business from an internally developed valuation system to a vendor based system in 2016 and further upgraded the system in 2017. Both events resulted in impacts to other policy revenues, policyholder benefits, and change in deferred policy acquisition costs. Neither event had significant impacts on operating income.
Other policy revenues, which include cost of insurance charges, earned policy service fees and surrender charges, have also increased during the year ended December 31, 2018 as the size of our interest sensitive block continues to grow, through increased sales and aging of the in-force. The decrease in other policy revenue during 2017 compared to 2016 is due to the change in estimates discussed in "Items affecting the comparability of life results" section.
(1) These are weighted amounts representing 10% of single and excess premiums and 31% of credit life premiums. In 2018, credit life weighting changed from 15% to 31% due to an increase in monthly outstanding balance; 2017 amounts have been updated for comparison purposes.
Life insurance sales measure activity associated with gaining new insurance business in the current period, and includes deposits received related to interest sensitive life and universal life-type products. In contrast, GAAP premium revenues are associated with policies sold in current and prior periods, and deposits received related to interest sensitive life and universal life-type products are recorded in a policyholder account which is reflected as a liability. Therefore, a reconciliation of premium revenues and insurance sales is not meaningful.
Life insurance sales increased during 2018 compared to 2017 primarily due to increased Indexed Universal Life sales. Life insurance sales increased in all major product lines during 2017 compared to 2016.
Commissions increased during the year ended December 31, 2018 compared to 2017 which was commensurate with the increase in indexed universal life and universal life sales. Commissions increased during 2017 compared to 2016 which was commensurate with the increase in life sales.
Total life insurance in-force increased during the year ended December 31, 2018 compared to 2017 and 2017 compared to 2016, due to increased sales, despite a reduction in the number of policies in-force. The reduction in policies in-force reflects continued decrease in lower face amount policies.
We use reinsurance to mitigate certain risks to the life segment. During 2018, our retention limits were $1.5 million for issue ages 65 and under, and $700,000 for issue ages 66 and older for traditional and universal life. In our life segment, we currently retain 100% of newly developed permanent and term products up to our retention limit and cede the excess. We also engage in facultative reinsurance through several reinsurers. Accidental death and premium waiver benefits are mostly retained on new business. Increases in reserves and premium amounts ceded primarily reflect increased use of reinsurance in conjunction with treaties related to universal life products.
In addition, 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 Specialty Markets Group are written on a 100% coinsurance basis with benefit limits of $100,000 on credit life.
The Company converted the valuation of its single premium immediate annuity business from a mainframe valuation system to a more robust vendor based system in 2017 resulting in a $9.6 million decrease in estimates affecting policyholder benefits.
Commissions decreased during the year ended December 31, 2018 compared to 2017 driven by a decrease in sales of fixed deferred and equity-indexed products partially offset by an increase in single premium immediate products. Commissions increased during 2017 compared to 2016 driven by an increase in sales of deferred annuity and equity-indexed products.
Overall, the margin earned on annuity reserves decreased during the year ended December 31, 2018 compared to 2017, due to continued spread compression and unfavorable market conditions reflected in the mark-to-market option values related to equity-indexed products.The following table summarizes the interest margin due to the impact of the investment performance, interest credited to policyholder’s account balances, and the end of period assets measured by account balance (in thousands):
During 2017, earnings increased due to the absence of a group health plan that was not renewed, slightly offset by a decrease in earned premiums.
Commissions increased during 2018 primarily due to the increase in premiums from the MGU and Medicare Supplement lines of business. Commissions increased during 2017 compared to 2016 due to the correlated sales in the credit health and MGU lines of business.
Other operating expenses increased during 2018 correlated to an increase in the Medicare Supplement line of business. Other operating expenses decreased during 2017 in correlation to the absence of a non-renewed group health plan.
For 2018, the companies to which we have ceded reinsurance for the health segment are shown below (in thousands, except percentages):
Property and Casualty earnings decreased during the year ended December 31, 2018 compared to 2017 due primarily to an increase in claim severity in the commercial auto line of business and increased losses impacting our homeowners and personal auto lines of business. Earnings increased during 2017 compared to 2016, primarily due to increased net premiums earned coupled with an improvement in the loss ratio.
Operating expenses increased during the year ended December 31, 2018 compared to 2017, but at a rate less than the increase in premiums. Operating expenses increased during 2017 compared to 2016, as a result of costs related to growth initiatives.
Automobile: Net premiums written and earned increased in our personal automobile line during the year ended December 31, 2018 compared to 2017 and the year ended December 31, 2017 compared to 2016 due to rate increases and an increase in policies in force. The loss and combined ratios increased during the year ended December 31, 2018 compared to 2017 primarily due to increased claim activity outpacing premium. The loss and combined ratios decreased during 2017 compared to 2016 primarily due to an improvement in rate adequacy somewhat offset by an increase in catastrophe losses.
Homeowners: Net premiums written and earned increased during the year ended December 31, 2018 compared to 2017 primarily due to increased sales to renters, as well as rate increases. The loss and combined ratios increased during the year ended December 31, 2018 compared to 2017 due to an increase in weather-related catastrophe and non-catastrophe losses. Net premiums written and earned increased during 2017 compared to 2016 primarily due to increased sales to renters. The loss and combined ratios increased during 2017 compared to 2016 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, personal umbrella, and rental owners. The loss ratio decreased during the year ended December 31, 2018 compared to 2017 primarily due to decrease in non-catastrophe related claims. The combined ratio decreased during the year ended December 31, 2018 compared to 2017 primarily due to increased premium outpacing expenses. The loss and combined ratios increased during 2017 compared to 2016 due to increased claims for rental owners along with several large umbrella claims.
Other Commercial: Net premiums written and earned increased during the year ended December 31, 2018 compared to 2017 primarily due to increased sales of business owners as well as the addition of the Investor Property Protection line of business. The decrease in the loss and combined ratios for the year ended December 31, 2018 compared to 2017 is primarily due to the favorable workers’ compensation experience. Net premiums written and earned increased during 2017 compared to 2016 primarily due to increased sales of mortgage security insurance and workers’ compensation. The decrease in the loss and combined ratios for 2017 compared to 2016 is primarily due to decreased claim activity on business owners’ lines of business and lower than anticipated prior year claim emergence on workers’ compensation.
Commercial Automobile: Net premiums written and earned increased during the year ended December 31, 2018 compared to 2017, due to an increase in policies in force and rate increases. The loss and combined ratios increased during the year ended December 31, 2018 compared to 2017 primarily due to an increase in the average severity of losses from prior accident years. 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 written and earned premiums decreased during the year ended December 31, 2018 compared to 2017 primarily due to a decrease in Collateral Protection Insurance ("CPI") business. The loss ratio for the year ended December 31, 2018 is comparable to the year ended December 31, 2017. The combined ratio for 2018 decreased compared to 2017 due to lower commission expense in the CPI business. Net written and earned premiums increased during 2017 compared to 2016 primarily due to an increase in debt cancellation business. The loss and combined ratios increased during 2017 compared to 2016 primarily due to an increase in claims in the Guaranteed Auto Protection ("GAP") business, partially resulting from catastrophes that caused flooding to automobiles.
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 "MSI" and "GAP" business written by the Specialty Markets Group.
Each per-event coverage above includes one automatic reinstatement except for a 12.4% portion of the Corporate Program (12.4% 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 39% portion is free for the first limit through reinstatement premium protection coverage purchased. The 12.4% placement of non-reinstateable coverage reduces the amount of reinstatement premium we are obligated to pay.
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 $40 million annual aggregate deductible. This cover was placed at 90% on July 1, 2018, and remains in place until June 30, 2019. American National expects to place the cover again on July 1, 2019.
Reinsurance is used in the credit property and casualty business primarily to provide producers of credit-related insurance products the opportunity to participate in the underwriting risk through various entities, such as producer-owned captive reinsurance companies or other Insurance Companies. A majority of the treaties entered into by our Specialty Markets Group are written on a 100% coinsurance basis without benefit limits on credit P&C. We also place a corporate catastrophe reinsurance program which covers P&C business written by the Specialty Markets Group as well as personal and commercial business written by our Multiple Line agents.
While we believe that our claims reserves at December 31, 2018 are adequate, new information, events or circumstances, unknown at the original valuation date, may lead to future developments in ultimate losses in amounts significantly greater or less than the reserves currently recorded. The actual final cost of settling both claims outstanding at December 31, 2018 and claims expected to arise from unexpired periods of risk is uncertain. There are many other possible changes that would cause losses to increase or decrease, which include but are not limited to: claim severity; the expected level of reported claims; judicial action changing the scope or liability of coverage; the regulatory, social and economic environment; and unexpected changes in loss inflation. For additional information regarding prior year development of our claims and CAE reserves, refer to Note 12, Liability for Unpaid Claims and Claim Adjustment Expenses, of the Notes to the Consolidated Financial Statements.
Equity Securities-We invest in companies publicly traded on national U.S. stock exchanges. See Note 4, Investments in Securities, of the Notes to the Consolidated Financial Statements for the cost, gross unrealized gains and losses, and fair value of the equity securities.
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 generally 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 4.9% and 4.7% at December 31, 2018 and 2017, respectively. For additional information regarding mortgage loans refer to Note 5, Mortgage Loans, of the Notes to the Consolidated Financial Statements
Net investment income decreased $107.7 million during 2018 compared to 2017 primarily due to a loss on options due to a downturn in the S&P 500 Index.
Interest income on mortgage loans is accrued on the principal amount of the loan at the contractual interest rate. Accretion of discounts is recorded using the effective yield method. Interest income, accretion of discounts and prepayment fees are reported in net investment income. Interest is not accrued on loans generally more than 90 days past due or when the collection of interest is not considered probable. Loans in foreclosure are placed on non-accrual status. Interest received on non-accrual status mortgage loans is included in net investment income in the period received.
The net change in the unrealized gains on fixed maturity securities between December 31, 2018 and December 31, 2017 is primarily attributable to the increase in benchmark ten-year interest rates which were 2.7% and 2.4% 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.
Funds received as premium payments and deposits, that are not used for liquidity requirements are generally invested in bonds and commercial mortgages. Funds are invested with the intent that income from the investments and proceeds from the maturities will meet our ongoing cash flow needs. We historically have not had to liquidate invested assets in order to cover cash flow needs. We believe our portfolio of highly liquid available-for-sale investment securities, including equity securities, is sufficient to meet future liquidity needs as necessary. Deposits of certain securities under the Company’s membership with the Federal Home Loan Bank of Dallas (“FHLB”) provided approximately $113 million of borrowing capacity as of December 31, 2018 should we require additional liquidity resources.
The Company holds collateral to offset exposure from its derivative counterparties. Cash flows associated with collateral received from counterparties change as the market value of the underlying derivative contract changes. As the value of a derivative asset declines or increases, the collateral requirements would also decline or increase respectively.
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 $26.6 million and $28.4 million at December 31, 2018 and 2017, respectively.
Estimated payments through continuing operations for benefit obligations of the non-qualified defined benefit pension plan. A liability has been established for the full amount of benefits accrued.
Consolidated Statements of Comprehensive Income for the years ended December 31, 2018, 2017, and 2016
Consolidated Statements of Changes in Equity for the years ended December 31, 2018, 2017, and 2016
Consolidated Statements of Cash Flows for the years ended December 31, 2018, 2017, and 2016
As discussed in Note 3 to the consolidated financial statements, the Company has changed its method of accounting for equity investments in 2018 due to the adoption of ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.
Short-term investments comprised of commercial paper are carried at amortized cost, which approximates fair value. Short-term investments have a maturity of less than one year.
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 its business risk and holds collateral to offset exposure from its counterparties. 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.
Annuity premiums received on limited-pay and supplemental annuity contracts involving a significant life contingency are recognized as revenue when due. Deferred annuity premiums are recorded as deposits rather than recognized as revenue. Revenues from deferred annuity contracts are principally surrender charges and, in the case of variable annuities, administrative fees assessed to contractholders.
For the majority of this participating business, profits earned 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 not included in net income.
American National files a consolidated life and non-life federal income tax return. Certain subsidiaries that are consolidated for financial reporting are not eligible to be included in the consolidated federal income tax return; accordingly, they file separate returns.
In May 2014, the FASB issued guidance that superseded most existing revenue recognition requirements in GAAP. Insurance contracts generally are excluded from the scope of the guidance. For those contracts which are impacted, the transaction price is attributed to the underlying performance obligations in the contract and revenue is recognized as the entity satisfies the performance obligations and transfers control of a good or service to the customer. The Company’s revenues include premium, other policy revenue, net investment income, realized investment gains, and other income. Other income includes fee income which is recognized when obligations under the terms specified within a contract with a customer are either (1) satisfied at a point in time or (2) the progress of completion is measured over a period of time as the obligation is performed using the input method. The Company adopted the standard on its required effective date of January 1, 2018 using the modified retrospective approach. The majority of our revenue sources are insurance related and not in the scope of the guidance. The adoption of the standard did not have a material impact on the Company’s consolidated financial position, results of operations, equity or cash flows as of the adoption date or for the year ended December 31, 2018.
In January 2016, the FASB issued Accounting Standard Update ("ASU") 2016-01, Financial Instruments guidance that changed certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The new guidance requires that equity investments, other than those accounted for under the equity method or those that result in consolidation of the investee, be measured at fair value and the changes in fair value are recognized through earnings. When the fair value option has been elected for financial liabilities, changes in fair value due to instrument-specific credit risk will be recognized separately in other comprehensive income. The guidance also simplifies the impairment assessment of equity investments and eliminates the disclosure requirements for methods and significant assumptions used to estimate fair value of financial instruments that are measured at amortized cost on the statement of financial position. The Company adopted the standard on its required effective date of January 1, 2018 using a modified retrospective approach. Upon adoption, cumulative unrealized gains and losses on equity securities of $667.7 million, partially offset by $30.4 million participating policyholders’ interest, net of tax, related to unrealized gains and losses on equity securities, were reclassified from accumulated other comprehensive income to retained earnings. In April 2018, an additional $10.2 million deferred policy acquisition cost adjustment, net of tax, related to net unrealized gains and losses on equity securities, was reclassified from accumulated other comprehensive income to retained earnings. Earnings decreased $84.7 million, net of tax, for December 31, 2018, from the change in net unrealized gains and losses on equity securities.
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 periodic pension cost are required to be presented in the income statement separately from the service cost component and outside of income from operations. The Company adopted the standard on its required effective date of January 1, 2018 using a retrospective approach. Upon adoption, other components of net periodic pension costs of $12.4 million, net of tax, for December 31, 2017, were reclassified from other operating expenses. The guidance changed presentation only and did not have an impact on the Company’s consolidated financial position, results of operations, equity or cash flows. Since the Company’s defined benefit pension plans have been frozen, the components of net periodic benefit costs have not materially changed from year-end 2017.
In February 2016, the FASB issued guidance that will require significant changes to the statement of financial position of lessees. The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight line basis over the term of the lease, respectively. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similarly to existing guidance for operating leases today. Lessor accounting is less affected by the standard, but has been updated to align with certain changes in the lessee model and the new revenue recognition standard. The standard is effective for annual periods and interim periods within those annual periods beginning after December 15, 2018 and will be implemented using the effective date method, which requires a cumulative-effect adjustment to the opening balance of retained earnings on the effective date. We have elected certain practical expedients permitted under the transition guidance. We have identified and analyzed the lease contracts and determined the adoption of the standard will not be material to the Company’s results of operations or financial position.
In June 2016, the FASB issued guidance that will significantly change how entities measure credit losses for most financial assets, reinsurance recoverables and certain other instruments that are not measured at fair value through net income. The guidance will replace the current “incurred loss” approach with an “expected loss” model for instruments measured at amortized cost. For available-for-sale debt securities, entities will be required to record allowances rather than reduce the carrying amount, as they do under the current other-than-temporary impairment model. The standard is effective for annual periods and interim periods within those annual periods beginning after December 15, 2019. The Company must develop appropriate models to measure expected credit losses to begin determining the impact of adopting the standard on our results of operations and financial position.
In August 2018, the FASB issued guidance that seeks to improve financial reporting for insurance companies that issue long duration contracts. The guidance improves the timeliness of recognizing changes in the liability for future policy benefits and modifies the rate used to discount future cash flows. The guidance will also simplify and improve accounting for certain market-based options or guarantees associated with deposit type contracts, simplify the amortization of deferred acquisition costs and provide users of the financial statements with enhanced disclosures. The standard is effective for annual periods and interim periods within those annual periods beginning after December 15, 2020. This standard could potentially have a material impact on our results of operations and financial position.
Gains and losses are determined using specific identification of the securities sold. During 2018 and 2017, bonds with a carrying value of $34,690,000 and $25,266,000, respectively were transferred from held-to-maturity to available-for-sale after a deterioration in the issuers’ credit worthiness. Further, during 2018, a bond with a carrying value of $38,381,000 was transferred from held-to-maturity to available-for-sale due to an isolated event that could not have been reasonably anticipated by the Company. No realized loss was recorded in 2018 and a realized loss of $6,000,000 was recorded in 2017 on a bond that was transferred due to an other-than-temporary impairment.
In accordance with various regulations, American National has bonds on deposit with regulating authorities with a carrying value of $48,068,000 and $47,556,000 at December 31, 2018 and 2017, respectively. In addition, American National has pledged bonds in connection with agreements and transactions, such as financing and reinsurance agreements. The carrying value of bonds pledged was $168,118,000 and $63,386,000 at December 31, 2018 and 2017, respectively
The components of the change in net losses on equity securities are shown below (in thousands):
*Effective January 1, 2018, the Company adopted ASU No. 2016-01. As a result, equity securities are no longer classified as available-for-sale with unrealized gains and losses recognized in other comprehensive income; rather, all changes in the fair value of equity securities are now recognized in earnings. Since changes in fair value are recognized in earnings each reporting period, OTTI is no longer recognized on equity securities in a loss position. Prior periods have not been restated to conform to the current presentation. See note 3, Recently Issued Accounting Pronouncements.
As of December 31, 2018, the securities with unrealized losses including those exceeding one year were not deemed to be other-than-temporarily impaired. American National has the ability and intent to hold those securities until a market price recovery or maturity. It is not more-likely-than-not that American National will be required to sell them prior to recovery, and recovery is expected in a reasonable period of time. It is possible an issuer’s financial circumstances may be different in the future, which may lead to a different impairment conclusion in future periods.
Generally, commercial mortgage loans are secured by first liens on income-producing real estate. American National attempts to maintain a diversified portfolio by considering the location of the underlying collateral. The distribution based on carrying amount of mortgage loans by location is as follows:
During 2018, American National foreclosed on four loans with a total recorded investment of $22,608,000, and one loan with a recorded investment of $7,363,000 was in the process of foreclosure. For the year ended December 31, 2017, American National foreclosed on one loan with a recorded investment of $2,285,000, and four loans with a total recorded investment of $17,263,000 were in the process of foreclosure. American National did not sell any loans during 2018 or 2017.
A loan is considered impaired when it is probable that all amounts due will not be collected according to the contractual terms of the loan agreement. Mortgage loans with temporary difficulties are not considered impaired when the borrower has the financial capacity to fund revenue shortfalls from the properties for the foreseeable future. Individual valuation allowances are established for impaired loans to reduce the carrying value to the fair value of the collateral. Loans not evaluated individually for collectability are segregated by property-type and location, and allowance factors are applied. These factors are developed based on historical loss experience adjusted for the expected trend in the rate of foreclosure losses. Allowance factors are higher for loans of certain property types and in certain regions based on loss experience or a blended historical loss factor.
American National regularly invests in real estate partnerships and joint ventures. American National frequently participates in the design of these entities with the sponsor, but in most cases, its involvement is limited to financing. Through analysis performed by American National, some of these partnerships and joint ventures have been determined to be variable interest entities (“VIEs”). In certain instances, in addition to an economic interest in the entity, American National holds the power to direct the most significant activities of the entity and is deemed the primary beneficiary or consolidator of the entity. The assets of the consolidated VIEs are restricted and must first be used to settle their liabilities. Creditors or beneficial interest holders of these VIEs have no recourse to the general credit of American National, as American National’s obligation is limited to the amount of its committed investment. American National has not provided financial or other support to the VIEs in the form of liquidity arrangements, guarantees, or other commitments to third parties that may affect the fair value or risk of its variable interest in the VIEs in 2018 or 2017.
The notes payable in the consolidated statements of financial position pertain to the borrowings of the consolidated VIEs. The liability of American National relating to notes payable of the consolidated VIEs is limited to the amount of its direct or indirect investment in the respective ventures, which totaled $26,635,000 and $28,377,000 at December 31, 2018 and 2017, respectively.
The Company’s equity in earnings of unconsolidated affiliates is the Company’s share of operating earnings and realized gains from investments in real estate joint ventures and other limited partnership interests (“joint ventures”) using the equity method of accounting. In 2018 and 2017 certain joint ventures took advantage of market opportunities to generate realized gains on the sale of real estate held or developed by the ventures.
The Company’s income from and investment in each joint venture did not exceed 20% and therefore no separate financial disclosure is required. The Company’s income from, assets held, and investment in each joint venture did not exceed 10% of operating income before tax. Additionally, the Company’s investment in joint ventures continues to be 2% or less of the Company’s total assets, and investments in individual joint ventures is not considered to be material to the Company in relation to its financial position or ongoing results of operations. Therefore, summarized financial information of equity method investees has not been included.
The Company’s total investment in and equity in earnings of unconsolidated affiliates, of which substantially all are LLC’s or limited partnerships, were comprised of the following (in thousands):
American National purchases over-the-counter equity-indexed options as economic hedges against fluctuations in the equity markets to which equity-indexed products are exposed. These options are not designated as hedging instruments for accounting purposes under U.S. GAAP. Equity-indexed contracts include a fixed host universal-life insurance or annuity contract and an equity-indexed embedded derivative. The detail of derivative instruments is shown below (in thousands, except number of instruments):
For securities priced using a quote from an independent broker, such as the equity-indexed options (which are priced monthly by the broker and quarterly by pricing service, SS&C Technologies Holdings, Inc.) and certain fixed maturity securities, American National uses a market-based fair value analysis to validate the reasonableness of prices received. Price variances above a certain threshold are analyzed further to determine if any pricing issue exists. This analysis is performed quarterly.
Mortgage Loans-The fair value of mortgage loans is estimated using discounted cash flow analyses on a loan by loan basis by applying a discount rate to expected cash flows from future installment and balloon payments. The discount rate takes into account general market trends and specific credit risk trends for the individual loan. Factors used to arrive at the discount rate include inputs from spreads based on U.S. Treasury notes and the loan’s credit quality, region, property type, lien priority, payment type and current status. These estimates would be disclosed as Level 2 measurements.
The separate account assets account also includes cash and cash equivalents, investments in unconsolidated affiliates, accrued investment income, and receivables for securities. These are not financial instruments and are not included in the quantitative disclosures of fair value hierarchy table.
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.
There were no transfers between Level 1 and Level 2 fair value hierarchies during the periods presented. The transfers into Level 3 during the years ended December 31, 2017, and 2016 were the result of existing securities no longer being priced by the third-party pricing service at the end of the period. Unless information is obtained from the brokers that indicate observable inputs were used in their pricing, there are not enough observable inputs to enable American National to classify the securities priced by the brokers as other than Level 3. American National’s valuation of these securities involves judgment regarding assumptions market participants would use including quotes from independent brokers. The inputs used by the brokers include recent transactions in the security, similar bonds with same name, ratings, maturity and structure, external dealer quotes in the security, Bloomberg evaluated pricing and prior months pricing. None of them are observable to American National as of December 31, 2018. The transfers out of Level 3 during the years end December 31, 2017, and 2016, were securities being priced by the third-party service at the end of the period, using inputs that are observable or derived from market data, which resulted in classification of these assets as Level 2.
Commissions comprise the majority of the additions to deferred policy acquisition costs.
Future policy benefit liabilities for individual fixed deferred annuities after annuitization and single premium immediate annuities are equal to the present value of expected future payments. The interest rate used in establishing such liabilities range from 3.0% to 6.0% for all policies in-force.
Liabilities for universal life secondary guarantees and paid-up guarantees are determined by estimating the expected value of death benefits payable when the account balance is projected to be zero and recognizing those benefits ratably over the accumulation period based on total expected assessments. American National regularly evaluates estimates used and adjusts the additional liability balances with a related charge or credit to benefit expense, if actual experience or other evidence suggests that earlier assumptions should be revised. The assumptions used in estimating the secondary and paid-up guarantee liabilities are consistent with those used for amortizing DAC, and are thus subject to the same variability and risk. The assumptions of investment performance and volatility for variable products are consistent with historical Standard & Poor’s experience. The benefits used in calculating the liabilities are based on the average benefits payable over a range of scenarios.
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 $19,852,000, $77,296,000, $36,788,000 in 2018, 2017, and 2016, respectively. This was a reflection of lower-than-anticipated losses in 2018 related to accident years prior to 2018 in the workers compensation, other commercial, business owner and commercial package policy lines of business. The decrease during 2017 reflects lower-than-anticipated losses in the workers compensation, auto and business owner and commercial package policy lines of business. Lower-than-anticipated losses in the auto and multi-peril lines of business resulted in favorable development in 2016.
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, 2018 was $39,337,000.
Calendar Year Paid Adjusting and Other Expense to Paid Loss-This method uses a selected prior calendar years’ paid expense to paid loss ratio to project ultimate loss adjustment expenses for adjusting and other expense. A percentage of the selected ratio is applied to the case reserves (depending on the line of insurance) and 100% to the indicated IBNR reserves. These ratios assume that a percentage of the expense is incurred when a claim is opened and the remaining percentage is paid throughout the claim’s life.
Pegged Frequency and Severity-Uses actual claims count data and emergence patterns of older accident periods to project the ultimate number of reported claims for a given accident year. A similar process projects the ultimate average severity per claim so that the product of the 2 projections results in a projection of ultimate loss for a given accident year.
The following contains information about incurred and paid claims development as of December 31, 2018, net of reinsurance, as well as cumulative claim frequency and the total of incurred-but-not-reported liabilities plus expected development on reported claims included within the net incurred claims amounts. The information about incurred and paid claims development for the years ended December 31, 2009 to 2017 is presented as supplementary information.
Commercial Multi-Peril-Consists of business owners insurance and mortgage fire business. Claims and claim adjustment expenses are shown below (in thousands):
Homeowners-Consists of homeowners and renters business. Claims and claim adjustment expenses are shown below (in thousands):
Credit-Consists of credit property insurance, vendor’s or lender’s single interest insurance, GAP insurance, GAP waiver, debt cancellation products, involuntary unemployment insurance and collateral protection insurance. 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):
GAAP requires us to evaluate the recoverability of our deferred tax assets and establish a valuation allowance, if necessary, to reduce our deferred tax assets to an amount that is more-likely-than-not to be realized. Considerable judgment is required in determining whether a valuation allowance is necessary, and if so, the amount of such valuation allowance. There were no material valuation allowances recorded during the years ended December 31, 2018 and 2017. Although realization is not assured, management believes it is more-likely-than-not that our remaining deferred tax assets will be realized and that no additional valuation allowance is necessary at this time.
American National’s federal income tax returns for years 2015 to 2017 are subject to examination by the Internal Revenue Service. 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 2018 relating to a dispute with the Internal Revenue Service. As of December 31, 2018, American National had no provision for uncertain tax positions. In addition, management does not believe there are any uncertain tax benefits that could be recognized within the next twelve months that would impact American National’s effective tax rate.
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, 2018 and 2017, American National Insurance Company’s statutory capital and surplus was $3,162,808,000 and $3,293,474,000, respectively. American National Insurance Company and each of its insurance subsidiaries had statutory capital and surplus at December 31, 2018 and 2017, substantially above 200% of the authorized control level.
American National and its insurance subsidiaries prepare statutory-basis financial statements in accordance with statutory accounting practices prescribed or permitted by the insurance department of the state of domicile, which include certain components of the National Association of Insurance Commissioners’ Codification of Statutory Accounting Principles (“NAIC Codification”). NAIC Codification is intended to standardize regulatory accounting and reporting to state insurance departments. However, statutory accounting practices continue to be established by individual state laws and permitted practices. Modifications by the various state insurance departments may impact the statutory capital and surplus of American National Insurance Company and its insurance subsidiaries.
American National Insurance Company's payment of dividends to stockholders is restricted by insurance law. The restrictions require life insurance companies to maintain minimum amounts of capital and surplus, and in the absence of special approval, limit the payment of dividends to the greater of the prior year's statutory net income from operations, or 10% of prior year statutory surplus. American National Insurance Company is permitted without prior approval of the Texas Department of Insurance to pay total dividends of $316,281,000 during 2019. Similar restrictions on amounts that can transfer in the form of dividends, loans, or advances to American National Insurance Company apply to its insurance subsidiaries.
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 $7,517,000 and $2,262,000 at December 31, 2018 and 2017, respectively.
Annuity-consists of fixed, indexed, and variable annuity products. Products are primarily sold through independent agents, brokers, and financial institutions, along with multiple-line and career agents.
Property and Casualty-consists of personal, agricultural and targeted commercial coverages and credit-related property insurance. Products are primarily sold through multiple-line, independent agents and managing general agents.
The accounting policies of the segments are the same as those described in Note 2 to the consolidated financial statements. All revenues and expenses specifically attributable to policy transactions are recorded directly to the appropriate operating segment. Revenues and expenses not specifically attributable to policy transactions are allocated to each segment as follows:
Net investment income from all other assets is allocated to the insurance segments in accordance with the amount of capital allocated to each segment, with the remainder recorded in the Corporate and Other segment.
American National sponsors qualified and non-qualified defined benefit pension plans each of which have been frozen. As such, no additional benefits are accrued through these plans for additional years of service credit or future salary increase credit, and no new participants are added to the plans. Benefits earned by eligible employees prior to the plans being frozen have not been affected. 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 funded from pension plan assets. A $7.2 million pension expense was recognized in the second quarter of 2017 for this de-risking. There was an additional pension settlement expense of $5.3 million recognized in the fourth quarter of 2017. This was part of the normal year-end actuarial valuation process of the defined pension plans and is primarily the result of higher lump sum payouts in 2017 due to plan amendments to make this option available.
American National’s funding policy for the qualified pension plans is to make annual contributions to meet the minimum funding standards of ERISA. American National contributed $60,000,000, $25,023,000, and $40,090,000 to the qualified pension plans in 2018, 2017 and 2016, respectively. American National and its affiliates do not expect to contribute to its qualified plans in 2019. The benefits paid from the non-qualified plans were $8,901,000, $12,212,000 and $12,287,000 in 2018, 2017 and 2016, respectively. Future payments from the non-qualified pension benefit plans will be funded out of general corporate assets.
The following table shows pension benefit payments, expected to be paid (in thousands):
The investment policy for the retirement plan assets is designed to provide the highest return possible commensurate with sound and prudent underwriting practices. The investment diversification goals are to have investments in cash and cash equivalents as necessary for liquidity, debt securities up to 100% and equity securities up to 75% of the total invested plan assets. The amount invested in any particular investment is limited based on credit quality, and no single investment may at the time of purchase be more than 5% of the total invested assets.
American National and its subsidiaries lease insurance sales office space, technological equipment, and automobiles. The remaining long-term lease commitments at December 31, 2018 were approximately $13,781,000.
American National had aggregate commitments at December 31, 2018, to purchase, expand or improve real estate, to fund fixed interest rate mortgage loans, and to purchase other invested assets of $854,849,000 of which $534,162,000 is expected to be funded in 2019 with the remainder funded in 2020 and beyond.
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. The Moody Foundation owns 34.0% % of Gal-Tex and 22.75% % of American National, and the Libbie Shearn Moody Trust owns 50.2% % of Gal-Tex and 37.01%% of American National.
The fourth quarter of 2017 includes the impact of the U. S. Tax Cut and Jobs Act ("Tax Reform") of $206.4 million, in Q4 of 2017 primarily due to the remeasurement of our deferred tax balances to the new 21% corporate income tax rate. Excluding the impact of Tax Reform, the Company’s net income for the three months ended December 31, 2017 would have been $138.2 million and net earnings per basic and diluted share of $5.14 and $5.12, respectively.