The following management's discussion and analysis ("MD&A") should be read in conjunction with the consolidated financial statements and the notes to the consolidated financial statements appearing elsewhere in this report. The consolidated financial statements include the results of all of our wholly-owned subsidiaries. Except for the historical information contained here, the discussions in the MD&A contain forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include, but are not limited to, those discussed under Item 1A. Risk Factors.
Our former insurance management operations, which provided insurance management services in New York and Pennsylvania, were discontinued in September 2006 in connection with the sale of these operations to a private investor. Our former TPA operations, which provided administrative and claims management services to employers, primarily in Florida, were sold in 2005. For additional information on our discontinued operations, see Note 18, Discontinued Operations to the consolidated financial statements included elsewhere herein.
During 2008, we launched an initiative to provide management services for alternative risk arrangements and recorded $2.9 million of direct premiums written. Total policyholders related to such business totaled 174 at December 31, 2008.
As a result of the current financial market crisis, we recorded realized investment losses of $13.5 million for investments that were other-than-temporarily impaired during 2008 ($6.3 million in fixed income securities, $6.8 million in equity securities and $0.4 million for other invested assets). As of December 31, 2008, we had a total of $712.7 million in cash and investments, which consisted of 89 percent fixed income securities, 2 percent equity securities, 8 percent cash and 1 percent other invested assets. Our fixed income investment portfolio had an average Moody’s credit quality rating of Aa2 (High Quality).
The number of professional liability policyholders, excluding policyholders under alternative risk arrangements, increased 3 percent to 13,728 policyholders at December 31, 2008 compared to 13,372 policyholders at December 31, 2007.
We continued our targeted market focus in 2008. National and Florida policyholder retention was 96 percent each, compared to National and Florida policyholder retention of 94 percent and 95 percent, respectively, for 2007.
On a trade date basis, we repurchased 1,477,741 shares of our common stock during 2008 at an average price of $45.10 per share and as of December 31, 2008, had remaining authority from our Board of Directors to repurchase 452,802 more shares under our stock repurchase program. Through February 27, 2009, we have repurchased an additional 191,950 shares of our common stock, on a trade date basis, at an average price of $39.03 per share and had remaining authority from our Board of Directors to repurchase an additional 260,852 shares as of that date.
Our loss and LAE reserves represent management’s best estimate as of the end of the period of the amounts we expect to pay out in the future on account of all insured events. The liability comprises estimated case reserves on reported claims plus estimates of insured losses and LAE incurred but not yet reported (“IBNR”). Also implicit in our loss and LAE reserves is a provision for case reserve development, which represents an estimate of the aggregate difference between our individually estimated case reserves and the amount for which they will ultimately be settled. This provision, which is included in our total IBNR reserves, comprises the majority of such reserves given our claims-made policy coverage.
Tort reform - Many of the states in which we operate, including Florida, Georgia, Arkansas, Missouri and Texas, have passed various medical malpractice tort reform measures. For instance, beginning in 2003, Florida enacted a series of laws and adopted a series of constitutional amendments that provide for, among other things, a $0.5 million cap on non-economic damages under certain circumstances, certain modifications to bad faith statutes, limitations on fees to plaintiff’s attorneys, and abolition of joint and several liability. In general, we believe that these reforms have provided an additional level of stability to the MPL market and in part, have contributed to the decline in frequency of claims since enactment. Given the nature of these reforms, the uncertainties surrounding future legislative initiatives and the fact that these reforms are being challenged in various state courts, we are unable to determine what specific effect these developments have had on our claims experience or to predict what their effect may be in the future. To the extent these reforms have contributed to lower frequency of claims and are not ultimately upheld, the reversal of these reforms may result in a higher frequency of claims in the future.
Each technique has inherent benefits and shortcomings (i.e., biases), particularly when applied to company-specific characteristics and trends. For example, certain methods (e.g., the Bornhuetter-Ferguson methods) are more relevant to immature accident years, and other methods (e.g., the loss development methods) provide more meaningful information for years with a greater level of maturity. Because each method has its own set of attributes, we do not rely exclusively upon a single method. Rather, we evaluate each of the methods for the different perspectives that they provide. Each method is applied in a consistent manner from period to period and the methods encompass a review of selected claims data, including claim and incident counts, average indemnity payments and loss adjustment costs.
In considering the potential sensitivity of the factors and assumptions underlying management’s best estimate of loss and LAE reserves, it is also important to understand that the MPL sector of the property and casualty insurance industry is characterized by a relatively small number of claims with a large average cost per claim. For instance:
Given the magnitude of our reserves and these characteristics, even relatively small changes in our estimates for factors such as the number of claims we expect to pay or the amount we expect to ultimately pay for such claims could have a significant impact on our reserves and, correspondingly, our financial position, results of operations and cash flows. This is the case for other key assumptions as well, such as the frequency of reported claims and incidents that will ultimately close with an indemnity payment versus those that will close without an indemnity payment. Because our aggregate loss and LAE reserves are so large, this also means that virtually any change in the level of our carried reserves will be material to our results of operations and may be material to our financial position.
Losses and LAE incurred related to the current year decreased approximately 13 percent and 15 percent in 2008 and 2007, respectively. As noted in our discussion of results of operations below, our net premiums earned declined 13 percent in 2008 and 12 percent in 2007. Our loss ratio (defined as the ratio of net losses and LAE to net premiums earned) related to the current year (excluding prior year development) was 67.5 percent, 67.3 percent and 69.0 percent for the years ended December 31, 2008, 2007 and 2006, respectively. Our current year loss ratio has declined in recent years as a result of overall favorable claims trends, including the level of newly reported claims and incidents.
Losses and LAE for claims related to prior years represent the total net change in estimates charged or credited to earnings in the current year with respect to liabilities established in prior years. Information regarding losses and LAE is accumulated over time and the estimates of the liability are revised accordingly, with the change recognized in the period revisions are made. As noted in the table above, during 2008 our loss and LAE reserve estimates for prior years decreased $17.0 million compared to $16.0 million in 2007, excluding the impact of the PRI commutation. The favorable prior year loss development reflects a decline in expected ultimate losses for years prior to 2008, primarily the 2004 through 2007 accident years, as a result of improved claim trends compared to earlier estimates, including lower incident to claim development, a lower number of claims closed with indemnity payment and stable payment severity.
The net cumulative redundancy / (deficiency) shown in the table below for each year end includes accident year development for all years leading up to that year. For example, for the year ended December 31, 2008, there was $17.0 million of favorable development for calendar year 2007 reserves, including all accident years leading up to and including 2007. This favorable development consists of $12.5 million of favorable development for accident years 2006 and earlier and $4.5 million of favorable development for accident year 2007. Further, the net cumulative redundancy / (deficiency) shown in the table below also includes development for multiple calendar years. For example, the $42.5 million cumulative redundancy in 2006 consists of $12.5 million of favorable development during calendar year 2008 and $30.0 million of favorable development during calendar year 2007.
Fair Value Measurements - Effective January 1, 2008, we adopted Financial Accounting Standard (“FAS”) 157, Fair Value Measurements, which provides a framework for measuring fair value under GAAP for financial assets and liabilities. The adoption of FAS 157 did not have an impact on our consolidated financial statements. As defined in FAS 157, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price methodology). We utilize market data or assumptions that we believe market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated or generally unobservable. We have primarily applied the market approach for recurring fair value measurements and endeavor to utilize the best available information. Accordingly, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. We then classify fair value balances based on the observability of those inputs.
The fair value hierarchy under FAS 157 prioritizes the inputs used to measure fair value. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data.
The following is a description of the valuation measurements used for our financial instruments carried or disclosed at fair value, as well as the general classification of such financial instruments pursuant to the valuation hierarchy.
Preferred stocks that trade in active markets are classified within Level 1 as fair values are based on quoted market prices for identical assets as of the reporting date. Preferred stocks that trade in less active markets are classified within Level 2 as fair values are based on valuation methodologies, the significant inputs into which include, but are not limited to, benchmark yields, reported trades, broker/dealer quotes and issuer spreads.
Other invested assets include an investment in a non-public entity and investments held as part of our deferred compensation plan.
A valuation allowance against deferred tax assets is estimated and recorded if it is more likely than not that all or some portion of the benefits related to the deferred tax assets will not be realized. Valuation allowances are based on estimates of taxable income and the period over which deferred tax assets will be recoverable. In the event that actual results differ from our estimates or those estimates are adjusted in future periods, we may need to establish a valuation allowance, which would impact our financial position and results of operations. During 2008, we recorded a valuation allowance of $0.7 million against our deferred tax assets associated with realized losses on investments other-than-temporarily impaired. The valuation allowance was recorded against deferred tax expense. No valuation allowance was recorded during 2007. For additional information concerning our income taxes, see Note 10, Income Taxes to the consolidated financial statements included elsewhere herein.
Goodwill and Other Intangible Assets - In accordance with FAS 142, Goodwill and Other Intangible Assets, we make an annual assessment by reporting unit to determine whether the value of our goodwill is impaired. We completed such assessments in 2008, 2007 and 2006 and concluded that the value of our goodwill was not impaired. We use both a market-based valuation analysis and a discounted cash flow analysis to estimate the fair value of each reporting unit. Changes to our assumptions could significantly lower our estimates of fair value and result in a determination that goodwill has suffered impairment in value. During 2006, we sold our insurance management operations, which included $8.0 million in goodwill, to a private investor.
Share-Based Payments - We account for our share-based payments in accordance with FAS 123(R), Share-Based Payment. FAS 123(R) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions and requires entities to recognize compensation expense for awards of equity instruments to employees based on the grant-date fair value of those awards (with limited exceptions). FAS 123(R) also requires the benefits of tax deductions in excess of recognized compensation expense to be reported as a financing cash flow, rather than as an operating cash flow as prescribed under the prior accounting rules. This requirement reduces net operating cash flows and increases net financing cash flows in periods after adoption. Total cash flow remains unchanged from what would have been reported under prior accounting rules. In determining the pool of windfall tax benefits for purposes of calculating assumed proceeds under the treasury stock method, we exclude the impact of pro forma deferred tax assets. We use the short-cut method in determining our pool of windfall tax benefits upon adoption of FAS 123(R).
Awards under our Omnibus Plan in 2007 and prior years consisted only of stock options and restricted stock. During 2008 we made grants of contingent stock with performance-based measures and restricted stock. The contingent stock has a performance period of January 1, 2008 through December 31, 2009. The final determination of the number of shares to be issued in respect of an award (which can vary between 50 and 150 percent of the number of performance units subject to the award, provided a threshold performance level is achieved) is determined by the Compensation Committee of our Board of Directors. The restricted stock grants are time based and vest in equal amounts over a three-year period, subject to forfeiture restrictions. Restricted stock becomes unrestricted as the awards vest. Time-vested awards made under the Omnibus Plan generally vest over a three-year period, which represents the requisite service period for such awards. Performance-based awards vest upon meeting the related performance objective. Under the plan, individuals who receive a restricted stock award are permitted to redeem an adequate number of shares from such award upon vesting to satisfy any tax withholding liability. Awards are generally made annually.
Pension Benefits - In September 2006, the FASB issued FAS 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R). In accordance with FAS 158, we recognized a liability for the under-funded status of our defined benefit plans for the difference between the plans’ projected benefit obligation and the fair value of plan assets. We also recorded all unrecognized prior service costs and credits, unrecognized actuarial gains and losses and any unrecognized transition obligations or assets in accumulated other comprehensive (loss) income. Such amounts are reclassified into earnings as components of net periodic benefit cost pursuant to the current recognition and amortization provisions of FAS 106, Employers’ Accounting for Postretirement Benefits Other than Pensions.
Our assumption for the expected long-term rate of return-on-assets in our pension plans, which impacts net periodic benefit cost, is 6.8% for 2008 and 2007 and 7.0% for 2006. The assumption for the expected return on assets for our defined benefit plans reflects our long-term assessment of forward-looking return expectations by asset classes, which is used to develop a weighted-average expected return based on the implementation of our targeted asset allocation in our respective plans. The following table shows the expected versus actual rate of return on plan assets for our defined benefit plans.
For additional information on our defined benefit plans, see Note 14, Employee Benefit Plans to the consolidated financial statements included elsewhere herein.
Revenue Recognition - Premiums, which are our main source of revenue, are generally recognized pro-rata over the respective period of each policy. Premium receivables are recorded net of an estimated allowance for uncollectible amounts. Unearned premiums represent the portion of the premium applicable to the unexpired period of the insurance policy. In the event it is determined that the unearned premium reserve for a book of business will not be sufficient to recover the future expected losses and LAE and acquisition costs, including consideration of related investment income, recognition of a premium deficiency would be required through a write down of deferred policy acquisition costs and a corresponding charge to income. In the event deferred policy acquisition costs are written off entirely, any remaining premium deficiency would be accounted for as a liability with a corresponding charge to income.
Commitments and Contingencies - For information concerning contingencies, to which we are subject, see Note 17, Commitments and Contingencies to the consolidated financial statements included elsewhere herein.
New Accounting Pronouncements - As described in Note 2, Significant Accounting Policies to the consolidated financial statements included elsewhere herein, under the heading “New Accounting Pronouncements,” there are accounting pronouncements that have recently been issued but not been implemented by us. Note 2 describes the potential impact that these pronouncements are expected to have on our consolidated financial statements.
Consolidated net income was $32.1 million for 2008, or $3.72 per diluted common share, a decrease of 37 percent and 29 percent, respectively, compared to $50.9 million, or $5.21 per diluted common share, for 2007. Included in net income for 2007 was a loss from discontinued operations of $0.2 million. Other changes in net income are due to the factors discussed in the paragraph above with regard to income from continuing operations.
Consolidated income from continuing operations was $51.1 million for 2007, or $5.23 per diluted common share, an increase of 55 percent and 69 percent, respectively, compared to $32.9 million, or $3.09 per diluted common share, for 2006. The increase in income from continuing operations for 2007 was primarily due to lower net losses and LAE, other expenses and other underwriting expenses, partially offset by lower net premiums earned. The lower net losses and LAE include favorable prior year loss development of $16.0 million, excluding the impact of the PRI commutation, during 2007 compared to $5.1 during 2006. Income from continuing operations for 2007 also includes an after-tax gain of $9.7 million on the reinsurance commutation between First Professionals and PRI. Other underwriting expenses for 2007 include a $4.2 million ($2.6 million after-tax) charge for a state levied insurance guaranty fund assessment with respect to the insolvency of the subsidiaries of Poe Financial Group. Other underwriting expenses for 2006 include a $9.4 million ($5.8 million after-tax) charge for two separate assessments with respect to the same insolvency. The lower net premiums earned for 2007 resulted from lower rates in our Florida market, a change in business mix to lower risk specialties and a small decline in professional liability policyholders.
During February 2007, our subsidiary, First Professionals, commuted, effective January 1, 2007, all assumed reinsurance treaties with PRI under which First Professionals acted as a reinsurer. In connection with the commutation, First Professionals recognized an after-tax gain of $9.7 million. For additional information on the commutation, see Item 1. Financial Statements, Note 7, Reinsurance. Excluding the impact of the PRI commutation, net premiums written were $182.4 million for the year ended December 31, 2007.
Net losses and LAE decreased 4 percent for 2008 compared to 2007. Net losses and LAE for 2007 include a $14.0 million reduction in net losses and LAE as a result of the PRI commutation. Excluding the impact of the PRI commutation, net losses and LAE declined 15 percent for 2008 compared to 2007. Excluding the impact of the PRI commutation, our loss ratio (defined as the ratio of net losses and LAE to net premiums earned) was 57.7 percent for 2008 compared to 59.3 percent for 2007. The decline in net losses and LAE reflects an increase in favorable prior year development as a percentage of premiums earned resulting from the continuation of favorable loss trends offset by a slightly higher current year loss ratio. The favorable prior year development ($17.0 million in 2008 and $16.0 million in 2007, excluding the impact of the PRI commutation) primarily reflects reductions in our estimates of incident to claim development, payment frequency and payment severity, principally for the 2004 through 2007 accident years. Lower net premiums earned and a decline in the corresponding provision for losses and LAE also contributed to the decline in net losses and LAE.
Direct premiums written declined for 2007 compared to 2006, primarily as a result of lower premium rates in our Florida market and to a lesser extent a change in business mix to lower risk specialties. Professional liability policyholders totaled 13,372 as of December 31, 2007, a slight decline from 13,402 policyholders as of December 31, 2006. Our policyholder retention rate in our core Florida market was 95 percent for 2007, compared to 94 percent for 2006. Our national policyholder retention was 94 percent for 2007 compared to 92 percent for 2006.
Net premiums earned declined for 2007 compared to 2006. The decline is primarily the result of lower rates in our Florida market, a change in business mix to lower risk specialties and a small decline in policyholders.
Net investment income declined for 2007 compared to 2006 primarily as a result of the non-recurrence of $0.9 million of investment income recognized in the second quarter of 2006 related to one of our limited partnership assets and a decline in average invested assets during 2007 as a result of the PRI commutation and share repurchases under our stock repurchase program, partially offset by an increase in the yield on our cash and fixed income investments during the current year.
Net losses and LAE decreased for 2007 compared to 2006. Net losses and LAE for 2007 include a $14.0 million reduction in net losses and LAE as a result of the PRI commutation. Excluding the impact of the PRI commutation, net losses and LAE declined 22 percent for 2007 compared to 2006. Excluding the impact of the PRI commutation, our loss ratio (defined as the ratio of net losses and LAE to net premiums earned) was 59.3 percent for 2007. The decline in net losses and LAE and our loss ratio for 2007 reflects a lower current year loss ratio and an increase in favorable prior year development compared to 2006 due to the continuation of favorable loss trends. The favorable prior year development ($16.0 million in 2007 and $5.1 million in 2006) primarily reflects reductions in our estimates of incident to claim development, payment frequency and payment severity, principally for the 2004 through 2006 accident years.
Selected professional liability insurance claims data. There was a 7% decrease in net paid losses and LAE on core professional liability business for 2007 compared with 2006. This decrease corresponds with a decrease in the number of claims on hand and closed during the year, including a decrease in the number of claims with an indemnity payment. The number of reported claims and incidents for 2007 was down slightly compared to 2006 and generally reflects continued lower frequency in newly reported claims and incidents in total in our Florida market that began in the fourth quarter of 2003. The number of professional liability claims with indemnity payment (“CWIP”) declined slightly for 2007 compared to 2006. For 2007, the CWIP Ratio and the CWIP Ratio, including incidents, continued to be within our expectations. Our inventory of open claims and incidents declined further during 2007, which follows declines in the number of claims and incidents reported. It is not unusual for our claims data to fluctuate from period to period, and our claims data remains within our expectations.
Our TPA operations were comprised of our former wholly-owned subsidiary, Employers Mutual, Inc. (“EMI”). On May 9, 2005, EMI’s employee benefits administration business was sold effective April 30, 2005. An after-tax gain of $0.2 million was recognized on the sale. On May 31, 2005, the remaining TPA operations were sold to a private investor. An after-tax gain of $1.5 million was recognized on the sale. During the third quarter of 2006, we recorded an additional gain on the sale of discontinued operations of $0.4 million related to the finalization of our 2005 tax return, which reflected the sale of our former TPA operations. The results of operations and gain on sale of the former TPA operations are reported as discontinued operations.
Liquidity is a measure of a company’s ability to generate cash flows sufficient to meet short-term and long-term cash requirements of its business operations. As a holding company, we possess assets that consist primarily of the stock of our subsidiaries and of other investments. The sources of liquidity available to us for the payment of operating expenses, taxes and debt-related amounts include management fees and dividends from our insurance subsidiaries. Management fees from our insurance subsidiaries are based upon agreements in place with First Professionals and APAC, pursuant to which we provide substantially all management and administrative services. In accordance with limitations imposed by Florida and Missouri laws, our insurance subsidiaries are permitted, within insurance regulatory guidelines, to pay us dividends of approximately $24.6 million during 2009 without prior regulatory approval. As of December 31, 2008, the holding company held cash and liquid investments of $24.4 million.
Sources of liquidity include cash from operations and routine sales of investments and financing arrangements. As reported in the consolidated statement of cash flows, net cash provided by operating activities was $21.1 million for 2008 compared to net cash used in operating activities of $31.4 million for 2007 and net cash provided by operations of $75.4 million for 2006. The increase in cash provided by operating activities is primarily due to the non-recurrence of the 2007 commutation of the reinsurance agreements between First Professionals and PRI offset by a decline in premiums received associated with the decline in written premiums and higher paid losses and LAE after reinsurance recoveries.
Net cash flows provided by investing activities was $26.3 million and $11.6 million for 2008 and 2007, respectively, compared to net cash flows used in investing activities of $27.3 million for 2006. The 2007 cash flows from investing activities include the transfer of securities in connection with the PRI commutation. Excluding the impact of the PRI commutation, net cash provided by investing activities for 2008 increased primarily due to transactions involving securities, which are dependent on our cash flows from operating activities and the management of our investment portfolio. Net sales and maturities of fixed income securities, equity securities and short-term investments, were $27.0 million and $15.9 million for 2008 and 2007, respectively, compared to net purchases of $61.0 million for 2006.
Net cash flows used in financing activities was $59.1 million and $48.5 million for 2008 and 2007, respectively, compared to $16.0 million for 2006. The increase in net cash used in financing activities for 2008 was primarily due to the repurchase of common shares under our stock repurchase program, which totaled $68.1 million for 2008 compared to $50.7 million and $24.6 million in 2007 and 2006, respectively.
As of December 31, 2008, we had cash and investments of $712.7 million. Included within cash and investments were cash and cash equivalents of $58.5 million, and equity securities and fixed income securities, available-for-sale, with fair values of $637.2 million and $10.9 million, respectively. Approximately $58.3 million of our fixed income securities have scheduled maturities during the next 12 months. We believe that our cash and investments as of December 31, 2008, combined with expected cash flows from operating activities and the scheduled maturities of investments, will be sufficient to meet our cash needs for operating purposes for at least the next 12 months.
During 2003, we completed the placement of $10.0 million in senior notes and created three trusts that issued 30-year trust-preferred securities for which the proceeds from such issuances together with cash previously contributed to the trusts were used to purchase junior subordinated debentures from FPIC totaling $36.1 million. The debentures that we issued, which are reported as long-term debt in the consolidated statements of financial position, to the three trusts are subordinated to all senior indebtedness, including the senior notes, and are equal in standing with one another. In accordance with the guidance given in FASB Interpretation No. 46(R), “Consolidation of Variable Interest Entities - an interpretation of ARB No. 51,” we have not consolidated these subsidiary trusts.
Paid in advance and unprocessed premiums declined 14 percent to $9.5 million as of December 31, 2008 from $11.0 million as of December 31, 2007. The decline in paid in advance and unprocessed premiums is associated with the decline in direct premiums written at our insurance subsidiaries.
We have various contractual obligations that are recorded as liabilities in our consolidated financial statements. We also have items that represent contractual obligations, commitments and contingent liabilities that are not recorded or that are considered to possess off-balance sheet risks beyond their respective amounts otherwise reflected in our consolidated financial statements. These include: (1) derivative financial instruments, which are used to hedge interest rate risk, (2) employee benefit plans and (3) guarantees by us and contractual obligations related to the trust-preferred securities issued by separately created, unconsolidated trusts. These items are discussed further below. We were not a party to any unconsolidated arrangement or financial instrument with special purpose entities or other vehicles at December 31, 2008 that would give rise to previously undisclosed market, credit or financing risk.
The following table summarizes our significant contractual obligations and commitments as of December 31, 2008, and the future periods in which such obligations are expected to be settled in cash. In addition, the table reflects the timing of principal payments on outstanding borrowings. Additional information regarding these obligations is provided in Note 6, Liability for Losses and LAE, Note 10, Income Taxes, Note 12, Long-term Debt, Note 14, Employee Benefit Plans and Note 17, Commitments and Contingencies to the consolidated financial statements included elsewhere herein.
Reflects amounts recognized in our statement of financial position for unrecognized tax benefits. These items are included in the “other” column as they technically do not meet the definition of a contractual obligation as we are not contractually obligated to pay these amounts to third parties and the amount and timing of their eventual payment is sufficiently uncertain.
Historical returns of multiple asset classes were analyzed to develop a risk-free rate of return and risk premiums for each asset class included within our defined benefit plans. The overall rate for each asset class was developed by combining a long-term inflation component, the risk-free real rate of return, and the associated risk premium. A weighted-average rate was developed based on those overall rates and the target asset allocation of the plans.
The following table illustrates the sensitivity to a change in the discount rate for our defined benefit plans as of December 31, 2008: