We own six buildings and related parking facilities in Cedar Rapids, Iowa. Three buildings are used as our corporate headquarters, and three buildings are available to commercial tenants as leased office space. Our corporate headquarters includes: a five-story office building, a two-story office building and an eight-story office building in which a portion of the first floor (approximately 6.0 percent of the building’s square footage) is leased to tenants. In December 2013, we acquired a three-building commercial real estate complex immediately adjacent to our corporate headquarters. This complex includes a three-story office building, a ten-story office building and a one-story office building which are available for lease to commercial tenants (approximately 41.0 percent of the complex’s square footage is leased). All six buildings are connected by a skywalk system. We also own a 250-space parking ramp for use by our employees. The parking ramp is located adjacent to our corporate headquarters upon one parcel of real estate that we own and another parcel that we lease with an option to purchase.
In addition, three of our regional office locations in Lock Haven, Pennsylvania, Pennington, New Jersey, and Rocklin, California, conduct operations in office space that we own. A portion of the Lock Haven (approximately 18.0 percent) and Pennington (approximately 5.0 percent) office space is currently leased to commercial tenants. We also own a tract of land adjacent to the Pennington office.
Our other two regional office locations in Westminster, Colorado, and Webster, Texas, and our claims office in Metairie, Louisiana, conduct operations in leased office space.
In 2012, we adopted new deferred policy acquisition cost accounting guidance on a prospective basis. As a result of the adoption, the amount of underwriting expenses eligible for deferral has decreased. For further information on the impact of adopting the new accounting guidance, please refer to Part II, Item 8, Note 1.
It is important to note that our actual results could differ materially from those projected in forward-looking statements. Information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in “Forward-Looking Information” and Part I, Item 1A, “Risk Factors” of this report.
For 2013, property and casualty business accounted for approximately 92.0 percent of our net premiums earned, of which 90.5 percent was generated from commercial insurance. Life insurance business made up approximately 8.0 percent of our net premiums earned, of which over 67.7 percent was generated from traditional life insurance products.
Catastrophe losses is a commonly used non-GAAP financial measure, which utilizes the designations of the Insurance Services Office (ISO) and are reported with loss and loss settlement expense amounts net of reinsurance recoverables, unless specified otherwise. According to the ISO, a catastrophe loss is defined as a single unpredictable incident or series of closely related incidents that result in $25.0 million or more in U.S. industry-wide direct insured losses to property and that affect a significant number of insureds and insurers (“ISO catastrophe”). In addition to ISO catastrophes, we also include as catastrophes those events (“non-ISO catastrophes”), which may include U.S. or international losses, that we believe are, or will be, material to our operations, either in amount or in number of claims made. Management, at times, may determine for comparison purposes that it is more meaningful to exclude extraordinary catastrophe losses and resulting litigation. The frequency and severity of catastrophic losses we experience in any year affect our results of operations and financial position. In analyzing the underwriting performance of our property and casualty insurance segment, we evaluate performance both including and excluding catastrophe losses. Portions of our catastrophe losses may be recoverable under our catastrophe reinsurance agreements. We include a discussion of the impact of catastrophes because we believe it is meaningful for investors to understand the variability in our periodic earnings.
The year 2011 will be remembered for its devastating catastrophes, both domestic and abroad. According to various reports, 2011 was the costliest catastrophe year on record for the property and casualty insurance industry globally. We experienced losses in our direct and assumed books of business that negatively impacted our full-year results. However, premium rates increased across all lines of business, and there were some positive signs in the overall economy. Additionally, we took steps to improve and strengthen our underwriting guidelines in response to our catastrophe experiences. Internal analyses of our catastrophe exposures, utilizing various approaches including the results of the updated RMS Model Version 11, supported the underwriting changes.
At a special meeting held on January 24, 2012, our shareholders approved our reorganization into a new holding company structure. United Fire Group, Inc. has replaced United Fire & Casualty Company as the publicly held corporation, and United Fire & Casualty Company is now a wholly owned subsidiary of United Fire Group, Inc. In addition to creating a more streamlined corporate structure, the new holding company’s organizational documents enhanced our shareholders’ rights by reducing the percentage of shareholders required to amend our Articles of Incorporation, approve the merger or sale of substantially all Company assets, and call a special meeting. This new structure will potentially provide us with more flexibility to operate and finance our businesses, particularly if we should need to raise capital in the future.
For the year ended December 31, 2013, our property and casualty insurance segment reported income before income taxes of $88.7 million compared to income before income taxes of $36.1 million in the same period in 2012. The increase in income before income taxes during 2013 as compared to 2012 is primarily a result of a 10.3 percent increase in net premiums earned and a decrease in catastrophe losses discussed in more detail throughout this section.
Amortization of deferred policy acquisition costs decreased during 2012 as compared to 2011 due to a change in accounting guidance that limits the amount of underwriting expenses eligible for deferral. We prospectively adopted the new accounting guidance effective January 1, 2012. As a result, the amount of underwriting expenses eligible for deferral has decreased, which resulted in the recognition of $8.7 million of additional expense in 2012 in our property and casualty insurance segment than would have been recognized had the guidance remained the same.
Direct premiums written increased $101.5 million in 2012 as compared to 2011, of which $37.2 million resulted from our acquisition of Mercer Insurance Group. The remaining $64.3 million is due to organic growth, primarily the result of rate increases and an increase in audit premiums.
We consolidated Mercer Insurance Group’s non-catastrophe reinsurance programs into our programs, effective August 1, 2011 and their catastrophe reinsurance program into our programs, effective January 1, 2012, resulting in increased coverage and retentions for Mercer Insurance Group. The change in programs increased Mercer Insurance Group’s catastrophe protection from $55.0 million to $200.0 million and increased their catastrophe retention from $5.0 million to $20.0 million. Mercer Insurance Group’s non-catastrophe retention was increased from $1.0 million to $2.0 million and the surety retention was increased from $0.5 million to $1.5 million. We had no other significant changes to coverage, limits, or retentions for our catastrophe or non-catastrophe programs.
Catastrophe losses are inherent risks of the property and casualty insurance business. Catastrophic events include, without limitation, hurricanes, tornadoes, earthquakes, hailstorms, wildfires, high winds, winter storms and other natural disasters, along with man-made exposures to losses resulting from, without limitation, acts of war, acts of terrorism and political instability. Such events result in insured losses that can be, and may continue to be, a material factor in our results of operations and financial position, as the extent of losses from a catastrophe is a function of both the total amount of insured exposure in an area affected by the event and the severity of the event. Because the level of insured losses that may occur in any one year cannot be accurately predicted, these losses contribute to fluctuations in our year-to-year results of operations and financial position. Some types of catastrophes are more likely to occur at certain times within the year than others, which adds an element of seasonality to our property and casualty insurance claims. The frequency and severity of catastrophic events are difficult to accurately predict in any year. However, some geographic locations are more susceptible to these events than others.
We control our direct insurance exposures in regions that are prone to naturally occurring catastrophic events through a combination of geographic diversification, restrictions on the amount and location of new business production in such regions, and reinsurance. We regularly assess our concentration of risk exposures in natural catastrophe exposed areas. We have strategies and underwriting standards to manage these exposures through individual risk selection, subject to regulatory constraints, and through the purchase of catastrophe reinsurance coverage. We use catastrophe modeling and a risk concentration management tool to monitor and control our accumulations of potential losses in natural catastrophe exposed areas of the United States, such as the Gulf and East Coasts, as well as in areas of exposure in other countries where we are exposed to a portion of an insurer’s underwriting risk under our assumed reinsurance contracts.
A new version of a third-party catastrophe modeling tool that we and others in the insurance industry utilize for estimating potential losses from natural catastrophes was released in 2011. Overall, the model increased risk estimates for our exposure to hurricanes in the United States, but the impact of the new model on our book of business varies significantly among the regions that we model for hurricanes. Based on our analysis, and the indications of other catastrophe models, we have begun to implement more targeted underwriting and rate initiatives in some regions. We will continue to take underwriting actions and/or purchase additional reinsurance as necessary to reduce our exposure.
In 2013, our pre-tax catastrophe losses were $30.2 million, a significant decrease as compared to $64.7 million and $80.8 million in 2012 and 2011, respectively. Our 2013 losses included 29 catastrophes, where our largest single pre-tax catastrophe loss totaled $4.0 million.
Our 2011 losses were the result of several large natural disasters in both our direct business and assumed reinsurance business. The losses in our direct business totaled $59.7 million and resulted from a string of devastating tornadoes that tore through the southern United States in April 2011, followed by storms that included a multiple-vortex tornado that destroyed Joplin, Missouri in May 2011. In July 2011, a powerful, long-lasting straightline windstorm known as a derecho hit Iowa, and in August 2011, Hurricane Irene impacted our East Coast policyholders. Our assumed reinsurance business contributed $21.1 million of catastrophe losses from prior year development and current year losses as a result of natural disasters (i.e., earthquakes and tsunamis) in New Zealand and Japan.
In 2013 and 2012, we did not exceed our catastrophe retention of $20.0 million. In 2011, only Mercer Insurance Group exceeded its $5.0 million catastrophe retention due to losses incurred from Hurricane Irene. Effective January 1, 2012, Mercer Insurance Group is included in our catastrophe reinsurance program.
Our planned exposure reduction in southern Louisiana that began after Hurricane Katrina was completed in 2011 and reduced our estimated 100-year maximum probable loss by over 60.0 percent. To maintain profitability of our remaining southern Louisiana business, we employed portfolio optimizing techniques (i.e., proximity to the coast, type of construction, the reduction of geographic risk concentration and higher deductibles) to reduce the impact of any one future catastrophe.
The following table represents the primary reinsurers we utilize and their financial strength ratings as of December 31, 2013:
The Terrorism Risk Insurance Program Reauthorization Act of 2007 (“TRIPRA”) was signed into law on December 27, 2007. TRIPRA coverage includes most direct commercial lines of business, including coverage for losses from nuclear, biological and chemical exposures if coverage was afforded by an insurer, with exclusions for commercial automobile insurance, burglary and theft insurance, surety, professional liability insurance and farm owners multiple peril insurance. Under TRIPRA, each insurer has a deductible amount, which is 20.0 percent of the prior year’s direct commercial lines earned premiums for the applicable lines of business, and retention of 15.0 percent above the deductible. No insurer that has met its deductible shall be liable for the payment of any portion of that amount that exceeds the annual $100.0 billion aggregate loss cap specified in TRIPRA. TRIPRA provides marketplace stability. As a result, coverage for terrorist events in both the insurance and reinsurance markets is often available. The amount of aggregate losses necessary for an act of terrorism to be certified by the U.S. Secretary of Treasury, the Secretary of State and the Attorney General was $100.0 million for 2013 and remains the same for 2014. Our TRIPRA deductible was $82.1 million for 2013 and our TRIPRA deductible will be $89.5 million for 2014. Our catastrophe and non-catastrophe reinsurance programs provide limited coverage for terrorism exposure excluding nuclear, biological and chemical-related claims.
For many liability claims, significant periods of time, ranging up to several years and for certain construction defect claims more than a decade, may elapse between the occurrence of the loss, the reporting of the loss to us and the settlement or other disposition of the claim. As a result, loss experience in the more recent accident years for the long-tail liability coverages has limited statistical credibility in our reserving process because a relatively small proportion of losses in these accident years are reported claims and an even smaller proportion are paid losses. In addition, long-tail liability claims are more susceptible to litigation and can be significantly affected by changing contract interpretations and the legal environment. Consequently, the estimation of loss reserves for long-tail coverages is more complex and subject to a higher degree of variability. Reserves for these long-tail coverages represent a significant portion of our overall carried reserves.
Reserves for all other lines of business, with the exception of assumed reinsurance, experienced favorable reserve development in 2011, only to a lesser extent than the other liability line. We attribute this remaining development to the factors noted above. Our assumed reinsurance line was impacted by adverse reserve development on prior year catastrophes of $10.6 million, with accident year 2010 (Canterbury, New Zealand earthquake) increasing by $11.6 million.
The improvement in the net loss ratio in 2013 as compared to 2012 was due to a combination of premium growth and a reduction in catastrophe losses. In 2013, net premiums earned in these lines increased 25.1 percent to $165.1 million as compared to 2012. The improvement in the net loss ratio in 2012 as compared to 2011, was due to an increase in premiums earned in these lines, which increased 12.0 percent to $132.0 million, primarily from an increase in renewal pricing. Also contributing to the improvement in 2012 was a decrease in catastrophe activity as compared to 2011.
Incurred losses from construction defect claims were $13.7 million in 2013 compared to $9.6 million and $11.1 million in 2012 and 2011, respectively. At December 31, 2013, we had $35.8 million in construction defect loss and loss settlement expense reserves (excluding IBNR reserves which is calculated at the overall other liability commercial line), which consisted of 2,102 claims. In comparison, at December 31, 2012, we had reserves of $34.0 million, excluding IBNR reserves, consisting of 1,839 claims.
guidelines to add a professional liability exclusion when contractors prepare their own design work or blueprints and implemented the multi-family exclusion and tract home building limitation form for the state of Colorado and our other western states as a means to reduce our exposure in future years. When offering commercial umbrella coverage for structural residential contractors, limits of liability are typically limited to a maximum of $2.0 million per occurrence. Requests to provide additional insured status for “developers” are declined.
Within our other liability lines of business (other than construction defect), frequency as measured by claim counts indexed to net earned premium and average claim size, continued to decrease in 2013 as compared to 2012 and 2011, primarily due to better underwriting results.
We consider our workers’ compensation business to be a companion product; we rarely write stand-alone workers’ compensation policies. Our workers’ compensation insurance covers primarily small- to mid-size accounts.
The deterioration in our workers’ compensation line of business in 2013 was the result of an increase in claim frequency. The improvement in this line for 2012 was the result of a decrease in frequency. Generally changes in experience year-over-year in this line are considered normal fluctuations that typically occur in the workers’ compensation line of business.
estimating the cost to complete the remaining work and to pay the contractor’s unpaid bills, offset by contract funds due to the contractor, reinsurance, and the value of any collateral to which we may have access.
In 2012, our claims frequency remained stable, yet we had an increase in our loss and loss settlement expenses, which is primarily the result of one large claim. In 2012, net premiums earned on the surety line increased by 6.3 percent to $17.7 million as compared to 2011.
In 2012, we renewed our participation in all of our assumed programs although with reduced participation in programs with heavier Northeast U.S. exposure, in response to the exposure added in this region from the Mercer Insurance Group acquisition. Loss and loss settlement expenses assumed were less than 2011 but still elevated from historic levels due to several natural disasters, primarily the Thailand floods and Super Storm Sandy.
Our underwriting expense ratio, which is a percentage of other underwriting expenses over net premiums earned, was 31.8 percent, 31.4 percent and 35.7 percent for 2013, 2012, and 2011, respectively. The increase in the underwriting expense ratio in 2013 was primarily driven by an increase in employee benefit costs and an increase in contingent commission expenses. In 2012, the decrease in the underwriting expense ratio was primarily due to expenses recorded in 2011 related to the Mercer Insurance Group acquisition, which was partially offset by the prospective adoption of new accounting guidance effective January 1, 2012 that limits the deferral of policy acquisition costs in 2012.
In 2013, net investment income decreased 5.1 percent and 10.2 percent, respectively, as compared to 2012 and 2011. This was due to the decrease in invested assets, resulting from negative cash flows on annuity products, and a decrease in the reinvestment interest rates from the the continued low interest rate environment. For discussion of our consolidated investment results, see the “Investments” section contained in this Item.
Net premiums earned decreased 7.5 percent in 2013 as compared to 2012 primarily due to decreased sales of single premium whole life products. Net premiums earned was 23.7 percent higher in 2012 as compared to 2011 primarily due to increased sales of single premium whole life products.
Amortization of deferred policy acquisition costs decreased 12.0 percent in 2013 as compared to 2012 primarily as a result of lower sales and fewer costs being deferred due to the change in accounting guidance noted previously.
Deferred annuity deposits increased 18.1 percent in 2013, as compared to 2012, due to crediting rate increases which occurred in the latter half of 2013. Deferred annuity deposits decreased 24.8 percent in 2012 as compared to 2011 as we lowered the credited rate offered during the low interest rate environment.
Net cash outflow related to the Company’s annuity business was $77.7 million and $42.3 million in 2013 and 2012, respectively, compared to a net cash inflow of $17.6 million in 2011. This result is attributed to the activity described previously.
Due to our determination that we may not be able to fully realize the benefits of the NOLs acquired in the purchase of American Indemnity Financial Corporation, which are only available to offset the future taxable income of our property and casualty insurance operations and are further limited as to the amount that can be utilized in any given year, we have recorded a valuation allowance against these NOLs that totaled $2.4 million at December 31, 2013. Based on a yearly review, we determine whether the benefit of the NOLs can be realized, and, if so, the decrease in the valuation allowance is recorded as a reduction to current federal income tax expense. If NOLs expire during the year, the decrease in the valuation allowance is offset with a corresponding decrease to the deferred income tax asset. The valuation allowance was reduced by $0.5 million in 2013 due to the realization of $1.6 million in NOLs.
The Company’s assets are invested to meet liquidity needs and maximize after-tax returns while maintaining appropriate risk diversification. The return on our portfolio is an important component of overall financial results, but quality and safety of principal is the highest priority of our investment program. Our general investment philosophy is to purchase financial instruments with the expectation that we will hold them to their maturity. However, close management of our available-for-sale portfolio is considered necessary to achieve portfolio objectives and maximize risk-adjusted returns as market conditions change.
Our invested assets at December 31, 2013 totaled $3.1 billion, compared to $3.0 billion at December 31, 2012, an increase of $5.8 million. At December 31, 2013, fixed maturity securities and equity securities comprised 90.5 percent and 7.6 percent of our investment portfolio, respectively. Because the primary purpose of the investment portfolio is to fund future claims payments, we utilize a conservative investment philosophy, investing in a diversified portfolio of high-quality, intermediate-term taxable corporate bonds, taxable U.S. government bonds and tax-exempt U.S. municipal bonds. Our overall investment strategy is to keep less cash on hand in the low interest rate environment. If additional cash is needed we have an ability to borrow funds available under our revolving credit facility.
As of December 31, 2013 and 2012, we did not have direct exposure to investments in subprime mortgages or other credit enhancement vehicles.
The weighted average effective duration of our portfolio of fixed maturity securities was 4.9 years at December 31, 2013 compared to 4.0 years at December 31, 2012.
We invest the premiums received from our policyholders and annuitants in order to generate investment income, which is an important component of our revenues and profitability. The amount of investment income that we are able to generate is affected by many factors, some of which are beyond our control. Some of these factors are volatility in the financial markets, economic growth, inflation, changes in interest rates, world political conditions, terrorist attacks or threats of terrorism, adverse events affecting other companies in our industry or the industries in which we invest and other unpredictable national or world events. In our life insurance segment, net investment income decreased 5.1 percent in 2013, compared with the same period of 2012, due to a lower asset base and historically low yields that reduce our investment income. We are maintaining our investment philosophy of purchasing quality investments rated investment grade or better.
In 2012, our investment income, net of investment expenses, increased $2.4 million to $111.9 million as compared to 2011. Net investment income benefited from having a full year of Mercer Insurance Group’s results included in 2012 along with an increase in value of investments that are accounted for under the equity method of accounting both somewhat offset by the impact of low investment yields.
In 2013, 86.3 percent of our gross investment income originated from interest on fixed maturities, compared to 91.9 percent and 94.1 percent in 2012 and 2011, respectively.
The following table details our annualized yield on average invested assets for 2013, 2012 and 2011, which is based on our invested assets (including money market accounts) at the beginning and end of the year divided by net investment income:
In 2013, 2012 and 2011, we reported net realized investment gains of $8.7 million, $5.5 million and $6.4 million, respectively. The following table summarizes the components of our net realized investment gains or losses:
As of December 31, 2013, net unrealized investment gains, after tax, totaled $116.6 million, compared to $144.1 million and $124.4 million as of December 31, 2012 and 2011, respectively. The decrease in unrealized gains in 2013 resulted from a decrease in the fair value of the fixed maturity portfolio partially offset by an increase in the equity portfolio. The increase in unrealized gains in 2012 resulted from an increase in fair value of both the fixed maturity and equity portfolios. In 2011, our acquisition of Mercer Insurance Group increased our holdings of fixed maturity securities that, in connection with a decrease in market interest rates, led to an increase in our net unrealized investment gains. We have and will continue to closely monitor market conditions and evaluate the long-term impact of the market volatility experienced in recent years on all of our investment holdings.
Duration relates primarily to our life insurance segment because the long-term nature of these reserve liabilities increases the importance of projecting estimated cash flows over an extended time frame. At December 31, 2013, our life insurance segment had $925.8 million in deferred annuity liabilities for which investments in fixed maturity securities were specifically allocated.
The amounts set forth in the following table detail the impact of hypothetical interest rate changes on the fair value of fixed maturity securities held at December 31, 2013. The sensitivity analysis measures the change in fair values arising from immediate changes in selected interest rate scenarios. We employed hypothetical parallel shifts in the yield curve of plus or minus 100 and 200 basis points in the simulations. Additionally, based upon the yield curve shifts, we employ estimates of prepayment speeds for mortgage-related products and the likelihood of call or put options being exercised within the simulations. According to this analysis, at current levels of interest rates, the duration of the investments supporting the deferred annuity liabilities is 0.18 years shorter than the projected duration of the liabilities. If interest rates increase by 100 or 200 basis points, the duration of the investments supporting the deferred annuity liabilities would be 0.57 years and 1.71 years longer, respectively, than the projected duration of the liabilities.
We have no direct exposure in any of the guarantors of our investments. Our largest indirect exposure with a single guarantor totaled $114.2 million or 29.7 percent of our insured municipal securities at December 31, 2013, as compared to $138.6 million or 30.3 percent at December 31, 2012. Our five largest indirect exposures to financial guarantors accounted for 79.9 percent and 79.3 percent of our insured municipal securities at December 31, 2013 and 2012, respectively.
We monitor our capital adequacy to support our business on a regular basis. The future capital requirements of our business will depend on many factors, including our ability to write new business successfully and to establish
Our cash flows from operations were sufficient to meet our liquidity needs for 2013, 2012 and 2011.
In addition to investment income, possible sales of investments and proceeds from calls or maturities of fixed maturity securities also can provide liquidity. During the next five years, $1.1 billion, or 40.7 percent of our fixed maturity portfolio will mature.
We invest funds required for short-term cash needs primarily in money market accounts, which are classified as cash equivalents. At December 31, 2013, our cash and cash equivalents included $37.8 million related to these money market accounts, compared to $45.6 million at December 31, 2012.
Our cash outflows for investment purchases totaled $601.8 million in 2013, compared to $663.8 million and $598.5 million for the same period in 2012 and 2011, respectively. We also had a net cash outflow in 2011 of $172.6 million related to our acquisition of Mercer Insurance Group.
As a holding company with no independent operations of its own, United Fire Group, Inc. relies on dividends received from its insurance company subsidiaries in order to pay dividends to its common shareholders. Dividends payable by our insurance subsidiaries are governed by the laws in the states in which they are domiciled. In all cases, these state laws permit the payment of dividends only from earned surplus arising from business operations. For example, under Iowa law, the maximum dividend or distribution that may be paid within a 12-month period without prior approval of the Iowa Insurance Commissioner is generally restricted to the greater of 10 percent of statutory surplus as of the preceding December 31, or net income of the preceding calendar year on a statutory basis, not greater than earned statutory surplus. Other states in which our insurance company subsidiaries are domiciled may impose similar restrictions on dividends and distributions. Based on these restrictions, at December 31, 2013, our insurance company subsidiary, United Fire & Casualty, is able to make a maximum of $53.7 million in dividend payments without prior regulatory approval. These restrictions will not have a material impact in meeting our cash obligations.
In December 2011, United Fire entered into a credit agreement with a syndicate of financial institutions as lenders. KeyBank National Association is the administrative agent, lead arranger, sole book runner, swingline lender, and letter of credit issuer, and Bankers Trust Company is the syndication agent. The four-year credit agreement provides for a $100.0 million unsecured revolving credit facility that includes a $20.0 million letter of credit subfacility and a swing line subfacility in the amount of up to $5.0 million. As of December 31, 2013, there were no balances outstanding under this credit agreement.
If no event of default has occurred or is continuing to occur, and certain other conditions are satisfied, during the term of this credit facility, we have the right to increase the total facility from $100.0 million up to $125.0 million. The credit facility is available for general corporate purposes, including working capital, acquisitions and liquidity purposes. Principal of the credit facility is due in full at maturity, on December 22, 2015. The interest rate is based on our monthly choice of either a base rate or the London Interbank Offered Rate (“LIBOR”) plus, in each case, a calculated margin amount. A commitment fee on each lender’s unused commitment under the credit facility is also payable quarterly.
The National Association of Insurance Commissioners (“NAIC”) adopted risk-based capital requirements, which requires us to calculate a minimum capital requirement for each of our insurance companies based on individual company insurance risk factors. These “risk-based capital” results are used by state insurance regulators to identify companies that require regulatory attention or the initiation of regulatory action. At December 31, 2013, all of our insurance companies had capital well in excess of required levels.
The following table shows our contractual obligations and commitments, including our estimated payments due by period, at December 31, 2013:
The amounts presented for future payments to be made to policyholders and beneficiaries must be actuarially estimated and are not determinable from the contract. The projected payments are based on our current assumptions for mortality, morbidity and policy lapse, but are not discounted with respect to interest. Additionally, the projected payments are based on the assumption that the holders of our annuities and life insurance policies will withdraw their account balances upon the expiration of their contracts. Policies must remain in force for the policyholder or beneficiary to receive the benefit under the policy. Depending on the terms of a particular policy, future premiums from the policyholder may be required for the policy to remain in force. In contrast, the future policy benefit reserves for our life insurance segment presented on the Consolidated Balance Sheets are generally based on historical assumptions for mortality and policy lapse rates and are on a discounted basis. Accordingly, the amounts presented above for future policy benefit reserves significantly exceeds the amount of future policy benefit reserves reported on our Consolidated Balance Sheets at December 31, 2013.
The amounts presented are estimates of the dollar amounts and time periods in which we expect to pay out our gross loss and loss settlement expense reserves. Because the timing of future payments may vary from the stated contractual obligation, these amounts are estimates based upon historical payment patterns and may not represent actual future payments. Refer to “Critical Accounting Estimates: Loss and Loss Settlement Expenses - Property and Casualty Insurance Segment” in this section for further discussion.
Our operating lease obligations are for the rental of office space, vehicles, computer equipment and office equipment. For further discussion of our operating leases, refer to Part II, Item 8, Note 13 “Lease Commitments.”
We offer our agents a profit-sharing plan as an incentive for them to place high-quality property and casualty insurance business with us. Based on business produced by the agencies in 2013, we estimate property and casualty agencies will receive profit-sharing payments of $19.2 million in 2014.
We estimated the pension contribution for 2014 in accordance with the Pension Protection Act of 2006 (the “Act”). Contributions for future years are dependent on a number of factors, including actual performance versus
Pursuant to an agreement with one of our limited liability partnership investments, we are contractually committed through December 31, 2017 to make capital contributions upon request of the partnership. Our remaining potential contractual obligation was $1.1 million at December 31, 2013.
Upon acquisition, we classify investments in marketable securities as held-to-maturity, available-for-sale, or trading. We record investments in held-to-maturity fixed maturity securities at amortized cost. We record available-for-sale fixed maturity securities, trading securities and equity securities at fair value. Other long-term investments consist primarily of our interests in limited liability partnerships that are recorded on the equity method of accounting. We record mortgage loans at their unpaid principal balance and policy loans at the outstanding loan amount due from policyholders.
is based on the lowest priority level input that is significant to the fair value measurement of the financial instrument.
We review our fair value hierarchy categorizations on a quarterly basis, at which time the classification of certain financial instruments may change if the input observations have changed.
The fair value of our Level 3 impaired securities was determined primarily based upon management’s assumptions regarding the timing and amount of future cash inflows. If a security has been written down or the issuer is in bankruptcy, management relies in part on outside opinions from rating agencies, our lien position on the security, general economic conditions and management’s expertise to determine fair value. We have the ability and the positive intent to hold securities until such time that we are able to recover all or a portion of our original investment. If the impaired security does not have a market at the balance sheet date, management will estimate the security’s fair value based on other securities in the market. Management will continue to monitor securities after the balance sheet date to confirm that their estimated fair value is reasonable.
We prospectively adopted new DAC accounting guidance effective January 1, 2012 which limits the amount of underwriting expenses eligible for deferral. The adoption of the new guidance resulted in $8.7 million additional expense recognized in the Consolidated Statement of Income and Comprehensive Income in 2012, as compared to 2011, in our property and casualty insurance segment than would have been had the guidance remained the same. In compliance with the new accounting guidance, the amount of underwriting compensation expense eligible for deferral is based on time studies and a ratio of success in policy placement. The 2013 DAC asset has been computed on a comparable basis at December 31, 2013 and 2012.
To calculate the premium deficiency charge by line of business, we estimate an expected loss and loss settlement expense ratio which is based on an analysis of actual experience of the line of business in the most recent three-year period. This calculation is performed on a quarterly basis. The expected loss and loss settlement expense ratios are the only assumptions we utilize in our premium deficiency calculation. Changes in these assumptions can have a significant impact on the amount of premium deficiency charge recognized for a line of business.
The following table illustrates the hypothetical impact on the premium deficiency charge recorded for the quarter ended December 31, 2013, of reasonably likely changes in the assumed loss and loss settlement expense ratios utilized for purposes of this calculation. The entire impact of these changes would be recognized through income as other underwriting expenses. The following table illustrates the impact of potential changes in the expected loss and loss settlement expense ratios for all lines of business on the premium deficiency charge. The base amount indicated below is the actual premium deficiency charge recorded as an offset against the DAC asset established as of the quarter ended December 31, 2013:
Actual future results could differ materially from our assumptions used to calculate the recorded DAC asset. Changes in our assumed loss and loss settlement expense ratios in the future would impact the amount of deferred costs in the period such changes in assumptions are made. The premium deficiency charge calculated for 2013, was $3.8 million as compared to the premium deficiency charge of $2.3 million calculated for 2012. The increase in the premium deficiency charge resulted in a comparatively smaller DAC asset at December 31, 2013, than at December 31, 2012.
We periodically review estimates of expected profitability and evaluate the need to “unlock” or revise the assumptions for the amortization of the DAC asset related to our non-traditional business. The primary assumptions utilized when estimating future profitability relate to interest rate spread, mortality experience and policy lapse experience. The table below illustrates the impact that a reasonably likely change in our assumptions used to
The DAC asset recorded in connection with our non-traditional business is also adjusted with respect to estimated expected gross profits as a result of changes in the net unrealized gains or losses on available-for-sale fixed maturity securities allocated to support the block of fixed annuities and universal life policies. That is, because we carry available-for-sale fixed maturity securities at fair value, we make an adjustment to the DAC asset equal to the change in amortization that would have been recorded if we had sold such securities at their stated fair value and reinvested the proceeds at current yields. We include this adjustment, which is called “shadow” DAC, net of tax, as a component of accumulated other comprehensive income. At December 31, 2013 and 2012, the “shadow” DAC adjustment increased our DAC asset by $3.4 million and decreased our DAC asset by $38.7 million, respectively.
Reserves for losses and loss settlement expenses are reported using our best estimate of ultimate liability for claims that occurred prior to the end of any given reporting period, but have not yet been paid. Before credit for reinsurance recoverables, these reserves were $960.7 million and $971.9 million at December 31, 2013 and 2012, respectively. We purchase reinsurance to mitigate the impact of large losses and catastrophic events. Loss and loss settlement expense reserves ceded to reinsurers were $75.2 million for 2013 and $103.9 million for 2012. Our reserves, before credit for reinsurance recoverables, by line of business as of December 31, 2013, were as follows:
On a quarterly basis, United Fire’s internal actuary performed a detailed analysis of IBNR reserves. This analysis uses various loss projections methods (paid and reported loss development) to provide several estimates of ultimate loss (or loss adjustment expense (“LAE”)) for each individual year and line of business. Results of the projection methods are compared and a point estimate of ultimate loss (or LAE) is established. The specific projection methods used to establish point estimates vary depending on what is deemed most appropriate for a particular line of business and year. In general, results of several methods are averaged together to provide a final point estimate. IBNR estimates are derived by subtracting reported loss from projected ultimate loss.
For our short-tail lines of business, IBNR reserves constitute a small portion of the overall reserves. As these claims are generally reported and settled shortly after the loss occurs. In our long-tail lines of business, IBNR reserves constitute a relatively higher proportion of total reserves, because, for many liability claims, significant periods of time may elapse between the initial occurrence of the loss, the reporting of the loss to us, and the ultimate settlement of the claim.
Our internal and external actuaries and management use a number of key assumptions in establishing an estimate of loss and loss settlement expense reserves, including the following assumptions: future loss settlement expenses can be estimated based on the Company’s historical ratios of loss settlement expenses paid to losses; the Company’s case-basis reserves reflect the most up-to-date information available about the unique circumstances of each individual claim; no new judicial decisions or regulatory actions will increase our case-basis obligations; historical aggregate claim reporting and payment patterns will continue into the future consistent with the observable past; significant unique and unusual claim events have been identified and appropriate adjustments have been made; and, to the best of our knowledge, there are no new latent trends that would impact our case-basis reserves.
We are unable to reasonably quantify the impact of changes in our key assumptions utilized to establish individual case-basis reserves on our total reported reserve because the impact of these changes would be unique to each specific case-basis reserve established. However, based on historical experience, we believe that aggregate case-basis reserve volatility levels of 5.0 percent and 10.0 percent can be attributed to the ultimate development of our net case-basis reserves. The impact to pre-tax earnings would be a decrease if the reserves were to be adjusted upwards and an increase if the reserves were to be adjusted downwards. The table below details the impact of this development volatility on our reported net case-basis reserves at December 31, 2013:
Due to the formula-based nature of our IBNR and loss settlement expense reserve calculations, changes in the key assumptions utilized to generate these reserves can result in a quantifiable impact on our reported results. It is not possible to isolate and measure the potential impact of just one of these factors, and future loss trends could be
partially impacted by all factors concurrently. Nevertheless, it is meaningful to view the sensitivity of the reserves to potential changes in these variables. To demonstrate the sensitivity of reserves to changes in significant assumptions, the following example is presented. The amounts reflect the pre-tax impact on earnings from a hypothetical percentage change in the calculation of IBNR and loss settlement expense reserves at December 31, 2013. The impact to pre-tax earnings would be a decrease if the reserves were to be adjusted upwards and an increase if the reserves were to be adjusted downwards. We believe that the changes presented are reasonably likely based upon an analysis of our historical IBNR and loss settlement expense reserve experience.
Our reserve for other liability claims at December 31, 2013, is $487.6 million and consists of 5,592 claims, compared with $522.7 million, consisting of 5,331 claims at December 31, 2012. Of the $487.6 million total reserve for other liability claims, $159.6 million is identified as defense costs and $10.2 million is identified as general overhead required in the settlement of claims.
Like the other liability line of business, workers’ compensation losses and loss settlement expense reserves are based upon variables that create imprecision in estimating the ultimate reserve. Estimates for workers’ compensation are particularly sensitive to assumptions about medical cost inflation, which has been steadily increasing over the past few years. Other variables that we consider and that contribute to the uncertainty in establishing reserves for workers’ compensation claims include: state legislative and regulatory environments; trends in jury awards; and mortality rates. Because of these variables, the process of reserving for the ultimate loss and loss settlement expense to be incurred requires the use of informed judgment and is inherently uncertain. Consequently, actual loss and loss settlement expense reserves may deviate from our estimates. Such deviations may be significant. Our reserve for workers’ compensation claims at December 31, 2013, is $186.0 million and consists of 2,348 claims, compared with $162.3 million, consisting of 2,117 claims, at December 31, 2012.
The following reserve development section should be read in conjunction with the “Results of Operations” section of this Item 7.
The factors contributing to our year-to-year redundancy include: establishing reserves at their ultimate expected loss amount as soon as practicable after information becomes available, which produces, on average, prudently
conservative case reserves; using claims negotiation to control the size of settlements; assuming that we have liability for all claims, even though the issue of liability may, in some cases, be resolved in our favor; promoting claims management services to encourage return-to-work programs, case management by nurses for serious injuries and management of medical provider services and billings; and using programs and services to help prevent fraud and to assist in favorably resolving cases.
It is management’s policy to utilize staff adjusters to develop our estimate of case-basis loss reserves. IBNR and loss settlement expense reserves are established through various formulae that utilize pertinent, recent Company historical data. The calculations are supplemented with knowledge of current trends and events that could result in adjustments to the level of IBNR and loss settlement expense reserves. On an annual basis, we compare our estimate of total reserves to the estimates prepared by Regnier by line of business to ensure that our estimates are within the actuary’s acceptable range. Regnier performs a review of loss and loss settlement expense reserves at each year end using generally accepted actuarial guidelines to ensure that the recorded reserves appear reasonable. Our net reserves for losses and loss settlement expenses as of December 31, 2013 and 2012 were $885.5 million and $868.0 million, respectively. In 2013 and 2012, after considering the independent actuary’s range of reasonable estimates, management believed that carried reserves were reasonable and therefore did not adjust the recorded amount.
emergence based on reported losses. The two methods utilized by Regnier to project loss expenses are: paid expenses-to-paid loss and paid expense-to-ultimate loss.
Our reserves for universal life and deferred annuity contracts are based upon the policyholders’ current account value. Acquisition expenses are amortized in relation to expected gross profits forecast based upon current best estimates of anticipated premium income, investment earnings, benefits and expenses. Annually, we review our estimates of reserves and the related DAC asset and compare them with actual experience. Differences between actual experience and the assumptions that we used in the pricing of these policies, guarantees and riders, and in the establishment of the related reserves will result in variances in profit for the underlying contract. The effects of the changes in such estimated reserves are included in our results of operations in the period in which the changes occur.
The process of estimating our pension and postretirement benefit obligations and related benefit expense is inherently uncertain, and the actual cost of benefits may vary materially from the estimates recorded. These liabilities are particularly volatile due to their long-term nature and are based on several assumptions. The main assumptions used in the valuation of our benefit obligations are: estimated mortality of the employees and retirees eligible for benefits; estimated expected long-term rates of returns on investments; estimated compensation increases; estimated employee turnover; estimated medical trend rate; and estimated rate used to discount the ultimate estimated liability to a present value. We engage an independent actuarial firm to assist in evaluating and establishing assumptions used in the valuation of our benefit obligations.
A 100 basis point decrease in our estimated long-term rate of return on pension plan assets would increase the benefit expense for the year ended December 31, 2013, by $0.9 million, while a 100 basis point increase in the rate would decrease benefit expense by $0.9 million, for the same period.
For the postretirement benefit plan, an increase in our estimated medical trend rate would increase the benefit expense for the year ended December 31, 2013, by $1.3 million, while a 100 basis point decrease in the rate would decrease benefit expense by $1.0 million, for the same period.
In February 2013, the Financial Accounting Standards Board (“FASB”) issued guidance that requires significant items that are reclassified out of accumulated other comprehensive income (“AOCI”) to net income in their entirety in the same reporting period, to be reported to show the effect of the reclassifications on the respective line items of the statement where net income is presented. These reclassifications can be presented either on the face of the statement where net income is presented or in the notes to the financial statements. For items that are not reclassified to net income in their entirety in the same reporting period, a cross reference to other disclosures currently required under GAAP is required in the notes to the financial statements. The new guidance also requires companies to report changes in the accumulated balances of each component of AOCI. This new guidance was effective for annual and interim periods beginning after December 15, 2012. The Company adopted the new guidance effective January 1, 2013. The adoption of the new guidance affects presentation only and therefore had no impact on the Company’s results of operations or financial position.
United Fire Group, Inc. (“United Fire”, the “Registrant”, the “Company”,“we,” “us,” or “our”) and its consolidated subsidiaries and affiliates are engaged in the business of writing property and casualty insurance and life insurance and selling annuities through a network of independent agencies. We report our operations in two business segments: property and casualty insurance and life insurance. Our insurance company subsidiaries are licensed as a property and casualty insurer in 43 states, plus the District of Columbia, and as a life insurer in 37 states.
On February 1, 2012, United Fire & Casualty Company completed a corporate reorganization (the “Reorganization”) that resulted in the creation of United Fire Group, Inc., an Iowa corporation, as the holding company and sole owner of United Fire & Casualty Company. In connection with the Reorganization, each share of United Fire & Casualty Company common stock (par value $3.33 1/3 per share) that was issued and outstanding immediately prior to the effective date was automatically converted into a share of United Fire Group, Inc. common stock (par value $0.001 per share). In addition, each outstanding option to purchase or other right to acquire shares of United Fire & Casualty Company common stock was automatically converted into an option to purchase or right to acquire, upon the same terms and conditions, an identical number of shares of United Fire Group, Inc. common stock. United Fire Group, Inc. became the publicly held corporation upon completion of the Reorganization.
The accompanying Consolidated Financial Statements include United Fire and its wholly owned subsidiaries: United Fire & Casualty Company, United Real Estate Holdings Company, LLC, United Life Insurance Company (“United Life”), Addison Insurance Company, American Indemnity Financial Corporation, Lafayette Insurance Company, United Fire & Indemnity Company, Texas General Indemnity Company (currently in run-off) and Mercer Insurance Group, Inc., which includes BICUS Services Corporation (currently inactive), Financial Pacific Insurance Company, Financial Pacific Insurance Group, Inc., Franklin Insurance Company, Mercer Insurance Company, and Mercer Insurance Company of New Jersey, Inc. (collectively, “Mercer Insurance Group”).
United Fire Lloyds, an affiliate of United Fire & Indemnity Company, is organized as a Texas Lloyds plan, which is an aggregation of underwriters who, under a common name, engage in the business of insurance through a corporate attorney-in-fact. United Fire Lloyds is financially and operationally controlled by United Fire & Indemnity Company, its corporate attorney-in-fact, pursuant to three types of agreements: trust agreements between United Fire
& Indemnity Company and certain individuals who agree to serve as trustees; articles of agreement among the trustees who agree to act as underwriters to establish how the Lloyds plan will be operated; and powers of attorney from each of the underwriters appointing a corporate attorney-in-fact, who is authorized to operate the Lloyds plan. Because United Fire & Indemnity Company can name the trustees, the Lloyds plan is perpetual, subject only to United Fire & Indemnity Company’s desire to terminate it.
United Real Estate Holdings, LLC, formed in 2013, is a wholly owned subsidiary of United Fire & Casualty Company and is organized as an Iowa Limited Liability Corporation, an unincorporated association formed for the purpose of holding United Fire & Casualty Company’s ownership in commercial real estate.
and inherently uncertain. When we establish and adjust reserves, we do so given our knowledge at the time of the circumstances and facts of known claims. To the extent that we have overestimated or underestimated our loss and loss settlement expense reserves, we adjust the reserves in the period in which such adjustment is determined.
We record our best estimate of reserves for claim litigation that arises in the ordinary course of business. We consider all of our pending litigation as of December 31, 2013 to be ordinary, routine and incidental to our business.
Changes in unrealized appreciation and depreciation, with respect to available-for-sale fixed maturities and equity securities, are reported as a component of accumulated other comprehensive income, net of applicable deferred income taxes, in stockholders’ equity.
In 2013, 2012 and 2011, we recorded a pre-tax realized loss of $139, $4 and $395, respectively, as a result of the recognition of other-than-temporary impairment (“OTTI”) charges on certain holdings in our investment portfolio. None of the OTTI charges were considered to have a noncredit related loss component. We review all of our investment holdings for appropriate valuation on an ongoing basis. Refer to Note 2 “Summary of Investments” for a discussion of our accounting policy for impairment recognition.
In October 2010, the Financial Accounting Standards Board (“FASB”) issued updated accounting guidance to address the diversity in practice for the accounting for costs associated with acquiring or renewing insurance contracts. This guidance modifies the definition of acquisition costs to specify that a cost must be incremental and directly related to the successful acquisition of a new or renewal insurance contract in order to be deferred. Acquisition costs that are not eligible for deferral are to be charged to expense in the period incurred.
Effective January 1, 2012, we elected to adopt the updated accounting guidance on a prospective basis. As a result of the adoption, the amount of underwriting expenses eligible for deferral has decreased. After consideration of our normal recoverability assessment and the amortization pattern of our deferred policy acquisition costs, we recognized approximately $10,291 more expense (pretax) in 2012 than we would have had the guidance remained the same. The impact of the adoption on the amounts reported in the accompanying Consolidated Statements of Income and Comprehensive Income was an increase to other underwriting expenses of $25,528, a decrease to deferred policy acquisition cost amortization of $15,237 and a reduction in net income of $6,689 or $0.26 per share. The 2013 DAC asset has been computed on a comparable basis at December 31, 2013 and 2012.
Property and equipment is presented at cost less accumulated depreciation. At December 31, 2013, the Company had property and equipment of $47,218, which included buildings of $29,072, land of $7,163, furniture and fixtures of $2,707, computer equipment and software of $3,197 and an airplane of $5,079. At December 31, 2012, the Company had property and equipment of $43,090, which included buildings of $25,186, land of $6,879, furniture and fixtures of $1,024, computer equipment and software of $3,076 and an airplane of $6,925. Expenditures for maintenance and repairs are generally expensed as incurred. We periodically review these assets for impairment whenever events or changes in business circumstances indicate that the carrying value of the underlying asset may not be recoverable. A loss would be recognized if the estimated fair value of the asset were less than its carrying value.
Goodwill and other intangible assets arise as a result of business combinations and consist of the excess of the fair value of consideration paid over the tangible assets acquired and liabilities assumed. We evaluate goodwill and other intangible assets for impairment at least on an annual basis or whenever events or changes in circumstances indicate that it is more likely than not that the carrying amount of goodwill and other intangible assets may exceed its implied fair value. Goodwill is evaluated at the reporting unit level. Any impairment is charged to operations in the period that the impairment is identified. In 2013 and 2012, we performed a qualitative assessment of our goodwill. As a result of this assessment, we did not recognize an impairment charge on our goodwill in 2013 or 2012.
Our intangible assets, which consist primarily of agency relationships, trade names, licenses, and software, are being amortized by the straight-line method over periods ranging from 2 years to 15 years, with the exception of licenses, which are indefinite-lived and not amortized. We performed a qualitative assessment of our intangible assets. As a result of this assessment, we did not recognize an impairment charge on our intangible assets in 2013, 2012 and 2011. Amortization expense, which is allocated to the property and casualty insurance segment, totaled $1,212, $2,539 and $1,922 for 2013, 2012 and 2011, respectively.
The table that follows is a reconciliation of the amortized cost (cost for equity securities) to fair value of investments in held-to-maturity and available-for-sale fixed maturity and equity securities as of December 31, 2013 and 2012.
Net realized gains (losses) on disposition of investments are computed using the specific identification method and are included in the computation of net income. A summary of net realized investment gains (losses) for 2013, 2012 and 2011, is as follows:
Our investment portfolio includes trading securities with embedded derivatives. These securities are primarily convertible securities which are recorded at fair value. Income or loss, including the change in the fair value of these trading securities, is recognized currently in earnings as a component of net realized investment gains and losses. Our portfolio of trading securities had a fair value of $12,427 and $15,371 at December 31, 2013 and 2012, respectively.
Net investment income for the years ended December 31, 2013, 2012 and 2011, is comprised of the following:
Pursuant to an agreement with one of our limited liability partnership investments, we are contractually committed through December 31, 2017 to make capital contributions upon request of the partnership. Our remaining potential contractual obligation was $1,050 at December 31, 2013.
We have evaluated the near-term prospects of the issuers of our equity securities in relation to the severity and duration of the unrealized loss which resulted in the recognition of a $4 OTTI in our Consolidated Statements of Income and Comprehensive Income for the year ended December 31, 2012. There were no OTTI losses on equity securities recognized in 2013 or 2011. Our largest unrealized loss greater than 12 months on an individual equity security at December 31, 2013 was $58. We have no intention to sell any of these securities prior to a recovery in value, but will continue to monitor the fair value reported for these securities as part of our overall process to evaluate investments for OTTI recognition.
The fair value of our policy loans is equivalent to carrying value, which is a reasonable estimate of fair value. We do not make policy loans for amounts in excess of the cash surrender value of the related policy. In all instances, the policy loans are fully collateralized by the related liability for future policy benefits for traditional insurance policies or by the policyholders’ account balance for non-traditional policies.
A summary of the carrying value and estimated fair value of our financial instruments at December 31, 2013 and 2012 is as follows:
The fixed maturities reported as disposals relate to the receipt of principal on scheduled calls.
We have several programs that provide reinsurance coverage. This reinsurance coverage limits the risk of loss that we retain by reinsuring direct risks in excess of our retention limits. The following table provides a summary of our primary reinsurance programs. Retention amounts reflect the accumulated retentions and co-participation of all layers within a program. In 2012, we added a $3,000 aggregate annual deductible to our core program multi-line (casualty excess and property excess).
The following table provides a summary of Mercer Insurance Group’s primary reinsurance programs for 2011:
United Life purchases reinsurance to limit the dollar amount of any one risk of loss. Our retention on standard individual life cases is $300. Our accidental death benefit rider on an individual policy is reinsured at 100 percent, up to a maximum benefit of $250. Our group coverage, both life and accidental death and dismemberment, is reinsured at 50.0 percent. Catastrophe excess reinsurance coverage applies when three or more insureds die in a catastrophic accident. For catastrophe excess claims, we retain the first $1,000 of ultimate net loss and the reinsurer agrees to indemnify us for the excess up to a maximum of $5,000. We supplement this coverage when appropriate
Premiums and losses and loss settlement expenses related to our ceded business is as follows:
The favorable reserve development in 2013 on prior year reserves was primarily related to our long-tail lines of commercial business including other liability, workers’ compensation and auto liability. The significant driver of the favorable reserve development in 2013 was the other liability line, primarily due to additional recognition of relatively recent changes in reserve development patterns which have shown increased redundancies in reserves for reported claims along with relatively less need for IBNR claim reserves. Also, contributing to the favorable development in 2013, only to a lesser extent than the other liability line of business, were workers’ compensation, commercial auto liability and surety lines of business
In 2012 we experienced favorable reserve development for reserves established for claims that occurred in prior years. The majority of this favorable development is related to our long-tail lines of commercial business including other liability, workers’ compensation and auto liability.
The significant driver of the favorable reserve development in 2012 was the other liability line. The favorable development is generally caused by changes in loss development patterns due to many of the factors cited above. Specifically, we observed a continuation of a trend, started in 2011, reducing the overall number of reported new
construction defect claims and lower than expected loss emergence on known claims. In addition, in 2009 management began an initiative to control legal defense costs. As these costs are a significant component of the carried reserves for the other liability line, management believes this initiative is also contributing to the favorable reserve development trends.
Generally, we base reserves for each claim on the estimated ultimate exposure for that claim, determined from a prudently conservative point of view. We believe that it is appropriate and reasonable to establish a best estimate for reserves within a range of reasonable estimates, especially when we are reserving for claims for bodily injury, disabilities and similar claims, for which settlements and verdicts can vary widely. Our reserving philosophy may result in favorable development in future years that will decrease losses and loss settlement expenses for prior year claims in the year of adjustment. While we realize that this philosophy, coupled with what we believe to be aggressive and successful claims management and loss settlement practices, has resulted in year-to-year redundancies in reserves, our approach is better than experiencing year-to-year uncertainty as to the adequacy of our reserves. We believe our approach produces recorded reserves that are reasonably consistent as to their relative position within a range of reasonable reserves from year-to-year. However, conditions and trends that have affected the reserve development for a given year do change. Therefore, such development cannot be used to project future reserve redundancies or deficiencies.
State insurance holding company laws and regulations generally require approval from the insurer’s domicile state insurance Commissioner for any material transaction or extraordinary dividend. For property and casualty insurers, a material transaction is defined as any sale, loan, exchange, transfer or guarantee with an affiliate where the aggregate value of the transaction exceeds 25 percent of the insurer’s policyholders’ surplus or three percent of its admitted assets (measured at December 31 of the preceding year), whichever is less. For life insurers, a material transaction with an affiliate is defined as a transaction with an aggregate value exceeding three percent of the life insurer’s admitted assets (measured at December 31 of the preceding year).
We paid dividends to our common shareholders of $17,484, $15,269 and $15,507 in 2013, 2012 and 2011, respectively. Payments of any future dividends and the amounts of such dividends, however, will depend upon factors such as net income, financial condition, capital requirements, and general business conditions. We will only pay dividends if declared by our Board of Directors, out of funds legally available, and subject to any other restrictions that may be applicable to us.
In 2013, 2012 and 2011 United Fire & Casualty Company received dividends from its wholly-owned subsidiaries of $26,335, $19,750 and $11,450, respectively. In 2013 and 2012, United Fire & Casualty Company paid dividends to
United Fire Group, Inc. totaling $13,175 and $26,950, respectively. These intercompany dividend payments are eliminated for reporting in our Consolidated Financial Statements.
At December 31, 2013, United Life had net admitted assets, on a statutory basis, of $1,648,019, $210,938 in excess of its legal reserve requirement. Therefore, any restriction on funds deposited by United Life with the Iowa Insurance Commissioner would not materially affect its financial position or results of operations and its cash flows are sufficient to meet its operational requirements. Under the material transaction and dividend standards described above, United Life would be able to enter into an affiliate transaction and/or pay a dividend of $5,797 without approval from the Commissioner.
We are directed by the state insurance departments’ solvency regulations to calculate a required minimum level of statutory capital and surplus based on insurance risk factors. The risk-based capital results are used by the NAIC and state insurance departments to identify companies that merit regulatory attention or the initiation of regulatory action. Both United Life and United Fire & Casualty Company and its property and casualty insurance subsidiaries and affiliate had statutory capital and surplus in regards to policyholders well in excess of their required levels at December 31, 2013.
The significant components of our net deferred tax liability at December 31, 2013 and 2012, are as follows:
Due to our determination that we may not be able to fully realize the benefits of the net operating losses (“NOLs”) acquired in the purchase of American Indemnity Financial Corporation in 1999, which are only available to offset the future taxable income of our property and casualty insurance operations and are further limited as to the amount that can be utilized in any given year, we have recorded a valuation allowance against these NOLs that totaled
$2,361 and $2,909, respectively, at December 31, 2013 and 2012. Based on a yearly review, we determine whether the benefit of the NOLs can be realized, and, if so, the decrease in the valuation allowance is recorded as a reduction to current federal income tax expense. If NOLs expire during the year, the decrease in the valuation allowance is offset with a corresponding decrease to the deferred income tax asset. The valuation allowance was reduced by $548 during 2013 due to the realization of $1,565 in NOLs. No portion of the NOLs expired in 2013 or will expire in 2014.
As of December 31, 2013, we had seven external investment managers that are allowed to exercise investment discretion, subject to limitations, if any, established by the investment/retirement committee. We utilize multiple investment managers in order to maximize the pension plan’s investment return while mitigating risk. None of our investment managers uses leverage in managing the pension plan. Annually, the investment/retirement committee meets with each investment manager to review the investment manager’s goals, objectives and the performance of the assets they manage. The decision to establish or terminate a relationship with an investment manager is at the discretion of our investment/retirement committee.
Investments in fixed maturity and equity securities are stated at fair value based upon quoted market prices reported on recognized securities exchanges on the last business day of the year. Purchases and sales of securities are recorded as of the trade date.
The pension plan invested in two pooled separate account funds in 2013, a bond and mortgage separate account fund and a U.S. property separate account fund. Investments in the bond and mortgage separate account fund are stated at fair value as provided by the administrator of the fund based on the fair value of the underlying assets owned by the fund. The fair value measurement is classified within Level 2 of the fair value hierarchy. The fair value of the investments in the U.S property separate account fund is provided by the administrator of the fund based on the net asset value of the fund. The net asset value is based on the fair value of the underlying properties included in the fund. The fair value measurement is classified within Level 3 of the fair value hierarchy. We have not adjusted the net asset value provided by the custodian.
The following table provides a summary of the changes in fair value of the pension plan’s Level 3 securities for 2013:
Our accumulated pension benefit obligation was $106,207 and $109,229 at December 31, 2013 and 2012, respectively.
We have a profit-sharing plan in which employees who meet service requirements are eligible to participate. The amount of our contribution is discretionary and is determined annually, but cannot exceed the amount deductible for federal income tax purposes. Our contribution to the profit-sharing plan for 2013, 2012 and 2011, was $6,029, $1,812 and $1,092, respectively.
We have an employee stock ownership plan (the “ESOP”) for the benefit of eligible employees and their beneficiaries. All employees are eligible to participate in the ESOP upon completion of one year of service, meeting the hourly employment requirements and attaining 21 years of age. Contributions to the ESOP are made at our discretion. When made, these contributions are based upon a percentage of total payroll and are allocated to participants on the basis of compensation. We can make contributions in stock or cash, which the trustee uses to acquire shares of our stock to allocate to participants’ accounts. As of December 31, 2013 and 2012, the ESOP owned 220,468 and 224,041 shares of United Fire common stock, respectively. Shares owned by the ESOP are included in shares issued and outstanding for purposes of calculating earnings per share, and dividends paid on the shares are charged to retained earnings. We did not make any contributions to the ESOP in 2013. We made contributions to the ESOP of $100 in 2012, and $175 in 2011.
The United Fire Group, Inc. 2008 Stock Plan (the “2008 Stock Plan”) authorized the issuance of restricted and unrestricted stock awards, stock appreciation rights, incentive stock options, and non-qualified stock options for up to 1,900,000 shares of United Fire common stock to employees, with 353,649 authorized shares remaining available for future issuance at December 31, 2013. The 2008 Stock Plan is administered by the Board of Directors, which determines those employees who will receive awards, when awards will be granted, and the terms and conditions of
Options granted pursuant to the 2008 Stock Plan are granted to buy shares of United Fire’s common stock at the market value of the stock on the date of grant. All outstanding option awards vest and are exercisable in installments of 20.0 percent of the number of shares covered by the option award each year from the grant date, unless the Board of Directors authorizes the acceleration of vesting. To the extent not exercised, vested option awards accumulate and are exercisable by the awardee, in whole or in part, in any subsequent year included in the option period, but not later than 10 years from the grant date. Restricted and unrestricted stock awards granted pursuant to the 2008 Stock Plan are granted at the market value of our common stock on the date of the grant. Restricted stock awards fully vest after 5 years from the date of issuance, unless accelerated upon the approval of the Board of Directors, at which time United Fire common stock will be issued to the awardee. All awards are generally granted free of charge to the eligible employees of United Fire as designated by the Board of Directors.
In 2013, 2012 and 2011 we recognized $407, $329 and $245, respectively, in compensation expense related to the restricted stock awards. At December 31, 2013, we had $790 in compensation expense that has yet to be recognized through our results of operations related to the restricted stock awards. The intrinsic value of the non-vested restricted stock awards outstanding totaled $358, $1,187 and $1,013 at December 31, 2013, 2012 and 2011, respectively.
The following table summarizes information regarding the stock options outstanding and exercisable at December 31, 2013:
Our primary commercial policies are tailored business packages that include the following coverages: fire and allied lines, other liability, automobile, workers’ compensation and surety. Our personal lines consist primarily of automobile and fire and allied lines coverage, including homeowners.
premium volume or market share. Our insurance company subsidiaries are subject to state laws and regulations regarding rate and policy form approvals. The applicable state laws and regulations establish standards in certain lines of business to ensure that rates are not excessive, inadequate, unfairly discriminatory, or used to engage in unfair price competition. Our ability to increase rates and the relative timing of the process are dependent upon each respective state’s requirements, as well as the competitive market environment.
The following table sets forth certain data for each of our business segments and is reconciled to our Consolidated Financial Statements. Depreciation and amortization expense and property and equipment acquisitions for 2013, 2012 and 2011, are reported in the property and casualty insurance segment.
At December 31, 2013, our future minimum rental payments are as follows:
There was no outstanding balance on the credit facility at December 31, 2013 or 2012. We did not incur any interest expense related to this credit facility in 2013 or 2011. We incurred $780 in interest expense related to this credit facility in 2012. We were in compliance with all covenants of the credit agreement at December 31, 2013.
The following table shows the changes in the components of our accumulated other comprehensive income (loss), net of tax, for the years ended December 31, 2013, 2012 and 2011:
On March 28, 2011, we acquired 100 percent of the outstanding common stock of Mercer Insurance Group, Inc. for $191,475. The acquisition was funded through a combination of cash and $79,900 of short-term debt. Accordingly, the results of operations for Mercer Insurance Group, Inc. have been included in the accompanying consolidated financial statements from that date forward. There were no acquisitions in 2013 and 2012.
The following is a summary of the fair value of the tangible and intangible assets acquired and liabilities assumed of Mercer Insurance Group at the date of acquisition:
The fair value of property and equipment related to land and buildings approximates the appraised value of the respective assets at the acquisition date.
The fair value of the intangible asset for agency relationships was established using the excess earnings method, which is an income approach based on estimated financial projections developed by management using market participant assumptions. Fair value has been estimated as the present value of the benefits anticipated from our continued relationship with these
The unaudited pro forma results above have been prepared for comparative purposes only and do not purport to be indicative of the results of operations that actually would have resulted had the acquisition occurred at January 1, 2011, and they are not necessarily indicative of future operating results. Annualized revenues of Mercer Insurance Group were $145,868 for 2011. Total revenues and net loss related to Mercer Insurance Group for the year ended December 31, 2011 recorded in the accompanying Consolidated Statements of Income and Comprehensive Income were $109,043 and $14,650, respectively.
We have audited the accompanying consolidated balance sheets of United Fire Group, Inc. as of December 31, 2013 and 2012, and the related consolidated statements of income and comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2013. Our audits also included the financial statement schedules listed in the Index at Item 15(a)(2). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.