Specialty Risk and Extended Warranty. We provide coverage for consumer and commercial goods and custom designed coverages, such as accidental damage plans and payment protection plans offered in connection with the sale of consumer and commercial goods, in the U.S. and Europe, and certain niche property, casualty and specialty liability risks in the U.S. and Europe, including general liability, employers’ liability and professional and medical liability.
For the year ended December 31, 2017, our results of operations include activity of the entities we acquired either in 2017 or 2016, primarily:
PDP Group, Incorporated, PDP Holdings, Inc., and Pitcher & Doyle, ULC (collectively, "PDP") - Specialty Risk and Extended Warranty segment
Commencing in the fourth quarter of 2016, our Group Reserve Committee observed adverse loss development trends in our commercial automobile and general liability lines of business in both our Specialty Program and Small Commercial Business segments predominantly in accident years 2012 and subsequent. These industry-wide trends, particularly in the case of commercial automobile, resulted from increasing claim severity and claim frequency. In addition, the Group Reserve Committee determined that our efforts to improve certain poor performing programs through underwriting actions and rate increases had been less successful than anticipated. This trend of increased frequency and severity in our commercial automobile and general liability lines of business continued in 2017 and resulted in our recognition of additional prior period development in 2017. We believe that the current reserve estimates reflect the negative loss trends observed in our loss experience, however, we cannot be certain that trends in these lines have stabilized. As a result, it is reasonably possible that we may experience future prior period development that would be significant to our results of operations. We believe it is unlikely that future development would have a material impact on our liquidity or capital resources.
In 2017, we also observed adverse trends in our workers’ compensation business in our Small Commercial Business segment accident years 2012 and subsequent. These trends were driven, primarily, by an increase in claims frequency and claims severity related to contracting, healthcare and fast food restaurant classes, which increased as a percentage of business written in this time period. We also observed adverse loss development trends in our medical malpractice business in our Specialty Risk and Extended Warranty segment, which resulted from failure to achieve certain anticipated benefits with respect to accident years 2013 and prior from operational changes in the claims department and the failure of the Italian government to implement a law passed in April 2017, which was expected to reduce medical malpractice costs. Having recognized adverse development consistent with these trends in 2016 and 2017, we will continue to monitor them as the impacted accident years mature for possible adverse or favorable development. It is possible that the continuation of these trends could result in future adverse or favorable development that would be significant to our results of operations, but we believe it is unlikely that it would have a material impact on liquidity or capital resources.
In the aggregate, we responded to these observed trends by increasing our estimated ultimate loss ratios, resulting in $419.0 million in prior year adverse development in 2017 and $257.9 million prior year adverse development in 2016. We will continue to monitor these trends through the processes described in “Critical Accounting Policies - Reserves for Loss and Loss Adjustment Expenses and Unearned Premium Reserves.
The consideration for this agreement is a premium amount of $675.0 million, of which $50.0 million represents a payment for the coverage above the carried loss reserves of approximately $6,587.2 million, and an annual claims monitoring fee paid to Premia. We deposited a total of $679.8 million representing the premium amount of $675.0 million and interest of $4.8 million into a collateral trust account established to secure Premia's claims payment obligation to us. Premia deposited an incremental $100.0 million of excess collateral at inception, and is obligated to deposit incremental collateral in accordance with a pre-agreed schedule.
We have accounted for the agreement as retroactive reinsurance. For the year ended December 31, 2017, we recorded $400.0 million of net adverse loss development covered under the agreement, which increased the retroactive reinsurance recoverable to the aggregate limit of $1,025.0 million as of December 31, 2017. We recorded the retroactive reinsurance recoverable in excess of the consideration as a deferred gain that is amortized to earnings using the interest method over the estimated claims settlement period. As of December 31, 2017, the deferred gain of $330.0 million, net accretion and amortization, is reported as "Deferred gain on retroactive reinsurance" on the consolidated balance sheets. Additional information is presented in Note 14. "Reinsurance" to our consolidated financial statements appearing elsewhere in this Form 10-K.
We have a 50% ownership interest in each of two entities (collectively, the "LSC Entities") formed for the purpose of acquiring life settlement contracts, with a subsidiary of NGHC owning the remaining 50%. The LSC Entities are: Tiger Capital LLC (“Tiger”); and AMT Capital Holdings, S.A. (“AMTCH”).
On August 16, 2017, we sold 114 life settlement contracts from the Tiger portfolio for consideration of $100.0 million, which included a payment of $90.0 million on the closing date. In addition, a payment of $5.0 million is due on the next two anniversaries of the closing date. Tiger paid a dividend to its members of $90.0 million, with $45.1 million going to NGHC and the remaining portion retained in the Company.
On December 28, 2017, the LSC Entities contributed 136 life settlement contracts to a limited partnership managed and operated by an unrelated third party. The consideration for the transaction included $217.8 million of cash (including an advance of $39.7 million on future payments from the limited partnership) and the right to receive certain contingent earn-out payments. The LSC Entities have a 30% non-controlling equity interest in the limited partnership while the remaining 70% is held by an unrelated third party. As of December 31, 2017, the LSC Entities’ carrying value of the investment in the limited partnership was $68.1 million.
Gross Written Premiums. Gross written premiums represents estimated premiums from each insurance policy that we write, including as a servicing carrier for assigned risk plans, during a reporting period based on the effective date of the individual policy. Certain policies that we underwrite are subject to premium audit at that policy’s cancellation or expiration. The final actual gross written premiums may vary from the original estimated premiums based on changes to the final rating parameters or classifications of the policy.
Net Investment Income and Net Realized Gains on Investment. We invest our statutory surplus funds and the funds supporting our insurance liabilities primarily in cash and cash equivalents, fixed maturity securities and equity securities. Our net investment income includes interest and dividends earned on our invested assets. We report net realized gains and losses on our investments separately from our net investment income. Net realized gains occur when we sell our investment securities for more than their costs or amortized costs, as applicable. Net realized losses occur when we sell our investment securities for less than their costs or amortized costs, as applicable, or we write down the investment securities as a result of other-than-temporary impairment ("OTTI"). We classify our fixed maturity securities and equity securities primarily as available-for-sale. We report net unrealized gains (losses) on those securities classified as available-for-sale separately within accumulated other comprehensive income on our consolidated balance sheets. Additionally, we have a small portfolio of fixed maturity securities and equity securities classified as trading. We report unrealized gains (losses) on those securities classified as trading within net realized gains on investments.
Loss and Loss Adjustment Expense. Loss and loss adjustment expense (“LAE”) incurred represent our largest expense item and, for any given reporting period, include estimates of future claim payments, changes in those estimates from prior reporting periods and costs associated with investigating, defending and servicing claims. These expenses fluctuate based on the amount and types of risks we insure. We record loss and loss adjustment expense related to estimates of future claim payments based on case-by-case valuations and statistical analysis. We seek to establish all reserves at the most likely ultimate exposure based on our historical claims experience. It is typical for our more serious bodily injury claims to take several years to settle, and we revise our estimates as we receive additional information about the condition of injured employees and claimants and the costs of their medical treatment. Our ability to estimate loss and loss adjustment expense accurately at the time of pricing our insurance policies is a critical factor in our profitability.
recognized in the consolidated statements of operations over the insurance contract period in proportion to the insurance protection provided and classified as a reduction of acquisition costs and other underwriting expenses. Ceding commissions received, but not yet earned, that represent the recovery of other underwriting expenses are classified as a component of accrued expenses and other current liabilities in the consolidated balance sheet. We allocate earned ceding commissions to our segments based on each segment’s proportionate share of total acquisition costs and other underwriting expenses recognized during the period.
Other Expense. Other expense includes those charges that are related to the amortization of tangible and intangible assets and non-insurance fee generating activities in which we engage, including salaries and benefits expenses and other charges directly attributable to non-insurance fee generating activities. As discussed above, on February 28, 2018, we completed the transfer of the U.S.-based fee business to Mayfield and the Investor's acquisition of a majority interest in Mayfield, which we expect will impact the charges related to non-insurance fee generating activities going forward.
Interest Expense. Interest expense represents amounts we incur on our outstanding indebtedness at the then-applicable interest rates adjusted for the amortization of any premiums, discounts, and debt issuance costs.
Loss Ratio. The loss ratio is a measure of the underwriting profitability of an insurance company’s business. Expressed as a percentage, this is the ratio of loss and LAE to net earned premiums.
Net Premiums Earned less Expenses Included in Combined Ratio (Underwriting (Loss) Income). Underwriting (loss) income is a measure of an insurance company’s overall operating profitability before items such as investment income, interest expense and income taxes.
Return on Equity. We calculate return on equity by dividing net income by average stockholders’ equity.
Our significant accounting policies are discussed in Note 2. "Significant Accounting Policies" to our consolidated financial statements appearing elsewhere in this Form 10-K. We believe that our most critical accounting policies relate to the reporting of earned premium, reserves for loss and loss adjustment expenses, including losses that have occurred but have not been reported prior to the reporting date, amounts recoverable from third party reinsurers, deferred policy acquisition costs, business combinations, goodwill and intangible assets, and income taxes and valuation allowance, each of which is discussed below.
Premiums. We recognize insurance premiums, other than in our Specialty Risk and Extended Warranty segment, as earned on the straight-line basis over the contract period. Insurance premiums on Specialty Risk and Extended Warranty business are earned based on estimated program coverage periods. We base these estimates on the expected distribution of coverage periods
by contract at inception, and because a single contract may contain multiple coverage period options, we revise these estimates based on the actual coverage periods selected by the insured. Unearned premiums represent the portion of premiums written that is applicable to the unexpired term of the contract or policy in force. We base premium adjustments on contracts and audit premiums on estimates made over the contract period. Earned but unbilled premium (“EBUB”) estimates the amount of audit premium for those policies that have yet to be audited as of the date of the reporting period. Workers’ compensation policies are subject to audit and the final premium may increase or decrease materially from the original premium due to revisions to actual payroll and/or employee classification. Based on guidance in FASB ASC 944, we determine EBUB using statistically supported aggregate calculations based on our historical premium audit results. We have not had a material adjustment as a result of actual premium audits differing from the estimates used in calculating EBUB. We also estimate an allowance for doubtful accounts based on a historical percentage of premium write-offs.
We record reserves for estimated losses under insurance policies that we write, as well as for loss adjustment expenses related to the investigation and settlement of claims. Our total reserves for loss and loss adjustment expenses represent the estimated cost to settle all reported and unreported loss and loss adjustment expenses unpaid at a given point in time.
For the years ended December 31, 2017 and 2016, this process resulted in an MBE that was $29.0 million higher and $155.4 million lower, respectively, than the ACE on a net basis. The following details the amount of the adjustments recorded in our financial statements, by segment, and the specific underlying reasons we felt these adjustments were appropriate:
Within the Specialty Risk and Extended Warranty segment, due to uncertainties primarily around our Italian medical malpractice line of business and international syndicate exposure (given the increased uncertainty due to exposure growth from the ANV acquisition and correspondingly larger syndicate platform), the Group Reserve Committee determined to hold the current accident year loss ratio above the ACE, resulting in an increase in the actuarial estimate by $20.8 million.
Within the Specialty Risk and Extended Warranty segment, our Group Reserve Committee considered a number of subjective factors, including changes in our medical malpractice claims staffing levels and initiatives to support reducing the actuarial estimate by $52.7 million.
Within the Specialty Program segment, our Group Reserve Committee determined that the emerging loss experience in our workers’ compensation line did not support our actuaries’ divergence from our pricing loss ratio because of immaturity and limited
For the year ended December 31, 2015, we made our determination of MBE based, primarily, on our expectations of our external actuaries’ indications at year-end, which covered approximately 95% of our total reserve balances and were based on actuarial studies, and our consideration of relevant information that was not fully addressed in the actuarial studies. We determined our 2015 MBE, which was $75 million, or approximately 1.5% lower than our external actuaries’ ACE, based on our consideration of items that we did not believe were fully considered by our external actuaries, including excess of loss reinsurance and recent trends in our European medical malpractice business. As a result, for 2015, we made $(325) million in net unallocated MBE Adjustments to carried reserves as recorded in the general ledger (the “2015 Adjustments”). The 2015 adjustments were not determined by line of business and resulted in a net consolidated loss reserve position that was approximately $75 million lower than the external actuaries' ACE.
We based the above allocations on the differences between our expectations at the time of the long-term profitability of the business in each segment and the amount of carried reserves, taking into consideration changes in factors that we believed impacted the performance of each segment’s business, such as rate changes and changes in the types of risks being insured.
A reconciliation of loss and loss adjustment expense reserves and information regarding loss and loss adjustment expense reserve development appears in Note 10. "Loss and Loss Adjustment Expense Reserves" and Note 11. "Short Duration Contracts," respectively, to our consolidated financial statements appearing elsewhere in this Form 10-K. Additional information can also be found in Item 1A. "Risk Factors."
Reinsurance. We account for reinsurance premiums, loss and LAE ceded to other companies on a basis consistent with those used in accounting for the original policies issued. We record premiums and losses ceded to other companies as reductions of net earned premiums and loss and LAE incurred. We account for commissions allowed by reinsurers on business ceded as ceding commission, which is a reduction of acquisition costs and other underwriting expenses. Reinsurance recoverables relate to the portion of reserves and paid loss and LAE that are ceded to other companies. Reinsurance recoverables are estimated as part of our loss reserving process and, consequently, are subject to similar judgments and uncertainties as the estimation of gross loss reserves. We remain contingently liable for all loss payments in the event of failure to collect from the reinsurer.
Deferred Policy Acquisition Costs. We defer commissions, premium taxes and certain other costs that are incrementally or directly related to the successful acquisition of new or renewal insurance contracts. Acquisition-related costs may be deemed ineligible for deferral when they are based on contingent or performance criteria beyond the basic acquisition of the insurance
contract, or when efforts to obtain or renew the insurance contract are unsuccessful. All eligible costs are capitalized and charged to expense ratably as premiums are earned. Judgments as to the ultimate recoverability of such deferred costs are reviewed on a segment basis and are dependent upon estimated future loss costs associated with the premiums written. This deferral methodology applies to both gross and ceded premiums and acquisition costs.
Business Combinations. We account for business combinations under the acquisition method of accounting, which requires us to record assets acquired, liabilities assumed and any non-controlling interest in the acquiree at their respective fair values as of the acquisition date in our consolidated financial statements. We adjust the fair value of loss and LAE reserves by recording the acquired loss reserves based on our existing accounting policies and then discounting them based on expected reserve payout patterns using a current risk-free rate of interest. This risk free interest rate is then adjusted based on different cash flow scenarios that use different payout and ultimate reserve assumptions deemed to be reasonably possible based upon the inherent uncertainties present in determining the amount and timing of payment of such reserves. The difference between the acquired loss and LAE reserves and our best estimate of the fair value of such reserves at the acquisition date is recorded either as an intangible asset or an other liability, as applicable, and amortized proportionately to the decrease in the acquired loss and loss adjustment expense reserves over the payout period for the acquired loss and loss adjustment expense reserves. We record contingent consideration at fair value based on the terms of the purchase agreement with subsequent changes in fair value recorded through earnings. The determination of fair value may require management to make significant estimates and assumptions. The purchase price is the fair value of the total consideration conveyed to the seller and we record the excess of the purchase price over the fair value of the acquired net assets, where applicable, as goodwill. We assign fair values to intangible assets based on valuation techniques including the income and market approaches. We expense costs associated with the acquisition of a business in the period incurred. We include the results of operations of an acquired business in our consolidated financial statements from the date of the acquisition.
Market Approach - For each reporting unit, we identify a group of peer companies, which have operations that are as similar as possible to the reporting unit. We use a comparison of various financial metrics of the peer group to the subject reporting unit in determining the appropriate valuation multiple. These metrics include size, growth, profitability, among others.
In the fourth quarters of 2017 and 2016, we conducted our annual impairment test of goodwill using the methodologies discussed above. In addition, due to the announcement of the U.S.-based fee business transaction mentioned earlier, we concluded that a triggering event had occurred. Therefore, we performed an additional goodwill impairment analysis as of the date of the announcement on all reporting units. Based on the impairment tests performed as of November 6, 2017, October 1, 2017 and October 1, 2016, the fair values exceeded the carrying values of the respective reporting units. No goodwill impairment losses were recognized for the years ended December 31, 2017 and 2016, respectively, as a result of the impairment tests.
Changes in certain assumptions could have a significant impact on the goodwill impairment assessment. For example, in our annual impairment test, an increase of the discount rate by 2% for the Small Commercial Business - Workers' Compensation and Commercial Package Reporting Unit, would result in its fair value being less than its net book value as of October 1, 2017. Likewise, a 5% reduction in revenue growth rates for the Small Commercial Business - Workers' Compensation and Commercial Package Reporting Unit would result in a fair value less than its net book value as of October 1, 2017. For our remaining Reporting Units, it would require movements in the discount rate or revenue growth rate assumptions in excess of the percentages noted previously to cause fair values to be less than net book values.
During 2017, we experienced a significant decline in our stock price. Our market capitalization was approximately $4.7 billion at December 31, 2016, but declined significantly during the first quarter upon announcement of the delay in filing our 2016 Form 10-K. The stock price had surges throughout 2017 related to various company announcements, but generally remained depressed through the end of 2017. Our market capitalization at December 31, 2017 was approximately 57% of our book value.
We recognize tax benefits only for tax positions that are more likely than not to be sustained upon examination by taxing authorities. Our policy is to prospectively classify accrued interest and penalties related to any unrecognized tax benefits in our income tax provision. We file our tax returns as prescribed by the tax laws of the jurisdictions in which we operate. Primarily tax years 2012 through 2016 are still subject to examination. We do not anticipate any significant changes to our total unrecognized tax benefits within the next 12 months.
For further discussion on income taxes, see Note 18. "Income Taxes" to our consolidated financial statements appearing elsewhere in this Form 10-K.
Gross Written Premiums. Gross written premiums increased $485.4 million, or 6.1%, to $8,434.6 million from $7,949.3 million for the years ended December 31, 2017 and 2016, respectively. The increase was attributable to growth in our Small Commercial Business and Specialty Risk and Extended Warranty segments. The majority of the growth in our Small Commercial Business segment was attributable to an increase in the number of workers' compensation policies issued and the acquisition of Republic, which contributed approximately $139.3 million of additional gross written premiums, partially offset by a slight decrease in premium rate. The growth in our Specialty Risk and Extended Warranty segment was attributable to our acquisition of ANV in November 2016, which contributed approximately $536.4 million. The increase in our gross written premiums was partially offset by the termination of certain workers' compensation and general liability programs in our Specialty Program segment.
Service and Fee Income. Service and fee income increased $74.2 million, or 13.8%, to $612.2 million from $538.0 million for the years ended December 31, 2017 and 2016, respectively. The increase includes $47.0 million related to the European service and fee business. The U.S. Specialty Risk and Extended Warranty segment increased fees by approximately $39.2 million driven by the May 2017 acquisition of PDP, and the full year impact from the 2016 acquisitions of First Nationwide Title Insurance Agency and Assure Space. These increases were partially offset by a decrease in fees in 2017 for the administration of commercial property and casualty insurance, and from product warranty registration and claims handling services.
Net Investment Income. Net investment income increased $19.5 million, or 9.4%, to $227.5 million from $208.0 million for the years ended December 31, 2017 and 2016, respectively. The increase resulted primarily from having a higher average invested asset base during the year ended December 31, 2017 compared to the same period in 2016, primarily arising from our investment of certain proceeds from 2016 preferred stock offerings, a 2017 common stock offering and investment portfolios obtained through acquisitions.
For the year ended December 31, 2017, we recorded $419.0 million adverse development. In the accompanying notes to our consolidated financial statements appearing elsewhere in this Form 10-K, the development included in Note 11. “Short Duration Contracts” was $517.2 million.
Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $392.3 million, or 31.9%, to $1,622.5 million for the year ended December 31, 2017 from $1,230.2 million for the year ended December 31, 2016. Acquisition costs and other underwriting expenses in each period were reduced by ceding commission primarily earned through the Maiden Quota Share. We receive a ceding commission from Maiden of 31% of premiums ceded for all business except retail commercial package business, and 34.375% for retail commercial package business. The ceding commission earned during the years ended December 31, 2017 and 2016 was $619.2 million and $599.5 million, respectively. Ceding commission increased as a result of an increase in gross written premiums. Our overall expense ratio was 32.1% and 26.4% for the years ended December 31, 2017 and 2016, respectively. The increase in the expense ratio was the result, primarily, of higher direct acquisition costs from our 2016 acquisitions of Republic, Nationale Borg and ANV, which were reflected in our results of operations for all of 2017 and only a portion of 2016, and higher professional service fees.
(Loss) Income Before Other Income (Expense), Income Taxes and Equity in Earnings of Unconsolidated Subsidiaries. Our underwriting loss of $453.9 million for the year ended December 31, 2017 was a decrease of $967.8 million, or 188.3%, from underwriting income of $513.9 million for the years ended December 31, 2017 and 2016, respectively. The decrease resulted primarily from the increase in loss and loss adjustment expense caused by adverse loss development and net catastrophe losses as well as higher acquisition costs and other underwriting expenses.
Net Interest Expense. Interest expense for the years ended December 31, 2017 and 2016 was $98.3 million and $79.5 million, respectively. The increase primarily related to an increased use of letters of credit. Additionally, the increase related to higher interest expense on real estate loans of $4.2 million, a decrease of interest received from our loan to ACP Re of $2.9 million, and higher interest expense on debt assumed in connection with the Republic acquisition of $1.6 million.
(Loss) Gain on Investment in Life Settlement Contracts Net of Profit Commission. We recognized a loss on investment in life settlement contracts of $2.4 million for the year ended December 31, 2017 compared to a gain of $46.1 million for the year ended December 31, 2016. The decrease primarily related to a loss on the sale of 250 policies during the year ended December 31, 2017, and a decline in the increase in the fair value of the portfolio of policies in 2017 prior to sale. During 2017, we sold all but 6 of our life settlement contracts.
Gain on Sale of Policy Management System. During the year ended December 31, 2017, we recognized a gain of $186.8 million related to the sale of a policy management system to NGHC. We did not have any transactions of this type during the year ended December 31, 2016.
Foreign Currency (Loss) Gain. The foreign currency transaction loss was $139.9 million during the year ended December 31, 2017 compared to a loss of $29.3 million during the years ended December 31, 2016. The loss during 2017 related to the weakening
of the U.S. dollar compared to the British pound and Euro, which negatively impacts our Bermuda reinsurance subsidiary that reinsures European-denominated risks. The loss for the prior period resulted from the weakening of the British pound compared to the Euro, which negatively impacts our U.K. insurance subsidiaries that write Euro-denominated risks that are re-valued at the end of the reporting period.
Service and Fee Income. Service and fee income increased $109.8 million, or 25.7%, to $538.0 million from $428.1 million for the years ended December 31, 2016 and 2015, respectively. The increase related primarily to the acquisition of Warranty
Solutions, which generated fees of approximately $86 million, and higher fees for services provided to Maiden, NGHC and ACP Re of approximately $11.0 million.
Net Realized Gains (Losses) on Investments. We had net realized gains on investments of $36.5 million and $8.1 million for the years ended December 31, 2016 and 2015, respectively. The increase related primarily to an increase in sales of securities in gain positions, but was partially offset by an increase in other-than-temporary impairments to $31.7 million for the year ended December 31, 2016 from $19.2 million for the year ended December 31, 2015.
Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses increased $454.2 million, or 16.9%, to $3,142.3 million for the year ended December 31, 2016 from $2,688.1 million for the year ended December 31, 2015. Our loss ratio for the years ended December 31, 2016 and 2015 was 67.3% and 66.8%, respectively. Included in the 67.3% loss ratio was $257.9 million of prior period adverse development (representing 5.5 loss ratio points and 5.7% of the prior year-ending net reserve balance), primarily in our Specialty Program and Small Commercial Business segments, which reflects the re-underwriting and rate changes achieved in the businesses that generated the prior period adverse development. Until our fourth quarter of 2016 reserve review, we established our current year loss ratio at a higher level, reflecting underwriting expectations in the absence of mature data on the current year.
We recorded adverse development of $257.9 million in 2016. In the notes accompanying our 2016 consolidated financial statements, the development included in Note 13. “Short Duration Contracts” of our 2016 Form 10-K was $392.5 million. The $134.6 million difference between the adverse development recorded in the 2016 financial statements and the accident year disclosure contained in Note 13. “Short Duration Contracts” of our 2016 Form 10-K is comprised of the following items:
Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $236.6 million, or 23.8%, to $1,230.2 million for the year ended December 31, 2016 from $993.6 million for the year ended December 31, 2015. Acquisition costs and other underwriting expenses in each period were reduced by ceding commission primarily earned through the Maiden Quota Share, through which we receive a ceding commission of 31% of premiums ceded
for all business except retail commercial package business, and 34.375% for retail commercial package business. The ceding commission earned during the years ended December 31, 2016 and 2015 was $599.5 million and $510.8 million, respectively. Ceding commission increased period over period as a result of increases in gross written premiums and a small decrease in our retention of gross written premiums. On a consolidated basis, we retained 61.0% of our gross written premiums for the year ended December 31, 2016, compared to retaining 62.7% of our gross written premiums for the year ended December 31, 2015. Our overall expense ratio was 26.4% and 24.8% for the years ended December 31, 2016 and 2015, respectively. The increase in the expense ratio was the result, primarily, of higher direct acquisition costs from our 2016 acquisitions of Republic, ANV and Nationale Borg.
Income Before Other Income (Expense), Income Taxes and Equity in Earnings of Unconsolidated Subsidiaries. Our underwriting income increased $55.1 million, or 12.0%, to $513.9 million from $458.8 million for the years ended December 31, 2016 and 2015, respectively. The $55.1 million increase resulted primarily from an increase in earned premium, investment income and realized gains.
Equity in Earnings of Unconsolidated Subsidiaries - Related Party. Equity in earnings of unconsolidated subsidiaries - related party decreased by $9.8 million for the year ended December 31, 2016 to $15.6 million compared to $25.4 million for the year ended December 31, 2015. The decrease in 2016 related to a non-recurring realized gain of $9.6 million recognized during the year ended December 31, 2015 related to a decrease in our ownership percentage of NGHC as the result of NGHC's public offering in August 2015.
Gross Written Premiums. Gross written premiums increased $322.4 million, or 8.0%, to $4,342.6 million for the year ended December 31, 2017 from $4,020.2 million for the year ended December 31, 2016. The increase was attributable to an increase in the number of workers' compensation policies issued, partially offset by a slight decrease in premium rate. In addition, the acquisition of Republic contributed approximately $139.3 million of incremental gross written premiums for the year ended December 31, 2017.
Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $127.2 million, or 21.5%, to $719.8 million for the year ended December 31, 2017 from $592.6 million for the year ended December 31, 2016. Acquisition costs and other underwriting expenses were reduced by ceding commission earned during the years ended December 31, 2017 and 2016 of $274.7 million and $288.8 million, respectively. The expense ratio increased to 31.2% from 26.9% for the years ended December 31, 2017 and 2016, respectively, primarily as a result of higher direct acquisition costs from the Republic business for the entire year in 2017 as compared to the business written in this segment during the entire year in 2016 before we acquired Republic.
Net Earned Premiums Less Expenses Included in Combined Ratio (Underwriting (Loss) Income). The segment's underwriting results decreased $376.5 million, or 250.3%, to a loss of $226.1 million for the year ended December 31, 2017 compared with income of $150.4 million for the year ended December 31, 2016. The decrease resulted primarily from an increase in the combined ratio during the year ended December 31, 2017 compared to the year ended December 31, 2016, which was primarily due to the adverse reserve development.
Gross Written Premiums. Gross written premiums increased $699.5 million, or 21.1%, to $4,020.2 million for the year ended December 31, 2016 from $3,320.7 million for the year ended December 31, 2015. The increase was attributable to an increase in the number of workers' compensation policies issued, improved pricing on commercial vehicle business and continued growth in California, New York and Florida. The acquisition of Republic contributed $483.3 million of gross written premium, and the acquisitions of ARI and Springfield collectively contributed an additional $54.1 million of gross written premiums for the year ended December 31, 2016.
Net Written Premiums. Net written premiums increased $314.1 million, or 16.3%, to $2,246.2 million from $1,932.1 million for the years ended December 31, 2016 and 2015, respectively. The increase in net written premiums resulted from an increase in gross written premiums for the year ended December 31, 2016 compared to the year ended December 31, 2015, partially offset by a decrease in the retention of gross written premiums during 2016 compared to 2015. Our retention of gross written premiums for the segment decreased to 55.9% from 58.2% for the years ended December 31, 2016 and 2015, respectively, primarily because we ceded to third party reinsurers a large portion of the gross written premiums generated as a result of our 2016 acquisition of Republic.
Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $289.7 million, or 77.8%, to $662.1 million for the year ended December 31, 2017 from $372.4 million for the year ended December 31, 2016. Acquisition costs and other underwriting expenses were reduced by ceding commission earned during the year ended December 31, 2017 and 2016 of $252.7 million and $181.5 million, respectively. The expense ratio was 32.9% for the year ended December 31, 2017 compared to 24.1% for the year ended December 31, 2016. The increase in the expense ratio resulted from direct (policy) acquisition costs from Nationale Borg and ANV, which were acquired in 2016.
Gross Written Premiums. Gross written premiums increased $362.4 million, or 16.8%, to $2,521.3 million for the year ended December 31, 2016 from $2,158.9 million for the year ended December 31, 2015. We experienced growth both domestically and in our European business during the year ended December 31, 2016 compared to the year ended December 31, 2015. In our European business, we grew our core businesses, including warranty and general liability products. In addition, our AmTrust at Lloyd's business grew by $80.0 million during the year ended December 31, 2016 compared to the year ended December 31, 2015. Our 2016 acquisitions of Nationale Borg and ANV collectively added gross written premiums of $149.0 million to our European business, while fluctuations in European currencies reduced our gross written premiums during 2016 by $155.0 million. Our U.S. business increased $116.0 million during the year ended December 31, 2016 compared to the year ended December 31, 2015, primarily based on growth in existing businesses and the acquisition of Warranty Solutions.
Net Written Premiums. Net written premiums increased $271.3 million, or 18.7%, to $1,722.1 million from $1,450.8 million for the years ended December 31, 2016 and 2015, respectively. The increase in net written premiums resulted from an increase of gross written premiums for the year ended December 31, 2016 compared to the year ended December 31, 2015, and an increase in our retention of gross written premiums period over period. Our overall retention of gross written premiums for the segment was 68.3% and 67.2% for the years ended December 31, 2016 and 2015, respectively. The slight increase in the retention of gross written premiums related to the Warranty Solutions business, acquired in September 2015, and the ANV business, acquired in November 2016, neither of which is reinsured under the Maiden Quota Share agreement. In addition, beginning in July 2016, our U.K. subsidiary began ceding 32.5% of its Italian medical liability business to Maiden, down from 40%.
Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expense increased $141.2 million, or 16.0%, to $1,023.5 million for the year ended December 31, 2016 from $882.3 million for the year ended December 31, 2015. Our loss ratio for the segment for the year ended December 31, 2016 decreased to 66.3% from 67.6% for the year ended December 31, 2015. The decrease in the loss ratio resulted from having a higher percentage of earned premiums in lines of business with lower ultimate loss selections during the year ended December 31, 2016 compared to the year ended December 31, 2015. We did not have any material increases or decreases as a result of prior year loss development.
Net Earned Premiums Less Expenses Included in Combined Ratio (Underwriting Income). The segment's underwriting income increased to $148.0 million for the year ended December 31, 2016 compared to $144.9 million for the year ended December 31, 2015. The increase was attributable to an increase in the segment's earned premiums and a decrease in the segment's loss ratio during the year ended December 31, 2016 compared to the year ended December 31, 2015.
Gross Written Premiums. Gross written premiums decreased $431.2 million, or 30.6%, to $976.5 million for the year ended December 31, 2017 from $1,407.8 million for the year ended December 31, 2016. Gross written premiums decreased period over period as the result of the termination of certain workers' compensation and general liability programs.
Loss and Loss Adjustment Expenses; Loss Ratio. Loss and loss adjustment expenses increased $79.7 million, or 12.1%, to $738.0 million for the year ended December 31, 2017 compared to $658.3 million for the same period in 2016. Our loss ratio for the segment increased to 99.8% compared to 71.5% for the years ended December 31, 2017 and 2016, respectively. The increase in the loss ratio resulted from prior period adverse development of $173.1 million (representing 23.4 loss ratio points), driven primarily by certain general liability, auto liability and workers' compensation programs, which has led to re-underwriting, rate changes and/or termination of the majority of the programs that generated the prior period adverse reserve development.
Net Earned Premiums Less Expenses Included in Combined Ratio (Underwriting Loss). The segment's underwriting result decreased $236.1 million to a loss of $238.9 million for the year ended December 31, 2017 compared to a loss of $2.9 million for
Gross written premiums. Gross written premiums increased $87.8 million, or 6.7%, to $1,407.8 million for the year ended December 31, 2016 from $1,320.0 million for the year ended December 31, 2015. Gross written premiums increased period over period from the acquisition of Republic, which contributed $154 million of gross written premium, but was partially offset by the termination or reduction of certain workers' compensation programs and commercial package programs.
Net written premiums. Net written premiums increased $4.0 million, or 0.5%, to $883.0 million for the year ended December 31, 2016 from $879.0 million for the year ended December 31, 2015. The increase in net written premiums resulted from the increase of gross written premiums for the year ended December 31, 2016 compared to the year ended December 31, 2015, partially offset by the cession of a larger percentage of gross written premiums to reinsurers during 2016 compared to 2015. Our overall retention of gross written premiums for the segment was 62.7% and 66.6% for the years ended December 31, 2016 and 2015, respectively, primarily because we retain less of the acquired business from Republic as compared to the program business we had historically written prior to the Republic acquisition.
Acquisition Costs and Other Underwriting Expenses; Expense Ratio. Acquisition costs and other underwriting expenses increased $36.2 million, or 15.8%, to $265.2 million for the year ended December 31, 2016 from $228.9 million for the year ended December 31, 2015. Acquisition costs and other underwriting expenses were reduced by ceding commission of $129.2 million and $119.2 million earned during the years ended December 31, 2016 and 2015, respectively. Our expense ratio for the year ended December 31, 2016 increased to 28.8% from 27.6% for the year ended December 31, 2015, primarily as a result of the higher direct acquisition costs from the Republic acquisition.
Our cash and investment portfolio is summarized in the table below by type of investment:
For further information on our assets classified as held for sale, see Note 27. “Divestitures” to our consolidated financial statements included elsewhere in this Form 10-K.
Our cash and investment portfolio increased $0.3 billion, or 3.4%, to $9.4 billion at December 31, 2017 from $9.1 billion as of December 31, 2016. The cash and investment portfolio increased during the year ended December 31, 2017, primarily from the utilization of excess cash from our common stock offering and our sale of assets during 2017, partially offset by the $675.0 million premium payment to Premia. Our investment portfolio is primarily classified as available-for-sale, as defined by ASC 320, Investments - Debt and Equity Securities. Our fixed maturity securities had a fair value of $7.5 billion and an amortized cost of $7.5 billion as of December 31, 2017. Our equity securities had a fair value of $211.7 million with a cost of $195.9 million as of December 31, 2017.
The table below summarizes the credit quality of our fixed maturity securities as of December 31, 2017 and 2016, as rated by Standard and Poor’s.
As of December 31, 2017, the weighted average duration rate of our fixed maturity securities was approximately 4.6 years and had an average yield of 3.0%.
Other investments represented approximately 2.3% and 1.7% of our total cash and investment portfolio as of December 31, 2017 and 2016, respectively. At December 31, 2017, other investments consisted primarily of real estate partnerships of $88.2 million, private limited partnerships of $86.8 million, syndicated term loans totaling $20.3 million, and other investments totaling $15.8 million. At December 31, 2016, other investments consisted primarily of real estate partnerships totaling approximately $101.0 million, private limited partnerships totaling approximately $24.0 million, an interest in a syndicated term loan of approximately $15.0 million, and annuity and other investments totaling approximately $12.0 million.
As of December 31, 2017, we had $77.8 million of gross unrealized losses related to fixed maturity securities. Corporate bonds represent 58.3% of the fair value of our fixed maturity securities and 54.7% of the total gross unrealized losses of our fixed maturity securities. We own 2,625 purchase lots of corporate bonds in the financial institutions, industrial, and other sectors, which account for approximately 23.4%, 30.3% and 4.4%, respectively, of the total fair value of our fixed maturity securities, and 15.3%, 36.6% and 2.9%, respectively, of the total unrealized losses of our fixed maturity securities. We believe that the unrealized losses in these securities are the result, primarily, of general economic conditions and not the condition of the issuers, which we believe are solvent and able to meet their obligations. Therefore, we expect that the market price for these securities should recover within a reasonable time. Additionally, we do not intend to sell the investments and it is more likely than not that we will not be required to sell the investments before recovery of their amortized cost basis.
The table below summarizes the gross unrealized losses of our available-for-sale fixed maturity securities and available-for-sale equity securities by length of time the security has continuously been in an unrealized loss position as of December 31, 2017:
Our principal sources of operating funds are premiums, service and fee income, investment income and proceeds from sales and maturities of investments. Our primary uses of operating funds include payments of claims and operating expenses. Currently, we pay claims using cash flow from operations and invest our excess cash primarily in fixed maturity and equity securities. We expect that projected cash flow from operations will provide us sufficient liquidity to fund anticipated growth, by providing capital to increase the surplus of our insurance subsidiaries, as well as for payment of claims and operating expenses, payment of interest and principal on our debt facilities, required purchase of our convertible notes upon the occurrence of a "fundamental change", and other holding company expenses for at least the next twelve months. However, if our growth attributable to potential acquisitions, internally generated growth or a combination of these, exceeds our projections, we may have to raise additional capital sooner to support our growth. If we cannot obtain adequate capital on favorable terms or at all, we may be unable to support future growth or operating requirements and, as a result, our business, financial condition and results of operations could be adversely affected.
Net cash provided by investing activities was $633.7 million for the year ended December 31, 2017, compared to net cash used of $1,606.0 million for the year ended December 31, 2016. The increase in cash provided by investing activities was primarily due to an increase in cash received from sales of fixed maturity securities and equity securities, common shares of NGHC, life settlement contracts, and the NPS system. Please see Note 15. "Related Party Transactions" for additional information on the sales of NGHC shares and of the NPS system and Note 6. "Investment in Life Settlement Contracts" for additional information on the sale of life settlement contracts.
During the year ended December 31, 2017, our debt increased $53.8 million. This increase is primarily attributable to $109.0 million in secured loan agreements entered into in 2017 to finance the purchase of buildings and $7.0 million current year accretion of discount on our convertible notes, partially offset by $63.0 million in principal payments made in 2017. Interest expense, including amortization of the deferred origination costs and fees associated with letters of credit, on our debt was $98.3 million, $79.5 million, and $55.4 million for the years ended December 31, 2017, 2016 and 2015, respectively. The increase in interest expense is primarily due to increased average indebtedness from year to year.
For further information on our debt, including interest rates, applicable restrictive covenants and events of default, see Note 13. “Debt” to our consolidated financial statements appearing elsewhere in this Form 10-K.
The Maiden Quota Share was renewed through June 30, 2019 and will automatically renew for successive three-year terms unless either AII or Maiden Reinsurance notifies the other of its election not to renew not less than nine months prior to the end of any such three-year term. In addition, either party is entitled to terminate on thirty days’ notice or less upon the occurrence of certain early termination events, which include a default in payment, insolvency, change in control of AII or Maiden Reinsurance, run-off, or a reduction of 50% or more of the stockholders’ equity of Maiden Reinsurance or the combined stockholders’ equity of AII and the AmTrust Ceding Insurers.
As of December 31, 2017, we owned 6 life settlement contracts with a fair value of $20.8 million. In order for us to derive the economic benefit of the face value of the policies, we are required to make these premium payments. The contractual obligations are on a consolidated basis. As we have a 50% ownership interest in these life insurance policies, NGHC has an obligation for 50% of the above contractual obligations.
The interest related to the debt by period is as follows: $68.8 million - less than 1 year, $122.4 million - 1 - 3 years, $116.4 million - 3 - 5 years and $965.2 million - more than 5 years. In addition, included within debt and interest is $168.0 million related to the Maiden collateral loan and $6.1 million of associated interest.
The financial statements and financial statement schedules listed in the accompanying Index to Consolidated Financial Statements and Schedules at page are filed as part of this Form 10-K.