During 2014 we focused on growing premium in California, Florida and Texas personal auto and countrywide Commercial Vehicle while improving the profitability in Arizona, Georgia, Nevada and Pennsylvania. Although we have seen improvement in the combined ratios, we have determined that our personal auto business in Georgia, Nevada and Pennsylvania, which accounted for 5.9% of our total gross written premium as of December 31, 2014, no longer meets our long-term strategic and financial objectives. As a result, we began offering renewal business only in these three states as of January 1, 2015. In addition, we are evaluating strategic alternatives for our Classic Collector book of business, which was 1.1% of our business as of December 31, 2014.
Included in net earnings for the year ended December 31, 2014, was $11.3 million ($17.4 million pre-tax) of favorable development on prior accident year loss and LAE reserves. This development was primarily due to property damage coverage in California and bodily injury coverage in Florida, related to accident year 2013. This compares to $1.9 million ($2.9 million pre-tax) of unfavorable development for 2013. The following table displays GAAP combined ratio results by accident year developed through December 31, 2014.
Our book value per share increased 6.4% from $57.09 at December 31, 2013, to $60.75 at December 31, 2014. This increase was primarily due to net earnings and an increase in unrealized gains as a result of a decrease in interest rates, partially offset by shareholder dividends during 2014.
We establish IBNR reserves for the quarter and year-end based on a quarterly reserve analysis by our actuarial staff. We apply various standard actuarial tests to subsets of the business at a state, product and coverage level. Included in the analyses are the following:
When possible, we make quantitative and qualitative modifications to, or selections of, such factors where deviations from historical trends in these key areas exist. We analyze the adequacy of reserves using actuarial data and analytical reserve development techniques, including projections of ultimate paid losses, to determine the ultimate amount of reserves. The list of historical trends provided above are non-exhaustive examples of major factors that we take into account in developing these estimates.
During each quarterly review by the internal actuarial staff, using the additional information obtained with the passage of time, factor selections are updated, which in turn adjust the ultimate loss estimates and held IBNR reserves for the subset of the business and accident periods affected by such updates. The actuarial staff also performs various tests to estimate ultimate average severity and frequency of claims. Severity represents the average cost per claim and frequency represents the number of claims per auto or per policy. As an overall review, the staff then evaluates for reasonableness loss and LAE ratios by accident year by state and by coverage.
We believe that our relatively low average policy limit and concentration on the nonstandard auto driver classification help stabilize fluctuations in frequency and severity. For example, approximately 85% of our policies include only the state-mandated minimum policy limits for bodily injury, which somewhat mitigates the challenge of estimating average severity. These low limits tend to reduce the exposure of the loss reserves on this coverage to medical cost inflation on severe injuries since the minimum policy limits will limit the total payout.
Ultimate loss estimates, excluding extra-contractual obligation (“ECO”) losses, usually experience the greatest adjustment within the first twelve to eighteen months after the accident year. Accordingly, the highest degree of uncertainty is associated with reserves for the current accident year because the current accident year contains the greatest proportion of losses that have not been reported or settled, and we must estimate these elements as of the current reporting date. The proportion of losses with these characteristics typically diminishes in subsequent years.
ECO losses represent estimates of losses incurred from actual or threatened litigation by claimants alleging improper handling of claims by us, which are commonly known as “bad faith” claims. Oftentimes, the onset of such litigation, subsequent discovery, settlement discussions, trial and appeal may occur several years after the date of the original claim. Because of the infrequent nature of such claims, we accrue a liability for each case based on the facts and circumstances in accordance with the Loss Contingency topic of the FASB Accounting Standards Codification, which requires that such loss be probable and estimable. As such, no reserve is permissible for IBNR for threatened litigation yet to occur on accidents with dates prior to the balance sheet date. Consequently, the effect of setting accruals for such items likely will result in unfavorable reserve development in the following reserve tables.
Calendar year losses incurred for ECO losses, gross and net of reinsurance, over the past five calendar years have ranged from $0.3 million to $4.2 million, averaging $1.7 million per year. Losses for 2014, 2013 and 2012 have been $4.2 million, $1.3 million and $1.7 million, respectively.
Decreases in severity in property damage coverage in California and in both severity and frequency in Florida bodily injury coverage, related to accident year 2013, were the primary sources of the $17.4 million favorable reserve development during the twelve months ended December 31, 2014.
accident year 2012 were the primary sources of the $2.9 million unfavorable reserve development during the twelve months ended December 31, 2013.
The determination of whether unrealized losses on investments are “other-than-temporary” requires judgment based on subjective as well as objective factors. We consider the following factors and resources:
We performed this test as of October 1, 2014, using a variety of methods, including estimates of future discounted cash flows and comparisons of our market value to that of our major competitors. Our cash flow projections rely on assumptions that are subject to uncertainty, including premium growth, loss and LAE ratios, interest rates and capital requirements.
The October 1, 2014, test results indicated that the fair value of our goodwill exceeded our carrying value and therefore no impairment charge was required at that date. Additionally, there was no indication of impairment at December 31, 2014.
Funds to meet expenditures at the holding company come primarily from dividends from the insurance subsidiaries as well as cash and investments held by the holding company. The ordinary dividend capacity and payment activity of our insurance companies for the two most recent years as well as the dividend capacity for the upcoming year are shown in the following table ($ in thousands):
Our insurance subsidiaries generate liquidity to satisfy their obligations, primarily by collecting and investing premium in advance of paying claims. Our insurance subsidiaries had positive cash flow from operations of approximately $117.9 million in 2014, $145.6 million in 2013 and $175.3 million in 2012. In addition, to satisfy their obligations, our insurance subsidiaries generate cash from maturing securities from their combined $1.4 billion portfolio.
In September 2012 we issued $275 million principal of senior notes due September 2022 (the “5.0% Senior Notes”). The 5.0%
Senior Notes accrue interest at 5.0%, payable semiannually each March and September. The majority of the proceeds from this
issuance were used to redeem the 5.5% senior notes due 2014 (the "5.5% Senior Notes"). On October 17, 2012, we fully redeemed the $195.0 million outstanding principal of 5.5% Senior Notes at a price of 106.729%, or $208.1 million plus accrued interest of $1.8 million. Refer to Note 4 - Long Term Debt of the Notes to Consolidated Financial Statements for more information on our long-term debt.
In August 2014 we renewed our agreement for a $50 million three-year revolving credit facility (the “Credit Agreement”) that
In June 2013 we filed a "shelf" registration statement with the Securities and Exchange Commission registering $300.0 million of our securities, which will allow us to sell any combination of senior or subordinated debt securities, common stock, preferred stock, warrants, depositary shares and units in one or more offerings should we choose to do so in the future.
In February 2015 we increased our quarterly dividend to $0.43 per share from $0.36 per share. At this current amount, our 2015 annualized dividend payments will be approximately $19.8 million.
Our Board of Directors previously authorized a share and debt repurchase program. On November 4, 2014, our Board of Directors increased the authority to a total of $75 million and extended the date to execute the program from December 31, 2014 to December 31, 2016. During 2014 we repurchased 85,600 shares at an average cost, excluding commissions, of $69.07 per share. As of December 31, 2014, we had $74.1 million of authority remaining under this program.
Because we carry all of these securities at fair value in the Consolidated Balance Sheets, there is virtually no effect on liquidity or financial condition upon the sale and ultimate realization of unrealized gains and losses. The average duration of our fixed maturity portfolio was 3.1 years at December 31, 2014.
Summarized information for our investment portfolio at December 31, 2014 follows ($ in thousands):
The following table presents the returns, gross of investment expenses, of our investment portfolios based on quarterly investment balances as reflected in the financial statements, excluding equities invested in a rabbi trust.
The $17.2 million and $39.9 million balances in payable for securities purchased at December 31, 2014, and December 31, 2013, respectively, represent fixed income securities and treasury stock purchased in the normal course of business that had not settled prior to the end of their respective years.
Changes in market interest rates directly affect the fair value of our fixed maturity portfolio. Generally, the fair value of fixed-income investments moves inversely with movements in market interest rates. Our fixed maturity portfolio is comprised of substantially all fixed rate investments with primarily short-term and intermediate-term maturities. We strive to maintain a "laddered" portfolio, with maturities and prepaid principal spread across the maturity spectrum. This portfolio composition allows flexibility in reacting to fluctuations of interest rates. In addition, higher market rates available for new funds available for investment partially mitigate the risk of loss in fair value. We manage the portfolios of our insurance companies to achieve an adequate risk-adjusted return while maintaining sufficient liquidity to meet policyholder obligations.
The fair values of our fixed maturity investments fluctuate in response to changes in market interest rates. Increases and decreases in prevailing interest rates generally translate into decreases and increases, respectively, in fair values of those instruments. Additionally, the creditworthiness of the issuer, prepayment options, relative values of alternative investments, the liquidity of the instrument and other general market conditions may affect fair values of interest rate sensitive instruments.
The following table provides information about our fixed maturity investments at December 31, 2014, which are sensitive to interest rate risk. The table shows expected principal cash flows by expected maturity date for each of the five subsequent years and collectively for all years thereafter. Callable bonds and notes are included based on call date or maturity date depending upon which date produces the most conservative yield. MBS and sinking fund issues are included based on maturity year adjusted for expected payment patterns.
The following table presents the credit rating and fair value of our residential mortgage-backed securities at December 31, 2014, by deal origination year ($ in thousands):
All of the $354.5 million of residential mortgage-backed securities were issued by government-sponsored enterprises (“GSE”) or by Government National Mortgage Association ("GNMA").
The following table presents the fair value of our state and municipal bond portfolio, by state and type of bond, at December 31, 2014 ($ in thousands):
investments with issues or guarantors in foreign countries, as follows ($ in thousands):
During 2014 personal auto insurance gross written premium in our Focus States grew 3.8% when compared with 2013. The increase in gross written premium is primarily due to growth in California and Florida, which grew a combined 3.8% during 2014 as a result of higher average premium in both states, renewal business growth in California and new business growth in Florida.
Our Commercial Vehicle gross written premium grew 11.3% during the twelve months ended December 31, 2013. This growth was primarily due to higher average premium and renewal business growth for this product.
Gross written premium in our Classic Collector product grew 7.5% during 2013. This growth was primarily due to growth in renewal business.
commissions, premium taxes and other variable costs incurred in connection with successfully writing new and renewal business are capitalized as deferred policy acquisition costs and amortized on a pro rata basis over the period in which the related premium is earned. On a statutory basis, these items are expensed as incurred. Additionally, bad debt charge-offs on agent balances and premium receivables are included only in the GAAP combined ratios.
The combined ratio for the Commercial Vehicle product decreased by 11.3 points during the twelve months ended December 31, 2014, primarily due to favorable development on loss and LAE reserves.
Excluding the effect of development, the GAAP combined ratio was 97.7% for the twelve months ended December 31, 2013.
The combined ratio in the Focus States decreased by 1.4 points for the twelve months ended December 31, 2013. The decline was primarily due to improvement in the loss and LAE ratio in all states except California coupled with an overall decline in the underwriting ratio in the Focus States. As we experience premium growth in these states, the ratio of fixed underwriting costs to premium has declined. Also, the average commission ratios declined due to a shift in business mix from new to renewal business. We typically pay lower commission rates on renewal business than on new business.
Installment and other fee income of $95.2 million, $98.4 million and $100.0 million for the twelve months ended December 31, 2014, 2013, and 2012, respectively, is primarily made up of installment and other fees charged to policyholders. The 3.2% decline during 2014 was primarily due to a reduction in late fees charged.
Investment income primarily includes gross investment revenue net of investment management fees as shown in the following table ($ in thousands):
Changes in investment income reflect fluctuations in market rates and changes in average invested assets. Net investment income in 2014 and 2013 declined when compared to the respective prior year primarily due to a decline in book yields because of a general decline in market interest rates for high quality bonds.
We recorded realized gains (losses) on sales and disposals and impairments for unrealized losses deemed other-than-temporary as follows (before tax, $ in thousands):
On September 30, 2012, we completed the sale of an inactive, shell subsidiary company to an unaffiliated third party. The total
Other income of $0.6 million, $0.7 million and $1.0 million for the twelve months ended December 31, 2014, 2013 and 2012, respectively, is primarily made up of items of a non-recurring nature.
On October 17, 2012, we fully redeemed the $195.0 million principal outstanding of the 5.5% Senior Notes at a price of
106.729%, or $208.1 million, plus accrued interest of $1.8 million. As a result, we recognized a pre-tax loss on redemption as follows ($ in thousands):
Other expenses for the twelve months ended December 31, 2014, decreased $1.2 million, primarily due to a $0.9 million decrease in corporate litigation expense.
In 2008 as a result of the significant fall in the stock market, the fair value of our exchange-traded fund (“ETF”) fell significantly. At that time, we wrote the book value down to market as an other-than-temporary impairment (“OTTI”) and thereby incurred a GAAP pre-tax loss. This loss created a basis difference that generated a significant deferred tax asset. Given the market conditions at the time, and the fact that we were in a capital loss carryforward position, we did not believe that it was more-likely-than-not that this deferred tax asset would be recognized. Therefore, a full valuation allowance was established for this deferred tax asset. This was consistent with the full valuation allowance that had been established for the deferred tax asset relating to the capital loss carryforward.
In the fourth quarter of 2012 the ETF was sold as part of our plan to seek better diversification in our equity portfolio, resulting
Consolidated Statements of Earnings: Years ended December 31, 2014, 2013 and 2012
Consolidated Statements of Cash Flows: Years ended December 31, 2014, 2013 and 2012