Net income of $2.62 billion, or $10.01 per share basic and $9.92 per share diluted
Repurchased 11.2 million common shares for total cost of $1.55 billion and paid $844 million of dividends to shareholders
Diluted net income per share of $9.92 in 2019 increased by 7% over diluted net income per share of $9.28 in 2018. Net income of $2.62 billion in 2019 increased by 4% over net income of $2.52 billion in 2018. The higher rate of increase in diluted net income per share reflected the impact of share repurchases in recent periods. The increase in income before income taxes primarily reflected the pre-tax impacts of (i) significantly lower catastrophe losses, partially offset by (ii) net unfavorable prior year reserve development in 2019 compared to net favorable prior year reserve development in 2018 and (iii) lower underwriting margins excluding catastrophe losses and prior year reserve development ("underlying underwriting margins"). Catastrophe losses in 2019 and 2018 were $886 million and $1.72 billion, respectively. Net unfavorable prior year reserve development in 2019 was $60 million, compared to net favorable prior year reserve development of $517 million in 2018. Underlying underwriting margins in each of the Company's business segments were lower than in 2018. Income tax expense in 2019 was higher than in 2018, primarily
The Company has insurance operations in Canada, the United Kingdom, the Republic of Ireland and throughout other parts of the world as a corporate member of Lloyd’s, as well as in Brazil and Colombia, primarily through joint ventures. Because these operations are conducted in local currencies other than the U.S. dollar, the Company is subject to changes in foreign currency exchange rates. For the years ended December 31, 2019 and 2018, changes in foreign currency exchange rates impacted reported line items in the statement of income by insignificant amounts. The impact of these changes was not material to the Company’s net income or segment income for the periods reported.
Excludes net unrealized investment gains and losses and reflects cash, receivables for investment sales, payables on investment purchases and accrued investment income.
for which the Company’s estimates of its ultimate losses before reinsurance and taxes exceed a pre-established dollar threshold.
The Company’s threshold for disclosing catastrophes is primarily determined at the reportable segment level. If a threshold for one segment or a combination thereof is exceeded and the other segments have losses from the same event, losses from the event are identified as catastrophe losses in the segment results and for the consolidated results of the Company. Additionally, an
(1) Amounts are reported pre-tax and net of recoveries under all applicable reinsurance treaties, except for the Underlying Property Aggregate Catastrophe Excess-of-Loss Treaty, the terms of which are described in "Part I-Item 1 - Business." That treaty covers the accumulation of certain property losses arising from one or multiple occurrences (both catastrophe and non-catastrophe events) for the period January 1, 2019 through and including December 31, 2019. As a result, the benefit from that treaty is not included in the table above as the allocation of the treaty's benefit to each identified catastrophe changes each time there are additional events or changes in estimated losses from any covered event.
General and administrative expenses in 2019 were $4.37 billion, $68 million or 2% higher than in 2018, primarily reflecting the impact of costs associated with higher business volumes. General and administrative expenses are discussed in more detail in the segment discussions that follow.
Catastrophe losses in 2019 and 2018 accounted for 3.1 points and 6.3 points, respectively, of the combined ratio. Net unfavorable prior year reserve development in 2019 accounted for 0.2 points of the combined ratio. Net favorable prior year reserve development in 2018 provided 1.9 points of benefit to the combined ratio. The combined ratio excluding prior year reserve development and catastrophe losses ("underlying combined ratio") in 2019 was 0.7 points higher than the 2018 ratio on the same basis, primarily reflecting the impacts of (i) higher loss estimates in the general liability product line for primary and excess coverages and in the commercial automobile product line, (ii) the impact on earned premiums related to the Company's new catastrophe reinsurance treaty and (iii) higher non-catastrophe weather-related losses, partially offset by (iv) lower loss estimates in the workers' compensation product line.
Segment income in 2019 was $1.39 billion, $246 million or 15% lower than segment income of $1.64 billion in 2018. The decrease in segment income before income taxes primarily reflected the pre-tax impacts of (i) net unfavorable prior year reserve development in 2019 compared to net favorable prior year reserve development in 2018 and (ii) lower underlying underwriting margins, partially offset by (iii) lower catastrophe losses. Net unfavorable prior year reserve development in 2019 was $258 million. Net favorable prior year reserve development in 2018 was $142 million. Catastrophe losses in 2019 and 2018 were $470 million and $639 million, respectively. The lower underlying underwriting margins primarily reflected the impacts of (i) higher loss estimates in the general liability product line for primary and excess coverages and in the commercial automobile product line and (ii) the impact on earned premiums related to the Company's new catastrophe reinsurance treaty, partially offset by (iii) higher business volumes and (iv) lower loss estimates in the workers' compensation product line. Income tax expense in 2019 was lower than in 2018, primarily reflecting the impacts of (i) the decrease in segment income before income taxes, partially offset by (ii) the reduction in income tax expense in 2018 resulting from the Company's voluntary contribution to its qualified domestic pension plan.
Earned premiums of $15.30 billion in 2019 were $578 million or 4% higher than in 2018, primarily reflecting an increase in net written premiums over the preceding twelve months, partially offset by the earned impact of the new catastrophe reinsurance treaty.
Net investment income in 2019 was $1.82 billion, $17 million or 1% lower than in 2018. Refer to the “Net Investment Income” section of the “Consolidated Results of Operations” discussion for a description of the factors contributing to the Company’s consolidated net investment income in 2019 compared with 2018. In addition, refer to note 2 of notes to the consolidated financial statements for a discussion of the Company’s net investment income allocation methodology.
National Accounts is the primary source of fee income due to revenue from its large deductible policies and service businesses, which include risk management, claims administration, loss control and risk management information services provided to third parties, as well as claims and policy management services to workers’ compensation residual market pools. Fee income in 2019 was $437 million, $25 million or 6% higher than in 2018, primarily reflecting higher claim volume under administration associated with its service businesses.
Claims and claim adjustment expenses in 2019 were $10.96 billion, $792 million or 8% higher than in 2018, primarily reflecting the impacts of (i) net unfavorable prior year reserve development in 2019 compared to net favorable prior year reserve development in 2018, (ii) loss cost trends, (iii) higher loss estimates in the general liability product line for primary and excess coverages and the commercial automobile product line and (iv) higher business volumes, partially offset by (v) lower catastrophe losses and (vi) lower loss estimates in the workers' compensation product line.
Amortization of deferred acquisition costs in 2019 was $2.50 billion, $115 million or 5% higher than in 2018, generally consistent with the increase in earned premiums.
Income tax expense in 2019 was $223 million, $36 million or 14% lower than in 2018, primarily reflecting the impacts of (i) the $282 million decrease in income before income taxes in 2019, partially offset by (ii) the reduction in income tax expense in 2018 resulting from the Company's voluntary contribution to its qualified domestic pension plan in 2018.
The combined ratio of 100.9% in 2019 was 1.8 points higher than the combined ratio of 99.1% in 2018. The loss and loss adjustment expense ratio of 70.3% in 2019 was 2.5 points higher than the loss and loss adjustment expense ratio of 67.8% in 2018. The underwriting expense ratio of 30.6% in 2019 was 0.7 points lower than the underwriting expense ratio of 31.3% in 2018.
Catastrophe losses in 2019 and 2018 accounted for 3.0 points and 4.4 points, respectively, of the combined ratio. Net unfavorable prior year reserve development in 2019 accounted for 1.7 points of the combined ratio. Net favorable prior year reserve development in 2018 provided 1.0 points of benefit to the combined ratio. The underlying combined ratio in 2019 was 0.5 points higher than the 2018 ratio on the same basis, primarily reflecting the impacts of (i) higher loss estimates in the general liability product line for primary and excess coverages and the commercial automobile product line and (ii) the impact on earned premiums related to
the Company's new catastrophe reinsurance treaty, partially offset by (iii) lower loss estimates in the workers' compensation product line and (iv) a lower underwriting expense ratio.
Gross written premiums in 2019 increased by 6% over 2018. Net written premiums in 2019 increased by 4% over 2018. Net written premium growth in 2019 was impacted by the Company's new catastrophe reinsurance treaty entered into in the first quarter of 2019.
Middle Market. Net written premiums of $8.63 billion in 2019 increased by 5% over 2018. Net written premiums in 2019 were reduced by the new catastrophe reinsurance treaty. Business retention rates remained strong in 2019. Renewal premium changes in 2019 remained positive and were higher than in 2018. New business premiums in 2019 were lower than in 2018.
Segment income in 2019 was $618 million, $175 million or 22% lower than segment income of $793 million in 2018. The decrease in segment income before income taxes primarily reflected the pre-tax impacts of (i) lower net favorable prior year reserve development and (ii) lower underlying underwriting margins. Net favorable prior year reserve development in 2019 and 2018 was $65 million and $266 million, respectively. Catastrophe losses in 2019 and 2018 were $5 million and $16 million, respectively. The lower underlying underwriting margins primarily reflected modestly higher loss estimates in the domestic general liability product line for management liability coverages. Income tax expense in 2019 was lower than in 2018, primarily reflecting the impact of the decrease in segment income before income taxes.
Earned premiums in 2019 were $2.57 billion, $145 million or 6% higher than in 2018, primarily reflecting an increase in net written premiums over the preceding twelve months.
Claims and claim adjustment expenses in 2019 were $1.09 billion, $322 million or 42% higher than in 2018, primarily reflecting the impacts of (i) lower net favorable prior year reserve development, (ii) higher business volumes and (iii) modestly higher loss estimates in the domestic general liability product line for management liability coverages.
General and administrative expenses in 2019 were $483 million, $24 million or 5% higher than in 2018, primarily reflecting the impact of costs associated with higher business volumes.
Net favorable prior year reserve development in 2019 and 2018 provided 2.5 points and 11.0 points of benefit, respectively, to the combined ratio. Catastrophe losses in 2019 and 2018 accounted for 0.2 points and 0.6 points, respectively, of the combined ratio. The underlying combined ratio in 2019 was 2.4 points higher than the 2018 ratio on the same basis, primarily reflecting the impacts of modestly higher loss estimates in the domestic general liability product line for management liability coverages.
Earned premiums in 2019 were $10.41 billion, $490 million or 5% higher than in 2018, primarily reflecting an increase in net written premiums over the preceding twelve months. The increase in earned premiums in 2019 was reduced by the earned impact of the new catastrophe reinsurance treaty.
Claims and claim adjustment expenses in 2019 were $7.08 billion, $272 million or 4% lower than in 2018, primarily reflecting the impacts of (i) significantly lower catastrophe losses and (ii) higher net favorable prior year reserve development, partially offset by (iii) higher non-catastrophe weather-related losses in Agency Homeowners and Other, (iv) higher business volumes and (v) loss cost trends.
General and administrative expenses in 2019 were $1.22 billion, $35 million or 3% higher than in 2018, primarily reflecting the impact of costs associated with higher business volumes.
Income tax expense in 2019 was $195 million, $153 million or 364% higher than in 2018, primarily reflecting the impacts of (i) the $680 million increase in income before income taxes in 2019 and (ii) the reduction in income tax expense in 2018 resulting from the Company's voluntary contribution to its qualified domestic pension plan. The level of income tax expense in both years reflected the impact of tax-exempt investment income on the calculation of the Company’s tax provision.
Catastrophe losses accounted for 4.0 points and 10.7 points of the combined ratio in 2019 and 2018, respectively. Net favorable prior year reserve development in 2019 and 2018 provided 1.3 and 1.1 points of benefit, respectively, to the combined ratio. The underlying combined ratio in 2019 was 0.5 points higher than the 2018 ratio on the same basis, primarily reflecting the impacts of (i) higher non-catastrophe weather-related losses in Agency Homeowners and Other and (ii) the impact on earned premiums related to the Company's new catastrophe reinsurance treaty, mostly impacting Agency Homeowners and Other, partially offset by (iii) earned pricing that exceeded loss cost trends in Agency Automobile and (iv) a lower underwriting expense ratio.
Domestic Agency gross written premiums in 2019 increased by 7% over 2018. Net written premiums in 2019 increased by 6% over 2018. Net written premium growth in 2019 was impacted by the Company's new catastrophe reinsurance treaty entered into in the first quarter of 2019.
For its domestic Agency business, Personal Insurance had approximately 7.5 million and 7.2 million active policies at December 31, 2019 and 2018, respectively.
Direct-to-Consumer net written premiums in 2019 were 4% higher than in 2018, primarily driven by growth in homeowners and other. Net written premiums in 2019 were reduced by the new catastrophe reinsurance treaty.
For its International and Direct-to-Consumer business, Personal Insurance had approximately 869,000 and 900,000 active policies at December 31, 2019 and 2018, respectively.
The Income (loss) for Interest Expense and Other in 2019 was $1 million lower than in 2018. Pre-tax interest expense in 2019 and 2018 was $344 million and $352 million, respectively. After-tax interest expense in 2019 and 2018 was $272 million and $278 million, respectively.
The Company believes that the property and casualty insurance industry has suffered from court decisions and other trends that have expanded insurance coverage for asbestos claims far beyond the original intent of insurers and policyholders. The Company has received and continues to receive a significant number of asbestos claims. Factors underlying these claim filings include continued intensive advertising by lawyers seeking asbestos claimants and the focus by plaintiffs on defendants who were not traditionally primary targets of asbestos litigation. The focus on these defendants is primarily the result of the number of traditional asbestos defendants who have sought bankruptcy protection in previous years. The bankruptcy of many traditional defendants has also caused increased settlement demands against those policyholders who are not in bankruptcy but remain in the tort system. Currently, in many jurisdictions, those who allege very serious injury and who can present credible medical evidence of their injuries are receiving priority trial settings in the courts, while those who have not shown any credible disease manifestation are having their hearing dates delayed or placed on an inactive docket. Prioritizing claims involving credible evidence of injuries, along with the focus on defendants who were not traditionally primary targets of asbestos litigation, contributes to the claims and claim adjustment expense payment patterns experienced by the Company. The Company’s asbestos-related claims and claim adjustment expense experience also has been impacted by the unavailability of other insurance sources potentially available to policyholders, whether through exhaustion of policy limits or through the insolvency of other participating insurers.
The Company continues to be involved in disputes, including litigation, with a number of policyholders, some of whom are in bankruptcy over coverage for asbestos-related claims. Many coverage disputes with policyholders are only resolved through settlement agreements. Because many policyholders make exaggerated demands, it is difficult to predict the outcome of settlement negotiations. Settlements involving bankrupt policyholders may include extensive releases which are favorable to the Company, but which could result in settlements for larger amounts than originally anticipated. Although the Company has seen a reduction in the overall risk associated with these disputes, it remains difficult to predict the ultimate cost of these claims. As in the past, the Company will continue to pursue settlement opportunities.
In addition to claims against policyholders, proceedings have been launched directly against insurers, including the Company, by individuals challenging insurers’ conduct with respect to the handling of past asbestos claims and by individuals seeking damages arising from alleged asbestos-related bodily injuries. It is possible that the filing of other direct actions against insurers, including the Company, could be made in the future. It is difficult to predict the outcome of these proceedings, including whether the
plaintiffs would be able to sustain these actions against insurers based on novel legal theories of liability. The Company believes it has meritorious defenses to any such claims and has received favorable rulings in certain jurisdictions.
a high level of litigation activity in certain jurisdictions involving individuals alleging serious asbestos-related illness, primarily involving mesothelioma claims;
The completion of these reviews and analyses in 2019, 2018 and 2017 resulted in $220 million, $225 million and $225 million increases, respectively, to the Company’s net asbestos reserves. In each year, the reserve increases were primarily driven by increases in the Company’s estimate of projected settlement and defense costs related to a broad number of policyholders in the home office and field office category. The increase in the estimate of projected settlement and defense costs resulted from payment trends that continue to be higher than previously anticipated due to the impact of the current litigation environment surrounding mesothelioma claims discussed above. Over the past decade, the property and casualty insurance industry, including the Company, has experienced net unfavorable prior year reserve development with regard to asbestos reserves, but the Company believes that over that period there has been a reduction in the volatility associated with the Company’s overall asbestos exposure as the overall asbestos environment has evolved from one dominated by exposure to significant litigation risks, particularly coverage disputes relating to policyholders in bankruptcy who were asserting that their claims were not subject to the aggregate limits contained in their policies, to an environment primarily driven by a frequency of litigation related to individuals with mesothelioma. The Company’s overall view of the current underlying asbestos environment is essentially unchanged from recent periods, and there remains a high degree of uncertainty with respect to future exposure to asbestos claims.
Net asbestos paid loss and loss expenses in 2019, 2018 and 2017 were $224 million, $225 million and $271 million, respectively. Approximately 4%, 9% and 4% of total net paid losses in 2019, 2018 and 2017, respectively, related to policyholders with whom the Company had entered into settlement agreements limiting the Company’s liability.
The Company has received and continues to receive claims from policyholders who allege that they are liable for injury or damage arising out of their alleged disposition of toxic substances. These claims are mainly brought pursuant to various state or federal statutes that require a liable party to undertake or pay for environmental remediation. Liability under these statutes may be joint and several with other responsible parties.
At December 31, 2019, approximately 92% of the net environmental reserve (approximately $296 million) was carried in a bulk reserve and included unresolved environmental claims, incurred but not reported environmental claims and the anticipated cost of coverage litigation disputes relating to these claims. The bulk reserve the Company carries is established and adjusted based upon the aggregate volume of in-process environmental claims and the Company’s experience in resolving those claims. The balance, approximately 8% of the net environmental reserve (approximately $25 million), consists of case reserves.
As a result of the processes and procedures discussed above, management believes that the reserves carried for asbestos and environmental claims are appropriately established based upon known facts, current law and management’s judgment. However, the uncertainties surrounding the final resolution of these claims continue, and it is difficult to determine the ultimate exposure for asbestos and environmental claims and related litigation. As a result, these reserves are subject to revision as new information becomes available and as claims develop. Changes in the legal, regulatory and legislative environment may impact the future resolution of asbestos and environmental claims and result in adverse loss reserve development. The emergence of a greater number of asbestos or environmental claims beyond that which is anticipated may result in adverse loss reserve development. Changes in applicable legislation and future court and regulatory decisions and interpretations, including the outcome of legal challenges to legislative and/or judicial reforms establishing medical criteria for the pursuit of asbestos claims, could affect the settlement of asbestos and environmental claims. It is also difficult to predict the ultimate outcome of complex coverage disputes until settlement negotiations near completion and significant legal questions are resolved or, failing settlement, until the dispute is adjudicated. This is particularly the case with policyholders in bankruptcy where negotiations often involve a large number of claimants and other parties and require court approval to be effective. As part of its continuing analysis of asbestos and environmental reserves, the Company continues to study the implications of these and other developments.
The Company’s invested assets at December 31, 2019 were $77.88 billion, of which 94% was invested in fixed maturity and short-term investments, 1% in equity securities, 1% in real estate investments and 4% in other investments. Because the primary purpose of the investment portfolio is to fund future claims payments, the Company employs a thoughtful investment philosophy that focuses on appropriate risk-adjusted returns. A significant majority of funds available for investment are deployed in a widely diversified portfolio of high quality, liquid, taxable U.S. government, tax-exempt U.S. municipal and taxable corporate and U.S. agency mortgage-backed bonds.
Sovereign corporate securities include corporate securities that are backed by a government and include sovereign banks and securities issued under the Federal Ship Financing Programs.
The Company’s fixed maturity investment portfolio at December 31, 2019 and 2018 included $29.92 billion and $28.61 billion, respectively, of securities which are obligations of states, municipalities and political subdivisions (collectively referred to as the municipal bond portfolio). The municipal bond portfolio is diversified across the United States, the District of Columbia and Puerto Rico and includes general obligation and revenue bonds issued by states, cities, counties, school districts and similar issuers. Included in the municipal bond portfolio at December 31, 2019 and 2018 were $2.06 billion and $2.85 billion, respectively, of pre-refunded bonds, which are bonds for which states or municipalities have established irrevocable trusts, almost exclusively comprised of U.S. Treasury securities and obligations of U.S. government and government agencies and authorities. These trusts were created to fund the payment of principal and interest due under the bonds. The irrevocable trusts are verified as to their sufficiency by an independent verification agent of the underwriter, issuer or trustee. All of the Company’s holdings of securities issued by Puerto Rico and related entities have been pre-refunded and therefore are defeased by U.S. Treasury securities.
The following table shows the geographic distribution of the $27.86 billion of municipal bonds at December 31, 2019 that were not pre-refunded:
No other single state accounted for 2.5% or more of the total non-pre-refunded municipal bonds.
In addition to fixed maturities noted in the foregoing table, the Company has exposure totaling $131 million to private equity limited partnerships and real estate partnerships (both of which are included in other investments in the Company’s consolidated balance sheet) whose primary investing focus is across Europe. The Company has unfunded commitments totaling $134 million to these partnerships. The Company has no non-redeemable preferred stock issued by companies in the Eurozone.
At December 31, 2019 and 2018, the Company held commercial mortgage-backed securities (including FHA project loans) of $1.51 billion and $1.22 billion, respectively. For more information regarding the Company’s investments in commercial mortgage-backed securities, see note 3 of notes to the consolidated financial statements.
The Company reported net unrealized investment gains included in shareholders’ equity at December 31, 2019 as compared to net unrealized losses at December 31, 2018. This change is due to a decline in interest rates during 2019. Equity securities, which
include public common and non-redeemable preferred stocks, are reported at fair value with changes in fair value recognized in net income. Prior to January 1, 2018, equity securities were classified as available for sale, and changes in their fair value were charged or credited directly to other comprehensive income.
The Company discusses how changing climate conditions may present other issues for its business under “Item 1A - Risk Factors” and “Outlook.” For example, among other things:
Increasingly unpredictable and severe weather conditions could result in increased frequency and severity of claims under policies issued by the Company. See “Item 1A - Risk Factors-High levels of catastrophe losses, including as a result of factors such as increased concentrations of insured exposures in catastrophe-prone areas, could materially and adversely affect our results of operations, our financial position and/or liquidity, and could adversely impact our ratings, our ability to raise capital and the availability and cost of reinsurance” and “-Outlook-Underwriting Gain/Loss.”
Increased regulation adopted in response to potential changes in climate conditions may impact the Company and its customers, including state insurance regulations that could impact the Company’s ability to manage property exposures in areas vulnerable to significant climate driven losses. For example, a state recently passed legislation that restricts a carrier's ability to cancel or non-renew policies within or adjacent to declared state emergency zip codes. If the Company is unable to implement risk-based pricing, modify policy terms or reduce exposures to the extent necessary to address rising losses related to catastrophes and smaller scale weather events (should those increased losses occur), its business may be adversely affected. See “Item 1A - Risk Factors-High levels of catastrophe losses, including as a result of factors such as increased concentrations of insured exposures in catastrophe-prone areas, could materially and adversely affect our results of operations, our financial position and/or liquidity, and could adversely impact our ratings, our ability to raise capital and the availability and cost of reinsurance.” In addition, climate change regulation could increase the Company’s customers’ costs of doing business. For example, insureds faced with carbon management regulatory requirements may have less available capital for investment in loss prevention and safety features which may, over time, increase loss exposures. Increased regulation may also result in reduced economic activity, which would decrease the amount of insurable assets and businesses.
The full range of potential liability exposures related to changing climate conditions continues to evolve. For example, from time to time third parties sue our policyholders alleging that they caused or contributed to changing climate conditions. Through the Company’s Emerging Issues Committee and its Committee on Climate, Energy and the Environment, the Company works with its business units and corporate groups, as appropriate, to identify and try to assess climate change-related liability issues, which are continually evolving and often hard to fully evaluate. The Company regularly reviews
The following table summarizes the composition of the Company’s reinsurance recoverables:
The following table presents the Company’s top five reinsurer groups by reinsurance recoverable at December 31, 2019 (in millions). Also included is the A.M. Best rating of the Company's predominant reinsurer from each such reinsurer group at February 13, 2020:
Included in total reinsurance recoverables are amounts related to structured settlements, which are annuities purchased from various life insurance companies to settle certain personal physical injury claims, of which workers’ compensation claims comprise a significant portion. In cases where the Company did not receive a release from the claimant, the amount due from the life insurance company related to the structured settlement is included in the Company’s consolidated balance sheet as a reinsurance recoverable and the related claim cost is included in the liability for claims and claim adjustment expense reserves, as the Company retains the contingent liability to the claimant. If it is expected that the life insurance company is not able to pay, the Company would recognize an impairment of the related reinsurance recoverable if, and to the extent, the purchased annuities are not covered by state guaranty associations. In the event that the life insurance company fails to make the required annuity payments, the Company would be required to make such payments. The following table presents the Company’s top five groups by structured settlements at December 31, 2019 (in millions). Also included is the A.M. Best rating of the Company’s predominant insurer from each such insurer group at February 13, 2020:
On October 23, 2016, Genworth Financial (Genworth) announced that they entered into a definitive agreement under which China Oceanwide Holdings Group Co., Ltd. (China Oceanwide) agreed to acquire all of the outstanding shares of Genworth. China Oceanwide is a privately held, family-owned international financial holding group headquartered in Beijing, China. On March 7, 2017, Genworth stockholders adopted the merger agreement, and the acquisition is pending the receipt of required regulatory approvals. On December 23, 2019, the parties agreed to extend the closing deadline for the transaction until March 31, 2020.
Underwriting Gain/Loss. The Company’s underwriting gain/loss can be significantly impacted by catastrophe losses and net favorable or unfavorable prior year reserve development, as well as underlying underwriting margins. Underlying underwriting margins can be impacted by a number of factors, including variability in non-catastrophe weather, large loss and other loss activity; changes in current period loss estimates resulting from prior period loss development; changes in loss trend; changes in business mix; changes in reinsurance coverages and/or costs; premium adjustments; and variability in expenses and assessments.
On average over the last ten years, the Company has experienced approximately 40% of its annual catastrophe losses during the second quarter, primarily arising out of severe wind and hail storms, including tornadoes. Hurricanes, wildfires and winter storms tend to happen at other times of the year and can also have a material impact on the Company's results of operations. Catastrophe losses incurred in a particular quarter in any given year may differ materially from historical experience. In addition, most of the Company's reinsurance programs renew on January 1 or July 1 of each year, and, therefore, any changes to the cost or coverage terms of such programs will be effective after such dates.
Over the past decade, the Company’s results have included significant amounts of net favorable prior year reserve development driven by better than expected loss experience. However, given the inherent uncertainty in estimating claims and claim adjustment expense reserves, loss experience could develop such that the Company recognizes in future periods higher or lower levels of favorable prior year reserve development, no favorable prior year reserve development or, as was the case in 2019, unfavorable prior year reserve development. In addition, the ongoing review of prior year claims and claim adjustment expense reserves, or other changes in current period circumstances, may result in the Company revising current year loss estimates upward or downward in future periods of the current year.
It is possible that changes in economic conditions could lead to higher or lower inflation than the Company had anticipated, which could in turn lead to an increase or decrease in the Company’s loss costs and the need to strengthen or reduce claims and claim adjustment expense reserves. These impacts of inflation on loss costs and claims and claim adjustment expense reserves could be more pronounced for those lines of business that require a relatively longer period of time to finalize and settle claims for a given accident year and, accordingly, are relatively more inflation sensitive. For a further discussion, see “Part I-Item 1A - Risk Factors-If actual claims exceed our claims and claim adjustment expense reserves, or if changes in the estimated level of claims and claim adjustment expense reserves are necessary, including as a result of, among other things, changes in the legal/tort, regulatory and economic environments in which the Company operates, our financial results could be materially and adversely affected.”
In Personal Insurance, the Company expects that for 2020 in the aggregate, the underlying underwriting margin will be higher, and the underlying combined ratio will be lower, than in 2019. The improvements are expected in the second through fourth quarters of the year assuming lower levels of non-catastrophe weather-related losses. In Agency Automobile, the Company expects
that for 2020 in the aggregate, the underlying underwriting margin and the underlying combined ratio will be broadly consistent with 2019. In Agency Homeowners and Other, the Company expects that for 2020 in the aggregate, the underlying underwriting margin will be higher, and the underlying combined ratio will be lower, than in 2019. The improvements are expected in the second through fourth quarters of the year assuming lower levels of non-catastrophe weather-related losses.
Investment Portfolio. The Company expects to continue to focus its investment strategy on maintaining a high-quality investment portfolio and a relatively short average effective duration. The weighted average effective duration of fixed maturities and short-term securities was 4.0 (4.3 excluding short-term securities) at December 31, 2019. From time to time, the Company enters into short positions in U.S. Treasury futures contracts to manage the duration of its fixed maturity portfolio. At December 31, 2019, the Company had no open U.S. Treasury futures contracts. The Company continually evaluates its investment alternatives and mix. Currently, the majority of the Company’s investments are comprised of a widely diversified portfolio of high-quality, liquid, taxable U.S. government, tax-exempt U.S. municipal and taxable corporate and U.S. agency mortgage-backed bonds.
The Company had a net pre-tax unrealized investment gain of $2.85 billion ($2.25 billion after-tax) in its fixed maturity investment portfolio at December 31, 2019. While the Company does not attempt to predict future interest rate movements, a rising interest rate environment would reduce the market value of fixed maturity investments and, therefore, reduce shareholders’ equity, and a declining interest rate environment would have the opposite effects. The Company’s investment portfolio has benefited from certain tax exemptions (primarily those related to interest from municipal bonds) and certain other tax laws, including, but not limited to, those governing dividends-received deductions and tax credits (such as foreign tax credits). Changes in these laws could adversely impact the value of the Company’s investment portfolio. See “Changes in U.S. tax laws or in the tax laws of other jurisdictions in which we operate could adversely impact us” included in “Part I-Item 1A - Risk Factors.”
For further discussion of the Company’s investment portfolio, see “Investment Portfolio.” For a discussion of the risks to the Company’s business during or following a financial market disruption and risks to the Company’s investment portfolio, see the risk factors entitled “During or following a period of financial market disruption or an economic downturn, our business could be materially and adversely affected” and “Our investment portfolio is subject to credit and interest rate risk, and may suffer reduced or low returns or material realized or unrealized losses” included in “Part I-Item 1A - Risk Factors.” For a discussion of the risks to the Company’s investments from foreign currency exchange rate fluctuations, see the risk factor entitled “We are also subject to a number of additional risks associated with our business outside the United States” included in “Part I-Item 1A - Risk Factors” and see “Part II-
We have audited the accompanying consolidated balance sheet of The Travelers Companies, Inc. and subsidiaries (the Company) as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2019, and the related notes and financial statement schedules as listed in the accompanying index to consolidated financial statements and schedules (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 13, 2020 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
The primary procedures we performed to address this critical audit matter included the following. We tested certain internal controls over the Company’s reserving process for claims and claim adjustment expense reserves, including controls related to the actuarial analyses and the determination of the Company’s estimate of the claims and claim adjustment expense reserves. We involved actuarial professionals with specialized skills and knowledge who assisted in:
Developing an overall range of reserve estimates and assessing the position of the Company’s recorded reserve relative to the range.
The consolidated financial statements include the accounts of The Travelers Companies, Inc. (together with its subsidiaries, the Company). The preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and claims and expenses during the reporting period. Actual results could differ from those estimates. All material intercompany transactions and balances have been eliminated.
In January 2016, the Financial Accounting Standards Board (FASB) issued updated guidance to address the recognition, measurement, presentation and disclosure of certain financial instruments. The updated guidance requires equity investments, except those accounted for under the equity method of accounting, that have readily determinable fair value to be measured at fair value with any changes in fair value recognized in net income. Equity securities that do not have readily determinable fair values may be measured at estimated fair value or cost less impairment, if any, adjusted for subsequent observable price changes, with changes in the carrying value recognized in net income. The updated guidance was effective for the quarter ended March 31, 2018 and early application of certain of the provisions in the updated guidance was allowed. The Company adopted the updated guidance for the quarter ended March 31, 2018 and elected to report changes in the fair value of equity investments in net realized investment gains (losses). The adoption of this guidance resulted in the recognition of $22 million of net after-tax unrealized gains on equity investments as a cumulative effect adjustment that increased retained earnings as of January 1, 2018 and decreased accumulated other comprehensive income (AOCI) by the same amount. At December 31, 2017, equity investments were classified as available-for-sale on the Company's balance sheet. However, upon adoption, the updated guidance eliminated the available-for-sale balance sheet classification for equity investments.
The updated guidance was effective for reporting periods beginning after December 15, 2018 and required that the earliest comparative period presented include the measurement and recognition of existing leases with an adjustment to equity as if the updated guidance had always been applied. Alternatively, an entity may elect to recognize a cumulative effect adjustment to the the opening balance of retained earnings in the year of adoption. Early adoption was permitted.
In August 2018, the FASB issued updated guidance on a customer's accounting for the implementation, set-up, and other upfront costs incurred in a cloud computing arrangement that is hosted by the vendor, i.e. a service contract. The updated guidance is effective for the quarter ending March 31, 2020, with early adoption permitted. The updated guidance requires an entity to determine the stage of a project that the implementation activity relates to and the nature of the associated costs in order to determine whether those costs should be expensed as incurred or capitalized. The updated guidance also requires the entity to amortize the capitalized implementation costs as an expense over the term of the hosting arrangement. The Company elected to adopt the guidance for the quarter ended March 31, 2019 and applied the guidance prospectively. The adoption of the updated guidance did not have a material effect on the Company’s results of operations, financial position or liquidity.
In May 2014, the FASB issued updated guidance to clarify the principles for recognizing revenue. The updated guidance was effective for the quarter ended March 31, 2018 and required an entity to recognize revenue as performance obligations are met, in order to reflect the transfer of goods or services to customers in an amount that reflects the consideration the entity is entitled to receive for those goods or services. For the year ended December 31, 2018, approximately $171 million, or less than 1% of the Company's total revenues, were within the scope of this updated guidance and were generated from the services described below.
The Company does not capitalize the costs to obtain or fulfill the contracts for which revenues are reported in fee income and other revenues and has not recognized any material impairment losses on the receivables related to these contracts.
The Company adopted the updated guidance for the quarter ended March 31, 2018. The adoption did not have a material effect on the Company’s results of operations, financial position or liquidity.
In June 2016, the FASB issued updated guidance for the accounting for credit losses for financial instruments. The updated guidance applies a new credit loss model (current expected credit losses or CECL) for determining credit-related impairments for financial
The updated guidance is effective for the quarter ending March 31, 2020. The Company expects to recognize an after-tax cumulative effect adjustment of approximately $43 million to reflect the impact of recognizing expected credit losses, as compared to incurred credit losses recognized under the previous guidance. This adjustment is primarily associated with structured settlements that are recorded as part of reinsurance recoverables. The cumulative effect adjustment will decrease retained earnings as of January 1, 2020 and increase the allowance for uncollectible reinsurance.
The updated guidance is effective for the quarter ending March 31, 2020 and is to be applied prospectively. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The adoption of this guidance is not expected to have a material effect on the Company’s results of operations, financial position or liquidity.
In December 2019, the FASB issued updated guidance for the accounting for income taxes. The updated guidance is intended to simplify the accounting for income taxes by removing several exceptions contained in existing guidance and amending other existing guidance to simplify several other income tax accounting matters. The updated guidance is effective for the quarter ending March 31, 2021. Early adoption is permitted. The adoption of this guidance is not expected to have a material effect on the Company’s results of operations, financial position or liquidity.
The Company conducts a periodic review to identify and evaluate invested assets having other-than-temporary impairments.
The Company reviews its investments in private equity limited partnerships, hedge funds and real estate partnerships for impairment no less frequently than quarterly and monitors the performance throughout the year through discussions with the managers/general partners. If the Company becomes aware of an impairment of a partnership’s investments at the balance sheet date prior to receiving the partnership’s financial statements, it will recognize an impairment by recording a reduction in the carrying value of the partnership with a corresponding charge to net investment income.
the invested asset (e.g., a downgrade or upgrade from a rating agency), significant unforeseen changes in liquidity needs, or changes in tax laws or the regulatory environment.
The Company performs a review, on at least an annual basis, of goodwill held by the reporting units which are the Company’s three operating and reportable segments: Business Insurance; Bond & Specialty Insurance; and Personal Insurance. The Company estimates the fair value of its reporting units and compares it to their carrying value, including goodwill. If the carrying values of the reporting units were to exceed their fair value, the amount of the impairment would be calculated and goodwill adjusted accordingly.
The Company performs a continuing review of its claims and claim adjustment expense reserves, including its reserving techniques and the impact of reinsurance. The reserves are also reviewed regularly by qualified actuaries employed by the Company. Since the reserves are based on estimates, the ultimate liability may be more or less than such reserves. The effects of changes in such estimated reserves are included in the results of operations in the period in which the estimates are changed. Such changes in estimates could occur in a future period and may be material to the Company’s results of operations and financial position in such period.
Included in other liabilities in the consolidated balance sheet is the Company’s estimate of its liability for guaranty fund and other insurance-related assessments. The liability for expected state guaranty fund and other premium-based assessments is recognized as the Company writes or becomes obligated to write or renew the premiums on which the assessments are expected to be based. The liability for loss-based assessments is recognized as the related losses are incurred. At December 31, 2019 and 2018, the Company had a liability of $184 million and $217 million, respectively, for guaranty fund and other insurance-related assessments and related recoverables of $13 million and $16 million, respectively. The liability for such assessments and the related recoverables are not discounted for the time value of money. The loss-based assessments are expected to be paid over a period ranging from one year to the life expectancy of certain workers’ compensation claimants and the recoveries are expected to occur over the same period of time.
Also included in other liabilities is an accrual for policyholder dividends. Certain insurance contracts, primarily workers’ compensation, are participating whereby dividends are paid to policyholders in accordance with contract provisions. Net written premiums for participating dividend policies were approximately 1% of total net written premiums for each of the years ended December 31, 2019, 2018 and 2017. Policyholder dividends are accrued against earnings using best available estimates of amounts to be paid. The liability accrued for policyholder dividends totaled $71 million and $72 million at December 31, 2019 and 2018, respectively.
The Company’s U.S. insurance subsidiaries, domiciled principally in the State of Connecticut, are required to prepare statutory financial statements in accordance with the accounting practices prescribed or permitted by the insurance departments of the states of domicile. Prescribed statutory accounting practices are those practices that are incorporated directly or by reference in state laws, regulations, and general administrative rules applicable to all insurance enterprises domiciled in a particular state. The State of Connecticut requires insurers domiciled in Connecticut to prepare their statutory financial statements in accordance with National Association of Insurance Commissioners’ (NAIC) statutory accounting practices.
Fee income includes servicing carrier fees and revenues from large deductible policies and service contracts and is recognized as the Company completes its performance obligations, which is primarily on a pro rata basis over the contract service period or the underlying policy periods.
Other revenues include revenues from premium installment charges, which are recognized as collected, revenues of noninsurance subsidiaries other than fee income and gains and losses on dispositions of assets and redemption of debt, and other miscellaneous revenues, including gains recognized as a result of settlements of reinsurance disputes and claims-related legal matters.
exchange rates for items recorded in earnings. The change in unrealized foreign currency translation gain or loss during the year, net of tax, is a component of other comprehensive income.
Select Accounts provides small businesses with property and casualty insurance products and services, including commercial multi-peril, workers’ compensation, commercial automobile, general liability and commercial property.
National Accounts provides large companies with casualty insurance products and services, including workers’ compensation, commercial automobile and general liability, generally utilizing loss-sensitive products, on both a bundled and unbundled basis, as well as risk management, claims handling and other services. National Accounts also includes the Company’s commercial residual market business, which primarily offers workers’ compensation claims, policy management and other administrative services related to the involuntary market.
National Property and Other provides traditional and customized commercial property insurance programs to large and mid-sized customers through National Property. National Property and Other also provides insurance coverage for the commercial transportation industry through Northland Transportation, and serves small- to medium-sized agricultural businesses, including farms, ranches and other agricultural-related operations through Agribusiness. National Property and Other also includes commercial property and general liability policies for small, difficult to place specialty classes of commercial business primarily on an excess and surplus lines basis through Northfield, and also offers tailored property and casualty insurance programs on an admitted basis for customers with common risk characteristics or coverage requirements through National Programs.
funds, a benchmark investment yield is developed that reflects the estimated duration of the loss reserves’ future cash flows, the interest rate environment at the time the losses were incurred and A+ rated corporate debt instrument yields. For capital, a benchmark investment yield is developed that reflects the average yield on the total investment portfolio. The benchmark investment yields are applied to each segment’s investable funds and capital, respectively, to produce a total notional investment income by segment. The Company’s actual net investment income is allocated to each segment in proportion to the respective segment’s notional investment income to total notional investment income. There are certain legal entities within the Company that are dedicated to specific reportable business segments. The invested assets and related net investment income from these legal entities are reported in the applicable business segment and are not allocated among the other business segments.
The cost of the Company’s catastrophe treaty program is included in the Company’s ceded premiums and is allocated among reportable business segments based on an estimate of actual market reinsurance pricing using expected losses calculated by the Company’s catastrophe model, adjusted for any experience adjustments.
Segment revenues for reportable business segments exclude net realized investment gains. Segment income for reportable business segments equals net income excluding the after-tax impact of net realized investment gains and, in 2017, the impact of the Tax Cuts and Jobs Act of 2017 at enactment.
The primary component of Interest Expense and Other was after-tax interest expense of $272 million, $278 million and $240 million in 2019, 2018 and 2017, respectively.
At December 31, 2019 and 2018, the Company held commercial mortgage-backed securities (CMBS, including FHA project loans) of $1.51 billion and $1.22 billion, respectively, which are included in “All other corporate bonds” in the tables above. At December 31, 2019 and 2018, approximately $559 million and $458 million of these securities, respectively, or the loans backing such securities, contained guarantees by the U.S. government or a government-sponsored enterprise. The weighted average credit rating of the $950 million and $759 million of non-guaranteed securities at December 31, 2019 and 2018, respectively, was “Aaa” at both dates. The CMBS portfolio is supported by loans that are diversified across economic sectors and geographical areas. The weighted average credit rating of the CMBS portfolio was “Aaa” at both December 31, 2019 and 2018.
Proceeds from sales of fixed maturities classified as available for sale were $2.19 billion, $3.55 billion and $1.85 billion in 2019, 2018 and 2017, respectively. Gross gains of $67 million, $51 million and $42 million and gross losses of $8 million, $18 million and $38 million were realized on those sales in 2019, 2018 and 2017, respectively.
At December 31, 2019 and 2018, the Company’s insurance subsidiaries had $4.34 billion and $4.23 billion, respectively, of securities on deposit at financial institutions in certain states pursuant to the respective states’ insurance regulatory requirements. Funds deposited with third parties to be used as collateral to secure various liabilities on behalf of insureds, cedants and other creditors had a fair value of $54 million and $37 million at December 31, 2019 and 2018, respectively. Other investments pledged as collateral securing outstanding letters of credit had a fair value of $1 million at both December 31, 2019 and 2018. In addition, the Company utilizes Lloyd’s trust deposits, whereby owned securities with a fair value of approximately $173 million and $115 million held by a wholly-owned subsidiary at December 31, 2019 and 2018, respectively, and $34 million and $33 million held by TRV at December 31, 2019 and 2018, respectively, were pledged into Lloyd’s trust accounts to provide a portion of the capital needed to support the Company’s obligations at Lloyd’s.
Proceeds from sales of equity securities previously classified as available for sale were $765 million in 2017. Gross gains of $239 million and gross losses of $3 million were realized on those sales in 2017.
The Company’s real estate investments include warehouses, office buildings and other commercial land and properties that are directly owned. The Company negotiates commercial leases with individual tenants through unrelated, licensed real estate brokers. Negotiated terms and conditions include, among others, rental rates, length of lease period and improvements to the premises to be provided by the landlord.
There were no sales of real estate investments in 2019. Proceeds from the sale of real estate investments were $74 million and $23 million in 2018 and 2017, respectively. Gross gains of $23 million and $10 million were realized on those sales in 2018 and 2017, respectively, and there were no gross losses. Accumulated depreciation on real estate held for investment purposes was $422 million and $383 million at December 31, 2019 and 2018, respectively.
Future minimum rental income on operating leases relating to the Company’s real estate properties is expected to be $110 million, $102 million, $85 million, $61 million and $45 million for 2020, 2021, 2022, 2023 and 2024, respectively, and $71 million for 2025 and thereafter.
The Company’s short-term securities consist of Aaa-rated registered money market funds, U.S. Treasury securities, high-quality commercial paper (primarily A1/P1) and high-quality corporate securities purchased within a year to their maturity with a combined average of 54 days to maturity at December 31, 2019. The amortized cost of these securities, which totaled $4.94 billion and $3.99 billion at December 31, 2019 and 2018, respectively, approximated their fair value.
and purpose and the Company’s relative exposure to the related risks of the VIE on the date it becomes initially involved in the VIE. The Company reassesses its VIE determination with respect to an entity on an ongoing basis.
At December 31, 2019 and 2018, other than U.S. Treasury securities and obligations of U.S. government and government agencies and authorities, the Company was not exposed to any concentration of credit risk of a single issuer greater than 5% of the Company’s shareholders’ equity.
Included in fixed maturities are below investment grade securities totaling $1.46 billion and $1.48 billion at December 31, 2019 and 2018, respectively. The Company defines its below investment grade securities as those securities rated below investment grade by external rating agencies, or the equivalent by the Company when a public rating does not exist. Such securities include below investment grade bonds that are publicly traded and certain other privately issued bonds that are classified as below investment grade loans.
The Company has a put/call option that was entered into in connection with a business acquisition that allows the Company to acquire the remaining shares of the acquired company at a future date. Net realized investment gains and losses related to this put/call option in 2019 and 2018 were not significant.
The Company also sells a small amount of U.S. equity index put option contracts that are settled for cash upon their expiration or when they are rolled over. Net realized investment losses related to these derivatives in 2019, 2018 and 2017 were not significant.
The Company utilized a pricing service to estimate fair value measurements for approximately 99% of its fixed maturities at both December 31, 2019 and 2018. The pricing service utilizes market quotations for fixed maturity securities that have quoted prices in active markets. Since fixed maturities other than U.S. Treasury securities generally do not trade on a daily basis, the pricing service prepares estimates of fair value measurements for these securities using its proprietary pricing applications, which include available relevant market information, benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. Additionally, the pricing service uses an Option Adjusted Spread model to develop prepayment and interest rate scenarios.
include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. The extent of the use of each market input depends on the asset class and the market conditions. Depending on the security, the priority of the use of inputs may change or some market inputs may not be relevant. For some securities, additional inputs may be necessary.
While the vast majority of the Company’s fixed maturities are included in Level 2, the Company holds a number of municipal bonds and corporate bonds which are not valued by the pricing service and also estimates the fair value of these bonds using another internal pricing matrix that includes some unobservable inputs that are significant to the valuation. Due to the limited amount of observable market information, the Company includes the fair value estimates for these particular bonds in Level 3. The fair value of the fixed maturities for which the Company used this internal pricing matrix was $73 million and $82 million at December 31, 2019 and 2018, respectively. Additionally, the Company holds a small amount of other fixed maturity investments that have characteristics that make them unsuitable for matrix pricing. For these fixed maturities, the Company obtains a quote from a broker (primarily the market maker). The fair value of the fixed maturities for which the Company received a broker quote was $28 million and $104 million at December 31, 2019 and 2018, respectively. Due to the disclaimers on the quotes that indicate that the price is indicative only, the Company includes these fair value estimates in Level 3.
The Company has a put/call option that was entered into in connection with a business acquisition that allows the Company to acquire the remaining shares of the acquired company at a future date. The fair value of the put/call at December 31, 2019 and 2018 was $8 million and $10 million, respectively, and was determined using an internal model and is based on the acquired company's financial performance, adjusted for a risk margin and discounted to present value. The Company includes the fair value estimate of the put/call in Level 3.
The Company also includes in Level 3 the put/call option entered into in connection with a business acquisition that is reported in other liabilities and had a fair value of $10 million at December 31, 2018.
Included in reinsurance recoverables are amounts related to involuntary reinsurance arrangements. The Company is required to participate in various involuntary reinsurance arrangements through assumed reinsurance, principally with regard to residual market mechanisms in workers’ compensation and automobile insurance, as well as homeowners’ insurance in certain coastal areas. In addition, the Company provides services for several of these involuntary arrangements (mandatory pools and associations) under which it writes such residual market business directly, then cedes 100% of this business to the mandatory pool. Such participations and servicing arrangements are arranged to mitigate credit risk to the Company, as any ceded balances are jointly backed by all the pool members.
In order for a loss to be covered under the program (subject losses), the loss must meet certain aggregate industry loss minimums and must be the result of an event that is certified as an act of terrorism by the U.S. Secretary of the Treasury, in consultation with the Secretary of Homeland Security and the Attorney General of the United States. The annual aggregate industry loss minimum under the program is $200 million. The program excludes from participation the following types of insurance: Federal crop insurance, private mortgage insurance, financial guaranty insurance, medical malpractice insurance, health or life insurance, flood insurance, reinsurance, commercial automobile, professional liability (other than directors' and officers’), surety, burglary and theft, and farm-owners multi-peril. In the case of a war declared by Congress, only workers’ compensation losses are covered by the program. All commercial property and casualty insurers licensed in the United States are generally required to participate in the program. Under the program, a participating insurer, in exchange for making terrorism insurance available, is entitled to be reimbursed by the Federal Government for 80% of subject losses, after an insurer deductible, subject to an annual cap.
Contract-based intangible assets subject to amortization are comprised of fair value adjustments on claims and claim adjustment expense reserves, reinsurance recoverables and other contract-related intangible assets. Fair value adjustments recorded in connection with insurance acquisitions were based on management’s estimate of nominal claims and claim adjustment expense reserves and reinsurance recoverables. The method used calculated a risk adjustment to a risk-free discounted reserve that would, if reserves ran off as expected, produce results that yielded the assumed cost-of-capital on the capital supporting the loss reserves. The fair value adjustments are reported as other intangible assets on the consolidated balance sheet, and the amounts measured in accordance with the acquirer’s accounting policies for insurance contracts have been reported as part of the claims and claim adjustment expense reserves and reinsurance recoverables. The intangible assets are being recognized into income over the expected payment pattern. Because the time value of money and the risk adjustment (cost of capital) components of the intangible assets run off at different rates, the amount recognized in income may be a net benefit in some periods and a net expense in other periods.
Gross claims and claim adjustment expense reserves at December 31, 2019 increased by $1.18 billion over December 31, 2018, primarily reflecting the impacts of higher volumes of insured exposures and loss cost trends for the current accident year. Gross claims and claim adjustment expense reserves at December 31, 2018 increased by $1.02 billion over December 31, 2017, primarily reflecting the impacts of (i) higher volumes of insured exposures and loss cost trends for the current accident year and (ii) catastrophe losses in 2018, partially offset by the impacts of (iii) payments related to catastrophe losses incurred in 2017 and (iv) net favorable prior year reserve development.
The Company continues to evaluate the impact of recent developments on the estimated realizable value of its subrogation claims related to the 2017 and 2018 California wildfires. Recent developments include (i) the approval of Restructuring Support Agreements (RSAs) by the United States Bankruptcy Court reflecting the settlement of subrogation claims and individual wildfire victim claims against Pacific Gas & Electric Company (PG&E) and a settlement between bondholders and PG&E, and (ii) objections to PG&E's plan of reorganization raised by the Governor of California and others. The RSAs may be terminated if PG&E's plan
The following disclosures regarding reserve development are on a “net of reinsurance” basis.
Asbestos reserves - an increase of $220 million, primarily in the segment's domestic general liability product line;
Commercial multi-peril - higher than expected loss experience in the segment's domestic operations for recent accident years; and
Commercial property - better than expected loss experience in the segment’s domestic operations for recent accident years,
Environmental reserves - an increase of $55 million, primarily in the segment's domestic general liability product line.
In 2017, estimated claims and claim adjustment expenses incurred included $458 million of net favorable development for claims arising in prior years, including $592 million of net favorable prior year reserve development and $50 million of accretion of discount that impacted the Company's results of operations.
Business Insurance. Net favorable prior year reserve development in 2017 totaled $439 million, primarily driven by the following:
General liability (excluding an increase to asbestos and environmental reserves) - better than expected loss experience in the segment's domestic operations for both primary and excess coverages for multiple accident years; and
Commercial automobile - higher than expected loss experience for recent accident years;
Total reinsurance recoverables (on paid and unpaid losses) at December 31, 2019 were $8.24 billion.
For prior accident years, the following estimation and analysis methods are principally used by the Company’s actuaries to estimate the ultimate cost of claims and claim adjustment expenses. These estimation and analysis methods are typically referred to as conventional actuarial methods.
The case incurred development method is the same as the paid loss development method but is based on cumulative case-incurred losses rather than paid losses.
At December 31, 2019 and 2018, the Company’s claims and claim adjustment expense reserves included $1.60 billion and $1.62 billion, respectively, for asbestos and environmental-related claims, net of reinsurance.
In the third quarter of 2019, the Company completed its annual in-depth asbestos claim review, including a review of active policyholders and litigation cases for potential product and “non-product” liability, and noted the continuation of the following trends:
The completion of these reviews and analyses in 2019, 2018 and 2017 resulted in $220 million, $225 million and $225 million increases, respectively, to the Company’s net asbestos reserves. In each year, the reserve increases were primarily driven by increases in the Company’s estimate of projected settlement and defense costs related to a broad number of policyholders in the home office and field office category. The increase in the estimate of projected settlement and defense costs resulted from payment trends that continue to be higher than previously anticipated due to the impact of the current litigation environment surrounding mesothelioma claims discussed above. Over the past decade, the property and casualty insurance industry, including the Company, has experienced net unfavorable prior year reserve development with regard to asbestos reserves, but the Company believes that over that period there has been a reduction in the volatility associated with the Company’s overall asbestos exposure as the overall asbestos environment has evolved from one dominated by exposure to significant litigation risks, particularly coverage disputes relating to policyholders in bankruptcy who were asserting that their claims were not subject to the aggregate limits contained in their policies, to an environment primarily driven by a frequency of litigation related to individuals with mesothelioma. The Company’s overall view of the current underlying asbestos environment is essentially unchanged from recent periods and there remains a high degree of uncertainty with respect to future exposure to asbestos claims.
The Company continues to receive notices from policyholders tendering claims for the first time, frequently under policies issued prior to the mid-1980s. These policyholders continue to present smaller exposures, have fewer sites and are lower tier defendants. Further, in many instances, clean-up costs have been reduced because regulatory agencies are willing to accept risk-based site analyses and more efficient clean-up technologies. Over the past several years, the Company has experienced generally favorable trends in the number of new policyholders tendering environmental claims for the first time and in the number of pending declaratory judgment actions relating to environmental matters. However, the degree to which those favorable trends have continued has been less than anticipated. In addition, reserve development on existing environmental claims as well as the costs associated with coverage litigation on environmental matters has been greater than anticipated, driven by claims and legal developments in a limited number of jurisdictions. As a result of these factors, in 2019, 2018 and 2017, the Company increased its net environmental reserves by $76 million, $55 million and $65 million, respectively.
The Company has geographic exposure to catastrophe losses, which include hurricanes, tornadoes and other windstorms, earthquakes, hail, wildfires, severe winter weather, floods, tsunamis, volcanic eruptions, solar flares and other naturally-occurring events. Catastrophes can also result from terrorist attacks and other intentionally destructive acts including those involving nuclear, biological, chemical and radiological events, cyber events, explosions and destruction of infrastructure. The incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophes are restricted to small geographic areas; however, hurricanes, earthquakes, wildfires and cyber attacks may produce significant damage in larger areas, especially those that are heavily populated. The Company generally seeks to mitigate its exposure to catastrophes through individual risk selection and the purchase of catastrophe reinsurance.
2019 Debt Issuance. On March 4, 2019, the Company issued $500 million aggregate principal amount of 4.10% senior notes that will mature on March 4, 2049. The net proceeds of the issuance, after the deduction of the underwriting discount and expenses payable by the Company, totaled approximately $492 million. Interest on the senior notes is payable semi-annually in arrears on March 4 and September 4. Prior to September 4, 2048, the senior notes may be redeemed, in whole or in part, at the Company’s option, at any time or from time to time, at a redemption price equal to the greater of (a) 100% of the principal amount of any senior notes to be redeemed or (b) the sum of the present values of the remaining scheduled payments of principal and interest to but excluding September 4, 2048 on any senior notes to be redeemed (exclusive of interest accrued to the date of redemption) discounted to the date of redemption on a semi-annual basis (assuming a 360-day year consisting of twelve 30-day months) at the then current Treasury rate (as defined in the senior notes), plus 20 basis points. On or after September 4, 2048, the senior notes may be redeemed, in whole or in part, at the Company’s option, at any time or from time to time, at a redemption price equal to 100% of the principal amount of any senior notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date.
2019 Debt Repayment. On June 2, 2019, the Company's $500 million, 5.90% senior notes matured and were fully paid.
2018 Debt Repayment. On May 15, 2018, the Company's $500 million, 5.80% senior notes matured and were fully paid.
2017 Debt Issuance. On May 22, 2017, the Company issued $700 million aggregate principal amount of 4.00% senior notes that will mature on May 30, 2047. The net proceeds of the issuance, after the deduction of the underwriting discount and expenses payable by the Company, totaled approximately $689 million. Interest on the senior notes is payable semi-annually in arrears on May 30 and November 30. Prior to November 30, 2046, the senior notes may be redeemed, in whole or in part, at the Company’s option, at any time or from time to time, at a redemption price equal to the greater of (a) 100% of the principal amount of any senior notes to be redeemed or (b) the sum of the present values of the remaining scheduled payments of principal and interest to November 30, 2046 on any senior notes to be redeemed (exclusive of interest accrued to the date of redemption) discounted to the date of redemption on a semi-annual basis (assuming a 360-day year consisting of twelve 30-day months) at the then current Treasury rate (as defined in the senior notes), plus 15 basis points. On or after November 30, 2046, the senior notes may be redeemed, in whole or in part, at the Company’s option, at any time or from time to time, at a redemption price equal to 100% of the principal amount of any senior notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date.
2017 Debt Redemption and Repayment. On June 2, 2017, the Company redeemed the remaining $107 million aggregate principal amount of its 6.25% Fixed-to-Floating Rate Junior Subordinated Debentures due 2067 at a price per debenture of 100% of the principal amount thereof, plus accrued and unpaid interest to the redemption date. On December 15, 2017, the Company’s $450 million, 5.75% senior notes matured and were fully paid.
Commercial Paper-The Company maintains an $800 million commercial paper program. Interest rates on commercial paper issued in 2019 ranged from 1.58% to 2.48%, and in 2018 ranged from 1.47% to 2.37%.
Maturities-The amount of debt obligations, other than commercial paper, that become due in each of the next five years is as follows: 2020, $500 million; 2021, $0; 2022, $0; 2023, $0; and 2024, $0.
The number of authorized shares of the Company is 1.755 billion, consisting of five million shares of preferred stock, 1.745 billion shares of voting common stock and five million undesignated shares. The Company’s Articles of Incorporation authorize the Board of Directors to establish, from the undesignated shares, one or more classes and series of shares, and to further designate the type of shares and terms thereof.
At December 31, 2019, 41,997 shares of restricted stock issued by the Company in August 2017 to certain employees of an acquired business remained outstanding and unvested. The restricted shares vest in August 2020 and are subject to service conditions. As a result, the value of the shares is recognized over the vesting period and is included with the share-based compensation cost of awards that are issued under the Company’s share-based incentive compensation plan (see note 13). Recipients generally have all the rights of a shareholder of the Company including the right to vote the applicable shares of common stock and to receive dividends on such shares, if and as declared by the Board of Directors. The restricted shares are held under the Company’s control with the Company’s transfer agent and will be released upon vesting.
The Company’s Board of Directors has approved common share repurchase authorizations under which repurchases may be made from time to time in the open market, pursuant to pre-set trading plans meeting the requirements of Rule 10b5-1 under the Securities Exchange Act of 1934, in private transactions or otherwise. The authorizations do not have a stated expiration date. The timing and actual number of shares to be repurchased in the future will depend on a variety of factors, including the Company’s financial position, earnings, share price, catastrophe losses, maintaining capital levels commensurate with the Company’s desired ratings from independent rating agencies, changes in levels of written premiums, funding of the Company’s qualified pension plan, capital requirements of the Company’s operating subsidiaries, legal requirements, regulatory constraints, other investment opportunities (including mergers and acquisitions and related financings), market conditions and other factors. In April 2017, the Board of Directors approved a share repurchase authorization that added an additional $5.0 billion of repurchase capacity. The following table summarizes repurchase activity in 2019 and remaining repurchase capacity at December 31, 2019.
The Company’s U.S. insurance subsidiaries, domiciled principally in the State of Connecticut, are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid by each insurance subsidiary to its respective parent company without prior approval of insurance regulatory authorities. A maximum of $2.79 billion is available by the end of 2020 for such dividends to the holding company, TRV, without prior approval of the Connecticut Insurance Department. The Company may choose to accelerate the timing within 2020 and/or increase the amount of dividends from its insurance subsidiaries in 2020, which could result in certain dividends being subject to approval by the Connecticut Insurance Department.
In addition to the regulatory restrictions on the availability of dividends that can be paid by the Company’s U.S. insurance subsidiaries, the maximum amount of dividends that may be paid to the Company’s shareholders is limited, to a lesser degree, by certain covenants contained in its line of credit agreement with a syndicate of financial institutions that require the Company to maintain a minimum consolidated net worth as described in note 8.
The following table presents the pre-tax and related income tax (expense) benefit components of the amounts reclassified from the Company’s AOCI to the Company’s consolidated statement of income.
(Increases) decreases net realized investment gains on the consolidated statement of income.
Basic earnings per share was computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the period. The computation of diluted earnings per share reflected the effect of potentially dilutive securities and excludes the effect of any anti-dilutive shares.
The Company paid income taxes of $428 million, $408 million and $514 million during the years ended December 31, 2019, 2018 and 2017, respectively. The current income tax payable of $126 million at December 31, 2019 was included in other liabilities in the consolidated balance sheet. The current income tax receivable of $12 million at December 31, 2018 was included in other assets in the consolidated balance sheet.
In computing taxable income, property and casualty insurers reduce underwriting income by claims and claim adjustment expenses incurred. The deduction for claims incurred is discounted at the interest rates and for the claim payment patterns prescribed by the U.S. Treasury. TCJA changed the prescribed interest rates to rates based on corporate bond yield curves and extended the applicable time periods for the claim payment pattern. These changes were effective for tax years beginning after 2017 and are subject to a transition rule that spreads the additional tax payment from the amount determined by applying these changes over the subsequent eight years beginning in 2018. This item is a taxable temporary difference and had no direct impact on total tax expense for 2017 and will not directly impact total tax expense in future years. The required additional tax payments are currently estimated to approximate $19 million per year through 2025 and will result in a modest reduction in net investment income over that period.
U.S. income taxes have not been recognized on any undistributed earnings that are intended to be permanently reinvested. After TCJA, any potential U.S. income tax on these amounts is immaterial.
For tax return purposes, as of December 31, 2019, the Company had net operating loss (NOL) carryforwards in the United States, Brazil, Canada, the Republic of Ireland and the United Kingdom. The amount and timing of realizing the benefits of NOL carryforwards depend on future taxable income and limitations imposed by tax laws. Only the benefits of the United Kingdom NOL carryforwards have been recognized in the consolidated financial statements and are included in net deferred tax assets. The NOL amounts by jurisdiction and year of expiration are as follows:
The following is a reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2019 and 2018:
The Company issues restricted stock unit awards to eligible officers and key employees under the Equity Awards program established pursuant to the 2014 Incentive Plan. A restricted stock unit represents the right to receive a share of common stock. These restricted stock unit awards are granted at market price, generally vest three years from the date of grant, do not have voting rights and the underlying shares of common stock are not issued until the vesting criteria is satisfied. In addition, members of the Company’s Board of Directors can be issued deferred stock units from (i) an annual award; (ii) deferred compensation (in lieu of cash retainer, committee chair fees and lead director fees); and (iii) dividend equivalents earned on outstanding deferred compensation.
In addition to the nonvested shares presented in the above table, there are related nonvested dividend equivalent shares. The number of nonvested dividend equivalent shares related to deferred stock units was 329 at the beginning of the year and 285 at the end of the year and the number of nonvested dividend equivalent shares related to performance shares was 24,876 at the beginning of the year and 22,359 at the end of the year. The dividend equivalent shares are subject to the same vesting terms as the deferred stock units and performance shares.
At December 31, 2019, there was $136 million of total unrecognized compensation cost related to all nonvested share-based incentive compensation awards. This includes stock options, restricted and deferred stock units and performance shares granted under the 2014 Incentive Plan and restricted common stock issued in connection with a 2017 business acquisition. The unrecognized compensation cost is expected to be recognized over a weighted-average period of 1.7 years. Cash received from the exercise of employee stock options under share-based compensation plans totaled $213 million , $132 million and $173 million in 2019, 2018 and 2017, respectively. The tax benefit for tax deductions from employee stock options exercised during 2019, 2018 and 2017 totaled $18 million, $14 million and $31 million, respectively.
The total accumulated benefit obligation for the Company’s defined benefit pension plans was $4.05 billion and $3.53 billion at December 31, 2019 and 2018, respectively. The qualified domestic pension plan accounted for $3.82 billion and $3.32 billion of the total accumulated benefit obligation at December 31, 2019 and 2018, respectively, whereas the nonqualified and foreign plans accounted for $0.23 billion and $0.21 billion of the total accumulated benefit obligation at December 31, 2019 and 2018, respectively.
For pension plans with a projected benefit obligation in excess of plan assets, the aggregate projected benefit obligation was $228 million and $203 million at December 31, 2019 and 2018, respectively, and the aggregate plan assets were $100 million and $87 million at December 31, 2019 and 2018, respectively. For pension plans with an accumulated benefit obligation in excess of plan assets, the aggregate accumulated benefit obligation was $218 million and $195 million at December 31, 2019 and 2018, respectively, and the aggregate plan assets were $100 million and $87 million at December 31, 2019 and 2018, respectively. For postretirement benefit plans with an accumulated benefit obligation in excess of plan assets, the aggregate accumulated benefit obligation was $171 million and $203 million at December 31, 2019 and 2018, respectively, and the aggregate plan assets were $12 million at both December 31, 2019 and 2018.
is no required contribution to the qualified domestic pension plan during 2020, and the Company has not determined whether or not additional funding will be made during 2020. With respect to the Company’s foreign pension plans, there are no significant required contributions in 2020.
The assumptions made for the Company’s foreign pension and foreign postretirement benefit plans are not materially different from those of the Company’s qualified domestic pension plan and the domestic postretirement benefit plan.
The Company has a savings plan, The Travelers 401(k) Savings Plan (the Savings Plan), in which substantially all U.S. domestic Company employees are eligible to participate. Under the Savings Plan, the Company matches employee contributions up to 5% of eligible pay, with a maximum annual match of $6,500 which becomes 100% vested after three years of service. The Company’s matching contribution is made in cash and invested according to the employee’s current investment elections and can be reinvested into other investment options in accordance with the terms of the Savings Plan. The Company’s non-U.S. employees participate in separate savings plans. The total expense related to all of the savings plans was $123 million, $118 million and $119 million for the years ended December 31, 2019, 2018 and 2017, respectively.
(1) Leases with an initial term of twelve months or less are not recorded on the balance sheet.
In the ordinary course of selling businesses to third parties, the Company has agreed to indemnify purchasers for losses arising out of breaches of representations and warranties, obligations arising from certain liabilities and any breach or failure to perform certain covenants with respect to the businesses being sold. Such indemnification provisions generally are applicable from the closing date to the expiration of the relevant statutes of limitations, although, in some cases, there may be agreed upon term limitations or no term limitations. Certain of these contingent obligations are subject to deductibles which have to be incurred by the obligee before the Company is obligated to make payments. The maximum amount of the Company’s contingent obligation for indemnifications related to the sale of businesses that are quantifiable was $351 million at December 31, 2019.
The Company also has contingent obligations for guarantees related to certain investments, certain insurance policy obligations of former insurance subsidiaries and various other indemnifications. The Company also provides standard indemnifications to service providers in the normal course of business. The indemnification clauses are often standard contractual terms. The maximum amount of the Company’s obligation related to the guarantee of certain insurance policy obligations of a former insurance subsidiary was $480 million at December 31, 2019, all of which is indemnified by a third party.
There were no material noncash financing or investing activities during the years ended December 31, 2019, 2018 and 2017.
The following consolidating financial statements of the Company have been prepared pursuant to Rule 3-10 of Regulation S-X. These consolidating financial statements have been prepared from the Company’s financial information on the same basis of accounting as the consolidated financial statements. The Travelers Companies, Inc. (excluding its subsidiaries, TRV) has fully and unconditionally guaranteed certain debt obligations of Travelers Property Casualty Corp. (TPC) and Travelers Insurance Group Holdings, Inc. (TIGHI), which totaled $700 million at December 31, 2019.
Total other-than-temporary impairments (OTTI) for the year ended December 31, 2019, and the amounts comprising total OTTI that were recognized in net realized investment gains and in other comprehensive income (OCI), were as follows: