Operating income before interest expense and income taxes was $465.6 million in 2015 compared to $406.2 million in 2014, an increase of $59.4 million. This increase is due to lower catastrophe losses, a lower expense ratio, and higher net investment income, partially offset by higher large loss activity in the Chaucer segment and lower favorable development on prior years’ loss and loss adjustment expense (“LAE”) reserves (“prior years’ loss reserves”). Pre-tax catastrophe losses were $181.3 million, compared to $223.0 million during 2014. Favorable development on prior years’ loss reserves was $94.3 million in 2015, compared to $99.1 million in 2014.
Underwriting results declined slightly in 2015, as compared to 2014, due to an increase in unfavorable development on prior years’ loss reserves, partially offset by growth in earned premium, underwriting expense efficiencies and improved current accident year loss performance. The competitive nature of the Commercial Lines market requires us to be highly disciplined in our underwriting process to ensure that we write business at acceptable margins, and we continue to seek rate increases across our lines of business.
Personal Lines focuses on partnering with high quality, value-oriented agencies that deliver consultative selling and stress the importance of account rounding (the conversion of single policy customers to accounts with multiple policies and additional coverages). Approximately 80% of our policies in force are account business. We are focused on making investments that help maintain profitability, build a distinctive position in the market, help diversify us geographically from our largest historical core states of Michigan, Massachusetts and New York, and provide us with profitable growth opportunities.
Underwriting results improved in 2015, as compared to 2014, primarily due to lower catastrophe losses and increased favorable development on prior years’ loss reserves. We continue to seek rate increases in excess of underlying loss cost trends, subject to regulatory and competitive considerations.
Underwriting results improved slightly in 2015, as compared to 2014, primarily due to increased favorable development on prior years’ loss reserves, lower catastrophe losses and lower expenses, partially offset by higher large loss activity in our energy line. Excluding the U.K. motor business, due to the aforementioned transfer effective June 30, 2015, Chaucer net premiums written declined by 3.9% in 2015, primarily due to lower volumes in the energy, marine and property lines, partially offset by growth in the specialist liability line.
Consolidated net income was $282.0 million in 2014, compared to $251.0 million in 2013, an increase of $31.0 million. Operating income increased slightly in 2014 as a result of an improvement from current accident year results, primarily in Commercial Lines, and from higher favorable development in both the Personal Lines and Chaucer segments. These increases in operating income were substantially offset by higher catastrophe losses in our domestic operations. The year ended December 31, 2013 included losses from the repayment of debt totaling $18.0 million, net of tax, which did not recur in 2014. Additionally, the year ended December 31, 2014 included higher realized investment gains from the sale of securities, partially offset by after-tax losses of $7.9 million from the settlement of a portion of the defined benefit pension plan obligation.
The following is our discussion and analysis of the results of operations by business segment. The operating results are presented before interest expense, taxes and other items which management believes are not indicative of our core operations, including realized gains and losses.
Excluding the effect of our transfer of the U.K. motor business, net premiums written increased by $112.7 million for the year ended December 31, 2015, compared to the year ended December 31, 2014. This increase was primarily driven by pricing increases, increased retention, and targeted new business expansion primarily in Commercial Lines. U.K. motor net premium written was $(8.3) million and $297.7 million in 2015 and 2014, respectively.
Operating income before interest expense and income taxes was $406.2 million for the year ended December 31, 2014, compared to $393.4 million for the year ended December 31, 2013, an increase of $12.8 million. This increase in the operating income is primarily due to improved current accident year results, primarily in Commercial Lines, and from higher favorable reserve development in both the Personal Lines and Chaucer segments. These increases were substantially offset by higher catastrophe losses in our domestic operations.
Pricing in Commercial Lines continued to be favorable in 2015 as we and the industry reacted to reduced investment income as a result of low interest rates, elevated loss trends in commercial automobile liability lines, recent weather-related losses, and other factors. We are continuing efforts to improve our underwriting results, including through increased rates; however, our ability to increase Commercial Lines net premiums written while maintaining or improving underwriting results may be affected by price competition and the challenging economic environment. We continue to monitor these trends and consider them in our rate actions.
Personal Lines net premiums written were $1,445.6 million for the year ended December 31, 2015, compared to $1,422.8 million for the year ended December 31, 2014, an increase of $22.8 million. This was due primarily to increased rates and improved retention in both the personal automobile and homeowners lines of business.
Other operating losses were $10.7 million for the year ended December 31, 2015, compared to $10.3 million for the year ended December 31, 2014, an increase of $0.4 million.
Personal Lines net premiums written were $1,422.8 million for the year ended December 31, 2014, compared to $1,428.0 million for the year ended December 31, 2013, a decrease of $5.2 million. The primary factors contributing to this decrease were our continued property-focused exposure management actions and actions to improve underwriting results in all lines of business. These decreases were partially offset by higher rates in both our homeowners and personal automobile lines.
Personal Lines underwriting profit for the year ended December 31, 2014 was $22.1 million, compared to $37.6 million for the year ended December 31, 2013, a decrease of $15.5 million. Catastrophe losses for the year ended December 31, 2014 were $106.4 million, compared to $66.9 million for the year ended December 31, 2013, an increase of $39.5 million. Favorable development on prior years’ loss reserves for the year ended December 31, 2014 was $5.1 million, compared to unfavorable development of $13.7 million for the year ended December 31, 2013, a change of $18.8 million, primarily in the personal automobile line.
The IBNR reserve includes a provision for claims that have occurred but have not yet been reported to us, some of which may not yet be known to the insured, as well as a provision for future development on reported claims. IBNR represents a significant proportion of our total net loss reserves, particularly for long-tail liability classes. In fact, approximately 51% of our aggregate net loss reserves at December 31, 2015 were for IBNR losses and loss expenses.
Given the inherent complexity of our loss reserve estimation process and the potential variability of the assumptions used, the actual emergence of losses will vary, perhaps substantially, from the estimate of losses included in our financial statements, particularly in those instances where settlements or other claim resolutions do not occur until well into the future. Our net loss reserves at December 31, 2015 were $4.3 billion. Therefore, a relatively small percentage change in the estimate of net loss reserves would have a material effect on our results of operations.
There is greater inherent uncertainty in estimating insurance reserves for certain types of property and casualty insurance lines, particularly liability lines, where a longer period of time may elapse before a definitive determination of ultimate liability and losses may be made. In addition, the technological, judicial, regulatory and political climates involving these types of claims are continuously evolving. There is also greater uncertainty in establishing reserves with respect to business that is new to us, particularly new business which is generated with respect to newly introduced product lines, by newly appointed agents or in geographies in which we have less experience in conducting business, such as the program business written by AIX Holdings, Inc. (“AIX”), Chaucer’s U.S. casualty treaty and international liability lines, our professional liability specialty lines, our excess and surplus specialty lines, and business written in the western part of the United States. In some of these cases, there is less historical experience or knowledge and less data upon which we can rely. A combination of business that is both new to us and has longer development periods provides even greater uncertainty in estimating insurance reserves. In our management and professional liability lines, we are modestly increasing, and expect to continue to increase, our exposure to longer-tailed liability lines, including directors and officers liability, errors and omissions liability and product liability coverages. The Chaucer business acquired in 2011 contains several liability lines, of which financial institution and professional liability, U.S. casualty treaty liability, international liability and energy liability, contribute the most uncertainty. Chaucer’s U.S. casualty treaty lines have grown in 2014 and 2015, due to our expanded underwriting capabilities.
We regularly review our reserving techniques, our overall reserving position and our reinsurance. Based on (i) our review of historical data, legislative enactments, judicial decisions, legal developments in impositions of damages and policy coverage, political attitudes and trends in general economic conditions, (ii) our review of per claim information, (iii) our historical loss experience and that of the industry, (iv) the nature of policies written by us, and (v) our internal estimates of required reserves, we believe that adequate provision has been made for loss reserves. However, establishment of appropriate reserves is an inherently uncertain process and there can be no certainty that current established reserves will prove adequate in light of subsequent actual experience. A significant change to the estimated reserves could have a material impact on our results of operations and financial position. An increase or decrease in reserve estimates would result in a corresponding decrease or increase in financial results. For example, each one percentage point change in the aggregate loss and LAE ratio resulting from a change in reserve estimation is currently projected to have an approximate $47 million impact on operating income, based on 2015 full year premiums.
The major causes of material uncertainty relating to ultimate losses and LAE (“risk factors”) generally vary for each line of business, as well as for each separately analyzed component of the line of business. In some cases, such risk factors are explicit assumptions of the estimation method and in others, they are implicit. For example, a method may explicitly assume that a certain percentage of claims will close each year, but will implicitly assume that the legal interpretation of existing contract language will remain unchanged. Actual results will likely vary from expectations for each of these assumptions, resulting in an ultimate claim liability that is different from that being estimated currently.
Inflation generally increases the cost of losses covered by insurance contracts. The effect of inflation varies by product. Our property and casualty insurance premiums are established before the amount of losses and LAE and the extent to which inflation may affect such expenses are known. Consequently, we attempt, in establishing rates and reserves, to anticipate the potential impact of inflation in the projection of ultimate costs. For example, we have experienced increasing medical and attendant care costs, including those associated with automobile personal injury protection claims, particularly in Michigan, as well as in our workers’ compensation line in most states. Increases are reflected in our current reserve estimates, but continued increases could contribute to increased losses and LAE in the future.
We are also defendants in various litigation matters, including putative class actions, which may claim punitive damages, bad faith or extra-contractual damages, legal fees and interest, or claim a broader scope of policy coverage or settlement and payment obligations than our interpretation. Resolution of these cases are often highly unpredictable and could involve material unanticipated damage awards.
Short-tail classes consist principally of automobile physical damage, homeowners property, commercial property and marine business. The Chaucer business, while having more longer-tail coverages than our traditional U.S. business, contains a substantial book of worldwide property insurance and reinsurance business, including certain high excess property layers, marine property, aviation property and energy property business which has relatively short development patterns. For these property coverages, claims are generally reported and settled shortly after the loss occurs because the claims relate to tangible property and are more likely to be discovered shortly after the loss occurs, and property losses are often more easily valued. Consequently, the estimation of loss reserves for these classes is generally less complex. However, this is less true for our Chaucer reinsurance business and high excess property layers where there is often a longer period of time between the date a claim is incurred and the date the claim is reported compared with our direct insurance operations. Therefore, the risk of delayed recognition of loss reserve development is higher for our assumed reinsurance and high excess property layers than for our direct insurance lines.
While we estimate that a majority of our written premium is in what we would characterize as shorter-tailed classes of business, most of our loss reserves relate to longer-tail liability classes of business. Long-tailed classes include commercial liability, automobile liability, workers’ compensation and other types of third party coverage. Chaucer’s longer-tailed lines include aviation liability, marine liability, energy liability, nuclear liability, U.S. casualty treaty liability, international liability, specialist liability, and financial institutions and professional liability. For many liability claims, significant periods of time, ranging up to several years or more, may elapse between the occurrence of the loss, the discovery and reporting of the loss to us and the settlement of the claim. As a result, loss experience in the more recent accident years for long-tailed liability coverage has limited statistical credibility because a relatively small proportion of losses in these accident years (the calendar years in which losses are incurred) are reported claims and an even smaller proportion are paid losses. Liability claims are also more susceptible to litigation and can be significantly affected by changing contract interpretations, the legal environment and the risk and expense of protracted litigation. Consequently, the estimation of loss reserves for these coverages is more complex and typically subject to a higher degree of variability and uncertainty compared to short-tailed coverages.
Berquist-Sherman methods are used for estimating reserves in business lines where historical development patterns may be deemed less reliable for more recent accident years’ ultimate losses. Under these methods, patterns of historical paid or reported losses are first adjusted to reflect current payment settlement patterns and case reserve adequacy and then evaluated in the same manner as the loss development factor methods described above. When the adequacy of case reserves change, the Berquist-Sherman incurred method may be deemed more reliable than the reported loss development factor method. Likewise, when the settlement patterns change, the Berquist-Sherman paid method may be deemed more reliable than the paid loss development factor method.
For longer-tailed lines of business, applying the loss development factor method often requires even more judgment in selecting development factors, as well as more significant extrapolation. For those long-tailed lines of business with high frequency and relatively low per-loss severity (e.g., personal automobile liability), volatility will often be sufficiently modest for the loss development factor method to be given significant weight, even in the most recent accident years, but expected loss methods and adjusted loss methods are always considered and frequently utilized in the selection process. For those long-tailed lines of business with low frequency and high loss potential (e.g., commercial liability), anticipated loss experience is less predictable because of the small number of claims and erratic claim severity patterns. In these situations, the loss development factor methods may not produce a reliable estimate of ultimate losses in the most recent accident years since many claims either have not yet been reported or are only in the early stages of the settlement process. Therefore, the loss reserve estimates for these accident years are based on methods less reliant on extrapolation, such as Bornheutter-Ferguson. Over time, as a greater number of claims are reported and the statistical credibility of loss experience increases, loss development factor methods or adjusted loss methods are given increasing weight.
Personal and Commercial Automobile Bodily Injury - reserves recorded for bodily injury on U.S. voluntary business were $530.9 million as of December 31, 2015. A key assumption for bodily injury is the inflation rate underlying the estimated reserve. A five point change (e.g. 4% changed to 9% or -1%) in the embedded inflation rate would have changed estimated IBNR by approximately $56 million, either positive or negative, respectively, at December 31, 2015.
Personal Automobile Personal Injury Protection Medical Payment - reserves recorded for personal injury protection medical payment on U.S. voluntary business were $153.9 million as of December 31, 2015. A key assumption for this coverage is the inflation rate underlying the estimated reserve. Given the long reporting pattern for this line of business, an additional key assumption is the amount of additional development required to reach full maturity, thereby reflecting ultimate costs, as represented by the tail factor. A five point change in the embedded inflation rate and a one point change to the tail factor assumption (e.g. 1.02 changed to 1.01 or 1.03) would have changed estimated IBNR by approximately $24 million, either positive or negative, at December 31, 2015.
Specialty Programs - reserves recorded (including allocated LAE) for the AIX Companies were $299.5 million as of December 31, 2015. Two key assumptions underlying the actuarial reserve analysis for specialty programs are the expected loss and allocated LAE ratio (“ELR”) and the tail factor selection. A ten point change to the ELR and a five point change in the tail factor on AIX would have changed estimated IBNR by approximately $29 million at December 31, 2015.
Other lines are primarily comprised of our professional and management liability, general liability, umbrella, marine, surety, voluntary pools, and healthcare lines. Included in the above table, primarily in other lines, are $57.7 million, $60.6 million and $61.9 million of asbestos and environmental reserves as of December 31, 2015, 2014 and 2013, respectively. Included in the Chaucer segment in the above table are $166.0 million, $203.3 million and $230.6 million of reserves as of December 31, 2015, 2014 and 2013, respectively, related to Chaucer’s financial and professional liability lines written in 2008 and prior periods.
The primary drivers of reserve development for the year ended December 31, 2015 including the aforementioned results of our domestic year end reserve review were as follows:
energy line of $39.9 million, primarily in the 2012 through 2014 accident years,
marine and aviation lines of $29.6 million, primarily in the 2010, 2012 and 2013 accident years,
Lower than expected losses within our homeowners’ line, primarily related to accident years 2010 through 2013.
Higher than expected losses in Other Commercial Lines of $53.7 million, which includes our AIX program business. This was driven by AIX commercial automobile and general liability lines in accident years 2011 through 2013, primarily from programs which have since been terminated. We also experienced higher than expected losses within our general liability lines, primarily in accident years 2009 through 2012. These losses were partially offset by lower than expected losses in our commercial umbrella line in accident years 2012 through 2014, and lower than expected losses in our healthcare line in accident years 2010 through 2014.
Higher than expected losses within our commercial automobile lines of $23.4 million, primarily related to liability coverage in accident years 2011 through 2013.
Higher than expected losses within our commercial multiple peril lines, primarily in accident years 2008, 2009 and 2011.
marine and aviation lines of $40.1 million, primarily in the 2011 through 2013 accident years,
within casualty and other lines, specialist liability lines of $21.4 million, primarily in the 2010 and 2013 accident years, and
Lower than expected losses within our workers’ compensation line, primarily related to accident years 2007 through 2012.
Higher than expected large losses within our commercial automobile coverages of $23.1 million, which includes our AIX program business, primarily related to liability coverage in accident years 2009 through 2012.
energy line of $30.4 million, primarily in the 2009 through 2012 accident years,
Lower than expected losses within our workers’ compensation line, primarily related to accident years 2006 through 2011 and lower involuntary pool losses including a $3.2 million benefit from the settlement of a legal proceeding.
Higher than expected losses within our other commercial lines, primarily related to accident years 2010 through 2012.
Activity for our asbestos and environmental reserves was not significant to our 2015, 2014 or 2013 financial results. In recent years, average asbestos and environmental payments have declined modestly. As a result of our historical direct underwriting mix of Commercial Lines policies toward smaller and middle market risks, past asbestos and environmental damage liability loss experience has remained minimal in relation to our total loss and LAE incurred experience.
Net investment income before taxes was $279.1 million, $270.3 million and $269.0 million for the years ended December 31, 2015, 2014 and 2013, respectively. The increase in net investment income in 2015 compared to 2014 was primarily due to the investment of higher operational cash flows and additional income from our growing asset classes such as commercial mortgage loan participations, partnerships and equities, and to lower investment expenses. These increases were partially offset by the effect of lower investment assets associated with our repurchase of stock and debt and the transfer of the U.K. motor business, as well as the impact of lower new money yields. The increase in net investment income in 2014 compared to 2013 was primarily due to additional income resulting from the investment of higher operational cash flows, partially offset by the impact of lower new money yields. Average pre-tax earned yields on fixed maturities were 3.61%, 3.71% and 3.95% for the years ended December 31, 2015, 2014 and 2013, respectively. We expect average investment yields to continue to decline as new money rates remain lower than embedded book yields. Total pre-tax earned yields were 3.44%, 3.42% and 3.63% for the years ended December 31, 2015, 2014 and 2013, respectively.
Based on ratings by the National Association of Insurance Commissioners (“NAIC”), approximately 94% of the fixed maturity portfolio consisted of investment grade securities at December 31, 2015 and December 31, 2014. The quality of our fixed maturity portfolio remains strong based on ratings, capital structure position, support through guarantees, underlying security, issuer diversification and yield curve position.
While the United States has reduced its extraordinary measures, other major central banks continue with their stimulus policies as they seek higher growth and confront inflation and inflation expectations running below target. The removal, modification or suggestion of changes in these policies could have an adverse effect on prevailing market interest rates and on issuers’ level of business activity or liquidity, increasing the probability of future defaults. Fundamental conditions in the corporate sector generally remain sound with the exception of the energy and metals and mining industries. Weakness in these two sectors is due to a combination of over-supply and weak demand, which has resulted in energy and commodity prices that are near multi-year lows. While we may experience defaults on fixed income securities, particularly with respect to non-investment grade debt securities, it is difficult to foresee which issuers, industries or markets, other than those previously cited, will be affected. As a result, the value of our fixed maturity portfolio could change rapidly in ways we cannot currently anticipate, and we could incur additional realized and unrealized losses in future periods.
Net realized gains on investments were $19.5 million, $50.1 million, and $33.5 million for 2015, 2014, and 2013, respectively. Net realized gains in 2015 were primarily due to $39.9 million of gains recognized from the sale of equity securities and, to a lesser extent, fixed maturities, and $6.4 million of gains from other investments, primarily partnerships. These gains were partially offset by $26.8 million of OTTI losses. Net realized gains in 2014 were primarily due to $55.4 million of gains recognized from the sale of equity securities and to a lesser extent, fixed maturities, partially offset by $5.5 million of OTTI losses. Net realized gains in 2013 were primarily due to $41.3 million of gains recognized from the sale of equities and fixed maturities, partially offset by $6.0 million of OTTI losses.
The following tables for the years ended December 31, 2015 and 2014 provide information about financial instruments that are sensitive to changes in interest rates. The tables present principal cash flows and related weighted average interest rates by expected maturities. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties, or we may have the right to put or sell the obligations back to the issuers. Mortgage-backed and asset-backed securities are included in the category representing their expected maturity. Available-for-sale securities include both U.S. and foreign-denominated fixed maturities. Additionally, we have assumed available-for-sale securities are similar enough to aggregate those securities for presentation purposes. Specifically, variable rate available-for-sale securities comprise an immaterial portion of the portfolio and do not have a significant impact on weighted average interest rates. Therefore, the variable rate investments are not presented separately; instead they are included in the tables at their current interest rate. Debt is presented at contractual maturities.
Our equity securities portfolio is exposed to equity price risk arising from potential volatility in equity market prices. Portfolio characteristics are analyzed regularly and price risk is actively managed through a variety of techniques. A hypothetical increase or decrease of 10% in the market price of our equity securities would have resulted in an increase or decrease in the fair value of the equity securities portfolio of approximately $58 million at December 31, 2015 and December 31, 2014, respectively.
Included in our deferred tax net asset as of December 31, 2015 are assets of $68.8 million related to alternative minimum tax (“AMT”) credit carryforwards and $1.7 million related to foreign tax credit carryforwards. We may utilize these credits to offset future taxable income. The result of their utilization will be a lower current tax rate offset by a higher deferred tax provision, and also lower cash expenditures for federal income taxes during the utilization period. There is no expiration on AMT credit carryforwards and our foreign tax credit carryforwards will expire beginning in 2022. It is our opinion that there will be sufficient future U.S. and U.K. taxable income to utilize these tax credit carryforwards. Our estimate of the amount and likely realization of tax credit carryforwards may change over time.
In prior years, we completed several transactions which resulted in the realization, for tax purposes only, of unrealized gains in our investment portfolio. As a result of these transactions, we were able to realize capital losses carried forward and to release the valuation allowance recorded against the deferred tax asset related to these losses. The releases of valuation allowances were recorded as a benefit in accumulated other comprehensive income. Previously unrealized benefits of $13.3 million, $16.2 million and $17.5 million attributable to non-operating income, are recognized as part of our income from continuing operations during 2015, 2014 and 2013, respectively. The remaining amount of $78.2 million in accumulated other comprehensive income will be released into income from continuing operations in future years, as the investment securities subject to these transactions are sold or mature.
The discussion and analysis of our financial condition and results of operations are based upon the consolidated financial statements. These statements have been prepared in accordance with U.S. GAAP, which requires us 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 financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates. The following critical accounting estimates are those which we believe affect the more significant judgments and estimates used in the preparation of our financial statements. Additional information about other significant accounting policies and estimates may be found in Note 1-“Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements included in Financial Statements and Supplementary Data of this Form 10-K.
See “Results of Operations - Segments - Reserve for Losses and Loss Adjustment Expenses” in Management’s Discussion and Analysis of Financial Condition and Results of Operations of this Form 10-K for a discussion of our critical accounting estimates for loss reserves.
For the years ended December 31, 2015 and 2014, the expected rate of return on our qualified plan assets was 5.00% and 5.50%, respectively. The decrease reflects the sustained challenging interest rate environment which is negatively impacting long-term returns. Actual returns of the plan investments generated approximately $4 million of losses and $59 million of gains during 2015 and 2014, respectively, as compared to expected returns of approximately $25 million and $28 million, respectively. The plan assets consisted of 85% fixed maturities and 15% equities at December 31, 2015.
In 2015, investment losses of approximately $28 million were partially offset by actuarial gains of approximately $23 million, primarily resulting from the increase in the discount rate from the prior year. In 2014, actuarial losses of approximately $53 million primarily resulting from the decrease in the discount rate from the prior year and changes in mortality assumptions were partially offset by investment gains of approximately $31 million. The net losses of $4.6 million and $21.8 in 2015 and 2014, respectively, are reflected as decreases to accumulated other comprehensive income. The change in these actuarial gains and losses is amortized into earnings in future periods. In 2015 and 2014, amortization of actuarial losses from prior years was $10.5 million and $10.6 million, respectively. In 2014, we also accelerated recognition of actuarial losses of $10.8 million, resulting from the settlement of pension obligations related to a voluntary settlement program.
Given the adverse effect of our actual investment experience in 2015, and taking into consideration the increase in discount rates for 2016, U.S. pension related expenses are expected to increase from $8.5 million in 2015 to approximately $9.8 million in 2016.
Expected Return on Plan Assets - A 25 basis point increase or decrease in the expected return on plan assets would decrease or increase our pension expense in 2016 by $1.1 million.
As of December 31, 2015 and 2014, we determined the discount rate utilizing an independent yield curve which provides for a portfolio of high quality bonds that are expected to match the cash flows of the Chaucer plan. At December 31, 2015, based upon Chaucer’s plan liabilities and cash flows in relation to these yield curves, we increased the discount rate to 3.85% from 3.75% at December 31, 2014.
For the years ended December 31, 2015 and 2014, the expected rate of return on plan assets was 5.45% and 6.55%, respectively. The composition of Chaucer’s plan assets are 56% equities, 32% fixed maturities, and 12% real estate funds at December 31, 2015. Actual returns of the plan investments generated approximately $3 million and $15 million of gains during the years ended December 31, 2015 and 2014, respectively, as compared to expected returns of approximately $7 million and $8 million, respectively.
We employ a systematic methodology to evaluate declines in fair values below amortized cost for all fixed maturity and equity security investments. The methodology utilizes a quantitative and qualitative process which seeks to ensure that available evidence concerning the declines in fair value below amortized cost is evaluated in a disciplined manner. In determining whether a decline in fair value below amortized cost is other-than-temporary, we evaluate several factors and circumstances, including the issuer’s overall financial condition; the issuer’s credit and financial strength ratings; the issuer’s financial performance, including earnings trends, dividend payments and asset quality; any specific events which may influence the operations of the issuer; the general outlook for market conditions in the industry or geographic region in which the issuer operates; and the length of time and the degree to which the fair value of an issuer’s securities remains below our cost. With respect to fixed maturity investments, we consider factors that might raise doubt about the issuer’s ability to make contractual payments as they become due and whether we expect to recover the entire amortized cost basis of the security. With respect to equity securities, we consider our ability and intent to hold the investment for a period of time to allow for a recovery in value.
We estimate the amount of the OTTI that relates to credit by comparing the amortized cost of the debt security with the net present value of the debt security’s projected future cash flows, discounted at the effective interest rate implicit in the investment prior to impairment. The non-credit portion of the impairment is equal to the difference between the fair value and the net present value of the debt security at the impairment measurement date.
We have $68.8 million of alternative minimum tax credit carryforwards and $1.7 million of foreign tax credit carryforwards. The alternative minimum tax credit carryforwards have no expiration date and may be used to offset regular federal income taxes due from future income. The foreign tax credit carryforwards will expire beginning in 2022 and may be used to offset federal income taxes due from future foreign sourced income. In addition, we have operating loss carryforwards from our Chaucer segment, which have no expiration date. Based on our projection of future economic conditions, taxable income, reversals of existing taxable temporary liabilities, and our strategic tax planning strategies, we believe that these tax credit carryforwards and operating loss carryforwards will be fully realized.
Liquidity is a measure of our ability to generate sufficient cash flows to meet the cash requirements of business operations. As a holding company, our primary ongoing source of cash is dividends from our insurance subsidiaries. However, dividend payments to us by our U.S. insurance subsidiaries are subject to limitations imposed by regulators, such as prior notice periods and the requirement that dividends in excess of a specified percentage of statutory surplus or prior year’s statutory earnings receive prior approval (so called “extraordinary dividends”). No dividends were paid to the holding company by Hanover Insurance in 2015, 2014 or 2013.
In connection with an intercompany borrowing arrangement between Chaucer and the holding company, interest on a $300 million note is paid by Chaucer on a quarterly basis to the holding company. This interest may be deferred at the election of the holding company. If deferred, the interest is added to the principal. Chaucer paid $22.5 million, $22.5 million and $28.1 million of interest to the holding company during 2015, 2014 and 2013, respectively.
Net cash used in investing activities was $171.5 million during 2015, as compared to $600.7 million during 2014 and $358.7 million in 2013. During 2015 cash used in investing activities primarily related to net purchases of commercial mortgage loan participations and fixed maturities. These cash outflows were partially offset by net cash received from the disposal of the U.K. motor business. In 2014 and 2013, cash used in investing activities primarily related to net purchases of fixed maturities, equity securities, and other investments. See Note 3 - “Investments” in the Notes to Consolidated Financial Statements included in Financial Statements and Supplementary Data of this Form 10-K.
Dividends to common shareholders are subject to quarterly board approval and declaration. During 2015, as declared by the Board, we paid three quarterly dividends of $0.41 per share and one quarterly dividend of $0.46 per share to our shareholders totaling $74.2 million. We believe that our holding company assets are sufficient to provide for future shareholder dividends should the Board of Directors declare them.
We expect to continue to generate sufficient positive operating cash to meet all short-term and long-term cash requirements relating to current operations, including the funding of our qualified defined benefit pension plan and the Chaucer pension plan. Based upon the current estimate of liabilities and certain assumptions regarding investment returns and other factors, our qualified defined benefit pension plans and Chaucer pension plan collectively have plan liabilities in excess of plan assets by approximately $32 million. The ultimate payment amounts for our benefit plans are based on several assumptions, including but not limited to, the rate of return on plan assets, the discount rate for benefit obligations, mortality experience, interest crediting rates, inflation and the ultimate valuation and determination of benefit obligations. Since differences between actual plan experience and our assumptions are almost certain, changes both positive and negative to our current funding status and ultimately our obligations in future periods are likely.
Since October 2007 and through December 2015, our Board of Directors has authorized aggregate repurchases of our common stock of up to $900 million. Under the repurchase authorizations, the Company may repurchase, from time to time, common shares in amounts, at prices and at such times as the Company deems appropriate, subject to market conditions and other considerations. Repurchases may be executed using open market purchases, privately negotiated transactions, accelerated repurchase programs or other transactions. We are not required to purchase any specific number of shares or to make purchases by any certain date under this program. During 2015, we repurchased approximately 1.6 million shares of our common stock at a cost of $127.3 million.
On October 15, 2015, we entered into a Standby Letter of Credit Facility Agreement (the “Facility Agreement”) not to exceed £170.0 million (or $250.6 million) outstanding at any one time, with the option to increase the amount available for issuances of letters of credit to £235.0 million (or $346.4 million) in the aggregate on one occasion only during the term of the Facility Agreement (subject to the consent of all lenders and assuming no default and satisfaction of other specified conditions). The Facility Agreement replaces a Standby Letter of Credit Facility Agreement entered into on November 15, 2013 (the “Prior Facility Agreement”). This prior agreement provided for amounts available for issuances of letters of credit not to exceed £130.0 million (or $191.6 million) outstanding at any one time, with a similar option to increase the amount available for issuances of letters of credit to £195.0 million (or $287.5 million). The Facility Agreement, like the Prior Facility Agreement, provides certain covenants including, but not limited to, the syndicates’ financial condition. The Facility Agreement provides regulatory capital supporting Chaucer’s underwriting activities for the 2015, 2016 and 2017 years of account and each prior open year of account. The Prior Facility Agreement provided regulatory capital supporting Chaucer’s underwriting activities for the 2014 and 2015 years of account and each prior open year of account. The Facility Agreement is generally renewed biennially to support new underwriting years.
Financing obligations generally include repayment of our senior debentures, subordinated debentures, borrowings from the FHLBB, and operating lease payments. The following table represents our annual payments related to the contractual principal and interest payments of these financing obligations as of December 31, 2015 and operating lease payments reflect expected cash payments based upon lease terms. In addition, we also have included our estimated payments related to our loss and LAE obligations and our current expectation of payments to be made to support the obligations of our benefit plans. The following table also includes commitments to purchase investment securities at a future date. Actual payments may differ from the contractual and/or estimated payments in the table.
Debt includes our senior debentures due in 2025, which pay annual interest at a rate of 7.625%, our senior debentures due in 2020, which pay annual interest at a rate of 7.50%, our senior debentures due in 2021, which pay annual interest at a rate of 6.375%, our subordinated debentures due in 2053, which pay annual interest at a rate of 6.35%, and our subordinated debentures due in 2027, which pay cumulative dividends at an annual rate of 8.207%. Payments related to the principal amounts of these agreements represent contractual maturity; therefore, principal and interest associated with these obligations are reflected in the above table based upon the contractual maturity dates. In addition, we have $125.0 million of borrowings under a collateralized borrowing program with the FHLBB which pays interest monthly at a rate of 5.50% annually. Such borrowings are available for a twenty-year term or through September 25, 2029. Also, interest includes contractual interest related to the uncollateralized portion of our £170.0 million Standby Letter of Credit Facility.
Catastrophe loss - Loss and directly identified loss adjustment expenses from catastrophes. The Insurance Services Office (“ISO”) Property Claim Services (“PCS”) defines a catastrophe loss as an event that causes $25 million or more in U.S. industry insured property losses and affects a significant number of property and casualty policyholders and insurers. In addition to those catastrophe events declared by ISO, claims management also generally includes within the definition of a “catastrophe loss”, a property loss event that causes approximately $5 million or more in Company insured losses and affects in excess of one hundred policy holders or multiple independent risks. For the international business in our Chaucer segment, management utilizes a “catastrophe loss” definition that is substantially consistent with the ISO definition framework.
Combined ratio - This ratio is the GAAP equivalent of the statutory ratio that is widely used as a benchmark for determining an insurer’s underwriting performance. A ratio below 100% generally indicates profitable underwriting prior to the consideration of investment income. A combined ratio over 100% generally indicates unprofitable underwriting prior to the consideration of investment income. The combined ratio is the sum of the loss and loss adjustment expense ratio and the expense ratio.
Other investments consist primarily of mortgage participations, overseas deposits and limited partnerships. Mortgage participations represent interests in commercial mortgage loans originated and serviced by a third party of which the Company shares, on a pro-rata basis, in all related cash flows of the underlying mortgage loans. Due to certain reacquisition rights retained by the third party in the loan participation, these investments are accounted for as secured borrowings under Accounting Standards Codification (“ASC”) 860, Transfers and Servicing (“ASC 860”).
The Company’s debt at December 31, 2015 includes senior debentures, subordinated debentures, and collateralized borrowings with the Federal Home Loan Bank of Boston (“FHLBB”). The senior debentures are carried at principal amount borrowed, net of any applicable unamortized discounts. The subordinated debentures and borrowings under the FHLBB program are carried at principal amount borrowed (See Note 6 - “Debt and Credit Arrangements”).
Insurance premiums written are generally recorded at the policy inception and are primarily earned on a pro rata basis over the terms of the policies for all products. Premiums written include estimates, primarily in the Chaucer segment, that are derived from multiple sources, which include the historical experience of the underlying business, similar businesses and available industry information. These estimates are regularly reviewed and updated, and any resulting adjustments are included in the current year’s results. Unearned premium reserves represent the portion of premiums written that relates to the unexpired terms of the underlying in-force insurance policies and reinsurance contracts. Premium receivables reflect the unpaid balance of premium written as of the balance sheet date. Premium receivables are generally short-term in nature and are reported net of an allowance for estimated uncollectible premium accounts. The Company reviews its receivables for collectability at the balance sheet date. The allowance for uncollectible accounts was not material as of December 31, 2015 and 2014. Ceded premiums are charged to income over the applicable term of the various reinsurance contracts with third party reinsurers. Reinsurance reinstatement premiums, when required, are recognized in the same period as the loss event that gave rise to the reinstatement premiums. Losses and related expenses are matched with premiums, resulting in their recognition over the lives of the contracts. This matching is accomplished through estimated and unpaid losses and amortization of deferred acquisition costs.
In July 2013, the FASB issued ASC Update No. 2013-11 (Topic 740) Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force). This ASC update clarifies the applicable guidance for the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward as long as it is available, at the reporting date under the tax law of the applicable jurisdiction, to settle any additional income taxes that would result from the disallowance of a tax position (with certain exceptions). The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. This guidance was applicable for reporting periods beginning after December 15, 2013, with early adoption permitted, and was to be applied prospectively to all unrecognized tax benefits that existed at the effective date. Retrospective application to all prior periods upon the date of adoption was permitted. The Company implemented this guidance effective January 1, 2014. The effect of implementing this guidance was not material to the Company’s financial position or results of operations.
In January 2016, the FASB issued ASC Update No. 2016-01, (Subtopic 825-10) Financial Instruments- Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. This ASC update requires unconsolidated equity investments to be measured at fair value with changes in the fair value recognized in net income, except for those accounted for under the equity method. This update eliminates the cost method for equity investments without readily determinable fair values and replaces with other methods, including the use of Net Asset Value (“NAV”). Additionally, when a public entity is required to measure fair value for disclosure purposes and holds financial instruments measured at amortized cost, the updated guidance requires these instruments to be measured using exit price. It also requires financial assets and financial liabilities to be presented separately in the notes to the financial statements, grouped by measurement category and form of financial asset. The updated guidance is effective for annual periods beginning after December 15, 2017. The Company is evaluating the impact of the adoption of ASC update 2016-01 on its financial position and results of operations.
The Company participates in a security lending program for the purpose of enhancing income. Securities on loan to various counterparties had a fair value of $36.2 million and $20.9 million at December 31, 2015 and 2014, respectively, and were fully collateralized by cash. The fair value of the loaned securities is monitored on a daily basis, and the collateral is maintained at a level of at least 102% of the fair value of the loaned securities. Securities lending collateral is recorded by the Company in cash and cash equivalents, with an offsetting liability included in expenses and taxes payable.
In accordance with Lloyd’s operating guidelines, the Company deposits funds at Lloyd’s to support underwriting operations. These funds are available only to fund claim obligations. At December 31, 2015 and 2014, fixed maturities with a fair value of approximately $441 million and $450 million, respectively, and cash of $7 million and $2 million, respectively, were on deposit with Lloyd’s.
The Company enters into various agreements that may require its fixed maturities to be held as collateral by others. At December 31, 2015 and 2014, fixed maturities with a fair value of $188.1 million and $208.2 million, respectively, were held as collateral for collateralized borrowings and other arrangements. Of these amounts, $176.0 million and $195.7 million related to the FHLBB collateralized borrowing program at December 31, 2015 and 2014, respectively. See Note 6-“Debt and Credit Arrangements” for additional information related to the Company’s FHLBB program.
The Company maintains an overall risk management strategy that incorporates the use of derivative instruments, as necessary, to manage significant unplanned fluctuations in earnings that may be caused by foreign currency exchange and interest rate volatility. The Company did not use derivative instruments in 2015, 2014 or 2013.
Equity securities and other balances at December 31, 2015, 2014 and 2013 include after-tax net appreciation on other invested assets of $2.2 million, $2.6 million and $2.9 million, respectively.
At December 31, 2015, scheduled maturities of mortgage participations and other mortgage loans were as follows: due in 2017 - $1.0 million; 2020 - $10.0 million; and thereafter - $189.9 million. There were no scheduled loan maturities in 2016, 2018 or 2019. Actual maturities could differ from contractual maturities because borrowers may have the right to prepay obligations with or without the prepayment penalties and loans may be refinanced. During 2015, the Company did not refinance any loans based on terms that differed from current market rates.
The Company held overseas deposits of $100.9 million and $132.6 million at December 31, 2015 and 2014, respectively, which are investments held in overseas funds and managed exclusively by Lloyd’s.
The Company had no concentration of investments in a single investee that exceeded 10% of shareholders’ equity except for fixed maturities invested in Federal Home Loan Mortgage Corp. (“FHLMC”) and Federal National Mortgage Association (“FNMA”). At December 31, 2015, the Company held FHLMC and FNMA with fair values of $467.9 million and $298.1 million, respectively. At December 31, 2014, the Company held FHLMC and FNMA with fair values of $394.4 million and $315.8 million, respectively.
At December 31, 2015, there were contractual investment commitments of up to $124.1 million.
For 2014, total OTTI was $5.4 million. Of this amount, $5.5 million was recognized in earnings including $0.1 million which was transferred from unrealized losses in AOCI. The $5.5 million of OTTI recognized in earnings was related to fixed maturity securities that the Company intended to sell.
For 2013, total OTTI was $7.0 million. Of this amount, $6.0 million was recognized in earnings and $1.0 million was recorded as unrealized losses in AOCI.
Other investments include mortgage participations and other mortgage loans, overseas trust funds required in connection with our Lloyd’s business and cost basis limited partnerships. Fair values of mortgage participations and other mortgage loans are estimated by discounting the contractual cash flows using the rates at which similar loans would be made to borrowers with comparable credit ratings and are reported as Level 3. Fair values of overseas trust funds are provided by the investment manager based on quoted prices for similar instruments in active markets and are reported as Level 2. The fair values of cost basis limited partnerships are based on the NAV provided by the general partner and recent financial information and are reported as Level 3.
The estimated fair value of the financial instruments were as follows:
The Company has processes designed to ensure that the values received from its third party pricing service are accurately recorded, that the data inputs and valuation techniques utilized are appropriate and consistently applied and that the assumptions are reasonable and consistent with the objective of determining fair value. The Company performs a review of the fair value hierarchy classifications and of prices received from its pricing service on a quarterly basis. The Company reviews the pricing services’ policies describing its methodology, processes, practices and inputs, including various financial models used to value securities. Also, the Company reviews the portfolio pricing, including securities with changes in prices that exceed a defined threshold are verified to independent sources, if available. If upon review, the Company is not satisfied with the validity of a given price, a pricing challenge would be submitted to the pricing service along with supporting documentation for its review. The Company does not adjust quotes or prices obtained from the pricing service unless the pricing service agrees with the Company’s challenge. During 2015 and 2014, the Company did not adjust any prices received from brokers or its pricing service.
The following table provides quantitative information about the significant unobservable inputs used by the Company in the fair value measurements of Level 3 assets. Where discounted cash flows were used in the valuation of fixed maturities, the internally-developed discount rate was adjusted by the significant unobservable inputs shown in the table. Valuations for securities based on broker quotes for which there was a lack of transparency as to inputs used to develop the valuations of $0.2 million have been excluded.
On June 17, 2011, the Company issued $300.0 million aggregate principal amount of 6.375% senior unsecured debentures due June 15, 2021. Additionally, on February 23, 2010, the Company issued $200.0 million aggregate principal amount of 7.50% senior unsecured debentures. At December 31, 2015 and 2014, the remaining 7.50% senior debentures have a par value of $80.0 million and $164.6 million, respectively, and mature on March 1, 2020. The Company also issued 7.625% senior unsecured debentures with a par value of $200.0 million on October 16, 1995. As of December 31, 2015 and 2014, the remaining 7.625% senior debentures have a par value of $74.6 million and $81.1 million, respectively, and mature on October 15, 2025. All of the Company’s senior debentures are subject to certain restrictive covenants, including limitations on the issuance or disposition of stock of restricted subsidiaries and limitations on liens. These debentures pay interest semi-annually.
On March 20, 2013, the Company issued $175.0 million aggregate principal amount of 6.35% subordinated unsecured debentures due March 30, 2053. These debentures pay interest quarterly. The Company may redeem these debentures in whole at any time, or in part from time to time, on or after March 30, 2018, at a redemption price equal to their principal amount plus accrued and unpaid interest. In addition, the Company’s subordinated debentures maturing February 3, 2027 have a par value of $59.7 million as of December 31, 2015 and 2014 and pay cumulative dividends semi-annually at 8.207%.
In 2015, the Company repurchased senior debentures maturing March 1, 2020, with a carrying value of $83.7 million at a cost of $106.0 million, resulting in a loss of $22.3 million, and senior debentures maturing October 15, 2025, with a carrying value of $6.5 million at a cost of $8.3 million, resulting in a loss of $1.8 million. These losses are included in other operating expenses.
Deferred tax assets are reduced by a valuation allowance if it is more likely than not that all or some portion of the deferred tax assets will not be realized.
During 2014, the Company released the valuation allowance related to its deferred tax assets of $2.9 million which was recorded in 2013. The release of this valuation allowance resulted from appreciation in the Company’s investment portfolio and is recorded as a $2.9 million decrease in its income tax expense.
There are no tax positions at December 31, 2015 and 2014 for which the ultimate deductibility is highly certain, but for which there is uncertainty about the timing of such deductibility. At December 31, 2013, the ultimate deductibility of a $4.8 million liability was highly certain, but there was uncertainty about the timing of such deductibility. Because of the impact of deferred tax accounting, other than interest and penalties, a change in the timing of deductions would not impact the annual effective tax rate.
Prior to 2002, the Chaucer segment provided defined benefit pension retirement benefits to certain of its employees. As of December 31, 2001, the defined benefit pension plan was closed to new members. The defined benefit obligation for this plan is based on the employees’ years of service and final pensionable salary. Contributions are made at least annually to this plan by both the Company and by employees. As of December 31, 2015, based on current estimates of plan liabilities and other assumptions, the projected benefit obligation of the qualified defined benefit pension plan exceeds plan assets by approximately $5 million.
The Company utilizes a measurement date of January 1st to determine its periodic pension costs. Weighted average assumptions used to determine net periodic pension costs for the defined benefit plans are as follows:
The expected rates of return were determined by using historical mean returns for each asset class, adjusted for certain factors believed to have an impact on future returns. These returns are generally weighted to the plan’s actual asset allocation. For the U.S. defined benefit plans, expectations with respect to the interest rate market resulted in a decrease in the expected return on plan assets for 2015 to 5.00%. Regarding the Chaucer defined benefit plan, the challenging equity markets in the U.K. and globally was the primary reason for the decrease in the expected rate of return on plan assets for 2015 to 5.45%. The Company reviews and updates, at least annually, its expected return on plan assets based on changes in the actual assets held by the plans and market conditions.
The following table provides 2015 target allocations and actual invested asset allocations for 2015 and 2014.
The following tables present for each hierarchy level the U.S. qualified defined benefit plan’s investment assets that are measured at fair value at December 31, 2015 and 2014. (Refer to Note 5 - “Fair Value” for a description of the different levels in the Fair Value Hierarchy).
Securities classified as Level 1 at December 31, 2015 and 2014 include actively traded mutual funds and publicly traded securities, which are valued at quoted market prices. Securities classified as Level 2 at December 31, 2015 and 2014 include commingled pools and investment grade fixed income securities that are held in a custom fund, as well as a separate investment account, which is invested entirely in the Vanguard Total Bond Market Index Fund, a mutual fund that in turn invests in investment grade fixed maturities. The fair value of each of the Level 2 investments is determined daily as the NAV based on the value of the underlying investments, which is determined independently by the investment manager. The daily NAV, which is not published as a quoted market price for these investments, is used as the basis for transactions. Redemption of these funds is not subject to restriction. Securities classified as Level 3 at December 31, 2015 and 2014 include assets held in a fixed account of an insurance company. The fair value of the investment is estimated using a comparable public market financial institution derived fair value curve that uses non-observable inputs for market liquidity and unique credit characteristics of its underlying securities.
The following table reflects the benefit obligations, fair value of plan assets and funded status of the plans at December 31, 2015 and 2014.
The U.S. Qualified Pension Plan included $59.0 million paid in 2014 to participants in settlement of their pension obligations, essentially as a result of a voluntary lump-sum pension payout program and the termination of a small qualified defined benefit plan.
The components of total net periodic pension cost are as follows:
The following table reflects the total amounts recognized in accumulated other comprehensive income relating to both the U.S. defined benefit pension plans and the Chaucer pension plan as of December 31, 2015 and 2014.
The unrecognized net actuarial gains (losses) which exceed 10% of the greater of the projected benefit obligation or the fair value of plan assets are amortized as a component of net periodic pension cost over the next five years. The following table reflects the total estimated amount of actuarial losses that will be amortized from accumulated other comprehensive income into net periodic pension cost in 2016:
In addition to the defined benefit plans, THG provides a defined contribution 401(k) plan for its U.S. employees, whereby the Company matches employee elective 401(k) contributions, up to a maximum of 6% of eligible compensation in 2015, 2014, and 2013. The Company’s expense for this matching provision was $20.1 million, $19.9 million and $18.3 million for 2015, 2014 and 2013, respectively. In addition to this matching provision, the Company can elect to make an annual contribution to employees’ accounts. Additional contributions amounted to $2.0 million, $2.1 million and $2.8 million for the 2015, 2014 and 2013 plan years, respectively.
Chaucer also provides a defined contribution plan for its employees which provides for employer provided contributions. The Company’s expense for 2015, 2014 and 2013 was $4.8 million, $6.1 million and $5.0 million, respectively.
Employers are required to measure the funded status of their plans as of the date of their year-end statement of financial position. As such, the Company has utilized a measurement date of December 31, 2015 and 2014, to determine its postretirement benefit obligations, consistent with the date of its Consolidated Balance Sheets. Weighted average discount rate assumptions used to determine postretirement benefit obligations and periodic postretirement costs are as follows:
A one-percentage point change in assumed health care cost trend rates in each year would have an immaterial effect on net periodic benefit cost during 2015 and accumulated postretirement benefit obligation at December 31, 2015.
The amount reclassified from accumulated other comprehensive income for the pension and postretirement benefits was allocated approximately 40% to loss adjustment expenses and 60% to other operating expenses for each of the years ended December 31, 2015, 2014 and 2013. In 2014, $12.1 million of this amount represented the accelerated recognition of unamortized losses due to the settlement of pension plan obligations.
On May 20, 2014 the shareholders approved The Hanover Insurance Group 2014 Long-Term Incentive Plan (the “2014 Stock Plan”). With respect to new share-based award issuances, the 2014 Stock Plan replaced The Hanover Insurance Group, Inc. 2006 Long-Term Incentive Plan (the “2006 Stock Plan”) and authorized the issuance of 6,100,000 shares in a new share pool plus any shares subject to outstanding awards under the 2006 Stock Plan that may become available for reissuance as a result of the cash settlement, forfeiture, expiration or cancellation of such awards. The 2014 Stock Plan provides for the granting of the same types of awards as the 2006 Stock Plan, which includes stock options and stock appreciation rights (“SARS”), restricted and unrestricted stock, stock units, performance and market-based stock awards, and cash awards. In accordance with the 2014 Stock Plan, the issuance of one share of common stock in the form of an option or SAR will reduce the share pool by one share, whereas the issuance of one share of common stock for the other types of stock awards provided by the plan will reduce the pool by 3.8 shares. As of December 31, 2015, there were 5,521,641 shares available for grants under the 2014 Stock Plan.
Under the 2014 Stock Plan, options may be granted to eligible employees, directors or consultants at an exercise price equal to the market price of the Company’s common stock on the date of grant. Option shares may be exercised subject to the terms prescribed by the Compensation Committee of the Board of Directors (the “Committee”) at the time of grant. Options granted in 2015, 2014 and 2013 generally vest over 3 years with 33 1/3% vesting in each year, whereas options granted in 2012 generally vest over 4 years with a 50% vesting rate in the third year and a 50% vesting rate in the fourth year. Options must be exercised not later than ten years from the date of grant.
The excess tax expense realized from options exercised for the years ended December 31, 2015, 2014, and 2013 was $9.7 million, $5.9 million, and $9.0 million, respectively. The aggregate intrinsic value at December 31, 2015 for shares outstanding and shares exercisable was $40.1 million and $12.7 million, respectively. At December 31, 2015, the weighted average remaining contractual life for shares outstanding and shares exercisable was 7.9 years and 6.6 years, respectively. Additional information about employee options outstanding and exercisable at December 31, 2015 is included in the following table:
In 2015, performance and market-based stock units of 3,125 and 36,875 were included as granted due to completion levels in excess of 100% for units granted in 2013 and 2012, respectively. The weighted average grant date fair value of these awards was $42.44 and $36.47, respectively. In 2014, performance and market-based stock units of 2,888 were included as granted due to completion levels in excess of 100% for units granted in 2012. The weighted average grant date fair value of these awards was $43.31. In 2013, performance-based stock units of 8,244 were included as forfeited due to completion levels less than 100% for units granted in 2011. The weighted average grant date fair value for these awards was $46.47.
The Company’s primary business operations include insurance products and services provided through four operating segments. The domestic operating segments are Commercial Lines, Personal Lines and Other, and the Company’s international operating segment is Chaucer. Commercial Lines includes commercial multiple peril, commercial automobile, workers’ compensation, and other commercial coverages, such as inland marine, specialty program business, management and professional liability and surety. Personal Lines includes personal automobile, homeowners and other personal coverages. Chaucer includes marine and aviation, energy, property, U.K. motor, and casualty and other coverages (which includes international liability, specialist coverages, and syndicate participations). As a result of the aforementioned transfer of the Company’s U.K. motor business, results from the Chaucer segment will no longer include this business subsequent to June 30, 2015. Included in Other are Opus Investment Management, Inc., which markets investment management services to institutions, pension funds and other organizations; earnings on holding company assets; and, a discontinued voluntary pools business. The separate financial information is presented consistent with the way results are regularly evaluated by the chief operating decision maker in deciding how to allocate resources and in assessing performance.
As a condition to conduct certain business in various states, the Company is required to participate in residual market mechanisms, facilities and pooling arrangements such as the Michigan Catastrophic Claims Association (“MCCA”). The Company is subject to concentration of risk with respect to reinsurance ceded to the MCCA. Funding for MCCA comes from assessments against automobile insurers based upon their share of insured automobiles in the state. Insurers are allowed to pass along this cost to Michigan automobile policyholders. The Company ceded to the MCCA premiums earned and losses and LAE incurred of $67.7 million and $78.8 million in 2015, $73.4 million and $99.2 million in 2014 and $72.2 million and $76.6 million in 2013, respectively. The MCCA represented 34.4% of the total reinsurance receivable balance at December 31, 2015. Reinsurance recoverables related to MCCA were $906.5 million and $899.5 million at December 31, 2015 and 2014, respectively. Because the MCCA is supported by assessments permitted by statute, and there have been no significant uncollectible balances from MCCA identified during the three years ending December 31, 2015, the Company believes that it has no significant exposure to uncollectible reinsurance balances from this entity. The Lloyd’s Syndicates total reinsurance receivable balance was $606.5 million as of December 31, 2015, as compared to $280.9 million as of December 31, 2014. The Lloyd’s receivable represented 23.0% of the total reinsurance receivable balance. The increase in this recoverable during 2015 was due to the transfer of the U.K. motor business to a third-party unaffiliated insurer that also operates this business through Lloyd’s. The Company believes that it has no significant exposure to uncollectable reinsurance balances from Lloyd’s as the Lloyd’s Central Fund provides recourse to all of its policyholders in the event of the failure of an individual syndicate and its capital providers.
Effective June 30, 2015, the Company transferred its U.K. motor business through a 100% reinsurance arrangement. This transaction resulted in the increase of ceded premiums written, premiums earned and losses and LAE for the year ended December 31, 2015. See also “Disposal of U.K. Motor Business” in Note 2 - Dispositions.
As part of an ongoing process, reserves have been re-estimated for all prior accident years and were decreased by $94.3 million, $99.1 million and $76.3 million in 2015, 2014 and 2013, respectively. For the years ended December 31, 2015, 2014 and 2013, these amounts include favorable loss and LAE reserve development of $120.1 million, $104.6 million and $94.6 million, respectively, for Chaucer. As a result of the Company’s year-end 2015 reserve review of domestic commercial and personal lines of business, carried reserves were adjusted between several of these lines of business impacting the prior year development by line. These adjustments had no impact on aggregate domestic carried reserves.
Chaucer’s favorable development during 2015 was primarily the result of lower than expected losses in the energy line of $39.9 million, primarily in the 2012 through 2014 accident years, and $29.6 million in the marine and aviation lines, primarily in the 2010, 2012 and 2013 accident years. Additionally, Chaucer experienced lower than expected losses within casualty and other lines, specifically the specialist and international liability lines, of $21.9 million primarily in the 2008, 2011 and 2013 accident years, and in the property line, primarily in the 2012 through 2014 accident years. Chaucer’s favorable development was also partially attributable to the favorable impact of foreign exchange rate movements on prior years’ loss reserves. For Commercial and Personal Lines, the net unfavorable loss and LAE development during 2015 of $25.8 million was primarily the result of higher than expected losses in Other Commercial Lines of $53.7 million, which includes the AIX Holdings, Inc. (“AIX”) program business. This was driven by AIX commercial automobile and general liability lines in accident years 2011 through 2013, primarily from programs which have since been terminated. The Company also experienced higher than expected losses within the general liability lines, primarily in accident years 2009 through 2012. These losses were partially offset by lower than expected losses in the commercial umbrella line in accident years 2012 through 2014, and lower than expected losses in the healthcare line in accident years 2010 through 2014, both within Other Commercial Lines. Development in 2015 also included higher than expected losses within the commercial automobile line of $23.4 million, primarily related to liability coverage in accident years 2011 through 2013, and in the commercial multiple peril lines, primarily in accident years 2008, 2009 and 2011. Partially offsetting the unfavorable development was lower than expected losses of $46.9 million within the workers’ compensation line, primarily related to accident years 2005 through 2014, in the homeowners’ line, primarily related to accident years 2010 through 2013, and in the personal automobile line, primarily related to accident year 2014.
The $76.3 million favorable loss and LAE reserve development during the year ended December 31, 2013 included favorable loss and LAE reserve development of $94.6 million for Chaucer. Chaucer’s favorable development during 2013 was primarily the result of lower than expected losses in the energy line of $30.4 million, primarily in the 2009 through 2012 accident years, and $27.3 million in the property line, primarily in the 2011 and 2012 accident years. Additionally, Chaucer experienced lower than expected losses within casualty and other lines, specifically the specialty liability lines of $21.6 million, primarily in the 2008 accident year, and $21.3 million in the marine and aviation line, primarily in the 2010 through 2012 accident years. For Commercial and Personal Lines, the unfavorable loss and LAE development during 2013 was primarily the result of higher than expected losses within the personal automobile line, due to severity in bodily injury coverage in the 2010 through 2012 accident years, commercial automobile line, primarily related to liability coverage in the 2009 through 2011 accident years, and other commercial lines, primarily in the 2010 through 2012 accident years. Partially offsetting the unfavorable development was lower than expected losses within the workers’ compensation line, primarily in the 2006 through 2011 accident years and lower involuntary pool losses, including a $3.2 million benefit from the settlement of a legal proceeding, and commercial multi-peril line, primarily in the 2012 accident year.
Loss and LAE reserves related to asbestos and environmental damage liability were $57.7 million, $60.6 million and $61.9 million as of December 31, 2015, 2014 and 2013, respectively, comprised of both direct and run-off voluntary assumed reinsurance pools business. Ending loss and LAE reserves for all direct business written by the Company related to asbestos and environmental damage liability, included in the reserve for losses and LAE, were $9.5 million, $10.1 million and $11.5 million, net of reinsurance of $20.5 million, $21.4 million and $20.6 million as of December 31, 2015, 2014 and 2013, respectively. As a result of the Company’s historical direct underwriting mix of Commercial Lines policies toward smaller and middle market risks, past asbestos and environmental damage liability loss experience has remained minimal in relation to the Company’s total loss and LAE incurred experience. Loss and LAE reserves related to the run-off voluntary assumed reinsurance pool business with asbestos and environmental damage liability were $27.7 million, $29.1 million and $29.8 million at December 31, 2015, 2014 and 2013, respectively. These reserves relate to pools in which the Company has terminated its participation; however, the Company continues to be subject to claims related to years in which it was a participant. Because of the inherent uncertainty regarding the types of claims in these pools, the Company cannot provide assurance that its reserves will be sufficient.
The Company estimates its ultimate liability for asbestos, environmental and toxic tort liability claims, whether resulting from direct business, or assumed reinsurance and pool business, based upon currently known facts, reasonable assumptions where the facts are not known, current law and methodologies currently available. Although these outstanding claims are not significant, their existence gives rise to uncertainty and are discussed because of the possibility that they may become significant. The Company believes that, notwithstanding the evolution of case law expanding liability in asbestos and environmental claims, recorded reserves related to these claims are adequate. The asbestos, environmental and toxic tort liability could be revised in the near term if the estimates used in determining the liability are revised, and any such revisions could have a material adverse effect on the Company’s results of operations for a particular quarterly or annual period or on its financial position.
On March 12, 2007, a putative class action suit captioned Jennifer A. Durand v. The Hanover Insurance Group, Inc., and The Allmerica Financial Cash Balance Pension Plan, was filed in the United States District Court for the Western District of Kentucky. The named plaintiff, a former employee of our former life insurance and annuity business who received a lump sum distribution from the Company’s Cash Balance Plan (the “Plan”) at or about the time of her separation from the company, claims that she and others similarly situated did not receive the appropriate lump sum distribution because in computing the lump sum, the Company and the Plan understated the accrued benefit in the calculation. The plaintiff claims that the Plan underpaid her distributions and those of similarly situated participants by failing to pay an additional so-called “whipsaw” amount reflecting the present value of an estimate of future interest credits from the date of the lump sum distribution to each participant’s retirement age of 65 (“whipsaw claim”).