Cincinnati Financial Corporation owns Gilmore Pointe, located on the northwest corner of our headquarters property. This four-story building contains approximately 103,000 square feet of usable space. The property is recorded in the financial statements at $6 million at December 31, 2017, and is classified as investment property in Other Invested Assets, net. At December 31, 2017, unaffiliated tenants occupied 88 percent, Cincinnati Financial affiliates occupy 12 percent.
The Cincinnati Insurance Company owns the CFC Winton Center used for multiple operations with approximately 48,000 square feet of total space, located approximately six miles from our headquarters. The property, including land, is recorded in our financial statements at $9 million at December 31, 2017, and is classified as land, building and equipment, net, for company use.
Realized investment gains and losses are integral to our financial results over the long term, but our substantial discretion in the timing of investment sales may cause this value to fluctuate substantially. Also, applicable accounting standards require us to recognize gains and losses from certain changes in fair values of securities and embedded derivatives without actual realization of those gains and losses. We discuss realized investment gains for the past three years in Item 7, Investments Results.
We are targeting an annual value creation ratio averaging 10 percent to 13 percent over the next five-year period. At 22.9 percent for 2017, we significantly exceeded the high end of that range. We slightly exceeded the high end of that range for the three-year and five-year periods that ended in December 2017.
The 2017 value creation ratio improved by 8.4 percentage points, compared with 2016, and again included a significant contribution of operating results. VCR in 2017 also included a 7.0 percent contribution from a tax benefit due to net deferred income tax liability revaluation related to U.S. tax reform. The 2017 ratio improvement included a rise in market valuation, with contributions of 1.8 percentage-points from our equity securities investment portfolio and 1.3 points from our fixed-maturity securities investment portfolio. The 2016 value creation ratio was 11.1 percentage points higher than in 2015, driven by a 12.1 point increase in the contribution from realized gains plus the change in unrealized gains from our investment portfolios in aggregate.
Premium growth - We believe over any five-year period our agency relationships and initiatives can lead to a property casualty written premium growth rate that exceeds the industry average. The compound annual growth rate of our net written premiums was 6.8 percent over the five-year period 2013 through 2017, nearly double the 3.8 percent estimated growth rate for the property casualty insurance industry. The industry’s growth rate excludes its mortgage and financial guaranty lines of business.
Investment income growth, on a pretax basis, had a compound annual growth rate of 2.8 percent over the five-year period 2013 through 2017. It has grown every year since 2009, except for 2013 with its slight decrease of less than 1 percent.
Over the five years ended December 31, 2017, our equity portfolio compound annual total return was 15.3 percent compared with a compound annual total return of 15.8 percent for the Index. Our equity portfolio favors larger-capitalization, high-quality, dividend growing stocks with a slight value orientation. In recent years, returns for this type of stocks have generally lagged the broader market. For the year 2017, our annual equity portfolio total return was 21.0 percent, compared with 21.8 percent for the Index.
improve earnings performance while growing insurance premium revenues. We discuss our financial position in more detail in Liquidity and Capital Resources.
Total investments grew 10 percent during 2017 on a fair value basis, with an increase in our securities portfolio valuation that added to the 5 percent increase in its cost basis. Entering 2018, we believe the portfolio continues to be well diversified and is well positioned to withstand short-term fluctuations. We discuss our investment strategy in Item 1, Investments Segment, and results for the segment in Investments Results. Total assets rose 7 percent. Shareholders’ equity and book value per share each grew by 17 percent, for reasons discussed in the preceding Executive Summary.
The amount of our debt obligations increased by $4 million in 2017, compared with 2016. Our 9.0 percent ratio of debt to total capital (debt plus shareholders’ equity) at year-end 2017 decreased by 1.3 percentage points compared with the prior-year ratio.
Net income decreased $43 million in 2016, compared with 2015, primarily due to a $94 million decrease in property casualty underwriting income after taxes that included $114 million from higher catastrophe losses.
Property casualty net written premiums grew 6 percent and earned premiums grew 5 percent in 2017, reflecting average renewal price increases, a higher level of insured exposures and premium growth initiatives. Premium growth rates in 2017 were similar to 2016. Trends and related factors are discussed in Commercial Lines, Personal Lines and Excess and Surplus Lines Insurance Results, respectively.
Our property casualty insurance operations generated underwriting profits for each of the three years ending in 2017. The $114 million decrease in 2017, compared with 2016, included a $4 million increase in losses from natural catastrophe events and less benefit from net favorable reserve development on prior accident years. The $144 million decrease in 2016, compared with 2015, included a $175 million increase in losses from natural catastrophe events.
We measure property casualty underwriting profitability primarily by the combined ratio. Our combined ratio measures the percentage of each earned premium dollar spent on claims plus all expenses related to our property casualty operations, all on a pretax basis. A lower ratio indicates more favorable results and better underlying performance. A ratio below 100 percent represents an underwriting profit. Initiatives to improve our combined ratio are discussed in Item 1, Our Business and Our Strategy, Strategic Initiatives. In 2017, 2016 and 2015, favorable development on reserves for claims that occurred in prior accident years helped offset other incurred losses and loss expenses. Reserve development is discussed further in Property Casualty Loss and Loss Expense Obligations and Reserves. Losses from weather-related catastrophes are another important item influencing the combined ratio and are discussed along with other factors in Financial Results for our property casualty business and related segments.
Our life insurance segment reported a $1 million loss in 2017 and a $1 million profit in 2016. We discuss results for the segment in Life Insurance Results. Most of this segment’s investment income is included in our investments segment results. In addition to investment income, realized investment gains from the life insurance investment portfolio are also included in our investments segment results.
margins can arise from additional information and more focused action on underperforming product lines, plus pricing capabilities we are expanding through the use of technology and analytics. In addition to enhancing company efficiency, improving internal processes also supports the ability of the independent agencies that represent us to grow profitably by allowing them to serve clients faster and to more efficiently manage agency expenses.
For some lines of business that we write, a considerable and uncertain amount of time can elapse between the occurrence, reporting and payment of insured claims. The amount we will actually have to pay for such claims also can be highly uncertain. This uncertainty, together with the size of our reserves, makes the loss and loss expense reserves our most significant estimate. Gross loss and loss expense reserves were $5.219 billion at year-end 2017 compared with $5.035 billion at year-end 2016.
Depending on the nature of the event, available claims intelligence could include surveys of field claims associates within the affected geographic area, feedback from a catastrophe claims team sent into the area, as well as data on claims reported as of the financial statement date. To determine whether an event is designated as a catastrophe, we generally use the catastrophe definition provided by Property Claims Service (PCS), a division of Insurance Services Office (ISO). PCS defines a catastrophe as an event that causes countrywide damage of $25 million or more in insured property losses and affects a significant number of policyholders and insureds.
For all other claims and events, including reinsurance assumed or ceded, IBNR reserves are calculated as the difference between an actuarial estimate of the ultimate cost of total loss and loss expenses incurred reduced by the sum of total loss and loss expense payments and total case reserves estimated for individual claims. Reserve amounts for those other claims and events are significant, and represent the majority of amounts shown as IBNR reserves and loss expense reserves in the table included in Liquidity and Capital Resources, Property Casualty Loss and Loss Expense Obligations and Reserves. We discuss below the development of actuarially based estimates of the ultimate cost of total loss and loss expenses incurred.
Our actuarial staff applies significant judgment in selecting models and estimating model parameters when preparing reserve analyses. Unpaid loss and loss expenses are inherently uncertain as to timing and amount. Uncertainties relating to model appropriateness, parameter estimates and actual loss and loss expense amounts are referred to as model, parameter and process uncertainty, respectively. Our management and actuarial staff address these uncertainties in the reserving process in a variety of ways.
Our actuarial staff uses diagnostics provided by stochastic reserving software to evaluate the appropriateness of the models and methods listed above. The software’s diagnostics have indicated that the appropriateness of these models and methods for estimating IBNR reserves for our lines of business tends to depend on a line’s tail. Tail refers to the time interval between a typical claim’s occurrence and its settlement. For our long-tail lines such as workers’ compensation and commercial casualty, models from the probabilistic trend family tend to provide superior fits and to validate well compared with models underlying the loss development and Bornhuetter-Ferguson methods. The loss development and Bornhuetter-Ferguson methods, particularly the reported loss variations, tend to produce the more appropriate IBNR reserve estimates for our short-tail lines such as homeowner and commercial property. For our mid-tail lines such as personal and commercial auto liability, all models and methods provide useful insights.
parameters. For the lines of business we write, process uncertainty - the inherent variability of loss and loss expense payments - typically contributes more to the imprecision of a reserve estimate than parameter uncertainty.
Our fixed-maturity and equity investment portfolios are our largest assets. The company’s asset impairment committee continually monitors the holdings in these portfolios and all other assets for signs of other-than-temporary or permanent impairment. The committee monitors decreases in the fair value of invested assets; an accumulation of company costs in excess of the amount originally expected to acquire or construct an asset; uncollectability of all receivable assets; or other factors such as bankruptcy, deterioration of creditworthiness, failure to pay interest or dividends; signs indicating that the receivable carrying amount may not be recoverable; and changes in legal factors or in the business climate.
The application of our impairment policy resulted in other-than-temporary impairment (OTTI) charges that reduced our income before income taxes by $9 million in 2017, $2 million in 2016 and $52 million in 2015. OTTI losses represent noncash charges to income and are reported as realized investment losses.
When determining OTTI charges for our equity portfolio, our invested asset impairment policy considers quantitative and qualitative factors, including facts and circumstances specific to individual securities, asset classes, the financial condition of the issuer, changes in dividend payment, the length of time fair value had been less than cost, the severity of the decline in fair value below cost, the volatility of the security and our ability and intent to hold each position until its forecasted recovery.
Over 99 percent of the $16.948 billion of securities in our investment portfolio at year-end 2017, measured at fair value, are classified as Level 1 or Level 2. Financial assets that fall within Level 1 and Level 2 are priced according to observable data from identical or similar securities that have traded in the marketplace. Also within Level 2 are securities that are valued by outside services or brokers where we have evaluated and verified the pricing methodology and determined that the inputs are observable.
Key assumptions used in developing the benefit obligation at year-end 2017 for our qualified plan were a 3.73 percent discount rate and rates of compensation increases ranging from 2.75 percent to 3.25 percent. To determine the discount rate, a theoretical settlement portfolio of high-quality, rated corporate bonds was chosen to provide payments approximately matching the plan’s projected benefit payments. A single interest rate was determined, resulting in a discounted value of the plan’s benefit payments that equates to the market value of the selected bonds. The discount rate is reflective of current market interest rate conditions and our plan's liability characteristics.
The fair value of the plan assets exceeded the accumulated benefit obligation by $23 million and $6 million at year-end 2017 and 2016, respectively. The fair value of the plan assets were $6 million and $25 million less than the projected plan benefit obligation at year-end 2017 and 2016, respectively. Market conditions and interest rates significantly affect future assets and liabilities of the pension plan. During the first quarter of 2018, we contributed $5 million to our qualified plan.
For life insurance policies, acquisition costs are amortized into income either in proportion to premium revenue recognized or in accordance with the recognition of gross profit from the contract, depending on the policy type. These costs are principally agent commissions and underwriting costs related to successful contract acquisition. We analyze our acquisition cost assumptions periodically to reflect actual experience; we evaluate our deferred acquisition cost for recoverability; and we regularly conduct reviews for potential premium deficiencies or loss recognition. Changes in the amounts or timing of estimated future profits could result in adjustments to the accumulated amortization of these costs.
We measure profit or loss for our commercial lines, personal lines, excess and surplus lines and life insurance segments based upon underwriting results (profit or loss), which represent net earned premium less loss and loss expenses and underwriting expenses on a pretax basis. We also evaluate results for our consolidated property casualty insurance operations. That is the total of our standard market segments (commercial lines and personal lines), our excess and surplus lines insurance segment and our reinsurance assumed operations. For analysis of our consolidated property casualty insurance results, it is important to include our reinsurance assumed operations earned premiums, loss and loss expenses and also underwriting expenses reported as Other. Underwriting results and segment pretax operating income are not substitutes for net income determined in accordance with GAAP.
New business written premiums produced through agencies increased $75 million in 2017, compared with 2016. Agents appointed during 2017 or 2016 produced a 2017 increase in standard lines new business of $58 million.
Net written premiums increased $54 million in 2017 from expansion of reinsurance assumed operations, known as Cincinnati ReSM. Cincinnati Re assumes risks through reinsurance treaties and in some cases cedes part of the risk and related premiums to one or more unaffiliated reinsurance companies through transactions known as retrocessions. In 2017, earned premiums for Cincinnati Re totaled $107 million.
Combined ratio - The 2017 combined ratio increased 2.7 percentage points compared with 2016, including a 0.3 percentage-point decrease in the ratio for natural catastrophe losses. The 2017 ratio for current accident year losses and loss expenses before catastrophes increased by 1.3 percentage points, in part due to large losses and the corresponding ratios for new losses above $1 million described below, and partially offset what we believe are improvements to some of our loss experience due to recent-year initiatives to improve pricing precision and claims and loss control practices. The remainder of the 2017 combined ratio increase included 1.6 percentage-points less benefit in the ratio for prior accident year losses and loss expenses before catastrophes. We further discuss ratios related to reserve development in the sections that follow the Catastrophe Losses Incurred table below.
The following table shows catastrophe losses incurred for the past three calendar years, net of reinsurance, as well as the effect of loss development on prior period catastrophe reserves. We individually list declared catastrophe events for which our incurred losses reached or exceeded $10 million. Included in all other 2017 catastrophes for Cincinnati Re is approximately $8 million for estimated assumed losses in total for wildfires in California and approximately $8 million in aggregate for other international catastrophe events, including Hurricane Maria.
For our commercial casualty line of business in 2017, we experienced a rising trend in paid losses and loss expenses that was more than we expected. As a result, we increased our actuarial best estimates of ultimate loss and loss expense ratios at the end of 2017, compared with year-end 2016. Net loss and loss expense reserves at December 31, 2017, for our commercial casualty line of business was $126 million higher than at year-end 2016. The IBNR portion of the reserve increase was $98 million.
Most of the incurred losses and loss expenses shown in the consolidated property casualty insurance results three-year highlights table are for the respective current accident years, with reserve development on prior accident years shown separately. Since less than half of our consolidated property casualty current accident year incurred losses and loss expenses represents net paid amounts, the majority represents reserves for our estimate of ultimate losses and loss expenses. These reserves develop over time, and we re-estimate previously reported reserves as we learn more about the development of the related claims. The table below illustrates that development. For example, the 67.5 percent accident year 2016 loss and loss expense ratio reported as of December 31, 2016, developed favorably by 1.0 percentage points to 66.5 percent due to claims settling for less than previously estimated, or due to updated reserve estimates for unpaid claims, as of December 31, 2017. Accident years 2016 and 2015 have both developed favorably, as indicated by the progression over time for the ratios in the table.
Catastrophe loss trends, discussed above, accounted for some of the movement in the current accident year loss and loss expense ratio for 2017, compared with 2016. Catastrophe losses added 7.8 percentage points in 2017, 7.7 points in 2016 and 4.1 points in 2015 to the respective consolidated property casualty current accident year loss and loss expense ratios in the table above.
due to less-than-anticipated loss emergence on known claims. We recognized $119 million of favorable development in 2017, compared with $168 million in 2016 and $184 million in 2015. Of the $49 million decrease in 2017, compared with 2016, $31 million was attributable to our commercial casualty line of business. Approximately 73 percent of our net favorable reserve development on prior accident years recognized during 2017 occurred in our commercial property and workers’ compensation lines of business. In 2016, our commercial casualty, commercial property and workers' compensation lines of business were responsible for approximately 70 percent of the favorable reserve development. As discussed in Liquidity and Capital Resources, Property Casualty Loss and Loss Expense Obligations and Reserves, Property Casualty Insurance Development of Estimated Reserves by Accident Year, commercial casualty and workers' compensation are considered long-tail lines with the potential for revisions inherent in estimating reserves. Favorable development recognized during 2015 was primarily from our commercial casualty and workers’ compensation lines of business. Development by accident year is further discussed in Liquidity and Capital Resources, Property Casualty Insurance Development of Estimated Reserves by Accident Year.
Commission expenses include our profit-sharing commissions, which are primarily based on one-year and three-year profitability of an agency’s business. The aggregate profit trend for agencies that earn these profit-based commissions can differ from the aggregate profit trend for all agencies reflected in our consolidated property casualty results.
Premiums - Earned premiums and net written premiums rose in 2017, primarily due to a $48 million increase in renewal written premiums that continued to include a price increase for an average policy. New business written premiums in 2017 increased $25 million, or 7 percent, compared with 2016. The increase was driven by production from agencies appointed since the beginning of 2016.
Combined ratio - The 2017 combined ratio increased 2.2 percentage points compared with 2016, including a 2.1 percentage-point decrease in the ratio for natural catastrophe losses. The 2017 ratio for current accident year losses and loss expenses before catastrophes increased by 1.8 percentage points, including 0.4 points from more current accident year losses of $1 million or more per claim, shown in the table below. Development on prior accident years’ loss and loss expense reserves before catastrophes during 2017 was 2.4 percentage points less favorable than in 2016, including 3.1 points from paid losses and loss expenses.
As discussed in Critical Accounting Estimates, Property Casualty Insurance Loss and Loss Expense Reserves, stable historical paid loss patterns are a key assumption used to make projections necessary for estimating IBNR reserves. During 2017, we observed paid losses or re-estimates of case reserves emerging at levels higher than
Commercial auto, representing 20 percent of 2017 earned premiums for our commercial lines insurance segment, was the only major line of business in that segment with a 2017 total loss and loss expense ratio significantly higher than we desired. During 2017, our commercial auto policies experienced average renewal estimated price percentage increases near the low end of the high-single-digit range, which we believe will help improve future profitability. We also continued to improve premium rate classification and use of other rating variables in risk selection and pricing.
Pricing precision and other initiatives to improve commercial lines underwriting profitability complement our business practices that continue to leverage the local presence of our field staff. Field marketing representatives meet with local agencies to assess each risk, determine limits of insurance and establish appropriate terms and conditions. They continue to underwrite new business while field loss control, machinery and equipment and claims representatives continue to conduct on-site inspections. Field claims representatives also assist underwriters by preparing full reports on their first-hand observations of risk quality.
Our commercial lines statutory combined ratio was 96.2 percent in 2017, compared with 93.9 percent in 2016 and 88.3 percent in 2015. The estimated commercial lines combined ratio for the industry was 103.5 percent in 2017, 99.6 percent in 2016 and 97.5 percent in 2015. The industry’s ratio excludes its mortgage and financial guaranty lines of business. The contribution of catastrophe losses to our commercial lines statutory combined ratio was 5.0 percentage points in 2017, 7.1 percentage points in 2016 and 3.1 percentage points in 2015, compared with industry estimates of 7.0, 2.9 and 2.1 percentage points, respectively.
measured. Therefore, the average commercial lines pricing change we report reflects a blend of policies that did not expire and other policies that did expire during the measurement period.
For only those commercial lines policies that did expire and were then renewed during 2017, we estimate that the average price increase was near the high end of the low-single-digit range, slightly higher in that range than full-year 2016. During 2017, we continued to further segment our commercial lines policies, emphasizing identification and retention of policies we believed had relatively stronger price adequacy. Conversely, we continued to seek more aggressive renewal terms and conditions on policies we believed had relatively weaker pricing, in turn retaining fewer of those policies.
For new business, our field associates are frequently in our agents’ offices to: help judge the quality of each account; emphasize the Cincinnati value proposition; call on sales prospects with those agents; carefully evaluate risk exposure; and provide their best quotes. Some of our new business comes from accounts that are not new to the agent. We believe these seasoned accounts tend to be priced more accurately than business that is new to us and the agency. As we appoint new agencies who choose to move accounts to us, we report these accounts as new business to us.
Most of the incurred losses and loss expenses shown in the commercial lines insurance segment three-year highlights table are for the respective current accident years, with reserve development on prior accident years shown separately. Since less than half of our commercial lines insurance segment current accident year incurred losses and loss expenses represents net paid amounts, the majority represents reserves for our estimate of ultimate losses and loss expenses. These reserves develop over time, and we re-estimate previously reported reserves as we learn more about the development of the related claims. The table below illustrates that development. For example, the 66.6 percent accident year 2016 loss and loss expense ratio reported as of December 31, 2016, developed favorably by 1.1 percentage points to 65.5 percent due to claims settling for less than previously estimated, or due to updates to reserve estimates for unpaid claims, as of December 31, 2016. Accident years 2016 and 2015 for the commercial lines insurance segment have both developed favorably, as indicated by the progression over time of the ratios in the table.
Catastrophe losses, as discussed in Consolidated Property Casualty Insurance Results, explain some of the movement in the current accident year loss and loss expense ratio for accident year 2017, compared with 2016. Catastrophe losses added 5.7 percentage points in 2017, 7.3 points in 2016 and 3.5 points in 2015 to the respective commercial lines current accident year loss and loss expense ratios in the table above.
In 2017, total large losses incurred increased by $62 million, or 33 percent, net of reinsurance. The corresponding ratio increased 1.8 percentage points. The 2017 increases on both a dollar and ratio basis were primarily due to higher amounts for our commercial casualty and commercial property lines of business. In 2016, total large losses incurred and the corresponding ratio were higher than in 2015, also largely due to higher amounts of large losses for our commercial casualty and commercial property lines of business. Our analysis indicated no unexpected concentration of these losses and reserve increases by geographic region, policy inception, agency or field marketing territory. We believe the inherent volatility of aggregate loss experience for our portfolio of larger policies is greater than that of our portfolio of smaller policies, and we continue to monitor the volatility in addition to general inflationary trends in loss costs.
Commercial lines commission expenses as a percent of earned premiums decreased slightly in 2017, compared with 2016, reflecting a decrease in the ratio for agency commissions other than profit sharing. The ratio for 2016 decreased slightly compared with 2015, reflecting a decrease in the ratio for agency profit-sharing commissions. In 2017, other underwriting expenses as a percent of earned premiums increased compared with 2016, as strategic investments that include enhancement of underwriting expertise offset the favorable effects of higher earned premiums and ongoing expense management efforts. In 2016, the ratio rose similarly, compared with 2015.
Premiums - Earned premiums and net written premiums continued to grow in 2017, largely due to higher renewal written premiums that included price increases. Renewal written premiums rose $57 million, or 5 percent, in 2017, compared with 2016.
Our personal lines statutory combined ratio was 102.4 percent in 2017, up from 100.8 percent in 2016 and 100.0 percent in 2015. By comparison, the estimated industry personal lines combined ratio was 104.9 percent in 2017, 102.5 percent in 2016 and 99.6 percent in 2015. Our concentration of business in areas affected by catastrophe events contributed to recent-year results that differed from the overall industry, an issue we are addressing in part through gradual geographic expansion. The contribution of catastrophe losses to our personal lines statutory combined ratio was 10.9 percentage points in 2017, 9.4 percentage points in 2016 and 6.2 percentage points in 2015, compared with industry estimates of 8.5, 5.8 and 4.8 percentage points, respectively.
The 5 percent increase in agency renewal written premiums in 2017 largely reflected various rate changes. We estimate that premium rates for our personal auto line of business increased at average percentages near the low end of the high-single-digit range during 2017, with some individual policies experiencing lower or higher rate changes based on enhanced pricing precision enabled by predictive models, which consider variables of specific risks. For our homeowner line of business, we estimate that rate increases during 2017 averaged in the mid-single-digit range. Similar to our personal auto line of business, that average varied widely by state, and some individual policies experienced lower or higher rate changes based on pricing precision and current rate level indications that help determine appropriate premium rates.
Other written premiums primarily consist of premiums that are ceded to reinsurers and that lower our net written premiums. Ceded premiums for 2017 essentially matched 2016.
Loss and loss expenses include both net paid losses and reserve changes for unpaid losses as well as the associated loss expenses. Most of the incurred losses and loss expenses shown in the personal lines insurance segment three-year highlights table are for the respective current accident years, with reserve development on prior accident years shown separately. Since approximately two-thirds of our personal lines current accident year incurred losses and loss expenses represent net paid amounts, the remaining one-third represents reserves for our estimate of ultimate losses and loss expenses. These reserves develop over time, and we re-estimate previously reported reserves as we learn more about the development of the related claims. The table below illustrates that development. For example, the 72.7 percent accident year 2016 loss and loss expense ratio reported as of December 31, 2016, developed favorably by 0.7 percentage points to 72.0 percent due to claims settling for less than previously estimated, or due to updated reserve estimates for unpaid claims, as of December 31, 2017. Accident year 2015 for the personal lines insurance segment developed favorably during 2016 and then developed unfavorably by a relatively small amount during 2017, as indicated by the progression over time for the ratios in the table.
Catastrophe losses, as discussed in Consolidated Property Casualty Insurance Results, explain much of the movement in the current accident year loss and loss expense ratio for accident year 2017, compared with accident year 2016. Catastrophe losses added 11.2 percentage points in 2017, 9.7 points in 2016 and 6.5 points in 2015 to the respective personal lines current accident year loss and loss expense ratios in the table above. Personal lines catastrophe losses for 2017 resulted in a ratio near our 10.7 percent 10-year annual average for personal lines that included 22.8 percent for 2011. Our personal lines catastrophe loss ratios for 2016 and 2015 reflect an average closer to our 9.5 percent average over the same 10-year period, excluding the unusually high ratio for 2011. Personal lines catastrophe losses are inherently volatile, as discussed above and in Consolidated Property Casualty Insurance Results.
The 64.0 percent ratio for current accident year loss and loss expenses before catastrophe losses for 2017 rose 1.0 percentage points compared with the 63.0 percent accident year 2016 ratio measured as of December 31, 2016. The increase included a 2.2 percentage-point increase in the ratio for current accident year losses of $1 million or more per claim, shown in the table below, that were primarily for homeowner claims and personal umbrella claims related to auto accidents.
In 2017, personal lines total large losses incurred increased by $40 million, compared with 2016, net of reinsurance. The ratio for 2017 large losses as a percent of earned premiums increased 3.1 percentage points. The 2017 increases on both a dollar and ratio basis were largely due to higher amounts for homeowner claims and personal umbrella claims related to auto accidents. In 2016, total large losses decreased, compared with 2015, primarily due to lower amounts of homeowner claims and personal umbrella claims related to auto accidents. Our analysis indicated no unexpected concentration of these losses and reserve increases by risk category, geographic region, policy inception, agency or field marketing territory. We believe the inherent volatility of aggregate loss experience for our portfolio of larger policies is greater than that of our portfolio of smaller policies, and we continue to monitor the volatility in addition to general inflationary trends in loss costs.
A.M. Best projections for 2018 indicate personal lines written premiums for the U.S. property casualty industry may grow approximately 5 percent, with an industry statutory combined ratio estimated at approximately 100 percent. We believe our growth rate will likely be higher than the industry projection for 2018, driven by our rate increases, stable policy retention rate, new state entry, accelerated pace of new agency appointments in recent years and increased focus on the high net worth personal lines market. Our high net worth initiative, along with various other actions to improve performance in our personal lines insurance segment, is discussed in greater detail in Item 1, Our Business and Our Strategy, Strategic Initiatives and Personal Lines Insurance Results. Our personal lines pricing trends need to exceed loss trends to improve personal lines profitability, thereby helping to achieve our corporate financial targets. We discuss our overall outlook for our property casualty insurance operations in the Executive Summary.
Premiums - Earned premiums and net written premiums continued to grow during 2017. Growth was driven by higher renewal written premiums that included average renewal estimated price increases in the low-single-digit range. New business written premiums grew 19 percent in 2017, reflecting an increase in our marketing efforts as we continued to carefully underwrite each policy in a highly competitive market.
Loss and loss expenses include both net paid losses and reserve changes for unpaid losses, as well as the associated loss expenses. The majority of the total incurred losses and loss expenses shown above in the three-year highlights table are for the respective current accident years, with reserve development on prior accident years shown separately. Since less than 20 percent of our 2017 excess and surplus lines current accident year incurred losses and loss expenses represents net paid amounts, a large majority represents reserves for our estimate of unpaid losses and loss expenses. These reserves develop over time, and we update our estimates of previously reported reserves as we learn more about the development of the related claims. The table below illustrates that development. For example, the 56.0 percent accident year 2016 loss and loss expense ratio reported as of December 31, 2016, developed favorably by 2.8 percentage points to 53.2 percent due to claims settling for less than previously estimated, or due to updated reserve estimates for unpaid claims, as of December 31, 2017. Accident years 2016 and 2015 for this segment have both developed favorably, as indicated by the progression over time of the ratios in the table.
Catastrophe losses, as discussed in Consolidated Property Casualty Insurance Results, explain some of the movement in the current accident year loss and loss expense ratio for accident year 2017, compared with 2016. Catastrophe losses added 1.1 percentage points in 2017, 1.6 percentage points in 2016 and 0.5 percentage points in 2015, to the respective excess and surplus lines current accident year loss and loss expense ratios in the table above.
Profitability - The life insurance segment frequently reports only a small profit or loss because most of its investment income is included in the investments segment results. We include only investment income credited to contract holders (interest assumed in life insurance policy reserve calculations) in life insurance segment results. The segment reported a $1 million loss in 2017, following a profit of $1 million in 2016 and a loss of $2 million in 2015. It has averaged a profit of less than $1 million over the past five years.
Earned premiums rose $4 million in 2017, primarily due to growth in our term life insurance business, as shown in the table below. Growth in 2016 was also primarily due to term life insurance.
We market term, whole and universal life products, fixed annuities and disability income products. In addition, we offer term, whole life and disability insurance to employees at their worksite. These products provide our property casualty agency force with excellent cross-serving opportunities for both commercial and personal accounts.
Life insurance segment profitability depends largely on premium levels, the adequacy of product pricing, underwriting skill and operating efficiencies. This segment’s results include only investment interest credited to contract holders (interest assumed in life insurance policy reserve calculations). The remaining investment income is reported in the investments segment results. The life investment portfolio is managed to earn target spreads between earned investment rates on general account assets and rates credited to policyholders. We consider the value of assets under management and investment income for the life investment portfolio as key performance indicators for the life insurance segment.
We recognize that assets under management, capital appreciation and investment income are integral to evaluation of the success of the life insurance segment because of the long duration of life products. On a basis that includes investment income and realized gains or losses from life insurance-related invested assets, our life insurance subsidiary reported net income of $155 million in 2017, compared with net income of $48 million in 2016 and $41 million in 2015. Net income in 2017 included a nonrecurring item, a $111 million benefit from net deferred income tax liability revaluation due to U.S. tax reform. The life insurance subsidiary portfolio had after-tax net realized investment gains of $4 million in 2017, compared with $5 million in 2016 and less than $1 million in 2015. Realized investment gains and losses are discussed under Investments Results. We exclude most of our life insurance company investment income from investments segment results.
We believe the life insurance market is undergoing significant change. Distribution is evolving along with the customer experience at point of sale. Technology and data are being used to segment markets, offer products and underwrite business. We believe we are taking the appropriate steps to stay on the leading edge of all of these developments where it makes sense to do so.
We were pleased with the impact that principle-based reserves had on our statutory operating results. We expect pressure on our statutory surplus to ease going into 2018 and beyond as more business is written under the new rules. We believe this will allow us more options with respect to capital management.
We view the new tax environment as very favorable. We look forward to competing in 2018, and beyond, on a more level playing field from a tax perspective, in what is still a very competitive term market.
We believe that the interest rate and regulatory environments are the biggest sources of risk for our segment of the life industry. Recent upticks in the yield curve are welcome but spreads remain very tight. If yields on fixed income assets fall or fail to improve, then pressure will continue to build on life companies to look for alternative assets or accept lower earnings due to anemic investment income growth.
Investment income - Pretax investment income grew $14 million, or 2 percent, in 2017, including increases from both interest and dividends. Dividend income reflected rising dividend rates that offset a small amount of net sales of equity securities. Interest income also rose, as net purchases of fixed-maturity securities offset the continuing effects on bond yields of the low interest rate environment. Pretax investment income rose 4 percent in 2016, reflecting increases in both dividend income and interest income. Average yields in the investment income table below are based on the average invested asset and cash amounts indicated in the table using fixed-maturity securities valued at amortized cost and all other securities at fair value.
Realized investment gains and losses - We reported realized investment gains in all three years, largely due to investment sales that were discretionary in timing and amount. Those gains were reduced by OTTI charges.
Interest income rose $5 million, or 1 percent, in 2017. The average fixed-maturity pretax yield declined by approximately 18 basis points but was offset by a larger average fixed-maturity portfolio that rose 5 percent on an amortized cost basis. Interest income increased 3 percent in 2016 when that yield declined by approximately 10 basis points while the portfolio rose 5 percent on an amortized cost basis.
Net Realized Investment Gains and Losses and Change in Unrealized Investment Gains and Losses
We believe that a reversal of the slow but steady improvement in economic conditions could heighten the risk of renewed pressure on securities markets, which could lead to additional OTTI charges. Our asset impairment committee continues to monitor the investment portfolio. The current asset impairment policy is described in Critical Accounting Estimates, Asset Impairment.
Total revenues in 2017 for our Other operations increased, compared with 2016, primarily due to earned premiums of Cincinnati Re, our reinsurance assumed operation. Other also includes noninvestment operations of the parent company and its commercial leasing and financial services subsidiary, CFC Investment Company. Total expenses for Other also increased in 2017, primarily due to losses and loss expenses and underwriting expenses from Cincinnati Re.
The Tax Act lowers the U.S. corporate income tax rate from a top marginal rate of 35 percent to a flat rate of 21 percent and changes the amount of dividends received deduction and proration effective January 1, 2018. Under the Tax Act, for our property casualty insurance subsidiaries, approximately 75 percent of interest from tax-advantaged, fixed-maturity investments and approximately 40 percent of dividends from qualified equities are exempt from federal tax after applying proration. For our noninsurance companies, the dividend received deduction exempts 50 percent of dividends from qualified equities. Assuming similar pretax income and portfolio mix for 2018 compared to 2017, we estimate our overall corporate effective tax rate will be approximately 16 percent and our investment income effective tax rate is also estimated to be approximately 16 percent. For all noninvestment income, we estimate our effective tax rate will be 21 percent.
Dividends received from the subsidiary in 2017 were $10 million less than 2016 while shareholder’s dividend payments increased $94 million, largely as a result of a special dividend declared and paid during the fourth quarter of 2017. We expect 2018 parent company sources of cash flow to be similar to 2017. The expenditures for the parent company have been fairly consistent during the last three years, and we expect future expenditures to remain stable. Share repurchases are discretionary depending on cash availability and capital management decisions. On January 26, 2018, an additional 15 million shares were authorized, which expanded our current repurchase program.
Cash in excess of operating requirements is invested in fixed-maturity and equity securities. Cash generated from investment income provides an important investment contribution to cash flow and liquidity. The sale of investments could provide an additional source of liquidity at either the parent company or insurance subsidiary level, if required. In addition to possible sales of investments, proceeds of call or maturities of fixed-maturity securities also can provide liquidity. During the five-year period beginning in 2017, fair value of $3.358 billion, or 31.4 percent, of our fixed-maturity portfolio is scheduled to mature. At year-end 2017, net unrealized gains in the investment portfolio, before deferred income taxes, were $3.540 billion.
The $225 million unsecured revolving line of credit is administered by PNC Bank, N.A., a subsidiary of The PNC Financial Services Group Inc. (NYSE:PNC). The agreement was established in 2012, extended for two years in 2014, and will expire in May 2019. Our subsidiary CFC Investment Company also is a borrower under this line of
credit. PNC Bank is the lead participant bookrunner with a $65 million share. Fifth Third Bancorp (Nasdaq:FITB) is the syndication agent with a $65 million share. U.S. Bancorp (NYSE:USB), BB&T Corp (NYSE:BBT) and Huntington Bancshares Inc. (Nasdaq:HBAN) each provide $25 million of capacity, and Northern Trust Corporation (Nasdaq:NTRS), provides $20 million of capacity.
Capital resources consisting of shareholders’ equity and total debt represent our overall financial strength to support current obligations and growth in our insurance businesses. At December 31, 2017, we had total capital of $9.054 billion. Shareholders’ equity was $8.243 billion, an increase of $1.183 billion, or 17 percent, from the prior year. Our total debt was $811 million, up $4 million from a year ago. We seek to maintain a solid financial position and provide capital flexibility by keeping our ratio of debt to total capital moderate. At year-end 2017, the ratio was 9.0 percent, compared with 10.3 percent at year-end 2016.
Dividends to shareholders -The ability of our company to continue paying cash dividends is subject to factors the board of directors deem relevant. While the board and management believe there is merit to sustaining the company’s long record of dividend increases, our first priority is the company’s financial strength. Over the past 10 years, the company has paid an average of 67 percent of net income as dividends. Through 2017, the board had increased our cash dividend for 57 consecutive years. The board decision in January 2018 to increase the dividend demonstrated confidence in the company’s strong capital, liquidity, financial flexibility and initiatives to grow earnings.
At December 31, 2017, we estimated our future contractual obligations as follows:
Other operating expenses - Many of our operating expenses are not contractual obligations but reflect the ongoing expenses of our business. For example, we anticipate capitalizing development costs for approximately $6 million in spending for key technology initiatives in 2018, compared with actual capitalization totaling $7 million in 2017 and $8 million in 2016. These activities are conducted at our discretion, and we have no material contractual obligations for activities planned as part of these projects.
At December 31, 2017, we had $657 million in cash and cash equivalents. During 2018, our insurance subsidiary can declare $509 million in dividends to our parent company without regulatory approval. That strong liquidity and our consistent cash flows give us the flexibility to meet current obligations and commitments while building value by prudently investing where we see potential for both current income and long-term return. Our cash provides adequate financial cushion when short-term operating results do not meet our objectives.
A long-term perspective governs our liquidity and capital resources decisions, with the goal of benefiting our policyholders, agents, shareholders and associates over time. Our underwriting philosophy and initiatives can drive performance to achieve our underwriting profitability target of a GAAP combined ratio over any five-year period that consistently averages within the range of 95 percent to 100 percent. Our GAAP combined ratio averaged 94.6 percent over the five-year period 2013 through 2017, resulting in strong underwriting profits.
In any year, we consider the most likely source of pressure on liquidity would be an unusually high level of catastrophe loss payments within a short period of time. There could be additional obligations for our insurance operations due to increasing severity or frequency of noncatastrophe claims. To address the risk of unusually large insurance loss obligations including catastrophe events, we maintain property casualty reinsurance contracts with highly rated reinsurers, as discussed under 2018 Reinsurance Ceded Programs. We also monitor the financial condition of our reinsurers because their insolvency could jeopardize a portion of our $432 million reinsurance recoverable asset at December 31, 2017. Parent-company liquidity could also be constrained by Ohio regulatory requirements that restrict the dividends insurance subsidiaries can pay.
Reserving data for asbestos and environmental claims has characteristics that limit the usefulness of the methods and models used to analyze loss and loss expense reserves for other claims. Specifically, asbestos and environmental loss and loss expenses for different accident years do not emerge independently of one another as loss development and Bornhuetter-Ferguson methods assume. In addition, asbestos and environmental loss and loss expense data available to date did not reflect a well-defined tail, greatly complicating the identification of an appropriate probabilistic trend family model. At year-end 2017, we used a weighted average of a paid survival ratio method and report year method to estimate reserves for IBNR asbestos and environmental claims. Our exposure to such claims is limited; we believe a weighted average of both methods produces a sufficient level of reserves.
Our estimates of gross property casualty loss and loss expense payments do not include reinsurance receivables or ceded losses. As discussed in 2018 Reinsurance Ceded Programs, we purchase reinsurance to mitigate our property casualty risk exposure. Ceded property casualty reinsurance unpaid receivables of $187 million at year-end 2017 are an offset to our gross property casualty loss and loss expense obligations. Our reinsurance program mitigates the liquidity risk of a single large loss or an unexpected rise in claim severity or frequency due to a catastrophic event. Reinsurance does not relieve us of our obligation to pay covered claims. The financial strength of our reinsurers is important because our ability to recover losses under our reinsurance agreements depends on the financial viability of the reinsurers.
We direct our associates and agencies to settle claims and pay losses as quickly as is practical, and we made $2.843 billion of net claim payments during 2017. At year-end 2017, total net property casualty reserves of $5.032 billion reflected $2.434 billion in unpaid amounts on reported claims (case reserves), $1.088 billion in loss expense reserves and $1.510 billion in estimates of claims that were incurred but had not yet been reported (IBNR). The specific amounts and timing of obligations related to case reserves and associated loss expenses are not set contractually. The amounts and timing of obligations for IBNR claims and related loss expenses are unknown. We discuss our methods of establishing loss and loss expense reserves and our belief that reserves are adequate in Critical Accounting Estimates, Property Casualty Insurance Loss and Loss Expense Reserves.
The historical pattern of using premium receipts for the payment of loss and loss expenses has enabled us to extend slightly the maturities of our investment portfolio beyond the estimated settlement date of the loss reserves. The effective duration of our consolidated property casualty fixed-maturity portfolio was 5.2 years at year-end 2017. By contrast, the duration of our loss and loss expense reserves was approximately 3.8 years. We believe this difference in duration does not affect our ability to meet current obligations because cash flow from operations is sufficient to meet these obligations. In addition, investment holdings could be sold, if necessary, to meet higher than anticipated loss and loss expenses.
Management’s best estimate of total loss and loss expense reserves as of year-end 2017 and 2016 was consistent with the corresponding actuarial best estimate.
The following table shows net reserve changes at year-end 2017, 2016 and 2015 by property casualty segment and accident year:
Overall favorable development for consolidated property casualty reserves of $119 million in 2017 illustrated the potential for revisions inherent in estimating reserves, especially for long-tail lines such as commercial casualty and workers’ compensation. As noted in Critical Accounting Estimates, Key Assumptions Loss Reserving, our models predict that actual loss and loss expense emergence will differ from projections, and we do not attempt to monitor or identify such normal variations. The table in Property Casualty Loss and Loss Expense Obligations and Reserves shows reserves by segment and lines of business and the components of gross reserves among case, IBNR and loss expense reserves.
Favorable reserve development of $54 million for our workers’ compensation line accounted for approximately 74 percent of our commercial lines insurance segment net total in 2017, while favorable reserve development was $33 million for our commercial property line of business. Our commercial auto line of business experienced $33 million of unfavorable reserve development on prior accident years recorded during 2017, and that 2017 measure for our commercial casualty line of business was also unfavorable at $11 million. Drivers of significant reserve development typically reflect loss emergence on known claims that was more favorable or less favorable than previously anticipated for various lines of business and are discussed below.
Commercial casualty - During 2017, we experienced unfavorable development on prior accident years in total for this line of business. However, results varied between component coverages and by accident year within coverage. For example, our umbrella liability coverage within commercial casualty experienced favorable results for some prior accident years and adverse development on other accident years to end the calendar year favorably on all prior years combined. Commercial multi-peril coverage developed adversely for many prior accident years, but products liability developed favorably.
Commercial auto - Loss emergence continued to develop unfavorably during calendar year 2017. This line of business has been troublesome for the industry as a whole in recent years. As part of the U.S. economic recession of a few years ago, slowing business activity influenced our estimates of reserves for ultimate losses and loss expenses during that period. As the economy slowly recovered, we believe we have been slow to recognize some of the higher loss cost effects in current accident year reserve estimates for at least part of that period. As claims that occurred during that period have become more mature, paid and reported loss cost trends resulted in us increasing our estimated ultimate losses. Initiatives to improve profitability of our commercial auto line of business are discussed in Commercial Lines Insurance Results.
Personal auto - Loss emergence continued to develop unfavorably during calendar year 2017. This line of business is subject to many of the same cost pressures related to the economic slowdown as commercial auto. Initiatives to improve profitability of our personal auto line of business are discussed in Personal Lines Insurance Results.
For the excess and surplus lines insurance segment, the table showing reserves by segment and lines of business in Property Casualty Loss and Loss Expense Obligations and Reserves, shows the components of gross reserves among case, IBNR and loss expense reserves. Total gross reserves were up $23 million from year-end 2016 primarily due to the increase in premiums and exposures for this segment, as we discussed in Excess and Surplus Lines Insurance Results. Favorable development during 2017 of $29 million for excess and surplus lines insurance segment reserves, shown in the table above, illustrates the potential for revisions inherent in estimating reserves.
A single large loss or an unexpected rise in claims severity or frequency due to a catastrophic event is a risk to the company's liquidity and financial strength. In an effort to control such losses, we avoid marketing property casualty insurance in specific geographic areas and monitor our exposure in certain coastal regions. An example of this is the reduction in recent years of our homeowner policies in the southeastern U.S. coastal region. Loss exposures in that area had been identified as a major contributor to our catastrophe probable maximum loss estimates shown in the table below. Those estimates were subsequently reduced, in large part due to less exposure from southeastern U.S. homeowner policies. We also continually review aggregate exposures to huge disasters and purchase reinsurance protection to cover these exposures. For business other than Cincinnati Re, we use the Risk Management Solutions (RMS) and Applied Insurance Research (AIR) models to evaluate exposures to a once-in-a-100-year and a once-in-a-250-year event to help determine appropriate reinsurance coverage programs. In conjunction with these activities, we also continue to evaluate information provided by our reinsurance broker.
Examples include deterministic modeling of probable maximum loss contribution from growth in new geographic territories.
The modeled losses according to RMS in the table are based on its RiskLink version 17.0 catastrophe model and use a long-term storm catalog methodology. The modeled losses according to AIR in the table are based on its AIR Touchstone® version 5.0 catastrophe model and use a long-term methodology. The AIR and RMS storm catalogs include decades of documented weather events used in simulations for probable maximum loss projections.
For 2018, the primary participants on our standard market property and casualty per-risk and per-occurrence reinsurance ceded programs include Hannover Reinsurance Company, Munich Reinsurance America, Partner Reinsurance Company of the U.S. and Swiss Reinsurance America Corporation, all of which had A.M. Best insurer financial strength ratings of A (Excellent) or better as of December 31, 2017. Our property catastrophe program is subscribed through a broker by reinsurers from the United States, Bermuda, London and the European markets. The largest participant in our property catastrophe program, representing approximately 48 percent of total participation, is the Lloyds of London placement that features numerous syndicates, with Amlin Underwriting Limited and the Catlin Syndicate taking the largest participations. Other primary participants in our property catastrophe program include Liberty Syndicate, R.J. Kiln & Company Limited, and Fidelis.
Property per risk treaty - The primary purpose of the property treaty is to provide capacity up to $50 million, adequate for the majority of the risks we write. It also includes protection for extra-contractual liability coverage losses. We retain the first $10 million of each loss. Losses between $10 million and $50 million are reinsured at 100 percent. The 2018 ceded premium estimate was $26 million, compared with $24 million for the 2017 estimate.
Property excess treaty - For 2018, we purchased a new property reinsurance treaty that provide an additional $50 million in protection for property losses. This treaty, along with the property per risk treaty, provides a total of $100 million of protection. The 2018 ceded premium estimate was approximately $2 million.
Property catastrophe treaty - To protect against catastrophic events such as wind and hail, hurricanes or earthquakes, we purchased property catastrophe reinsurance with a limit up to $600 million. Losses from the same occurrence can now be aggregated into one limit over a 120-hour period and applied to the treaty towards recovery. The treaty contains one reinstatement provision. The 2018 ceded premium estimate was $43 million, compared with a $39 million estimate for 2017. We retain the first $100 million of any loss, and a share of losses up to $600 million, as indicated below:
Beginning in 2013 we added an alternative reinsurance structure to protect against certain catastrophic events, and a similar structure is in place for 2017 through 2019. For certain exposures in the United States, we arranged for the purchase of collateralized reinsurance funded through the issuance of collateralized risk-linked securities, known as catastrophe bonds with Skyline Re Ltd ("Skyline"). The catastrophe bond arrangements generally provide reinsurance coverage for specific types of losses in specific geographic locations. They are generally designed to supplement coverage provided under the property catastrophe treaty. Effective January 2017, we have a catastrophe bond arrangement providing up to $200 million in earthquake reinsurance protection or $80 million in severe convective storm coverage or various combinations of those coverages. It expires in January 2019 and meets the requirements to be accounted for as reinsurance in accordance with the guidance for reinsurance contracts. The earthquake coverage is countrywide, excluding California, and the severe convective storm coverage territory is also countrywide, excluding Florida. The storm coverage provides loss recovery when storm losses for all events in aggregate exceed $190 million, after an $8 million deductible per event.
After reinsurance, and before any applicable benefit from our catastrophe bond, our maximum exposure to a catastrophic event that causes $600 million in covered losses in 2018 would be $125 million, matching our retention for 2017. The largest catastrophe loss event in our history occurred during 2011 from a May 20-27 storm system that included a tornado in Joplin, Missouri, and also significant losses from hail in the Dayton, Ohio, area. Our losses from that storm were estimated at December 31, 2017, to be $226 million before reinsurance.
Casualty treaties - The casualty treaty is written on an excess of loss basis and provide limits up to $6 million, which is adequate capacity for the risk profile we insure. A second treaty layer of $5 million excess of $6 million is written to provide coverage for extra contractual obligations or clash exposures. The maximum retention for any
The following table shows our five largest life reinsurance receivable amounts by reinsurer at year-end 2017 and 2016. The A.M. Best insurer financial strength ratings are also shown.
Disruption of the insurance market caused by technology innovations such as driverless cars that could decrease consumer demand for insurance products
The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
The Cincinnati Insurance Company leads our insurance group that also includes two subsidiaries: The Cincinnati Casualty Company and The Cincinnati Indemnity Company. This group markets a broad range of standard market commercial and personal policies. The group focuses on delivery of quality customer service to our select group of 1,702 independent insurance agencies with 2,256 reporting locations across 42 states. Other subsidiaries of The Cincinnati Insurance Company include The Cincinnati Life Insurance Company, which markets life and disability income insurance and fixed annuities, and The Cincinnati Specialty Underwriters Insurance Company, which offers excess and surplus lines property casualty insurance products. The Cincinnati Insurance Company also conducts the business of our reinsurance assumed operations, Cincinnati ReSM.
Our portfolio investments are primarily in publicly traded fixed-maturity and equity security investments. Fixed-maturity investments (taxable bonds, tax-exempt bonds, redeemable preferred equities and commercial mortgage- backed securities) and equity investments (common and nonredeemable preferred equities) are classified as available for sale and recorded at fair value in the consolidated financial statements. The number of fixed-maturity securities with fair value below 100 percent of amortized cost can be expected to fluctuate as interest rates rise or fall. Because of our strong capital and long-term investment horizon, our general intent is to hold fixed-maturity investments until maturity, regardless of short-term fluctuations in fair values.
When determining OTTI charges for our equity portfolio, our invested asset impairment policy considers qualitative and quantitative factors, including facts and circumstances specific to individual securities; asset classes; the financial condition of the issuer; changes in dividend payment; the length of time fair value had been less than cost; the severity of the decline in fair value below cost; the volatility of the security; and our ability and intent to hold each position until its forecasted recovery.
Certain workers’ compensation policies include the possibility of a policyholder earning a return of a portion of premium in the form of a policyholder dividend. The dividend generally is calculated by determining the profitability of a policy year along with the associated premium. We reserve for all probable future policyholder dividend payments. We record policyholder dividends as other underwriting expenses.
We establish a liability for traditional long-duration contracts as we receive premiums. The amount of this liability is the present value of future expenses and benefits less the present value of future net premiums. Net premium is the portion of gross premium required to provide for all expenses and benefits. We estimate future expenses and benefits and net premium using assumptions for expected expenses, mortality, morbidity, withdrawal rates and investment income. We include a provision for deviation, meaning we allow for some uncertainty in making our assumptions. We establish our assumptions when the contract is issued, and we generally maintain those assumptions for the life of the contract. We use both our own experience and industry experience, adjusted for historical trends, in arriving at our assumptions for expected mortality, morbidity and withdrawal rates. We use our own experience and historical trends for setting our assumption for expected expenses. We base our assumption for expected investment income on our own experience, adjusted for current economic conditions.
We establish known loss reserves when reported. We establish reserves for losses in excess of reported activity in the form of IBNR. Reserves are established using actuarial analysis which includes models and methods
traditionally used for the types of exposures written. We establish reserves for event specific occurrences using modeling data and company specific data when available.
Premiums that we cede are deferred and recorded as earned premiums on a pro rata basis over the terms of the contracts. We estimate loss amounts recoverable from our reinsurers based on the reinsurance policy terms. Historically, our claims with reinsurers have been paid. We establish an insignificant allowance for uncollectible reinsurance.
We calculate deferred income tax liabilities and assets using tax rates in effect when temporary differences in the consolidated financial statement income and taxable income are expected to reverse. We recognize deferred income taxes for numerous temporary differences between our taxable income and consolidated financial statement income and other changes in shareholders’ equity. Such temporary differences relate primarily to unrealized gains and losses on investments and differences in the recognition of deferred acquisition costs, unearned premiums, insurance reserves and basis differences in the carrying value of investments held. We charge deferred income taxes associated with balances that impact other comprehensive income, such as unrealized appreciation and depreciation of investments (except the amount related to the effect of income tax rate changes), to shareholders’ equity in accumulated other comprehensive income (AOCI). We charge deferred taxes associated with other differences to income. Although no Internal Revenue Service (IRS) penalties currently are accrued, if incurred, they would be recognized as a component of income tax expense.
We record land at cost, and record building and equipment at cost less accumulated depreciation. Equipment held under capital leases also is classified as property and equipment with the related lease obligations recorded as liabilities. We capitalize and amortize costs for internally developed computer software during the application development stage. These costs generally consist of external consulting, internal payroll and payroll-related costs. Our depreciation is based on estimated useful lives (ranging from three years to 39.5 years) using straight-line and accelerated methods. Depreciation expense was $28 million for 2017, $30 million for 2016 and $36 million for 2015. We review our accumulated depreciation for our building, equipment and software assets and write off fully depreciated assets for obsolesce and nonuse. We monitor land, building and equipment and software assets for potential impairments. Potential impairments may include a significant decrease in the fair values of the assets, considerable cost overruns on projects, a change in legal factors or business climate or other factors that indicate that the carrying amount may not be recoverable or useful. There were no recorded land, building and equipment impairments for 2017, 2016 or 2015.
ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities
ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting
In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting. ASU 2017-09 clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The amendment should be applied on a prospective basis. The effective date of ASU 2017-09 is for interim and annual reporting periods, beginning after December 15, 2017. The ASU has not yet been adopted; however, it will not have a material impact on our company's consolidated financial position, cash flows or results of operations.
The net unrealized investment gains in our fixed-maturity portfolio at December 31, 2017, are primarily the result of the continued low interest rate environment that increased the fair value of our fixed-maturity portfolio. Our commercial mortgage-backed securities had an average rating of Aa1/AA at December 31, 2017 and 2016. The seven largest net unrealized investment gains in our common stock portfolio are from JP Morgan Chase & Co. (NYSE:JPM), Honeywell International Incorporated (NYSE:HON), BlackRock Inc. (NYSE:BLK), Microsoft Corporation (Nasdaq:MFST), Apple Inc. (Nasdaq:AAPL), 3M Company (NYSE:MMM) and Johnson and Johnson (NYSE:JNJ), which had a combined gross unrealized gain of $1.013 billion. At December 31, 2017, JP Morgan Chase & Co. was our largest single equity holding with a fair value of 4.0 percent of our publicly traded common equities portfolio and 1.4 percent of the total investment portfolio.
At December 31, 2017 and 2016, the company had fixed-maturity investments with a fair value of $101 million and $72 million, respectively, on deposit with various states in compliance with regulatory requirements. In addition, cash and fixed-maturity investments deposited with third parties used as collateral to secure liabilities on behalf of insureds, cedants and other creditors had a fair value of $57 million and $22 million at December 31, 2017 and 2016, respectively.
For the years ended December 31, 2017, 2016 and 2015, there were no credit losses on fixed-maturity securities for which a portion of OTTI has been recognized in other comprehensive income.
The following table provides the change in Level 3 assets during 2017 and 2016:
With the exception of the above table, additional disclosures for the Level 3 category are not material, and therefore not provided.
Fair value of the note payable was determined based upon the outstanding balance at December 31, 2017 and 2016, because it is short term and tied to a variable interest rate. Fair value of the long-term debt was determined under the fair value measurements and disclosure accounting rules based on market pricing of similar debt instruments that are actively trading. We determine fair value for our debt the same way that we value corporate fixed maturities in our investment portfolio. Fair value can vary with macroeconomic conditions. Regardless of the fluctuations in fair value, the outstanding principal amount of our long-term debt is $793 million at both December 31, 2017 and 2016. None of the long-term debt is encumbered by rating triggers. The note payable and long-term debt were classified as Level 2 as an active market does not exist, but fair value is determined based on observable inputs.
Recorded reserves for the deferred annuities were $835 million and $861 million at December 31, 2017 and 2016, respectively. Recorded reserves for the structured settlements were $161 million and $170 million at December 31, 2017 and 2016, respectively.
personal auto line. Both lines developed unfavorable due to higher loss cost effects in recent accident years, resulting in an increase of our reserve estimate for claims that have not yet been settled.
$35 million of favorable development in excess and surplus lines. We recognized favorable development of
2.0 percent of total net loss and loss expense reserves at these year-end dates. We believe our exposure to asbestos and environmental claims is limited, largely because our reinsurance retention was $500,000 or below prior to 1987. We also were predominantly a personal lines company in the 1960s and 1970s. During the 1980s and early 1990s, commercial lines grew as a percentage of our overall business and our exposure to asbestos and environmental claims grew accordingly. Over that period, we included an asbestos and environmental exclusion in almost all policies or endorsed the exclusion to the policies. We have not engaged in any mergers or acquisitions through which such a liability could have been assumed. We continue to monitor our claims for evidence of material exposure to other mass tort classes but have found no such credible evidence to date.
was uniform amongst all of our systems, including legacy systems. Therefore, consistent definitions are only available for accident year 2009 and forward. We will increase the commercial casualty and workers’ compensation cumulative number of reported claims by one year in future periods, not to exceed 10 years. Commercial auto, commercial property, personal auto and homeowner each disclose five accident years of loss and ALAE reserves and cumulative number of reported claims as each of these lines have five year cumulative average annual percentage payouts of approximately 95 percent or higher. The excess and surplus lines began operations in 2008 with earned premiums and loss and ALAE reserves being immaterial prior to 2011. Accordingly, we disclosed seven accident years of loss and ALAE reserves and cumulative number of reported claims for the excess and surplus lines, and will disclose additional accident years in subsequent annual filings, not to exceed 10 years.
No premium deficiencies were recorded in the consolidated statements of income in 2017, 2016 and 2015, as the sum of the anticipated loss and loss expenses, policyholder dividends and unamortized deferred acquisition expenses did not exceed the related unearned premiums and anticipated investment income.
We have one line of credit through multiple commercial banks with a borrowing capacity of $225 million and an additional $50 million accordion feature. Our unsecured revolving credit facility has a term of five years that expires May 13, 2019. We had no compensating balance requirements on short-term debt for either 2017 or 2016. At December 31, 2017 and 2016, $24 million and $20 million was drawn on the line of credit, respectively. The interest rate charged on our borrowings on this credit agreement ranged from 1.65 percent to 2.45 percent during 2017 and ranged from 1.31 percent to 1.49 percent during 2016.
This table summarizes the principal amounts of our long-term debt excluding unamortized discounts, none of which are encumbered by rating triggers:
Our insurance subsidiary declared dividends to the parent company of $465 million in 2017, $475 million in 2016 and $447 million in 2015. State regulatory requirements restrict the dividends insurance subsidiaries can pay. Generally, the most our insurance subsidiary can pay without prior regulatory approval is the greater of 10 percent of statutory capital and surplus or 100 percent of statutory net income for the prior calendar year. Dividends exceeding these limitations may be paid only with approval of the insurance department of the domiciliary state. During 2018, the total that our insurance subsidiary, which is the parent of all other insurance subsidiaries, may declare in dividends is approximately $509 million.
Investments realized gains and life deferred acquisition costs, life policy reserves and other realized gains are recorded in the realized investment gains, net, line item in the consolidated statements of income. Amortization on pension obligations is recorded in the insurance losses and contract holders' benefits and underwriting, acquisition and insurance expenses line items in the consolidated statements of income.
Primary components of our property casualty reinsurance assumed operations include involuntary and voluntary assumed as well as contracts from our reinsurance assumed operations, known as Cincinnati Re. Primary components of our ceded reinsurance include a property per risk treaty, property excess treaty, casualty per occurrence treaty, casualty excess treaty, property catastrophe treaty and catastrophe bonds and retrocessions on our reinsurance assumed operations. Management’s decisions about the appropriate level of risk retention are affected by various factors, including changes in our underwriting practices, capacity to retain risks and reinsurance market conditions.
The tables below summarize our consolidated property casualty insurance net written premiums, earned premiums and incurred loss and loss expenses:
Our changes in direct incurred and ceded incurred compared to prior years resulted primarily from a large settlement paid by USAIG, a joint underwriting association of individual insurance companies that collectively functions as a worldwide aviation insurance market. This settlement resulted in offsetting amounts to direct incurred and ceded incurred with no change to our net incurred loss and loss expenses. We terminated our participation in the USAIG pool after policy year 2002.
The tables below summarize our consolidated life insurance earned premiums and contract holders' benefits incurred:
Income taxes paid in our consolidated statements of cash flows are shown net of refunds received of $18 million in 2017, $2 million in 2016 and an immaterial amount in 2015.
In addition to our IRS filings, we file income tax returns with immaterial amounts in various state jurisdictions. The statute of limitations for state income tax purposes has closed for tax years 2013 and earlier. There are no state income returns under examination and we have not been notified of any upcoming state examinations.
The current sources of dilution of our common shares are certain equity-based awards as discussed in Note 17, Share-Based Associate Compensation Plans. The above table includes the number of anti-dilutive share-based awards at year-end 2017, 2016 and 2015. We did not include these share-based awards in the computation of net income per common share (diluted) because their exercise would have anti-dilutive effects. Our 2017 net income and basic and diluted earnings per share were impacted by the Tax Act as discussed in Note 11, Income Taxes.
$14 million and $12 million during the years 2017, 2016 and 2015, respectively. Associates who are not accruing benefits under the pension plan are eligible to receive the company match of up to 6 percent of cash compensation. Participants vest in the company match for the 401(k) plan after three years of eligible service.
year-end 2017 and $15 million at year-end 2016, which is included in the projected benefit obligation. The company also makes available to a select group of associates the CFC Top Hat Savings Plan, a nonqualified deferred compensation plan, which had a fair value of $31 million and $24 million at December 31, 2017 and 2016, respectively. Company matching contributions to the CFC Top Hat Savings Plan totaled $1 million for the year 2017 and less than $1 million for both years 2016 and 2015.
Our unfunded status improved for 2017 primarily due to better-than-expected return on plan assets partially offset by actuarial losses resulting largely from decreases in discount rate and assumed lump sum rates.
The 2017 amount recognized in net periodic benefit cost and other comprehensive income remained unchanged from 2016. The 2016 change in the amount recognized in other comprehensive income from 2015 is largely due to better-than-expected investment return partially offset with decreases in discount and assumed lump sum rates. The estimated costs to be amortized from AOCI into net periodic benefit cost over the next year for our plans are
Our pension plan assets included 232,113 shares of the company’s common stock at both December 31, 2017 and 2016, which had a fair value of $17 million and $18 million at December 31, 2017 and 2016, respectively. The defined benefit pension plan did not purchase any shares of our common stock during 2017 and 2016. No shares of our common stock were sold during 2017. During 2016, the pension plan sold 35,000 shares of the company’s common stock. The company paid $1 million in 2017 and less than $1 million in 2016 in cash dividends on our common stock to the pension plan.
We contributed $5 million to our qualified plan during the first quarter of 2018 and estimate $5 million of benefit payments from the SERP during 2018. We expect to make the following benefit payments for our qualified plan and SERP, reflecting expected future service:
$7 million in 2017, 2016 and 2015, on premium volume of $45 million, $44 million and $42 million for 2017, 2016 and 2015, respectively.
Share-based compensation cost after tax was $17 million, $15 million and $14 million for the years ended
Risk-free rates are the implied yield currently available on zero-coupon U.S. Treasury issues with a remaining term approximating the expected term.
Cash received from the exercise of options was $13 million, $21 million and $24 million for the years ended December 31, 2017, 2016 and 2015, respectively. We acquired 96,030, 186,097 and 292,414 shares totaling
$7 million, $13 million and $16 million, respectively, from associates in consideration for option exercises during 2017, 2016 and 2015. The weighted-average remaining contractual life for options expected to vest as of December 31, 2017, was 8.69 years.
Under all active shareholder approved plans, a total of 17.3 million shares were authorized to be granted. At December 31, 2017, 11.3 million shares remained available for future issuance under the plans. During 2017, we granted 15,040 shares of common stock to our directors for 2016 board service fees.
We have performance-based awards that vest on the first day of March after a three-calendar-year performance period. These awards vest according to the level of three-year total shareholder return achieved compared with a peer group over a three-year performance period with payouts ranging from 0 to 200 percent for awards granted in 2015, 2016 and 2017. Three-year total shareholder return is calculated by using annualized total return of a stock to an investor due to capital gain appreciation plus reinvestment of all dividends.
For the three-year performance period ended December 31, 2017, our total shareholder return exceeded five of our nine peers. We expect payout of these shares at the target level to occur in March of 2018. During 2017, we issued 87,228 shares of performance-based restricted stock units at the target-level performance hurdle for the three-year performance period ended December 31, 2016, as our total shareholder return exceeded five of nine peers in our 2014 peer group. We issued 25,461 shares of performance-based restricted stock units during 2016 at the threshold-level performance hurdle for the three-year performance period ended December 31, 2015, as we achieved a three-year total shareholder return that exceeded four of 10 peers in our 2013 peer group. Performance-based awards vested during the year had an intrinsic value of $7 million for the year ended December 31, 2017 and $6 million for both years ended 2016 and 2015.
Below is a summary of service-based and performance-based share information, assuming a target payout for performance-based shares, for the year 2017:
This table includes unaudited quarterly financial information for the years ended December 31, 2017 and 2016: