Effective January 1, 2012, we prospectively adopted the change in accounting guidance that limits the amount of underwriting expenses eligible for deferral. The adoption of the updated accounting guidance resulted in the recognition of approximately $10.3 million ($8.7 million for our property and casualty insurance segment; $1.6 million for our life insurance segment) of additional expense during 2012 that we would not have recognized had the accounting guidance remained unchanged. This represents a reduction to net income of $0.26 per share. Refer to the “Deferred Policy Acquisition Costs” section of Part II, Item 8, Note 1 “Summary of Significant Accounting Policies” for further discussion of the impact of the updated accounting guidance on our reported results.
In 2013, our loss and loss settlement expenses were affected by a reduction of $34.5 million in catastrophe losses in both our direct business and assumed reinsurance business as compared to 2012, and also, to a lesser extent, by an improvement in our non-catastrophe results.
The property and casualty insurance segment experienced $57.5 million of favorable development in our net reserves for prior accident years for the year ended December 31, 2013. The favorable reserve development on prior year reserves was primarily related to our long-tail lines of commercial business including other liability, workers’ compensation and auto liability. The significant driver of the favorable reserve development in 2013 was the other liability line which contributed $33.5 million of the total, primarily due to additional recognition of relatively recent changes in reserve development patterns which have shown increased redundancies in reserves for reported claims along with relatively less need for IBNR claim reserves. Also, contributing to the favorable development in 2013, only to a lesser extent than the other liability line of business, were workers’ compensation, commercial auto liability and surety lines of business, which contributed $7.5 million, $6.3 million and $4.7 million, respectively, to the favorable reserve development.
In 2012 we experienced favorable reserve development of $73.4 million for reserves established for claims that occurred in prior years. The majority of this favorable development is related to our long-tail lines of commercial business including other liability, workers’ compensation and auto liability.
As of December 31, 2013, we have a net operating loss (“NOL”) carryforward of $7.8 million, which is due to our purchase of American Indemnity Financial Corporation in 1999. No NOLs will expire in 2014.
As of December 31, 2013, we have alternative minimum tax (“AMT”) credit carryforwards of $0.5 million. These have an indefinite life and we expect to realize the entire benefit in the future.
In 2013, our investment income, net of investment expenses, increased $0.9 million to $112.8 million as compared to 2012, primarily due to an increase in value of investments that are accounted for under the equity method of accounting somewhat offset by the impact of low investment yields.
well as the sale of defective building materials. These claims seek recovery due to damage caused by alleged deficient construction techniques or workmanship. At December 31, 2013, we had $35.8 million in construction defect loss and loss settlement expense reserves, excluding IBNR reserves that are calculated for the overall other liability commercial line, which consisted of 2,102 claims. At December 31, 2012, our reserves, excluding IBNR reserves, totaled $34.0 million, which consisted of 1,839 claims. The reporting of such claims can be delayed, as the statute of limitations can be up to 10 years. Also, court decisions in recent years have expanded insurers’ exposure to construction defect claims. As a result, claims may be reported more than 10 years after a project has been completed, as litigation can proceed for several years before an insurance company is identified as a potential contributor. Claims have also emerged from parties claiming additional insured status on policies issued to other parties, such as contractors seeking coverage from a subcontractor’s policy.
We did not recognize any liability for unrecognized tax benefits at December 31, 2013, or 2012 or at any time during 2013, 2012, and 2011. In addition, we have not accrued for interest and penalties related to unrecognized tax benefits. However, if interest and penalties would need to be accrued related to unrecognized tax benefits, such amounts would be recognized as a component of federal income tax expense.
The tables on the following pages summarize our fixed maturity and equity securities that were in an unrealized loss position at December 31, 2013 and 2012. The securities are presented by the length of time they have been continuously in an unrealized loss position. It is possible that we could recognize OTTI charges in future periods on securities held at December 31, 2013, if future events or information cause us to determine that a decline in fair value is other-than-temporary.
The fixed maturities reported as disposals relate to the receipt of principal on calls or sinking fund bonds, in accordance with the indentures. The reported transfers are the result of stale pricing due to a lack of current trading activity for the underlying securities.
(2) On January 1, 2012, Mercer Insurance Group’s catastrophe reinsurance programs were changed to match those of the Company.
In 2011, we experienced favorable reserve development for reserves established for claims that occurred in prior years. The majority of this favorable development is related to our long-tail lines of commercial business including other liability, workers’ compensation and auto liability.
State laws and regulations generally limit the amount of funds that an insurance company may distribute to a parent as a dividend without Commissioner approval. As a holding company with no independent operations of its own, United Fire Group, Inc. relies on dividends received from its insurance company subsidiaries in order to pay dividends to its common shareholders. Dividends payable by our insurance subsidiaries are governed by the laws in the states in which they are domiciled. In all cases, these state laws permit the payment of dividends only from earned surplus arising from business operations. For example, under Iowa law, the maximum dividend or distribution that may be paid within a 12-month period without prior approval of the Iowa Insurance Commissioner is generally restricted to the greater of 10 percent of statutory surplus as of the preceding December 31, or net income of the preceding calendar year on a statutory basis, not greater than earned statutory surplus. Other states in which our insurance company subsidiaries are domiciled may impose similar restrictions on dividends and distributions. Based on these restrictions, at December 31, 2013, our insurance company subsidiary, United Fire & Casualty is able to make a maximum of $53,702 in dividend payments without prior approval. At December 31, 2013, we were in compliance with applicable state laws and regulations. These restrictions will not have a material impact in meeting our cash obligations. In addition, United Fire Group, Inc. maintains a credit agreement, as discussed in Part II, Note 8 “Debt”, which permits us to borrow up to an aggregate principal amount of $125,000.
A reconciliation of income tax expense (benefit) computed at the applicable federal tax rate of 35.0 percent to the amount recorded in the accompanying Consolidated Statements of Income and Comprehensive Income is as follows:
The following tables present the categorization of the pension plan’s assets measured at fair value on a recurring basis at December 31, 2013 and 2012:
Outstanding awards that are not “in-the-money” are excluded from the diluted earnings per share calculation because the effect of including them would have been anti-dilutive.
At December 31, 2013, we were obligated under noncancelable operating lease agreements for office space, vehicles, computer equipment and office equipment. Most of our leases include renewal options, purchase options or both. These provisions may be exercised by us upon the expiration of the related lease agreements. Rental expense under our operating lease agreements was $6,521, $6,017 and $5,232 for 2013, 2012 and 2011, respectively. Our most significant lease arrangement is for office space for our regional office in Galveston, Texas. This lease expires in November 2014. The annual lease payments for this office space total approximately $2,105.
On June 4, 2013, United Fire & Casualty Company, United Fire Group, Inc. and the syndicated lenders entered into an Assignment, Joinder, Assumption, and Release Agreement (the “Joinder Agreement”) transferring the obligations under the credit agreement from United Fire & Casualty Company to United Fire Group, Inc. Effective with the execution of the Joinder Agreement, United Fire & Casualty Company was released from any further obligations under the credit agreement.
The value of business acquired (“VOBA”) at the acquisition date is an intangible asset relating to the difference between the unearned premium reserves acquired in the transaction and the estimated fair value of the unexpired insurance policies, which consists of two components: (1) a provision for loss and loss settlement expenses that will be incurred as the premium is earned and (2) a provision for policy maintenance costs related to servicing those policies until they expire. Loss and loss settlement expenses are valued in a manner identical to that used for loss reserve valuation. Policy maintenance costs are valued based on estimates of future cash flows that are discounted to present value using duration-matched risk-free interest rates. VOBA is reported as a component of deferred policy acquisition costs in the accompanying Consolidated Balance Sheets and is amortized over a twelve-month period from the acquisition date in proportion to the timing of the estimated underwriting profit associated with the in-force business. The amortization pattern for the VOBA asset will be greater in the initial months subsequent to the acquisition date in correlation to the remaining term of the policies that were underwritten by Mercer Insurance Group. We recorded amortization expense of $1,673 and $25,763 in 2012 and 2011, respectively.