The largest component of our liabilities is our reserve for losses and loss adjustment expenses ("reserve for losses" or "reserve") and the largest component of expense for our operations is incurred losses and loss adjustment expenses (also referred to as “losses and loss adjustment expenses,” “incurred losses,” “losses incurred,” and “losses”). Incurred losses reported in any period reflect our estimate of losses incurred related to the premiums earned in that period as well as any changes to our previous estimate of the reserve required for prior periods.
Because of the implicit and wide-ranging nature of severity trend assumptions on the loss reserving process it is not practical to specifically isolate the impact of changing severity trends. However, because severity is an explicit component of our HCPL pricing process we can better isolate the impact that changing severity can have on our loss costs and loss ratios as regards our pricing models for this business component. Our current HCPL pricing models assume a severity trend of 2% to 3% in most states and products. If the severity trend were to be higher by 1 percentage point, the impact would be an increase in our expected loss ratio for this business of 3.2 percentage points, based on current claim disposition patterns. An increase in the severity trend of 3 percentage points would result in a 10.1 percentage point increase in our expected loss ratio. Due to the long tailed nature of our claims and the previously discussed historical volatility of loss costs, selection of a severity trend assumption is a subjective process that is inherently likely to prove inaccurate over time. Given the long-tail and volatility, we are generally cautious in making changes to the severity assumptions within our pricing models. Also of note is that all open claims and accident years are generally impacted by a change in the severity trend, which compounds the effect of such a change.
Fair values for a majority of our equity securities and portions of our corporate debt, short term and convertible securities are determined using exchange traded prices. There is little judgment involved when fair value is determined using an exchange traded or quoted price. In accordance with GAAP, for disclosure purposes we classify securities valued using an exchange price as Level 1 securities.
Intangible assets with definite lives are amortized over the estimated useful life of the asset. Amortizable intangible assets primarily consist of agency and policyholder relationships, renewal rights and trade names. Intangible assets with an indefinite life, primarily state licenses, are not amortized. Intangible assets are evaluated for impairment on an annual basis. Additional information regarding intangible assets is included in Note 1 of the Notes to Consolidated Financial Statements.
These adverse severity trends later moderated with that moderation becoming more pronounced beginning in 2009. We have been cautious in giving full recognition to indications that the pace of severity increase had slowed, but have given measured recognition of the improved trend in our reserve estimates, as discussed more fully under “Critical Accounting Estimates-Reserve for Losses and Loss Adjustment Expenses (reserve for losses or reserve).” The favorable development was most pronounced for years 2004 to 2008, as the initial reserves for these accident years were established prior to substantial indication that severity trends were moderating. We have given stronger recognition to the lower severity trend as time has elapsed and a greater percentage of claims have closed.
Segment underwriting, policy acquisition and operating expenses were comprised as follows:
The underwriting expense ratio for the Specialty P&C segment reflects a decrease in 2015 as compared to 2014, as shown below:
The tax benefits received from our tax credit partnerships, which are not reflected in our investment results above, reduced our tax expenses in 2015 and 2014 as follows:
we utilized tax credits transferred to us from our tax credit partnership investments.
Our consolidated expense ratio increased in 2014 due to a number of factors, including the acquisition of Eastern and additional expenses associated with our participation in Syndicate 1729. The ratios for both 2014 and 2013 were also affected by expenses attributable to discrete events, such as transaction and other costs associated with business combinations or expansions, and costs associated with technology initiatives. Our 2014 ratio also reflects an increase due to the effect of purchase accounting on deferred policy acquisition cost amortization in 2013. Exclusive of expenses attributable to discrete events, we estimate that the addition of our Workers' Compensation segment, which carries a higher expense ratio, and our Lloyd's Syndicate segment, which had a high expense ratio due to its start-up phase, increased our consolidated expense ratio by approximately 1.3 percentage points for the year ended December 31, 2014. Otherwise, our consolidated ratio increased in 2014 due to lower earned premium from our Specialty P&C segment and the aforementioned effect of purchase accounting on the 2013 ratio.
Our operating ratio (calculated as our combined ratio, less our investment income ratio) increased by 18.1 percentage points in the year ended December 31, 2014, reflecting higher net loss and expense ratios, and a decline in our investment ratio of 6.6 percentage points for the year ended December 31, 2014, primarily due to the acquisition of Eastern. Compared to our professional liability business, workers' compensation generally requires lower reserves which necessitates lower investment assets to support those reserves in proportion to earned premium.
Gross, ceded and net premiums written for the year ended December 31, 2014 were as follows:
The SPCs are segregated pools of assets and liabilities that provide an insurance facility for a defined set of risks. Assets of each SPC are solely for the benefit of that individual cell and each SPC is solely responsible for the liabilities of that individual cell. Assets of one SPC are statutorily protected from the creditors of the others. We participate to a varying degree in the results of selected SPCs. Our ownership interest in the SPCs in which we participate is generally 50%, but we have ownership interests as low as 25% and as high as 82.5%. Under the SPC structure, the net operating results of each cell, net of our participation, are due to the SPC participants of that cell.
Through a wholly owned and consolidated subsidiary (the Corporate Member), we are a Corporate Member of Lloyd's of London. Our Corporate Member is the majority (58%) capital provider to Syndicate 1729, which began writing and reinsuring property and casualty business as of January 1, 2014. The remaining capital for Syndicate 1729 is provided by unrelated third parties, including private names and other corporate members.
Underwriting expenses were $9.5 million for the year ended December 31, 2014, and primarily consisted of underwriting and administrative salaries and benefits, professional fees and amortization of policy acquisition costs (approximately $3.2 million). No underwriting salaries or benefits were deferred during the period due to the Syndicate being in a start-up phase. The high expense ratio for the segment reflects these and other start-up costs expensed during the year, as well as reduced levels of earned premium due to Syndicate 1729 being in its initial stage of operations.