The preparation of financial statements in accordance with GAAP requires estimates and assumptions that often involve a significant degree of judgment. These estimates and judgments include expectations of current and future mortality, morbidity, persistency, claims and claim adjustment expenses, recoverability of receivables, investment returns and interest rates which extend well into the future. In developing these estimates, there is inherent uncertainty, and material changes to facts and circumstances may develop. Although variability is inherent in these estimates, we believe the amounts as reported are appropriate, based upon the facts available upon compilation of the consolidated financial statements.
Completion Factor Approach-This method assumes that the historical claim patterns will be an accurate representation of unpaid claim liabilities. An estimate of the unpaid claims is calculated by subtracting period-to-date paid claims from an estimate of the ultimate “complete” payment for all incurred claims in the period. Completion factors are calculated which “complete” the current period-to-date payment totals for each incurred month to estimate the ultimate expected payout.
We manage our insurance underwriting risk exposures by purchasing reinsurance. We manage counterparty risk by entering into agreements with reinsurers we consider creditworthy, generally measured by the individual entity or entities’ financial strength rating. However, we do require a specified minimum rating by a NRSO. We monitor the concentrations of the reinsurers and reduce the participation percentage of lower-rated and unrated companies when appropriate in our judgment. While we believe we currently have no significant credit risk related to reinsurance counterparties, we continue to monitor their financial condition.
We use reinsurance to mitigate certain risks to the life segment. During 2019, our retention limits were $5 million for issue ages 75 and under, and $2 million for issue ages 76 through 80, and $1,000,000 for issue ages 81 and older for traditional and universal life. In our life segment, we currently retain 100% of newly developed permanent and term products up to our retention limit and cede the excess. We also engage in facultative reinsurance through several reinsurers. Accidental death and premium waiver benefits are mostly retained on new business. Increases in reserves and premium amounts ceded primarily reflect increased use of reinsurance in conjunction with treaties related to universal life products. Reduction in reinsurance ceded is due to a higher retention limit in 2019 than in previous years.
The change in DAC represents acquisition costs capitalized less the amortization of existing DAC, which is calculated in proportion to expected gross profits. The following shows the components of the change in DAC (in thousands):
For 2019, the companies to which we have ceded reinsurance for the Health segment are shown below (in thousands, except percentages):
Commissions decreased primarily due to a decrease in the CPI business
Automobile: Net premiums written and earned increased in our personal automobile line due primarily to an increase in rates charged for these policies and to a lesser extent an increase in policies sold. The loss and loss adjustment expense and combined ratios improved due to better rate adequacy achieved during 2019.
Increase in net gains on equity securities resulting from favorable market conditions.
Evaluating the actuarial assumptions utilized in deriving the estimate based on an analysis of the actuarial assumptions as compared to actual experience and current economic environmental factors affecting policyholder behavior;
As discussed in Notes 2 and 12 to the consolidated financial statements, the property and casualty liability for unpaid claims (property and casualty reserves) consists of the amount estimated for incurred but not reported claims and claims that have been reported but not settled. As of December 31, 2019, the balance of property and casualty reserves was included within the Policy and Contract Claims balance of $1,490 million in the consolidated statements of financial position. The Company estimates property and casualty reserves based upon the Company’s historical experience and actuarial assumptions that consider the effects of current developments, anticipated trends and risk management programs, less anticipated salvage and subrogation. The Company periodically evaluates such estimates in light of recent experience and current information and adjusts the reserves accordingly.
All fixed maturity securities with unrealized losses are assessed to determine if the creditworthiness of any of those securities has deteriorated to a point where its carrying value will not be realized at maturity. For fixed maturity securities at December 31, 2019, the unrealized losses that were not other-than-temporarily impaired were the result of credit spread widening. There were no delinquent coupon payments attributed to these securities for the year ended December 31, 2019.
Stock Appreciation Rights (“SARs”) liability and compensation cost is based on the fair value of the grants and is remeasured each reporting period through the settlement date. The fair value of the SAR’s is calculated using the Black-Scholes-Merton option-pricing model. The key assumptions used in the model include: the grant date and remeasurement date stock prices, expected life of the SARs and the risk-free rate of return. The compensation liability related to the SAR award is included in “Other liabilities” in the consolidated statements of financial position.
In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, "Revenue from Contracts with Customers," that superseded most existing revenue recognition requirements in GAAP. Insurance contracts generally are excluded from the scope of the guidance. For those contracts which are impacted, the transaction price is attributed to the underlying performance obligations in the contract and revenue is recognized as the entity satisfies the performance obligations and transfers control of a good or service to the customer. The Company’s revenues include premiums, other policy revenues, net investment income, realized investment gains, net gains and losses on equity securities, and other income. Other income includes fee income which is recognized when obligations under the terms specified within a contract with a customer are either (1) satisfied at a point in time or (2) based upon the progress of completion measured over a period of time as the obligation is performed using the input method. The Company adopted the standard on its required effective date of January 1, 2018 using the modified retrospective approach. The majority of our revenue sources are insurance related and not in the scope of the guidance. The adoption of the standard did not have a material impact on the Company’s consolidated financial position, results of operations, equity or cash flows as of the adoption date or for the years ended December 31, 2019 and 2018, respectively.
American National holds a small amount of private placement debt and fixed maturity securities that have characteristics that make them unsuitable for matrix pricing. For these securities, a quote from an independent broker (typically a market maker) is obtained. Due to the disclaimers on the quotes that indicate the price is indicative only, American National includes these fair value estimates in Level 3.
Fixed Maturity Securities-The fair value of held-to-maturity securities is determined consistent with the disclosure under Valuation Techniques for the Financial Instrument Recorded at Fair Value section.
The following contains information about incurred and paid claims development as of December 31, 2019, net of reinsurance, as well as cumulative claim frequency and the total of IBNR liabilities plus expected development on reported claims included within the net incurred claims amounts. The information about incurred and paid claims development for the years ended December 31, 2010 to 2018 is presented as supplementary information.
There is no expected development on reported claims in the health blocks. Claim frequency is determined by totaling the number of unique claim numbers during the period as each unique claim number represents a claim event for an individual claimant.
This includes the impact of the U. S. Tax Cut and Jobs Act ("Tax Reform") of a $206.4 million tax benefit, primarily due to the remeasurement of our existing deferred tax balances to the 21% corporate income tax rate. Excluding the impact of Tax Reform, the Company’s net income for the year ended December 31, 2017 would have been $287.3 million and net earnings per basic and diluted share would have been $10.68 and $10.65, respectively.
American National has a $100,000,000 short-term variable rate borrowing facility containing a $55,000,000 sub-feature for the issuance of letters of credit. Borrowings under the facility are at the discretion of the lender and would be used only for funding working capital requirements. The combination of borrowings and outstanding letters of credit cannot exceed $100,000,000 at any time. As of December 31, 2019 and 2018, the outstanding letters of credit were $3,484,000 and $2,995,000, respectively, and there were no borrowings on this facility. This facility expires on October 31, 2020.