ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition and Results of Operation should be read in conjunction with Part II, Item 6, "Selected Financial Data" and Part II, Item 8, "Financial Statements and Supplementary Data." Amounts (except per share amounts) are presented in thousands, unless otherwise noted.
FORWARD-LOOKING STATEMENTS
It is important to note that our actual results could differ materially from those projected in any forward-looking statements in this Form 10-K. Please refer to "Forward-Looking Information" and Part I, Item 1A, "Risk Factors" of this report for information concerning factors that could cause actual results to differ materially from the forward-looking statements contained in this Form 10-K.
BUSINESS OVERVIEW
Originally founded in 1946 as United Fire & Casualty Company, United Fire Group, Inc. and its consolidated insurance company subsidiaries provide insurance protection for individuals and businesses through several regional companies. Our property and casualty insurance company subsidiaries are licensed in 49 states plus the District of Columbia and are represented by approximately 1,000 independent agencies.
Discontinued Operations
On September 18, 2017, the Company signed a definitive agreement to sell its subsidiary, United Life, to Kuvare and on March 30, 2018, the sale closed. As a result, our life insurance business, previously a separate segment, was considered held for sale and reported as discontinued operations in the Consolidated Financial Statements. All periods presented have been revised to show results from continuing and discontinued operations, unless otherwise noted. For more information, refer to Part II, Item 8, Note 17 "Discontinued Operations."
Reportable Segments
Prior to the announcement of the sale of our life insurance business, we have historically reported our operations in two business segments, each with a wide range of products:
•property and casualty insurance, which includes commercial lines insurance, personal lines insurance and assumed reinsurance; and
•life insurance, which includes deferred and immediate annuities, universal life products and traditional life (primarily single premium whole life) insurance products.
We managed these businesses separately, as they generally do not share the same customer base, and each has different products, pricing, and expense structures.
Subsequent to the announcement of the sale of our life insurance business on September 19, 2017, we operate and report one business segment, which contains our continuing operations. Our life insurance business was considered held for sale and reported as discontinued operations throughout this Form 10-K, unless otherwise noted. For more information, refer to Part II, Item 8, Note 10 "Segment Information" and Note 17 "Discontinued Operations."
Pooling Arrangement
All of our property and casualty insurance subsidiaries are members of an intercompany reinsurance pooling arrangement. The Company's pooling arrangement permits the participating companies to rely on the capacity of the entire pool's capital and surplus, rather than being limited to policy exposures of a size commensurate with each participant’s own surplus level.
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Geographic Concentration
Continuing Operations - Property and Casualty Insurance Business
For 2020, approximately 50.4 percent of our property and casualty premiums were written in Texas, California, Iowa, Missouri and New Jersey.
In 2020, 2019 and 2018 the direct statutory premiums written by our property and casualty insurance operations were distributed as follows:
Years Ended December 31, % of Total
Discontinued Operations - Life Insurance Business
Our life insurance subsidiary marketed its products primarily in the Midwest, East Coast and West. In 2020, 2019 and 2018 the direct statutory premiums written by our life insurance operations were distributed as follows:
Years Ended December 31, % of Total
Direct Statutory Premiums Written $ — $ — $ 31,763 — % — % 100.0 %
Sources of Revenue and Expense
We evaluate profit or loss based upon operating and investment results. Profit or loss described in the following sections of this Management's Discussion and Analysis is reported on a pre-tax basis. Our primary sources of revenue are premiums and investment income. Major categories of expenses include losses and loss settlement expenses, underwriting and other operating expenses.
Profit Factors
Our profitability is influenced by many factors, including price, competition, economic conditions, investment returns, interest rates, catastrophic events and other natural disasters, man-made disasters, state regulations, court decisions, and changes in the law. To manage these risks and uncertainties, we seek to achieve consistent profitability through strong agency relationships, exceptional customer service, fair and prompt claims handling,
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disciplined underwriting, superior loss control services, prudent management of our investments, appropriate matching of assets and liabilities, effective use of ceded reinsurance and effective and efficient use of technology.
COVID-19
The spread of the COVID-19 virus, beginning in mid-March 2020, caused significant financial market volatility, economic uncertainty and interruptions to normal business activities. The COVID-19 pandemic has had a profound impact on day-to-day life, financial markets and the economy in the United States. The Company, in response to the challenges presented by the COVID-19 pandemic, activated its pre-existing business continuity plans to respond to a pandemic in mid-March 2020. With the exception of our essential services employees, UFG has dispatched its staff to work remotely for the safety, health and well-being of our employees. We are fully operational, but have limited some non-essential travel. Our essential services employees are following recommended health and safety policies. We are and will continue to monitor the state and federal responses to the pandemic and, when appropriate, will adjust our operations in response. We have a return to workplace plan for our employees. The plan will be implemented at the appropriate time and in a way that is designed to ensure the health and safety of our employees.
The implementation of our business continuity plans did not have a material effect on our internal control environment. We believe our operational processes, internal controls over financial reporting and disclosures, and financial reporting systems are operating effectively in the present environment. Our business teams are working remotely and continue to support our customers, agents and claimants as they did when we were in the office.
Nearly all of the policies we have issued contain contract language that specifically excludes business interruption coverage for losses due to viruses such as the COVID-19 pandemic, but we continue to carefully scrutinize each claim and will afford coverage when appropriate. At this time, we expect the effect of the COVID-19 pandemic on claims currently under our coverages to be manageable, based on the information presently available. However, the effects of the COVID-19 pandemic continue to evolve and we cannot predict the extent to which our business, results of operations, financial condition or liquidity will ultimately be impacted. Additionally, if established written contract policy exclusions of business interruption coverage for losses attributable to the COVID-19 pandemic are voided or changed through legislation, regulations or interpretations by the courts, such changes have the potential to materially increase claims, losses and legal expenses which could impact our business, financial condition, results of operations and liquidity.
We anticipate that the larger impact on our financial condition and results of operations will likely result from developments in the economy as a whole and the effect on financial markets and the investments we hold in our investment portfolio, premiums and demand for our products, and our ability to collect premiums or any requirement to return premiums to policyholders. We believe our current liquidity position is sufficient to maintain our current operations and we have the ability to draw on our credit facility if needed. See "Credit Facilities" in Part II, Item 8, Note 14 "Debt" for more information. We implemented state-mandated and optional payment leniency programs for our policyholders, all of which have expired as of December 31, 2020. As of December 31, 2020, we did not see a significant impact to cash flows or allowance for doubtful accounts as a result of these programs. During the fourth quarter of 2020, management did not repurchase any shares of stock, and the share repurchase program has been suspended since mid-March 2020. Also, the Company maintained the payment of quarterly cash dividends during 2020, with fourth quarter of 2020 marking the 211th consecutive quarter of paying dividends since March 1968.
Stockholders' equity decreased to $825.1 million at December 31, 2020, from $910.5 million at December 31, 2019. This decrease was primarily attributed to a net loss of $112.7 million, shareholder dividends of $28.5 million and share repurchases of $2.7 million, partially offset by an increase in net unrealized investment gains on fixed maturity securities of $35.8 million, net of tax, during 2020 and a decrease in our pension and post-retirement liabilities of $17.9 million, net of tax.
We evaluate goodwill and other intangible assets for impairment at least on an annual basis or whenever events or changes in circumstances indicate that it is more likely than not that the carrying amount of goodwill and other intangible assets may exceed their implied fair value. Goodwill is evaluated at the reporting unit level, for which we have one reporting unit level. Any impairment is charged to operations in the period that the impairment is
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identified. During the third quarter of 2020, we completed our annual quantitative analysis of goodwill. As a result of the quantitative analysis, we impaired the remaining balance of our goodwill of $15.1 million as of September 30, 2020 based on the following factors: (i) disruptions in the equity markets, specifically for property and casualty insurance companies, as a result of the COVID-19 pandemic and due to recent weather related catastrophes; (ii) recent elevated commercial auto loss ratios; and (iii) the fair value of our stock trading significantly below book value. The Company used a weighting of the income and market approaches to determine the fair value of the reporting unit.
As of December 31, 2020, we intend to keep all assets currently leased and honor the terms of the contracts. Also, we have four lease contracts where we are the lessor which we evaluated for impairment. As of December 31, 2020, all payments on these contracts had been received and we fully expect to receive all future payments on time. In the event that we receive any lease-related relief provided to mitigate the economic effects of the COVID-19 pandemic, we elect not to evaluate whether or not the relief represents a lease modification.
The decline in certain sectors of the equity markets in 2020 due to the COVID-19 pandemic did have a material impact on the fair value of our investments in equity securities and limited liability partnerships. The Company's investment philosophy, objectives, approach and program have not changed as a result of the COVID-19 pandemic. In 2020 the decrease in the fair value of equity securities from December 31, 2019 was $6.9 million.
The Company has a highly rated fixed maturity portfolio, with low credit risk. The Company recognized an unrealized gain of $35.8 million, net of tax, in 2020 on its available-for-sale fixed maturity portfolio.
MEASUREMENT OF RESULTS
Our consolidated financial statements are prepared on the basis of GAAP. We also prepare financial statements for each of our insurance company subsidiaries based on statutory accounting principles and file them with insurance regulatory authorities in the states where they do business.
Management evaluates our operations by monitoring key measures of growth and profitability. We believe that disclosure of certain non-GAAP financial measures enhances investor understanding of our financial performance. The following provides further explanation of the key measures management uses to evaluate our results:
Catastrophe losses is a commonly used non-GAAP financial measure which utilizes the designations of the Insurance Services Office ("ISO") and are reported with losses and loss settlement expense amounts net of reinsurance recoverables, unless specified otherwise. According to the ISO, a catastrophe loss is defined as a single unpredictable incident or series of closely related incidents that result in $25.0 million or more in U.S. industry-wide direct insured losses to property and that affect a significant number of insureds and insurers ("ISO catastrophe"). In addition to ISO catastrophes, we also include as catastrophes those events ("non-ISO catastrophes"), which may include U.S. or international losses, that we believe are, or will be, material to our operations, either in amount or in number of claims made. Management, at times, may determine for comparison purposes of our financial results that it is more meaningful to exclude extraordinary catastrophe losses and resulting litigation. The frequency and severity of catastrophic losses we experience in any year affect our results of operations and financial position. In analyzing the underwriting performance of our property and casualty insurance business, we evaluate performance both including and excluding catastrophe losses. Portions of our catastrophe losses may be recoverable under our catastrophe reinsurance agreements. We include a discussion of the impact of catastrophes because we believe it is meaningful for investors to understand the variability in our periodic earnings.
Years Ended December 31,
(1) Includes international assumed losses.
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RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2020, 2019 AND 2018
FINANCIAL HIGHLIGHTS
Years Ended December 31, % Change
Revenues
Other income 6,270 — — NM —
Benefits, losses and expenses
Goodwill impairment 15,091 — — NM —
Net income (loss) from continuing operations $ (112,706) $ 14,820 $ 2,255 NM NM
Income (loss) from discontinued operations, net of tax — — (1,912) NM (100.0) %
Gain on sale of discontinued operations, net of tax — — 27,307 NM (100.0) %
GAAP Ratios:
Net loss ratio (without catastrophes) 68.9 % 70.5 % 66.0 % (2.3) % 6.8 %
Catastrophes - effect on net loss ratio 13.5 % 5.9 % 4.5 % 128.8 % 31.1 %
NM = not meaningful
(1) The net loss ratio is calculated by dividing the sum of losses and loss settlement expenses by net premiums earned. We use the net loss ratio as a measure of the overall underwriting profitability of the insurance business we write and to assess the adequacy of our pricing. Our net loss ratio is meaningful in evaluating our financial results as reported in our Consolidated Financial Statements.
(2) The expense ratio is calculated by dividing non-deferred underwriting expenses and amortization of deferred policy acquisition costs by net premiums earned. The expense ratio measures a company's operational efficiency in producing, underwriting and administering its insurance business.
(3) The combined ratio is a commonly used financial measure of property and casualty underwriting performance. A combined ratio below 100.0 percent generally indicates a profitable book of business. The combined ratio is the sum of the net loss ratio and the underwriting expense ratio.
In 2020, the decrease in net income from continuing operations compared to 2019 was primarily due to a decrease in the fair value of equity securities, realized losses on sales of equity securities, increases in losses and loss settlement expenses, namely from catastrophe losses and an increase in severity of losses, decrease in net premiums earned, a decrease in net investment income and goodwill impairment.
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In 2019, the increase in net income from continuing operations compared to 2018 was primarily due to an increase in the value of our investments in equity securities from strong increases in equity markets and an increase in net premiums earned, from rate increases, offset by an increase in losses and loss settlement expenses from an increase in severity of commercial auto and auto liability losses, reserve strengthening in our Gulf Coast Region and an increase in catastrophe losses.
Premiums from continuing operations
The following table shows our premiums written and earned from continuing operations for 2020, 2019 and 2018:
% Change
NM = not meaningful
(1) Net premiums written: Net premiums written is a non-GAAP measure. While not a substitute for any GAAP measure of performance, net premiums written is frequently used by industry analysts and other recognized reporting sources to facilitate comparisons of the performance of insurance companies. Net premiums written are the amount charged for insurance policy contracts issued and recognized on an annualized basis at the effective date of the policy. Management believes net premiums written are a meaningful measure for evaluating insurance company sales performance and geographical expansion efforts. Net premiums written for an insurance company consists of direct premiums written and reinsurance assumed, less reinsurance ceded. Net premiums earned is calculated on a pro rata basis over the terms of the respective policies. Unearned premium reserves are established for the portion of premiums written applicable to the unexpired term of insurance policy in force. The difference between net premiums earned and net premiums written is the change in unearned premiums and change in prepaid reinsurance premiums.
Net Premiums Written
Net premiums written comprise direct and assumed premiums written, less ceded premiums written. Direct premiums written are the total policy premiums, net of cancellations, associated with policies issued and underwritten by our property and casualty insurance business. Assumed premiums written are the total premiums associated with the insurance risk transferred to us by other insurance and reinsurance companies pursuant to reinsurance contracts. Ceded premiums written is the portion of direct premiums written that we cede to our reinsurers under our reinsurance contracts. Net premiums earned are recognized ratably over the life of a policy and differ from net premiums written, which are recognized on the effective date of the policy.
Direct Premiums Written
Direct premiums written from continuing operations decreased $78.1 million in 2020 as compared to 2019 primarily due to our focus on improving profitability through non-renewal of underperforming accounts in our commercial auto line of business, sale of the renewal rights of our personal lines business to Nationwide and, to a lesser extent, a reduction due to the COVID-19 pandemic. Direct premiums written from continuing operations increased $31.7 million in 2019 as compared to 2018 primarily due to rate increases, premium audits and endorsements.
Assumed Premiums Written
Assumed premiums written increased $6.5 million in 2020 as compared to 2019 due to growth of our assumed book by the addition of new programs and cedant premium growth.
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Assumed premiums written increased $11.1 million in 2019 as compared to 2018 due to an increase in cedant premium growth and additional program placements.
Ceded Premiums Written
Direct and assumed premiums written are reduced by the ceded premiums that we pay to reinsurers. For 2020, we ceded 18.6 percent more premiums to reinsurers as a result of increased placement of facultative reinsurance, continued growth in managing general agency contracts and ceded reinstatement paid. For 2019, we ceded 11.5 percent more premiums to reinsurers as a result of continued growth in direct premiums written, facultative reinsurance and addition of new managing general agency contracts.
Losses and Loss Settlement Expenses from continuing operations
Catastrophe Exposures
Catastrophe losses are inherent risks of the property and casualty insurance business. Catastrophic events include, without limitation, hurricanes, tornadoes, earthquakes, hailstorms, wildfires, high winds, winter storms and other natural disasters, along with man-made exposures to losses resulting from, without limitation, acts of war, acts of terrorism and political instability. Such events result in insured losses that can be, and may continue to be, a material factor in our results of operations and financial position, as the extent of losses from a catastrophe is a function of both the total amount of insured exposure in an area affected by the event and the severity of the event. Because the level of insured losses that may occur in any one year cannot be accurately predicted, these losses contribute to fluctuations in our year-to-year results of operations and financial position. Some types of catastrophes are more likely to occur at certain times within the year than others, which adds an element of seasonality to our property and casualty insurance claims. Our property and casualty insurance business experiences some seasonality with regard to premiums written, which are generally highest in January and July and lowest during the fourth quarter. Losses and loss settlement expenses incurred tend to remain consistent throughout the year, with the exception of catastrophe losses, which generally are highest in the second and third quarters. The frequency and severity of catastrophic events are difficult to accurately predict in any year. However, some geographic locations are more susceptible to these events than others.
We control our direct insurance exposures in regions that are prone to naturally occurring catastrophic events through a combination of geographic diversification, restrictions on the amount and location of new business production in such regions, and reinsurance. We regularly assess our concentration of risk exposures in natural catastrophe exposed areas. We have strategies and underwriting standards to manage these exposures through individual risk selection, subject to regulatory constraints, and through the purchase of catastrophe reinsurance coverage. We use catastrophe modeling and a risk concentration management tool to monitor and control our accumulations of potential losses in natural catastrophe exposed areas of the United States, such as the Gulf and East Coasts, as well as in areas of exposure in other countries where we are exposed to a portion of an insurer's underwriting risk under our assumed reinsurance contracts.
Overall, the models indicate increased risk estimates for our exposure to hurricanes in the U.S., but the impact of the models on our book of business varies significantly among the regions that we model for hurricanes. Based on our analysis, we have implemented more targeted underwriting and rate initiatives in some regions. We will continue to take underwriting actions and/or purchase additional reinsurance as necessary to reduce our exposure.
Catastrophe modeling generally relies on multiple inputs based on experience, science, engineering and history, and the selection of those inputs requires a significant amount of judgment. The modeling results may also fail to account for risks that are outside the range of normal probability or are otherwise unforeseen. Because of this, actual results may differ materially from those derived from our modeling assumptions.
Despite our efforts to manage our catastrophe exposure, the occurrence of one or more severe natural catastrophic events in heavily populated areas could have a material effect on our results of operations, financial condition or liquidity.
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The process of estimating and establishing reserves for losses incurred from catastrophic events is inherently uncertain and the actual ultimate cost of a claim, net of reinsurance recoveries, may vary materially from the estimated amount reserved. Although we reinsure a portion of our exposure, reinsurance may prove to be inadequate if a major catastrophic event exceeds our reinsurance limits or if we experience a number of small catastrophic events that individually fall below our reinsurance retention level.
Catastrophe Losses
In 2020, our pre-tax catastrophe losses were $142.0 million, an increase of $77.6 million compared to $64.4 million in 2019 and an increase of $95.3 million as compared to $46.7 million in 2018. In 2020, our catastrophe losses included 60 catastrophes with the largest event being the August Midwest derecho. Catastrophe losses in 2020 added 13.5 percentage points to the combined ratio, which is above our historical 10-year average of 7.4 percentage points.
In 2019, our catastrophe losses included 54 catastrophes with no one event more than $5.0 million. Catastrophe losses in 2019 added 5.9 percentage points to the combined ratio, which is below our historical 10-year average of 6.4 percentage points. In 2018, catastrophe losses included 46 catastrophes with our largest pre-tax catastrophe losses coming from the California wildfires, which totaled $9.2 million. Catastrophe losses in 2018 added 4.5 percentage points to the combined ratio, which is below our historical 10-year average of 6.4 percentage points.
Catastrophe Reinsurance
In 2020, we exceeded our catastrophe reinsurance retention level of $20.0 million with the August Midwest derecho, causing widespread storms and high winds. The August Midwest derecho was a full retention loss, with losses in excess of our stated reinsurance retention of $20.0 million. Total losses from this storm were $101.8 million with $81.8 million of reinsurance recoveries. In 2019 and 2018, we did not exceed our catastrophe reinsurance retention level of $20.0 million per event.
We use many reinsurers, both domestic and foreign, which helps us to avoid concentrations of credit risk associated with our reinsurance. All reinsurers we do business with must meet the following minimum criteria: capital and surplus of at least $300.0 million and an A.M. Best rating or an S&P rating of at least "A-." If a reinsurer is rated by both rating agencies, then both ratings must be at least an "A-."
The following table represents the primary reinsurers we utilize and their financial strength ratings as of December 31, 2020:
Name of Reinsurer A.M. Best S&P Rating
Everest Reinsurance Company(2) A+ A+
General Reinsurance Corporation(2) A++ AA+
Hannover Rueckversicherung AG (1) (2) A+ AA-
Lloyd's A A+
Munich Re(2) A+ A-
Odyssey Re(2) A A-
Partner Re(1)(2) A+ A+
QBE Reinsurance Corporation(1) A A+
SCOR Reinsurance Company(1)(2) A+ AA-
Toa Re(1) A A+
Transatlantic Re(1) A+ A+
(1)Primary reinsurers participating in the property and casualty excess of loss programs.
(2)Primary reinsurers participating in the surety excess of loss program.
Refer to Part II, Item 8, Note 4 "Reinsurance" for further discussion of our reinsurance programs.
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Terrorism Coverage
The Terrorism Risk Insurance Program Reauthorization Act of 2019 ("TRIPRA") is the fourth reauthorization of the law, which was previously reauthorized in 2005, 2007, and 2015. TRIRPA coverage is effective through December 31, 2027 and preserves the current industry loss trigger of $200 million per year, and gradually increased the industry-wide retention to $37.5 billion per year. TRIPRA coverage includes most direct commercial lines of business, including coverage for losses from nuclear, biological and chemical exposures if coverage was afforded by an insurer, with exclusions for commercial automobile insurance, burglary and theft insurance, surety, professional liability insurance and farm owners multiple peril insurance. Under TRIPRA, each insurer has a deductible amount, which is 20.0 percent of the prior year's direct commercial lines earned premiums for the applicable lines of business, and retention of 15.0 percent above the deductible. No insurer that has met its deductible shall be liable for the payment of any portion of that amount that exceeds the annual aggregate loss cap specified in TRIPRA. TRIPRA provides marketplace stability. As a result, coverage for terrorist events in both the insurance and reinsurance markets is often available. The amount of aggregate losses necessary for an act of terrorism to be certified by the U.S. Secretary of Treasury, the Secretary of State and the Attorney General was $200.0 million for 2020 and remains the same for 2021. Our TRIPRA deductible was $140.4 million for 2020 and our TRIPRA deductible is expected to be $139.8 million for 2021. Our catastrophe and non-catastrophe reinsurance programs provide limited coverage for terrorism exposure excluding nuclear, biological and chemical-related claims.
2020 Results
In 2020, our losses and loss settlement expenses were 4.7 percent higher than 2019 and our net loss ratio increased 6.0 points. The increase was primarily driven by an increase in the severity of losses from social inflation, an increase in catastrophe losses and prior accident year reserve strengthening. With the continued escalation of losses from social inflation, especially with commercial auto and auto liability losses industry wide we are focusing on continuing our strategic plan to reduce the size of our commercial auto book in 2021. By reducing commercial auto exposure units in underperforming accounts and growing more profitable lines of business such as excess and surplus, surety and assumed reinsurance, we intend to achieve a better balance in our portfolio. Catastrophe losses increased to $142.0 million in both our direct business and assumed reinsurance business as compared to $64.4 million in 2019.
2019 Results
In 2019, our losses and loss settlement expenses were 13.5 percent higher than 2018 and our net loss ratio increased
5.9 points. The increase was primarily driven by an increase in the severity of losses in commercial auto line of
business, an increase in catastrophe losses and prior accident year reserve strengthening in our Gulf Coast region. Catastrophe losses increased to $64.4 million in both our direct business and assumed reinsurance business as compared to $46.7 million in 2018.
Reserve Development
For many liability claims, significant periods of time, ranging up to several years, and for certain construction defect claims, more than a decade, may elapse between the occurrence of the loss, the reporting of the loss to us and the settlement or other disposition of the claim. As a result, loss experience in the more recent accident years for the long-tail liability coverages has limited statistical credibility in our reserving process because a relatively small proportion of losses in these accident years are reported claims and an even smaller proportion are paid losses. In addition, long-tail liability claims are more susceptible to litigation and can be significantly affected by changing contract interpretations and the legal environment. Consequently, the estimation of loss reserves for long-tail coverages is more complex and subject to a higher degree of variability. Reserves for these long-tail coverages represent a significant portion of our overall carried reserves.
When establishing reserves and monitoring reserve adequacy, we analyze historical data and consider the potential impact of various loss development factors and trends including historical loss experience, legislative enactments, judicial decisions, legal developments in imposition of damages, experience with alternative dispute resolution, results of our medical bill review process and changes and trends in general economic
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conditions, including the effects of inflation. All of these factors influence our estimates of required reserves and for long-tail lines these factors can change over the course of the settlement of the claim. However, there is no precise method for evaluating the specific dollar impact of any individual factor on the development of reserves.
Our reserving philosophy is to reserve claims to their ultimate expected loss amount as soon as practicable after information about a claim becomes available. This approach tends to produce, on average, cautiously pessimistic case reserves, which we expect to result in some level of favorable development over the course of settlement.
2020 Development
The property and casualty insurance business experienced $17.7 million of favorable development in our net reserves for prior accident years for the twelve-month period ended December 31, 2020. Four lines contributed the majority of favorable development with the largest contribution coming from workers' compensation which had $25.4 million favorable development followed by commercial fire and allied lines which had $10.7 million favorable development. The two other lines which experienced favorable development were fidelity and surety with $2.1 million favorable development and personal automobile with $1.9 million favorable development. The favorable development for workers' compensation was primarily from reductions in reserves for reported claims which were more than sufficient to offset paid loss. Reductions in reserves for IBNR claims also contributed favorable development in addition to loss adjustment expense ("LAE") where reductions in reserves more than sufficient to offset payments. Commercial fire and allied lines developed favorably because reductions in reserves for reported claims combined with reductions in reserves for IBNR claims were more than sufficient to offset paid loss; LAE also contributed favorable development with reductions in reserves more than sufficient to offset payments. Fidelity and surety loss developed favorably because a reduction in reserves for IBNR claims was more than sufficient to offset both paid loss and increases in reserves for reported claims. The personal automobile line of business developed favorably because reductions of reserves for reported claims combined with reductions of reserves for IBNR claims were more than sufficient to offset paid loss; LAE also contributed favorable development with reductions in reserves more than sufficient to offset payments. Much of the favorable development was offset by unfavorable development from three lines with the largest contribution coming from commercial liability which experienced $12.8 million unfavorable development. The two other lines which experienced unfavorable development were reinsurance assumed with $6.4 million unfavorable development and commercial automobile with $4.0 million unfavorable development. The commercial liability line of business experienced unfavorable development due to paid loss which was greater than reductions in reserves for unpaid loss; LAE developed favorably and partially offset the unfavorable loss development. The unfavorable development for the reinsurance assumed line of business was due to paid loss which was greater than reductions in reserves for unpaid loss. The commercial automobile line of business experienced unfavorable development because paid loss was greater than reductions in reserves for unpaid loss, but a portion of the unfavorable loss development was offset by favorable development from LAE where payments were more than offset by reductions of reserves for unpaid loss adjustment expense. On an all lines combined basis, favorable development is attributable to LAE which continues to benefit from additional litigation management efforts. The lines of business not mentioned individually above contributed an additional combined total of $0.8 million of favorable development.
2019 Development
The property and casualty insurance business experienced $5.3 million of favorable development in our net reserves for prior accident years for the year ended December 31, 2019. Four lines contributed favorable development with the largest contribution coming from workers' compensation, which had $37.3 million favorable development. The three other lines that experienced favorable development were fidelity and surety with $3.1 million favorable development, commercial fire and allied lines with $2.3 million favorable development, and personal automobile with $1.2 million favorable development. The favorable development for workers' compensation was primarily from reductions in reserves for reported claims which were more than sufficient to offset paid loss; LAE also contributed favorable development with reductions in reserves more than sufficient to offset payments. Fidelity and surety loss developed favorably because reductions inclaim reserves and salvage recoverieswere more than sufficient to offset loss payments. Commercial fire and allied lines developed favorably due to paid LAE where reductions in reserves
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for unpaid LAE were more than sufficient to offset payments. Personal automobile developed favorably primarily due to paid LAE where reductions in reserves for unpaid LAE were more than sufficient to offset payments. Much of the favorable development was offset by unfavorable development from two lines with the largest contribution coming from commercial liability which experienced $35.0 million unfavorable development. The other line which experienced unfavorable development was commercial automobile with $3.4 million unfavorable development. Commercial liability experienced unfavorable development primarily due to paid loss which was greater than reductions in reserves for unpaid loss. Paid LAE also contributed to the unfavorable result in commercial liability. Commercial automobile experienced unfavorable development because paid loss was greater than reductions in reserves for unpaid loss, but a portion of the unfavorable loss development was offset by favorable development from LAE. On an all lines combined basis, favorable development is attributable to LAE which continues to benefit from additional litigation management efforts. The lines of business not mentioned individually above contributed an additional total of $0.2 million of unfavorable development in the aggregate.
2018 Development
The property and casualty insurance business experienced $54.2 million of favorable development in our net reserves for prior accident years for the year ended December 31, 2018. The majority of favorable development came from four lines, workers' compensation with $27.0 million favorable development, reinsurance assumed with $15.6 million favorable development, commercial automobile with $9.5 million favorable development, and fidelity and surety with $2.8 million favorable development. The only individual line with unfavorable development was commercial liability with $3.7 million of unfavorable development. Workers' compensation favorable development was primarily from reserve reductions for both reported claims and loss IBNR which were more than sufficient to offset paid loss with additional favorable development coming from LAE where the LAE IBNR reduction was more than sufficient to offset paid LAE which continues to benefit from additional litigation management efforts when compared to prior years. Reinsurance assumed favorable development is attributable reductions in reserves for both reported claims and loss IBNR as we reviewed our book of business and released excess reserves during 2018. Commercial automobile favorable development was driven by LAE where LAE IBNR reductions were more than sufficient to offset paid LAE. Fidelity and surety favorable development is attributable to reductions in reserves for both reported claims and loss IBNR which were more than sufficient to offset paid loss. Commercial liability adverse development is attributable to reserve strengthening for both reported claims and loss IBNR primarily in response to an increase in umbrella auto related claims while LAE developed favorably with reductions of LAE IBNR more than sufficient to offset paid LAE.
Reserve development amounts can vary significantly from year-to-year depending on a number of factors, including the number of claims settled and the settlement terms, and are subject to reallocation between accident years and lines of business.
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Net Loss Ratios by Line
The following table depicts our net loss ratios for 2020, 2019 and 2018:
Commercial lines
Personal lines
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Commercial Lines
The net loss ratio in our commercial lines of business, excluding assumed reinsurance, was 77.8 percent in 2020 compared to 75.6 percent in 2019 and 71.4 percent in 2018. The net loss ratio in 2020 increased compared to 2019 primarily due to an increase in catastrophe losses. The net loss ratio in 2019 increased compared to 2018 with a deterioration in commercial auto and other liability lines of business from an increase in severity of commercial auto losses and auto related bodily injury claims. Also contributing to the deterioration in 2019 compared to 2018, was an increase in commercial fire and allied lines of business due to an increase in catastrophe losses.
Other Liability
Other liability is business insurance covering bodily injury and property damage arising from general business operations, accidents on the insured's premises and products manufactured or sold. Because of the long-tail nature of liability claims, significant periods of time, ranging up to several years, may elapse between the occurrence of the loss, the reporting of the loss to us and the settlement of the claim.
In recent years, we began to use our loss control department more extensively in an attempt to return this line of business to a higher level of profitability. For example, our loss control department has representatives who make multiple visits each year to businesses and job sites to ensure safety. We also do not renew accounts that no longer meet our underwriting or pricing guidelines. We avoid accounts that have become too underpriced for the risk.
Construction Defect Losses
Incurred losses from construction defect claims were $14.8 million in 2020 compared to $19.4 million and $15.9 million in 2019 and 2018, respectively. At December 31, 2020, we had $73.6 million in construction defect loss and loss settlement expense reserves (excluding IBNR reserves which are calculated at the overall other liability commercial line), which consisted of 3,983 claims. In comparison, at December 31, 2019, we had reserves of $60.4 million, excluding IBNR reserves, consisting of 3,439 claims. Our West Coast region continue to be the origin of the majority of the construction defect claim activity.
Construction defect claims generally relate to allegedly defective work performed in the construction of structures such as apartments, condominiums, single family dwellings or other housing, as well as the sale of defective building materials. Such claims seek recovery due to damage caused by alleged deficient construction techniques or workmanship. The reporting of such claims can be quite delayed due to an extended statute of limitations, sometimes up to ten years. Court decisions have expanded insurers' exposure to construction defect claims as well. Defense costs are also a part of the insured expenses covered by liability policies and can be significant, sometimes greater than the cost of the actual paid claims.
We have exposure to construction defect liabilities in Colorado and surrounding states. We have historically insured small- to medium-sized contractors in this geographic area. In an effort to limit the number of future claims from multi-unit buildings, we implemented policy exclusions in 2009, later revised in 2010, that exclude liability coverage for contractors performing "residential structural" operations on any building project with more than 12 units or on single family homes in any subdivision where the contractor is working on more than 15 homes. The exclusions do not apply to remodeling or repair of an existing structure. We also changed our underwriting guidelines to add a professional liability exclusion when contractors prepare their own design work or blueprints and implemented the multi-family exclusion and tract home building limitation form for the state of Colorado and our other western states as a means to reduce our exposure in future years. When offering commercial umbrella coverage for structural residential contractors, limits of liability are typically limited to a maximum of $2.0 million per occurrence. Requests to provide additional insured status for "developers" are declined.
As a result of our acquisition of Mercer Insurance Group, Inc. in 2011, we added construction defect exposure in the states of California, Nevada and Arizona. Mercer Insurance Group, Inc. has been writing in these states for more than 20 years. In order to minimize our exposure to construction defect claims in this region, we continually review the coverage we offer and our pricing models. In an effort to limit our exposure from residential multi-unit buildings, we started including condominium and townhouse construction policy exclusions in 2012 for our
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contracting policies in this region. For the majority of our residential contractors we limit the size of any tracts the contractor is working on to 25 homes or less and do not include a continuous trigger with our designated work exclusion. In a majority of the policies in our small service, repair and remodel contractors program, we have a favorable new residential construction exclusion. We also apply strict guidelines when additional insured forms are required and changed our underwriting guidelines to limit our exposure to large, multi-party construction defect claims.
Commercial Fire and Allied Lines
Commercial fire and allied lines include fire, allied lines, commercial multiple peril and inland marine. The insurance covers losses to an insured's property, including its contents, from weather, fire, theft or other causes. We provide this coverage through a variety of business policies.
The net loss ratio deteriorated 17.2 percentage points in 2020 compared to 2019. The deterioration was primarily due to an increase in catastrophe losses.
Commercial Automobile
Our commercial automobile insurance covers physical damage to an insured's vehicle, as well as liabilities to third parties. Automobile physical damage insurance covers loss or damage to vehicles from collision, vandalism, fire, theft, flood or other causes. Automobile liability insurance covers bodily injury, damage to property resulting from automobile accidents caused by the insured, uninsured or underinsured motorists and the legal costs of defending the insured against lawsuits.
The net loss ratio improved 7.6 percentage points in 2020 compared to 2019. In both years, the loss ratio was at an elevated level due to the severity of losses from social inflation of bodily injury claims from prior accident years. In 2020, the improvement was from less prior accident year reserve strengthening than in 2019.
Workers' Compensation
We consider our workers' compensation business to be a companion product; we rarely write stand-alone workers' compensation policies. Our workers' compensation insurance covers primarily small- to mid-size accounts. The net loss ratio deteriorated 9.3 percentage points in 2020 compared to 2019. The deterioration is attributable to a few large claims in 2020. The current year loss ratios are more in line with an average year as compared to 2019 which had less than average losses.
Competitive market conditions continue in 2020 for workers' compensation business, putting downward pressure on rates. The challenges faced by workers' compensation insurance providers to attain profitability include the regulatory climates in some states that make it difficult to obtain appropriate premium rate increases and inflationary medical costs. Consequently, we have increased the utilization of our loss control unit in the analysis of current risks, with the intention of increasing the quality of our workers' compensation book of business. We are currently using these modeling analytics to assist us in risk selection, and we will continue to evaluate the model results.
Fidelity and Surety
Our surety products guarantee performance and payment by our bonded principals. Our contract bonds protect owners from failure to perform on the part of our principals. In addition, our surety bonds protect material suppliers and subcontractors from nonpayment by our contractors. When surety losses occur, our loss is determined by estimating the cost to complete the remaining work and to pay the contractor's unpaid bills, offset by contract funds due to the contractor, reinsurance, and the value of any collateral to which we may have access.
The net loss ratio deteriorated 1.6 percentage points in 2020 compared to 2019, however the loss ratio remained at a low level and is immaterial to overall losses.
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Personal Lines
Our personal lines consist primarily of fire and allied lines (including homeowners) and automobile lines. The net loss ratio deteriorated 58.0 percentage points in 2020 compared to 2019. The deterioration is primarily attributable to our personal fire and allied line of business due to an increase in catastrophe losses. Also, net premiums earned decreased due to the renewal rights agreement for our personal lines business we entered into in May 2020, providing our independent insurance agents with the opportunity to transfer their personal lines policies to Nationwide Mutual Insurance Company beginning in the third quarter of 2020.
Assumed Reinsurance
Our assumed reinsurance is the business we choose to write by participating in programs insuring insurance companies. The net loss ratio deteriorated 32.0 percentage points in 2020 compared to 2019. The deterioration is attributable to strengthening reserves for incurred but not reported claim events.
Other Underwriting Expenses
Our underwriting expense ratio, which is a percentage of other underwriting expenses over net premiums earned, was 33.5 percent, 32.6 percent and 33.5 percent for 2020, 2019, and 2018, respectively. The increase in the expense ratio in 2020 as compared to 2019 was primarily due to our continued investment in technology, including our multi-year Oasis project, an upgrade to our technology platform designed to enhance core underwriting decisions, selection of risks and productivity. The decrease in the expense ratio during in 2019 as compared to 2018 was primarily due to lower employee benefit accruals and expenses caused by post-retirement benefit plan amendments made at the end of 2018.
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Discontinued Operations Results
Years Ended December 31, % Change
Revenues
Net premiums earned $ — $ — $ 13,003 — % (100.0) %
Investment income, net — — 12,663 — % (100.0) %
Net realized investment gains (losses) — — (1,057) — % (100.0) %
Benefits, Losses and Expenses
Losses and loss settlement expenses $ — $ — $ 10,823 — % (100.0) %
Increase in liability for future policy benefits — — 5,023 — % (100.0) %
Amortization of deferred policy acquisition costs — — 1,895 — % (100.0) %
Other underwriting expenses — — 3,864 — % (100.0) %
Interest on policyholders' accounts — — 4,499 — % (100.0) %
Total benefits, losses and expenses $ — $ — $ 26,104 — % (100.0) %
Income (loss) before income taxes $ — $ — $ (1,349) — % (100.0) %
The sale of our discontinued operations closed on March 30, 2018, and therefore income was only earned in the first quarter of 2018. For the year ended December 31, 2018, our discontinued operations had a loss before income taxes of $1.3 million.
Federal Income Taxes
We reported a federal income tax benefit on a consolidated basis of $56.8 million or 33.5 percent of pre-tax loss in 2020. In 2019, federal income tax expense on a consolidated basis was $2.1 million or 12.2 percent of pre-tax income and federal income tax benefit on a consolidated basis of $3.3 million or 13.5 percent of pre-tax income in 2018.
On March 27, 2020, the CARES Act was enacted in response to the COVID-19 pandemic. The CARES Act, among other things, permits net operating loss ("NOL") carryovers and carrybacks to offset 100 percent of taxable income for taxable years beginning before 2021. In addition, the CARES Act allows NOLs incurred in 2018, 2019, and 2020 to be carried back to each of the five preceding taxable years to generate a refund of previously paid income taxes. The Company has considered the implications of the CARES Act on its tax provision and has included an income tax benefit of $18.6 million as the result of this Act.
Our effective tax rate was impacted by the The Tax Cuts and Jobs Act of 2017 (the "Tax Act"), which was enacted on December 22, 2017. The Tax Act significantly revised the U.S. corporate income tax laws including lowering the U.S. federal corporate tax rate from 35 percent to 21 percent effective January 1, 2018. Our effective federal tax rate varied from the statutory federal income tax expense rate in each year, due primarily to the impact of the provisions of the CARES Act.
In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, which addresses how a company recognizes provisional amounts when a company does not have the necessary information available, prepared or analyzed in reasonable detail to complete its accounting for the effect of the changes in the Tax Act. The measurement period ends when a company has obtained, prepared and analyzed the information necessary to finalize its accounting, but cannot extend beyond one year. As of December 31, 2018 we had completed accounting for the tax effects of enactment of the Tax Act, and no adjustment was made during the measurement period.
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Due to our determination that we may not be able to fully realize the benefits of the net operating loss ("NOL") acquired in the purchase of American Indemnity Financial Corporation in 1999, which are only available to offset the future taxable income of our property and casualty insurance operations and are further limited as to the amount that can be utilized in any given year, we have recorded a valuation allowance against these NOLs. Based on a yearly review, we determine whether the benefit of the NOLs can be realized, and, if so, the decrease in the valuation allowance is recorded as a reduction to current federal income tax expense. If NOLs expire during the year, the decrease in the valuation allowance is offset with a corresponding decrease to the deferred income tax asset. The valuation allowance was reduced by $0.7 million in 2018 due to the realization of $3.1 million in NOLs, therefore reducing the valuation allowance to zero. During 2018, the remaining NOL from the purchase of American Indemnity Financial Corporation was fully realized.
As of December 31, 2020, we had no alternative minimum tax credit carryforwards.
INVESTMENTS
Investment Environment
Domestic and global capital markets weathered truly unprecedented adversity in 2020. The year began with projections for steady GDP growth and expectations of continued strength in labor and housing markets. In response, risk investors were rewarded as financial assets priced higher into February. By late February, however, the global economy could no longer ignore the health and economic risks posed by the novel coronavirus, COVID-19.
The ensuing sell-off was sharp. Over the past 30 years the S&P 500 Index has only produced double-digit negative weekly returns five times. Two of these weeks occurred during a four-week span from February through March of 2020. The week ended March 20, 2020 was the third worst weekly performance for the S&P 500 Index since its inception. Over the same period, the spread on investment grade corporate bonds more than tripled while interest rates plummeted. The selling became so widespread that even Treasuries began to lose stability. The price on the 10-year note surged in late February as rates dropped 70 basis points. Less than 10 days later, prices collapsed as rates reversed course and surged 70 basis points. Rates dropped precipitously again and began to stabilize after historic and decisive action taken by the Federal Reserve ("The Fed"). The Fed entered the market boldly in mid-March, activating multiple funding facilities, some for the first time ever, and pledging to buy certain financial assets with no limit, including corporate and municipal debt in either primary or secondary markets.
The Fed’s intervention, along with historic fiscal stimulus provided by the U.S. Treasury, proved powerful enough to restore confidence in the market. Risk asset prices stabilized and then retraced their March losses. The S&P 500 Index gained 11.7 percent in the fourth quarter to close the year up 16.3 percent. The UFG equity security portfolio, which is weighted more heavily in the financial sector, also partially recovered in the fourth quarter, recovering a portion of the losses recognized in the first three quarters of 2020. U.S. fixed income markets closed the year near all-time strength in nearly any dimension that can be measured. Treasury yields finished well inside of last year’s levels with short-term rates anchored close to zero.
Overall, the current investment environment is challenging with the U.S. equity market seeing stretched valuations only encountered a handful of times in history. Fixed income markets face a near zero-rate environment with no sign of relief on the horizon. We believe the global economy is in the process of recovering from recession. While successful vaccine developments have given us a line of sight to what many are predicting to be a strong second half of 2021, the long-term economic damage caused by COVID-19 has yet to be fully understood. With an increase in debt during the pandemic, companies around the globe are relying on an imminent recovery so as to avoid an avalanche of defaults. Our investment program is defensive in nature and designed to outperform during periods of market uncertainty.
Investment Philosophy
The Company's assets are invested to preserve capital and maximize after-tax returns while maintaining an appropriate balance of risk. The return on our portfolio is an important component of overall financial results, but
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quality and safety of principal is the highest priority of our investment program. Our general investment philosophy is to purchase financial instruments with the expectation that we will hold them to their maturity. However, active management of our portfolio is considered necessary to appropriately manage risk, achieve portfolio objectives and maximize investment income as market conditions change.
Each of our insurance company subsidiaries develops an appropriate investment strategy that aligns with its business needs and supports United Fire's strategic plan and risk appetite. The portfolio is structured so as to be in compliance with state insurance laws that prescribe the quality, concentration and type of investments that may be made by insurance companies.
Investment Portfolio
Our invested assets from continuing operations at December 31, 2020 totaled $2.1 billion, compared to $2.2 billion at December 31, 2019, a decrease of $5.9 million. At December 31, 2020, fixed maturity securities and equity securities comprised 85.0 percent and 9.6 percent of our investment portfolio, respectively. Because the primary purpose of the investment portfolio is to fund future claims payments, we utilize a conservative investment philosophy, investing in a diversified portfolio of high-quality, intermediate-term taxable corporate bonds, taxable U.S. government and government agency bonds and tax-exempt U.S. municipal bonds. Our overall investment strategy is to stay fully invested (i.e., minimize cash balances). If additional cash is needed we have an ability to borrow funds available under our revolving credit facility.
Composition
We develop our investment strategies based on a number of factors, including estimated duration of reserve liabilities, short- and long-term liquidity needs, projected tax status, general economic conditions, expected rates of inflation and regulatory requirements. We administer our investment portfolio based on investment guidelines approved by management and the investment committee of our Board of Directors that comply with applicable statutory regulations.
The composition of our investment portfolio at December 31, 2020 is presented at carrying value in the following table:
Percent
(In Thousands) of Total
Fixed maturities:
Other long-term investments 69,305 3.2
Short-term investments 175 —
At December 31, 2020, we classified $1.8 billion, or 100.0 percent, of our fixed maturities portfolio as available-for-sale, compared to $1.7 billion, or 99.1 percent, at December 31, 2019. Available-for-sale fixed maturity securities are carried at fair value, with changes in fair value recognized as a component of accumulated other comprehensive income in stockholders' equity. We record fixed maturity trading securities, primarily convertible redeemable preferred debt securities, and equity securities at fair value, with any changes in fair value recognized in earnings.
As of December 31, 2020 and 2019, we did not have direct exposure to investments in subprime mortgages or other credit enhancement vehicles.
Credit Quality
The following table shows the composition of fixed maturity securities held in our available-for-sale and trading security portfolios by credit rating at December 31, 2020 and 2019. Information contained in the table is generally
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based upon the issue credit ratings provided by Moody's, unless the rating is unavailable, in which case we obtain it from Standard & Poor's.
Rating Carrying Value % of Total Carrying Value % of Total
Duration
Our investment portfolio is invested primarily in fixed maturity securities whose fair value is susceptible to market risk, specifically interest rate changes. Duration is a measurement used to quantify our inherent interest rate risk and analyze our ability to match our invested assets to our reserve liabilities. If our invested assets and reserve liabilities have similar durations, then any change in interest rates will have an equal effect on these accounts. The primary purpose for matching invested assets and reserve liabilities is liquidity. With appropriate matching, our investments will mature when cash is needed, preventing the need to liquidate other assets prematurely. Mismatches in the duration of assets and liabilities can cause significant fluctuations in our results of operations.
The weighted average effective duration of our portfolio of fixed maturity securities was 3.4 years at December 31, 2020 compared to 4.2 years at December 31, 2019.
The amortized cost and fair value of available-for-sale and trading fixed maturity securities at December 31, 2020, by contractual maturity, are shown in the following table. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Asset-backed securities, mortgage-backed securities and collateralized mortgage obligations may be subject to prepayment risk and are therefore not categorized by contractual maturity.
(In Thousands) Available-For-Sale
Amortized Fair
Asset-backed securities 314 926
Investment Results
We invest the premiums received from our policyholders in order to generate investment income, which is an important component of our revenues and profitability. The amount of investment income that we are able to generate is affected by many factors, some of which are beyond our control. Some of these factors are volatility in the financial markets, economic growth, inflation, changes in interest rates, world political conditions, terrorist attacks or threats of terrorism, adverse events affecting other companies in our industry or the industries in which we invest and other unpredictable national or world events. Net investment income decreased 34.3 percent in 2020, compared with the same period of 2019 and was primarily due to the change in the fair value of our investments in
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limited liability partnerships with an increase in the fourth quarter but a decrease for the full year 2020. The valuation of our investments in limited liability partnerships varies from period to period due to current equity market conditions. We expect to maintain our investment philosophy of purchasing quality investments rated investment grade or better.
An allowance for credit losses is recorded based on a number of factors including the current economic conditions, management's expectations of future economic conditions and performance indicators, such as market value vs. amortized cost, investment spreads widening or contracting, rating actions, payment and default history. The following table contains a rollforward of the allowance for credit losses for available-for-sale fixed maturity securities at December 31, 2020:
As of
Beginning balance, January 1, 2020 $ —
Reductions for securities sold during the period (realized) —
Writeoffs charged against the allowance —
Recoveries of amounts previously written off —
Ending balance, December 31, 2020 $ 5
Changes in unrealized gains and losses on available-for-sale fixed maturity securities do not affect net income and earnings per share but do impact comprehensive income, stockholders' equity and book value per share. We believe that any unrealized losses on our available-for-sale fixed-maturity securities at December 31, 2020 are temporary based upon our current analysis of the issuers of the securities that we hold and current market conditions. We invest in high quality assets to provide protection from future credit quality issues. Non-credit related unrealized gains and losses are recognized as a component of other comprehensive income and represent other market movements that are not credit related, for example interest rate changes. We have no intent to sell, and it is more likely than not that we will not be required to sell, these securities until the fair value recovers to at least equal our cost basis or the securities mature.
Net Investment Income
In 2020, our investment income, net of investment expenses, decreased $20.7 million to $39.7 million as compared to 2019, primarily due to the change in the fair value of our investments in limited liability partnerships, a decrease in interest on fixed maturities and interest on cash and cash equivalents due to declining interest rates.
In 2019, our investment income for continuing operations, net of investment expenses, increased $7.5 million to $60.4 million as compared to 2018, primarily due to an increase in the value of our investments in limited liability partnerships resulting from the increase in the equity markets and an increase in invested assets in 2019 compared to 2018.
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The following table summarizes the components of net investment income:
Investment income from continuing operations:
Income on other long-term investments
Interest on short-term investments 107 522 606
Total investment income from continuing operations $ 48,127 $ 67,395 $ 60,554
Net investment income from discontinued operations — — 12,663
(1)Represents the change in value of our interests in limited liability partnerships that are recorded on the equity method of accounting.
In 2020, 96.6 percentof our gross investment income from continuing operations originated from interest on fixed maturities, compared to 74.6 percent and 84.8 percent in 2019 and 2018, respectively.
The following table details our annualized yield on average invested assets from continuing operations for 2020 and 2019, and both continuing and discontinued operations for 2018, which is based on our invested assets (including money market accounts) at the beginning and end of the year divided by net investment income:
(In Thousands)
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Net Realized Investment Gains and Losses
The following table summarizes the components of our net realized investment gains or losses:
Net realized investment gains (losses) from continuing operations:
Net realized gains (losses):
Fixed maturities:
Allowance for credit losses (5) — —
Trading securities
Equity securities
Mortgage loans (4) (26) (46)
Net Unrealized Investment Gains and Losses
As of December 31, 2020, net unrealized investment gains, after tax, totaled $83.1 million compared to unrealized gains of $47.3 million and unrealized losses of $9.3 million as of December 31, 2019 and 2018, respectively. The increase in net unrealized investment gains in 2020 was primarily the result of an increase in the value of the fixed maturity portfolio due to lower interest rates during 2020.
The increase in net unrealized investment gains in 2019 was primarily the result of an increase in the value of the fixed maturity portfolio due to lower interest rates during 2019. The decrease in net unrealized investment gains in 2018 was primarily the result of the cumulative change in accounting principles on recognizing the change in the value of equity securities in the income statement. The change in accounting principles required unrealized gains on equity securities of $191.2 million, after-tax, as of January 1, 2018, to be reclassified to retained earnings from accumulated other comprehensive income, both within shareholders equity. The remaining decrease is due to a decrease in the value of the fixed maturity portfolio due to rising interest rates.
The following table summarizes the change in our net unrealized investment gains (losses):
Changes in net unrealized investment gains (losses):
Deferred policy acquisition costs — — 7,274
Cumulative change in accounting principles — — (191,244)
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MARKET RISK
Our Consolidated Balance Sheets include financial instruments whose fair values are subject to market risk. The active management of market risk is integral to our operations. Market risk is the potential for loss due to a decrease in the fair value of securities resulting from uncontrollable fluctuations, such as: interest rate risk, equity price risk, foreign exchange risk, credit risk, inflation, or geopolitical conditions. Our primary market risk exposures are: changes in interest rates, deterioration of credit quality in specific issuers, sectors or the economy as a whole, and an unforeseen decrease in the liquidity of securities we hold. We have no foreign exchange risk.
Interest Rate Risk
Interest rate risk is the price sensitivity of a fixed income maturity security or portfolio of securities to changes in level of interest rates. Generally, there is an inverse relationship between changes in interest rates and changes in the price of a fixed income/maturity security. Plainly stated, if interest rates go up (down), bond prices go down (up). A vast majority of our holdings are fixed income maturity and other interest rate sensitive securities that will decrease (increase) in value as interest rates increase (decrease). While it is generally our intent to hold our investments in fixed maturity securities to maturity, we have classified a majority of our fixed maturity portfolio as available-for-sale. Available-for-sale fixed income maturity securities are carried at fair value on the Consolidated Balance Sheets with unrealized gains or losses reported net of tax in Accumulated Other Comprehensive Income. A change in the prevailing interest rates generally translates into a change in the fair value of our fixed income/maturity securities, and by extension, our overall book value.
Market Risk and Duration
We analyze potential changes in the value of our investment portfolio due to the market risk factors noted above within the overall context of asset and liability management. A technique we use in the management of our investment portfolio is the calculation of duration. Our actuaries estimate the payout pattern of our reserve liabilities to determine their duration, which is the present value of the weighted average payments expressed in years. We then establish a target duration for our investment portfolio so that at any given time the estimated cash generated by the investment portfolio will closely match the estimated cash required for the payment of the related reserves. We structure the investment portfolio to meet the target duration to achieve the required cash flow, based on liquidity and market risk factors.
Impact of Interest Rate Changes
The amounts set forth in the following table detail the impact of hypothetical interest rate changes on the fair value of fixed maturity securities held at December 31, 2020. The sensitivity analysis measures the change in fair values arising from immediate changes in selected interest rate scenarios. We employed hypothetical parallel shifts in the yield curve of plus or minus 100 and 200 basis points in the simulations. Additionally, based upon the yield curve shifts, we employ estimates of prepayment speeds for mortgage-related products and the likelihood of call or put options being exercised within the simulations.
The selection of a 100-basis-point and 200-basis-point increase or decrease in interest rates should not be construed as a prediction by our management of future market events, but rather as an illustration of the potential impact of an event.
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(In Thousands) Points Points Base Points Points
AVAILABLE-FOR-SALE
Fixed maturities
Bonds
States, municipalities and political subdivisions
General obligations:
Special revenue:
Corporate bonds
Collateralized mortgage obligations
To the extent actual results differ from the assumptions utilized, our duration and interest rate measures could be significantly affected. As a result, these calculations may not fully capture the impact of nonparallel changes in the relationship between short-term and long-term interest rates.
Equity Price Risk
Equity price risk is the potential loss arising from changes in the fair value (i.e., market price) of equity securities held in our portfolio. Changes in the price of an equity security may be due to a change in the future earnings capacity or strategic outlook of the security issuer, and what investors are willing to pay for those future earnings and related strategy. The carrying values of our equity securities are based on quoted market prices, from an independent source, as of the balance sheet date. Market prices of equity securities, in general, are subject to fluctuations that could cause the amount to be realized upon the future sale of the securities to differ significantly from the current reported value. The fluctuations may result from perceived changes in the underlying economic characteristics of the security issuer, the relative price of alternative investments, general market conditions, and supply/demand factors related to a particular security.
Impact of Price Change
The following table details the effect on the fair value of our investments in equity securities for a positive and negative 10 percent price change at December 31, 2020:
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(In Thousands) -10% Base +10%
Foreign Currency Exchange Rate Risk
Foreign currency exchange rate risk arises from the possibility that changes in foreign exchange rates will impact our transactions with foreign reinsurers relating to the settlement of amounts due to or from foreign reinsurers in the normal course of business. We consider this risk to be immaterial to our operations.
Credit Risk
Credit risk is the willingness and ability of a borrower to repay on time and in full any principal and interest due to the lender. Losses related to credit risk are realized through the income statement and have a direct impact on the earnings of UFG. Given the vast majority of our holdings are fixed income maturity securities, we view credit risk as our primary investment risk. Our internal Investment Department has developed and maintains a rigorous underwriting process to analyze and measure the expected frequency and severity of loss (i.e., credit quality) for government, agency, municipal, structured security, and corporate bond issuers. The objective is to maintain the appropriate balance of risk in our portfolio, consistent with our Investment Policy Statement and conservative investment style, and ensure the portfolio is compensated appropriately for the credit risk it holds. We do have within our municipal bond holdings a small number of securities whose ratings were enhanced by third-party insurance for the payment of principal and interest in the event of an issuer default. Of the insured municipal securities in our investment portfolio, 99.5 percent and 99.6 percent were rated "A" or above, and 95.8 percent and 95.6 percent were rated "AA" or above at December 31, 2020 and 2019, respectively, without the benefit of insurance. Due to the underlying financial strength of the issuers of the securities, we believe that the loss of insurance would not have a material impact on our operations, financial position, or liquidity.
We have no direct exposure in any of the guarantors of our investments. Our largest indirect exposure with a single guarantor totaled $9.7 million or 21.0 percent of our insured municipal securities at December 31, 2020, as compared to $11.7 million or 24.2 percent at December 31, 2019. Our five largest indirect exposures to financial guarantors accounted for 81.5 percent and 81.2 percent of our insured municipal securities at December 31, 2020 and 2019, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity measures our ability to generate sufficient cash flows to meet our short- and long-term cash obligations. Our cash inflows are primarily a result of the receipt of premiums, reinsurance recoveries, sales or maturities of investments, and investment income. Cash provided from these sources is used to fund the payment of losses and loss settlement expenses, the purchase of investments, operating expenses, dividends, pension plan contributions, and in recent years, common stock repurchases.
We monitor our capital adequacy to support our business on a regular basis. The future capital requirements of our business will depend on many factors, including our ability to write new business successfully and to establish premium rates and reserves at levels sufficient to cover losses. Our ability to underwrite is largely dependent upon the quality of our claims paying and financial strength ratings as evaluated by independent rating agencies. In particular, we require (1) sufficient capital to maintain our financial strength ratings, as issued by various rating agencies, at a level considered necessary by management to enable our insurance company subsidiaries to compete and (2) sufficient capital to enable our insurance company subsidiaries to meet the capital adequacy tests performed by regulatory agencies in the United States.
Cash outflows may be variable because of the uncertainty regarding settlement dates for losses. In addition, the timing and amount of individual catastrophe losses are inherently unpredictable and could increase our liquidity requirements. The timing and amount of reinsurance recoveries may be affected by reinsurer solvency and reinsurance coverage disputes.
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Historically, we have generated substantial cash inflows from operations. It is our policy to invest the cash generated from operations in securities with maturities that, in the aggregate, correlate to the anticipated timing of payments for losses and loss settlement expenses. The majority of our assets are invested in available-for-sale fixed maturity securities.
The following table displays a summary of cash sources and uses in 2020, 2019 and 2018 from continuing and discontinued operations:
Cash Flow Summary Years Ended December 31,
Cash provided by (used in)
In the Consolidated Statement of Cash Flows, cash flows from discontinued operations are shown in separate lines in each of the operating, investing and financing sections of the Cash Flow Statement. Our cash flows from continuing operations were sufficient to meet our current liquidity needs for the full-year periods ended December 31, 2020, 2019 and 2018 and we anticipate they will be sufficient to meet our future liquidity needs. We also have the ability to draw on our credit facility if needed. See Note 14 "Debt" for more information. During 2020, the Company implemented state-mandated and optional payment leniency programs for our policyholders as a result of the COVID-19 pandemic. As of December 31, 2020, we did not see a significant impact to cash flows or an increase in our allowance for doubtful accounts as a result of these programs. These payment modifications did not have a material impact on our financial condition, liquidity or capital position.
Operating Activities
Net cash flows provided by operating activities totaled $41.4 million, $93.8 million and $110.1 million in 2020, 2019 and 2018, respectively. Our cash flows from operating activities were sufficient to meet our liquidity needs for 2020, 2019 and 2018.
Investing Activities
Cash in excess of operating requirements is generally invested in fixed maturity securities and equity securities. Fixed maturity securities provide regular interest payments and allow us to match the duration of our liabilities. Equity securities provide dividend income, potential dividend income growth and potential appreciation. For further discussion of our investments, including our philosophy and portfolio, see the "Investment Portfolio" section contained in this Item.
In addition to investment income, possible sales of investments and proceeds from calls or maturities of fixed maturity securities also can provide liquidity. During the next five years, $0.5 billion, or 26.6 percent of our fixed maturity portfolio will mature.
We invest funds required for short-term cash needs primarily in money market accounts, which are classified as cash equivalents. At December 31, 2020, our cash and cash equivalents included $24.8 million related to these money market accounts, compared to $9.3 million at December 31, 2019.
Net cash flows used by investing activities totaled $92.9 million in 2020 and provided in investing activities totaled $4.5 million and used by investing activities totaled $19.2 million in 2019 and 2018, respectively. In 2020, we had cash inflows from scheduled and unscheduled investment maturities, redemptions, prepayments, and sales of investments from continuing operations that totaled $376.2 million compared to $311.7 million and $263.8 million for the same period in 2019 and 2018, respectively. Our cash inflows from scheduled and unscheduled investment maturities, redemptions, prepayments, and sales of investments from discontinued operations totaled $29.7 million in 2018.
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Our cash outflows for investment purchases from continuing operations totaled $450.2 million in 2020, compared to $274.7 million and $540.4 million for the same period in 2019 and 2018, respectively. Our cash outflows for investment purchases from discontinued operations totaled $15.4 million in 2018.
Financing Activities
Net cash flows provided in financing activities totaled $18.7 million in 2020 and net cash flows used in financing activities from continuing operations totaled $42.0 million and $103.6 million in 2019 and 2018, respectively. The net cash flows provided in financing activities in 2020 is primarily from borrowings of long term debt of $50.0 million offset by the payment of cash dividends of $28.5 million. The higher net cash flows used in financing activities in 2018 was primarily due to the special cash dividend of $3.00 per share paid on August 20, 2018. Net cash flows used in financing activities from discontinued operations totaled $11.5 million in 2018 primarily due to net annuity withdrawals.
Dividends
Dividends paid to shareholders totaled $28.5 million, $32.7 million and $105.4 million in 2020, 2019 and 2018, respectively. The increase in dividends paid to shareholders in 2018 was primarily due to a special cash dividend of $3.00 per share paid to shareholders on August 20, 2018. Our practice has been to pay quarterly cash dividends, which we have paid every quarter since March 1968.
Payments of any future dividends and the amounts of such dividends, however, will depend upon factors such as net income, financial condition, capital requirements, and general business conditions. We will only pay dividends if declared by our Board of Directors out of legally available funds.
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, 2020, our insurance company subsidiary, United Fire & Casualty, is able to make a maximum of $66.8 million in dividend payments without prior regulatory approval. These restrictions are not expected to have a material impact in meeting our cash obligations.
Share Repurchases
Under our share repurchase program, first announced in August 2007, we may purchase our common stock from time to time on the open market or through privately negotiated transactions. The amount and timing of any purchases will be at our discretion and will depend upon a number of factors, including the share price, economic and general market conditions, and corporate and regulatory requirements. Our share repurchase program may be modified or discontinued at any time.
During 2020, 2019 and 2018, pursuant to authorization by our Board of Directors, we repurchased 70,467, 258,756, and 120,372 shares of our common stock, respectively, which used cash totaling $2.7 million in 2020, $11.7 million in 2019 and $5.4 million in 2018. At December 31, 2020, we were authorized to purchase an additional 1,786,977 shares of our common stock under our share repurchase program, which expires in August 2022.
Credit Facilities
Information specific to our credit facilities is incorporated by reference from Note 14 "Debt" contained in Part II, Item 8. As of December 31, 2020, we were in compliance with two of three financial covenants of the Credit Agreement (the “Credit Agreement”) with Wells Fargo Bank, National Association ("Wells Fargo"), as
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administrative agent (the "Administrative Agent"), issuing lender, swing-line lender and lender, and the other lenders from time to time party thereto (collectively with Wells Fargo, the "Lenders"). We have received a waiver from the Lenders on the third financial covenant. We have the ability to draw on our credit facility if needed.
Stockholders' Equity
Stockholders' equity decreased 9.4 percent to $825.1 million at December 31, 2020, from $910.5 million at December 31, 2019. The decrease is primarily attributed to the net loss of $112.7 million, stockholder dividends of $28.5 million, share repurchases of $2.7 million, all offset by increase in net unrealized investment gains net of tax of $35.8 million and change in liability for employee benefit plans of $18.0 million. As of December 31, 2020, the book value per share of our common stock was $32.93, compared to $36.40 at December 31, 2019.
Risk-Based Capital
The NAIC adopted risk-based capital requirements, which requires us to calculate a minimum capital requirement for each of our insurance companies based on individual company insurance risk factors. These "risk-based capital" results are used by state insurance regulators to identify companies that require regulatory attention or the initiation of regulatory action. At December 31, 2020, all of our insurance companies had capital well in excess of required levels.
Contractual Obligations and Commitments
The following table shows our contractual obligations and commitments, including our estimated payments due by period at December 31, 2020:
(In Thousands) Payments Due By Period
Loss and Loss Settlement Expense Reserves
The amounts presented are estimates of the dollar amounts and time periods in which we expect to pay out our gross loss and loss settlement expense reserves. Because the timing of future payments may vary from the stated contractual obligation, these amounts are estimates based upon historical payment patterns and may not represent actual future payments. Refer to "Critical Accounting Policies — Losses and Loss Settlement Expenses" in this section for further discussion.
Long term debt
The Company executed a private placement debt transaction on December 15, 2020 between United Fire & Casualty Company, Federated Mutual Insurance Company, a mutual insurance company domiciled in Minnesota ("Federated Mutual"), and Federated Life Insurance Company, an insurance company domiciled in Minnesota ("Federated Life and together with Federated Mutual, the "Note Purchasers").
UFG sold an aggregate $50.0 million of notes due 2040 to the Note Purchasers. One note with a principal amount of $35.0 million was issued to Federated Mutual and one note with a principal amount of $15.0 million was issued to Federated Life.
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Interest payments will be paid quarterly on March 15, June 15, September 15 and December 15 of each year (each such date, an “Interest Payment Date”). The interest rate will equal the rate that corresponds to the A.M. Best Co. (or its successor’s) financial strength rating for members of the United Fire & Casualty Pooled Group as of the applicable Interest Payment Date. As of December 31, 2020, interest expense totaled $133. Payment of interest is subject to approval by the Iowa Insurance Division.
Operating Leases
Our operating lease obligations are for the rental of office space, vehicles, computer equipment and office equipment. For further discussion of our operating leases, refer to Part II, Item 8, Note 13 "Lease Commitments."
Profit-Sharing Commissions
We offer our agents a profit-sharing plan as an incentive for them to place high-quality property and casualty insurance business with us. Based on business produced by the agencies in 2020, property and casualty agencies expect to receive profit-sharing payments of $15.4 million in 2021.
Pension Plan Payments
We estimate the pension contribution for 2021 in accordance with the Pension Protection Act of 2006 (the "Act"). Contributions for future years are dependent on a number of factors, including actual performance versus assumptions made at the time of the actuarial valuations and maintaining certain funding levels relative to regulatory requirements. Contributions in 2021, and in future years, are expected to be at least equal to the IRS minimum required contribution in accordance with the Act.
OFF BALANCE SHEET ARRANGEMENTS
Funding Commitments
We hold investments in limited liability partnerships as part of our investment strategy. Pursuant to agreements with our limited liability partnership investments, we are contractually committed through July 10, 2030 to make capital contributions upon request of the partnerships. Our remaining potential contractual obligation was $8.5 at December 31, 2020.
In addition, the Company invested $25.0 million in December 2019 in a limited liability partnership investment fund which is subject to a 3-year lockup with a 60 day minimum notice, with 4 possible repurchase dates per year, after the 3-year lockup period is met. The fair value of the investment at December 31, 2020 was $24.9 million and there are no remaining capital contributions with this investment.
These partnerships are included in our other long term investments on the Consolidated Balance Sheets with a current fair value of $69.3 million, or 3.2% of our total invested assets, at December 31, 2020.
CRITICAL ACCOUNTING POLICIES
Critical accounting policies are defined as those that are representative of significant judgments and uncertainties and that may potentially result in materially different results under different assumptions and conditions. We base our discussion and analysis of our results of operations and financial condition on the amounts reported in our Consolidated Financial Statements, which we have prepared in accordance with GAAP. As we prepare these Consolidated Financial Statements, we must make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses for the reporting period. We evaluate our estimates on an ongoing basis. We base our estimates on historical experience and on other assumptions we believe to be reasonable under the circumstances. Actual results could differ from those estimates. We believe our most critical accounting policies are as follows.
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Investment Valuation
Upon acquisition, we classify investments in marketable securities as held-to-maturity, available-for-sale, or trading. We record investments in available-for-sale and trading fixed maturity securities and equity securities at fair value. Other long-term investments consist primarily of our interests in limited liability partnerships that are recorded on the equity method of accounting. We record mortgage loans at their amortized cost less any valuation allowance.
In general, investment securities are exposed to various risks, such as interest rate risk, credit risk, and overall market volatility risk. Therefore, it is reasonably possible that changes in the fair value of our investment securities that are reported at fair value will occur in the near term and such changes could materially affect the amounts reported in the Consolidated Financial Statements. Also, it is reasonably possible that changes in the value of our investments in trading securities and limited liability partnerships could occur in the future and such changes could materially affect our results of operations as reported in our Consolidated Financial Statements.
Fair Value Measurement
Information specific to the fair value measurement of our financial instruments and disclosures is incorporated by reference from Note 3 "Fair Value of Financial Instruments" contained in Part II, Item 8.
Deferred Policy Acquisition Costs ("DAC")
We record an asset for certain costs of underwriting new business, primarily commissions, premium taxes and variable underwriting and policy issue expenses that have been deferred. The amount of underwriting compensation expense eligible for deferral is based on time studies and a ratio of success in policy placement. At December 31, 2020 and 2019, our DAC asset was $87.1 million and $94.3 million, respectively.
The DAC asset is amortized over the life of the policies written, generally one year. We assess the recoverability of DAC on a quarterly basis by line of business. This assessment is performed by comparing recorded unearned premium to the sum of unamortized DAC and estimates of expected losses and loss settlement expenses. If the sum of these costs exceeds the amount of recorded unearned premium (i.e., the line of business is expected to generate an operating loss), the excess is recognized in current period other underwriting expenses as an offset against the established DAC asset. We refer to this offset as a premium deficiency charge.
To calculate the premium deficiency charge by line of business, we estimate an expected loss and loss settlement expense ratio which is based on our best estimate of future losses for each line of business. This calculation is performed on a quarterly basis and developed in conjunction with our quarterly reserving process. The expected loss and loss settlement expense ratios are the only assumptions we utilize in our premium deficiency calculation. Changes in these assumptions can have a significant impact on the amount of premium deficiency charge recognized for a line of business. The premium deficiency calculation is aggregated by line of business in a manner consistent with how the policies are currently being marketed and managed.
The following table illustrates the hypothetical impact on the premium deficiency charge recorded for the quarter ended December 31, 2020, of reasonably likely changes in the assumed loss and loss settlement expense ratios utilized for purposes of this calculation. The entire impact of these changes would be recognized through income as other underwriting expenses. The following table illustrates the impact of potential changes in the expected loss and loss settlement expense ratios for all lines of business on the premium deficiency charge. The base amount indicated below is the actual premium deficiency charge recorded as an offset against the DAC asset established as of the quarter ended December 31, 2020:
(In Thousands) -10% -5% Base +5% +10%
Premium deficiency charge estimated $ — $ — $ 1,453 $ 8,235 $ 16,530
Actual future results could differ materially from our assumptions used to calculate the recorded DAC asset. Changes in our assumed loss and loss settlement expense ratios in the future would impact the amount of deferred
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costs in the period such changes in assumptions are made. The premium deficiency charge calculated for the quarter ended December 31, 2020 was $1.5 million compared to the premium deficiency charge of $4.6 million calculated for the same period of 2019.
Losses and Loss Settlement Expenses
Reserves for losses and loss settlement expenses are reported using our best estimate of ultimate liability for claims that occurred prior to the end of any given reporting period, but have not yet been paid. Before credit for reinsurance recoverables, these reserves were $1,578.1 million and $1,421.8 million at December 31, 2020 and 2019, respectively. We purchase reinsurance to mitigate the impact of large losses and catastrophic events. Loss and loss settlement expense reserves ceded to reinsurers were $131.8 million for 2020 and $68.5 million for 2019. Our reserves, before credit for reinsurance recoverables, by line of business as of December 31, 2020, were as follows:
(In Thousands) Case Basis IBNR LossSettlementExpense Total Reserves
Commercial lines
Personal lines
Case-Basis Reserves
For each of our lines of business, with respect to reported claims, we establish reserves on a case-by-case basis. Our experienced claims personnel estimate these case-basis reserves using adjusting guidelines established by management. Our goal is to set the case-basis reserves at the ultimate expected loss amount as soon as possible after information about the claim becomes available.
Establishing the case reserve for an individual claim is subjective and complex, requiring us to estimate future payments and values that will be sufficient to settle an individual claim. Setting a reserve for an individual claim is an inherently uncertain process. When we establish and adjust individual claim reserves, we do so based on our knowledge of the circumstances and facts of the claim. Upon notice of a claim, we establish a preliminary (average claim cost) reserve based on the limited claim information initially reported. Subsequently, we conduct an investigation of each reported claim, which allows us to more fully understand the factors contributing to the loss and our potential exposure. This investigation may extend over a long period of time. As our claim investigation progresses, and as our claims personnel identify trends in claims activity, we may refine and adjust our estimates of case reserves. To evaluate and refine our overall reserving process, we track and monitor all claims until they are settled and paid in full, with all salvage and subrogation claims being resolved.
Most of our insurance policies are written on an occurrence basis that provides coverage if a loss occurs during the policy period, even if the insured reports the loss many years later. For example, some liability claims for
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construction defect coverage are reported 10 years or more after the policy period, and the workers' compensation coverage provided by our policies pays unlimited medical benefits for the duration of the claimant's injury up to the lifetime of the claimant. In addition, final settlement of certain claims can be delayed for years due to litigation or other reasons. Reserves for these claims require us to estimate future costs, including the effect of judicial actions, litigation trends and medical cost inflation, among others. Reserve development can occur over time as conditions and circumstances change many years after the policy was issued and/or the loss occurred.
Our loss reserves include amounts related to both short-tail and long-tail lines of business. "Tail" refers to the time period between the occurrence of a loss and the ultimate settlement of the claim. A short-tail insurance product is one where ultimate losses are known and settled comparatively quickly. Ultimate losses under a long-tail insurance product are sometimes not known and settled for many years. The longer the time span between the incidence of a loss and the settlement of the claim, the more the ultimate settlement amount can vary from the reserves initially established. Accordingly, long-tail insurance products can have significant implications on the reserving process.
Our short-tail lines of business include fire and allied lines, homeowners, commercial property, auto physical damage and inland marine. The amounts of the case-based reserves that we establish for claims in these lines depend upon various factors, such as individual claim facts (including type of coverage and severity of loss), our historical loss experience and trends in general economic conditions (including changes in replacement costs, medical costs and inflation).
For short-tail lines of business, the estimation of case-basis loss reserves is less complex than for long-tail lines because the claims relate to tangible property. Because of the relatively short time from claim occurrence to settlement, actual losses typically do not vary significantly from reserve estimates.
Our long-tail lines of business include workers' compensation and other liability. In addition, certain product lines such as personal and commercial auto, commercial multi-peril and surety include both long-tail coverages and short-tail coverages. For many long-tail liability claims, significant periods of time, ranging up to several years, may elapse between the occurrence of the loss, the reporting of the loss to us and the settlement of the claim. As a result, loss experience in the more recent accident years for the long-tail liability coverages has limited statistical credibility in our reserving process because a relatively small proportion of losses in these accident years are reported claims and an even smaller proportion are paid losses. In addition, long-tail liability claims are more susceptible to litigation and can be significantly affected by changing contract interpretations and the legal environment. Consequently, the estimation of loss reserves for long-tail coverages is more complex and subject to a higher degree of variability than for short-tail coverages.
The amounts of the case-basis loss reserves that we establish for claims in long-tail lines of business depends upon various factors, including individual claim facts (including type of coverage, severity of loss and underlying policy limits), company historical loss experience, changes in underwriting practice, legislative enactments, judicial decisions, legal developments in the awarding of damages, changes in political attitudes and trends in general economic conditions, including inflation. As with our short-tail lines of business, we review and make changes to long-tail case-based reserves based on our review of continually evolving facts as they become available to us during the claims settlement process. Our adjustments to case-based reserves are reported in the financial statements in the period that new information arises about the claim. Examples of facts that become known that could cause us to change our case-based reserves include, but are not limited to: evidence that loss severity is different than previously assessed; new claimants who have presented claims; and the assessment that no coverage exists.
Incurred But Not Reported Reserves
On a quarterly basis, the Company's internal actuary performs a detailed analysis of IBNR reserves. This analysis uses various loss projection methods to provide several estimates of ultimate loss (or loss adjustment expense (LAE)) for each individual year and line of business. The loss projection methods include paid loss development; reported loss development; expected loss emergence based on paid losses; and expected loss emergence based on reported losses. The two methods utilized by our internal actuary to project loss settlement expenses are paid expenses development and development of the ratio of paid expense versus paid loss. Results of the projection methods are compared and a point estimate of ultimate loss (or LAE) is established for each individual year and line
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of business. The specific projection methods used to establish point estimates vary depending on what is deemed most appropriate for a particular line of business and year. Results of these methods are usually averaged together to provide a final point estimate. Given that there are several inputs depending on the line of business, the methods may be averaged and modified based on changes known to management or trends in the market. IBNR estimates are derived by subtracting reported loss from the final point estimate loss.
Senior management meets with our internal actuary and controller quarterly to review the adequacy of carried IBNR reserves based on results from this actuarial analysis and makes adjustments for changes in business and other factors not completely captured by the data within the actuarial analysis. There are two fundamental types or sources of IBNR reserves. We record IBNR for "normal" types of claims and also specific IBNR reserves related to unique circumstances or events. A major hurricane is an example of an event that might necessitate specific IBNR reserves because an analysis of existing historical data would not provide an appropriate estimate. This method of establishing our IBNR reserves has consistently resulted in aggregate reserve levels that management believes are reasonable in comparison to the reserve estimates indicated by the actuarial analysis.
For our short-tail lines of business, IBNR reserves constitute a small portion of the overall reserves. These claims are generally reported and settled shortly after the loss occurs. In our long-tail lines of business, IBNR reserves constitute a relatively higher proportion of total reserves, because, for many liability claims, significant periods of time may elapse between the initial occurrence of the loss, the reporting of the loss to us, and the ultimate settlement of the claim.
Loss Settlement Expense Reserves
Loss settlement expense reserves include amounts ultimately allocable to individual claims, as well as amounts required for the general overhead of the claims handling operation that are not specifically allocable to individual claims. We do not establish loss settlement expense reserves on a claim-by-claim basis. Instead, on a quarterly basis, our internal actuary performs a detailed statistical analysis (using historical data) to estimate the required reserve for unpaid loss settlement expenses. On a monthly basis, the required reserve estimate is adjusted to reflect additional earned exposure and expense payments that have occurred subsequent to completion of the quarterly analysis.
LAE is composed of two distinct kinds of expenses which are allocated LAE ("ALAE") and unallocated LAE ("ULAE"). These two expense types have different purposes and characteristics which necessitates different estimation methods in order to provide a valid quarterly estimate of the required reserve for unpaid expense which is generally referred to as an LAE IBNR reserve.
Reserves for unpaid ALAE are estimated quarterly by line of business for each individual accident year using three methods: (1) Paid development, (2) Expected emergence of ALAE, and (3) Development of the ratio of paid ALAE to paid loss. Each of the three methods produces an estimate of the ultimate ALAE cost for an individual accident year and the final estimate is generally a weighted average of the various methods. Inception to date paid ALAE is subtracted from the final ultimate ALAE estimate to provide the estimated ALAE IBNR reserve for each individual accident year.
Reserves for unpaid ULAE are estimated quarterly by line of business for each individual accident year using a single method. This method consists of applying a percentage factor to unpaid loss reserves. The percentage factor used differs by line of business and is evaluated and established on an annual basis using year-end data. The percentage factor is evaluated and selected after reviewing the ratio of paid ULAE to paid loss using calendar year data for the most recent five years.
Generally, the loss settlement expense reserves for long-tail lines of business are a greater portion of the overall reserves, as there are often substantial legal fees and other costs associated with the complex liability claims that are associated with long-tail coverages. Because short-tail lines of business settle much more quickly and the costs are easier to determine, loss settlement expense reserves for such claims constitute a smaller portion of the total reserves.
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Reinsurance Reserves
The estimation of assumed and ceded reinsurance loss and loss settlement expense reserves is subject to the same factors as the estimation of loss and loss settlement expense reserves. In addition to those factors, which give rise to inherent uncertainties in establishing loss and loss settlement expense reserves, there exists a delay in our receipt of reported claims for assumed business due to the procedure of having claims first reported through one or more intermediary insurers or reinsurers.
Reserves for assumed reinsurance are established using methods and techniques identical to those used for direct lines of business. The additional delay inherent in assumed reinsurance reporting is considered in our reserving process and payment is not problematic. Assumed reinsurance, like every independent line of business, has unique reporting and payment patterns that are reviewed as part of the reserve estimation process.
There are three distinct types of reserves ceded to reinsurers: (1) reported claim reserves, (2) loss IBNR, and (3) LAE IBNR. Ceded reserves for reported claims are calculated by subtracting the primary retention from the claim value established by our claim adjuster. Ceded loss IBNR originates from our boiler and machinery business which is 100 percent reinsured and from the Midwest August derecho catastrophe. For this business ceded loss IBNR is equal to direct loss IBNR. Boiler and machinery business is included in our commercial fire and allied line of business. We will cede some LAE expenses when we cede loss. Our ceded LAE IBNR is estimated based on our ceded unpaid loss reserves and the general relation, by line of business, between LAE and loss. Our primary retention was $2.0 million for 2012 through 2015 and increased to $2.5 million for 2016 through 2020.
Key Assumptions
Our internal and external actuaries and management use a number of key assumptions in establishing an estimate of loss and loss settlement expense reserves, including the following assumptions: future loss settlement expenses can be estimated based on the Company's historical ratios of loss settlement expenses paid to losses; the Company's case-basis reserves reflect the most up-to-date information available about the unique circumstances of each individual claim; no new judicial decisions or regulatory actions will increase our case-basis obligations; historical aggregate claim reporting and payment patterns will continue into the future consistent with the observable past; significant unique and unusual claim events have been identified and appropriate adjustments have been made; and, to the best of our knowledge, there are no new latent trends that would impact our case-basis reserves.
Our key assumptions are subject to change as actual claims occur and as we gain additional information about the variables that underlie our assumptions. Accordingly, management reviews and updates these assumptions periodically to ensure that the assumptions continue to be valid. If necessary, management makes changes not only in the estimates derived from the use of these assumptions, but also in the assumptions themselves. Due to the inherent uncertainty in the loss reserving process, management believes that there is a reasonable chance that modification to key assumptions could individually, or in aggregate, result in reserve levels that are either significantly above or below the actual amount for which the related claims will eventually settle.
As an example, if our loss and loss settlement expense reserves of $1,578.1 million as of December 31, 2020, is 10.0 percent inadequate, we would experience a reduction in future pre-tax earnings of up to $157.8 million. This reduction could be recorded in one year or multiple years, depending on when we identify the deficiency. The deficiency would also affect our financial position in that our equity would be reduced by an amount equivalent to the reduction in net income. Any deficiency that would be recognized in our loss and loss settlement expense reserves usually does not have a material effect on our liquidity because the claims have not been paid. Conversely, if our estimates of ultimate unpaid loss and loss settlement expense reserves prove to be redundant, our future earnings and financial position would be improved. We believe our reserving philosophy, coupled with what we believe to be aggressive and successful claims management and loss settlement practices, has resulted in year-to-year redundancies in reserves. We believe our approach produces recorded reserves that are reasonable as to their relative position within a range of reasonable reserves from year-to-year.
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We are unable to reasonably quantify the impact of changes in our key assumptions utilized to establish individual case-basis reserves on our total reported reserves because the impact of these changes would be unique to each specific case-basis reserve established. However, based on historical experience, we believe that aggregate case-basis reserve volatility levels of 5.0 percent and 10.0 percent can be attributed to the ultimate development of our net case-basis reserves. The impact to pre-tax earnings would be a decrease if the reserves were to be adjusted upwards and an increase if the reserves were to be adjusted downwards. The table below details the impact of this development volatility on our reported net case-basis reserves at December 31, 2020:
(In Thousands)
Change in level of net case-basis reserve development 5% 10%
Impact on reported net case-basis reserves $ 43,118 $ 86,236
Due to the formula-based nature of our IBNR and loss settlement expense reserve calculations, changes in the key assumptions utilized to generate these reserves can impact our reported results. It is not possible to isolate and measure the potential impact of just one of these factors, and future loss trends could be partially impacted by all factors concurrently. Nevertheless, it is meaningful to view the sensitivity of the reserves to potential changes in these variables such as claim frequency and severity. To demonstrate the sensitivity of reserves to changes in significant assumptions, the following example is presented. The amounts reflect the pre-tax impact on earnings from a hypothetical percentage change in the calculation of IBNR and loss settlement expense reserves at December 31, 2020. The impact to pre-tax earnings would be a decrease if the reserves were to be adjusted upwards and an increase if the reserves were to be adjusted downwards. We believe that the changes presented are reasonably likely based upon an analysis of our historical IBNR and loss settlement expense reserve experience.
(In Thousands)
Change in claim frequency and claim severity assumptions 5% 10%
Impact due to change in IBNR reserving assumptions $ 12,874 $ 25,748
(In Thousands)
Change in LAE paid to losses paid ratio 1% 2%
Impact due to change in LAE reserving assumptions $ 3,264 $ 6,529
In 2020, we did not change the key method through which we develop our assumptions on which we based our reserving calculations. In estimating our 2020 loss and loss settlement expense reserves, we did not anticipate future events or conditions that were inconsistent with past development patterns.
Certain of our lines of business are subject to the potential for greater loss and loss settlement expense development than others, which are discussed below:
Other Liability Reserves
Other liability is considered a long-tail line of business, as it can take a relatively long period of time to settle claims from prior accident years. This is partly due to the lag time between the date a loss or event occurs that triggers coverage and the date when the claim is actually reported. Defense costs are also a part of the insured expenses covered by liability policies and can be significant, sometimes greater than the cost of the actual paid claims. For the majority of our products, defense costs are outside of the policy limit, meaning that the amounts paid for defense costs are not subtracted from the available policy limit.
Factors that can cause reserve uncertainty in estimating reserves in this line include: reporting time lags; the number of parties involved in the underlying tort action; whether the "event" triggering coverage is confined to only one time period or is spread over multiple time periods; the potential dollars involved in the individual claim actions; whether such claims were reasonably foreseeable and intended to be covered at the time the contracts were written (i.e., coverage disputes); and the potential for mass claim actions.
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Claims with longer reporting time lags may result in greater inherent risk. This is especially true for alleged claims with a latency feature, particularly where courts have ruled that coverage is spread over multiple policy years, hence involving multiple defendants (and their insurers and reinsurers) and multiple policies (thereby increasing the potential dollars involved and the underlying settlement complexity). Claims with long latencies also increase the potential time lag between writing a policy in a certain market and the recognition that such policy has potential mass tort and/or latent claim exposure.
Our reserve for other liability claims at December 31, 2020, was $652.3 million and consisted of 5,895 claims,compared with $600.0 million, consisting of 6,461 claims at December 31, 2019. Of the $652.3 million total reserve for other liability claims,$154.9 millionis identified as defense costs and $37.0 million is identified as general overhead required in the settlement of claims.
Included in the other liability line of business are gross reserves for construction defect losses and loss settlement expenses. Construction defect is a liability allegation relating to defective work performed in the construction of structures such as commercial buildings, apartments, condominiums, single family dwellings or other housing, as 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, 2020, we had $73.6 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 3,983 claims. At December 31, 2019, our reserves, excluding IBNR reserves, totaled $60.4 million, which consisted of 3,439 claims. The reporting of such claims can be delayed, as the statute of limitations can be up to 10 years. 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.
In addition to these issues, other variables also contribute to a high degree of uncertainty in establishing reserves for construction defect claims. These variables include: whether coverage exists; when losses occur; the size of each loss; expectations for future interpretive rulings concerning contract provisions; and the extent to which the assertion of these claims will expand geographically. In recent years, we have implemented various underwriting measures that we anticipate will mitigate the amount of construction defect losses experienced. These initiatives include increased care regarding additional insured endorsements; stricter underwriting guidelines on the writing of residential contractors; and an increased utilization of loss control.
Asbestos and Environmental Reserves
Included in the other liability and assumed reinsurance lines of business are reserves for asbestos and other environmental losses and loss settlement expenses. At December 31, 2020 and 2019, we had $2.5 million and $3.1 million, respectively, in direct and assumed asbestos and environmental loss reserves. The estimation of loss reserves for environmental claims and claims related to long-term exposure to asbestos and other substances is one of the most difficult aspects of establishing reserves, especially given the inherent uncertainties surrounding such claims. Although we record our best estimate of loss and loss settlement expense reserves, the ultimate amounts paid upon settlement of such claims may be more or less than the amount of the reserves, because of the significant uncertainties involved and the likelihood that these uncertainties will not be resolved for many years.
Commercial Auto Reserves
Commercial auto claim reserves are established at exposure based on information either known and provided or obtained through the investigation, with some pessimism built in. Incorporated are the perspective and experience the claims staff has acquired, which may include assumptions as to how the claim will develop over time, and with a slightly pessimistic view. Exposures are identified and reserves established within 30 to 60 days depending on the complexity of the case.
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Workers' Compensation Reserves
Like the other liability line of business, workers' compensation losses and loss settlement expense reserves are based upon variables that create imprecision in estimating the ultimate reserve. Estimates for workers' compensation are particularly sensitive to assumptions about medical cost inflation, which has been steadily increasing over the past few years. Other variables that we consider and that contribute to the uncertainty in establishing reserves for workers' compensation claims include: state legislative and regulatory environments; trends in jury awards; and mortality rates. Because of these variables, the process of reserving for the ultimate loss and loss settlement expense to be incurred requires the use of informed judgment and is inherently uncertain. Consequently, actual loss and loss settlement expense reserves may deviate from our estimates. Such deviations may be significant. Our reserve for workers' compensation claims at December 31, 2020 was $173.6 million and consisted of 3,192 claims, compared with $182.5 million, consisting of 3,869 claims, at December 31, 2019.
Reserve Development
The following reserve development section should be read in conjunction with the "Results of Operations for the Years Ended December 31, 2020, 2019 and 2018" section of this Item 7.
In 2020, 2019 and 2018, we recognized a favorable development in our net reserves for prior accident years totaling $17.7 million, $5.3 million and $54.2 million, respectively.
The factors contributing to our year-to-year redundancy include: establishing reserves at their ultimate expected loss amount as soon as practicable after information becomes available, which produces, on average, cautiously pessimistic case reserves; using claims negotiation to control the size of settlements; assuming that we have liability for all claims, even though the issue of liability may, in some cases, be resolved in our favor; promoting claims management services to encourage return-to-work programs; case management by nurses for serious injuries and management of medical provider services and billings; and using programs and services to help prevent fraud and to assist in favorably resolving cases.
Based upon our comparison of carried reserves to actual claims experience over the last several years, we believe that using our Company's historical premium and claims data to establish reserves for losses and loss settlement expenses results in adequate and reasonable reserves. Reserve development is discussed in more detail under the heading "Reserve Development" in the "Results of Operations for the Years Ended December 31, 2020, 2019 and 2018" section in this Item 7.
The following table details the pre-tax impact on our property and casualty insurance business' financial results and financial condition of reasonably likely reserve development. Our lines of business that have historically been most susceptible to significant volatility in reserve development have been shown separately and utilize hypothetical levels of volatility of 5.0 percent and 10.0 percent. Our other, less volatile, lines of business have been aggregated and utilize hypothetical levels of volatility of 3.0 percent and 5.0 percent.
(In Thousands)
Hypothetical Reserve Development Volatility Levels -10% -5% +5% +10%
Impact on loss and loss settlement expenses
Hypothetical Reserve Development Volatility Levels -5% -3% +3% +5%
Impact on loss and loss settlement expenses
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Independent Actuary
We engage an independent actuarial firm to render an opinion as to the reasonableness of the statutory reserves internal management establishes. During 2020 and 2019, we engaged the services of Regnier as our independent actuarial firm for the property and casualty insurance business. We anticipate that this engagement will continue in 2021.
It is management's policy to utilize staff adjusters to develop our estimate of case-basis loss reserves. IBNR and loss settlement expense reserves are established through various formulae that utilize pertinent, recent Company historical data. The calculations are supplemented with knowledge of current trends and events that could result in adjustments to the level of IBNR and loss settlement expense reserves. On a quarterly basis, we compare our estimate of total reserves to the estimates prepared by Regnier by line of business to ensure that our estimates are within the actuary's acceptable range. Regnier performs a review of loss and loss settlement expense reserves at each year end using generally accepted actuarial guidelines to ensure that the recorded reserves appear reasonable. Our net reserves for losses and loss settlement expenses as of December 31, 2020 and 2019 were $1,446.3 million and $1,353.2 million, respectively. In 2020 and 2019, after considering the independent actuary's range of reasonable estimates, management believes that carried reserves were reasonable and therefore did not adjust the recorded amount.
Regnier uses four projection methods in its actuarial analysis of our loss reserves and uses two projection methods in its actuarial analysis of our loss settlement expense reserves. Based on the results of the projection methods, the actuaries select an actuarial point estimate of the reserves, which is compared to our carried reserves to evaluate the reasonableness of the carried reserves. The four methods utilized by Regnier to project losses are: paid loss development; reported loss development; expected loss emergence based on paid losses; and expected loss emergence based on reported losses. The two methods utilized by Regnier to project loss expenses are: paid expenses-to-paid loss and paid expense-to-ultimate loss.
Pension and Post-Retirement Benefit Obligations
The process of estimating our pension and post-retirement benefit obligations and related benefit expense is inherently uncertain, and the actual cost of benefits may vary materially from the estimates recorded. These liabilities are particularly volatile due to their long-term nature and are based on several assumptions. The main assumptions used in the valuation of our benefit obligations are: estimated mortality of the employees and retirees eligible for benefits; estimated expected long-term rates of return on investments; estimated compensation increases; estimated employee turnover; estimated medical expense trend rate; and estimated rate used to discount the ultimate estimated liability to a present value. We engage a consulting actuary from Principal Financial Group, an independent firm, to assist in evaluating and establishing assumptions used in the valuation of our benefit obligations.
A change in any one or more of these assumptions is likely to result in an ultimate liability different from the original actuarial estimate. Such changes in estimates may be material. For example, a 100 basis point decrease in our estimated discount rate would increase the pension and post-retirement benefit obligation at December 31, 2020, by $51.1 million and $5.9 million, respectively, while a 100 basis point increase in the rate would decrease the benefit obligation at December 31, 2020, by $39.8 million and $4.6 million, respectively.
In addition, for the post-retirement benefit plan, a 100 basis point decrease in the medical trend rate would decrease the post-retirement benefit obligation at December 31, 2020, by $4.5 million, while a 100 basis point increase in the medical trend rate would increase the benefit obligation at December 31, 2020, by $5.5 million.
A 100 basis point decrease in our estimated long-term rate of return on pension plan assets would increase the benefit expense for the year ended December 31, 2020, by $2.5 million, while a 100 basis point increase in the rate would decrease benefit expense by $2.5 million, for the same period.
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For the post-retirement benefit plan, a 100 basis point increase in our estimated medical trend rate would increase the benefit expense for the year ended December 31, 2020, by $0.6 million, while a 100 basis point decrease in the rate would decrease benefit expense by $0.5 million, for the same period.
Goodwill
As described in Part II, Item 8, Note 15 "Intangible Assets," the Company performed a quantitative impairment analysis on its one reporting unit and recognized an impairment charge of $15.1 million for the year ended December 31, 2020. The Company tests goodwill for impairment annually, during the third quarter, or more frequently if events or changes in circumstances indicate that goodwill might be impaired. An impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value. The Company used a weighting of the income and market approaches to determine the fair value of the reporting unit. The impairment was based on the following factors: (i) disruptions in the equity markets, specifically for property and casualty insurance companies, as a result of the COVID-19 pandemic and due to the current year weather related catastrophes; and (ii) the fair value of our stock trading significantly below book value.
The Company's quantitative goodwill impairment test involved estimating the fair value of the Company, which was sensitive to significant assumptions, such as forecasted revenues and loss and loss settlement expenses, discount rate, and terminal growth rate which are used in the income approach and comparable publicly traded companies and estimated valuation multiples which are used in the market approach.
Recently Issued Accounting Standards
Information specific to accounting standards that we adopted in 2020 or pending accounting standards that we expect to adopt in the future is incorporated by reference from Note 1 "Summary of Significant Accounting Policies" contained in Part II, Item 8, "Financial Statements and Supplementary Data."
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information required by this Item 7A is incorporated by reference from Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" under the headings "Investments" and "Market Risk."
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
United Fire Group, Inc. Consolidated Balance Sheets
December 31,
(In Thousands, Except Share Data) 2020 2019
Assets
Investments
Fixed maturities
Less: allowance for mortgage loan losses 76 72
Goodwill and net intangible assets 6,743 22,542
Liabilities and stockholders' equity
Liabilities
Stockholders' equity
Accumulated other comprehensive income, net of tax 66,911 13,152
The Notes to Consolidated Financial Statements are an integral part of these statements.
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United Fire Group, Inc.
Consolidated Statements of Income and Comprehensive Income
For the Years Ended December 31,
Revenues
Other income 6,270 — —
Benefits, losses and expenses
Goodwill impairment 15,091 — —
Income (loss) from discontinued operations, net of taxes — — (1,912)
Gain on sale of discontinued operations, net of taxes — — 27,307
Other comprehensive income (loss)
Total reclassification adjustments, before tax 2,539 6,018 7,426
Total reclassification adjustments, after tax 2,005 4,755 5,867
Earnings (loss) per common share from continuing operations:
Earnings (loss) per common share:
The Notes to Consolidated Financial Statements are an integral part of these statements.
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United Fire Group, Inc.
Consolidated Statement of Stockholders' Equity
Common Stock
Change in net unrealized investment appreciation(1) — — — — (32,944) (32,944)
Cumulative effect of change in accounting principle — — — 191,244 (191,244) —
Dividends on common stock ($1.30 per share) — — (32,662) — (32,662)
Change in net unrealized investment appreciation(1) — — — — 56,602 56,602
Cumulative effect of change in accounting principle — — — (514) — (514)
Dividends on common stock ($1.14 per share) — — — (28,526) — (28,526)
Change in net unrealized investment appreciation(1) — — — — 35,791 35,791
Cumulative effect of change in accounting principle — — — (30) — (30)
(1)The change in net unrealized appreciation is net of reclassification adjustments and income taxes.
(2)The change in liability for underfunded employee benefit plans is net of income taxes.
The Notes to Consolidated Financial Statements are an integral part of these statements.
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United Fire Group, Inc.
Consolidated Statements of Cash Flows
For the Years Ended December 31,
Cash Flows From Operating Activities
Less net income (loss) from discontinued operations, net of taxes — — (1,912)
Adjustments to reconcile net income to net cash provided by operating activities
Goodwill impairment 15,091 — —
Changes in:
Cash from operating activities - discontinued operations — — 4,024
Cash Flows From Investing Activities
Proceeds from short-term and other investments 6,494 4,397 9,303
Proceeds from sale of discontinued operations — — 276,055
Purchase of short-term and other investments (6,629) (44,375) (7,119)
Net purchases and sales of property and equipment (18,862) (32,426) (33,053)
Cash from investing activities - continuing operations (92,871) 4,501 (33,547)
Cash from investing activities - discontinued operations — — 14,343
Cash Flows From Financing Activities
Borrowings of long-term debt $ 50,000 $ — $ —
Cash from financing activities - discontinued operations — — (11,547)
The Notes to Consolidated Financial Statements are an integral part of these statements.
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Index of Notes to Consolidated Financial Statements Page
Note 1. Summary of Significant Accounting Policies 73
Note 2. Summary of Investments 83
Note 3. Fair Value of Financial Instruments 88
Note 4. Reinsurance 98
Note 5. Reserves for Losses and Loss Settlement Expenses 100