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UNITED FIRE GROUP INC – 10-K/A – 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 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 Annual Report on 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 Annual Report on Form 10-K.
BUSINESS OVERVIEW
Originally founded in 1946 asUnited 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 50 states plus theDistrict of Columbia and are represented by approximately 1,000 independent agencies. Reportable Segments
Our property and casualty insurance business operates and reports as one
business segment. For more information, refer to Part I, Item 1 "Business" under
"General Description."
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.
Geographic Concentration
Property and Casualty Insurance Business
For 2022, approximately 47.5 percent of our property and casualty premiums were
written in
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In 2022, 2021 and 2020 the direct statutory premiums written by our property and
casualty insurance operations were distributed as follows:
Years Ended December 31, % of Total
(In Thousands) 2022 2021 2020 2022 2021 2020
Texas $ 148,207 $ 158,676 $ 192,841 16.6 % 17.4 % 18.1 %
California 111,037 119,171 127,168 12.4 13.1 11.9
Iowa 70,128 73,097 91,176 7.8 8.0 8.6
Missouri 54,090 55,693 72,527 6.1 6.1 6.8
New Jersey 41,030 49,468 53,406 4.6 5.4 5.0
Louisiana 37,124 39,280 45,168 4.2 4.3 4.2
Colorado 34,480 38,761 46,394 3.9 4.3 4.4
Minnesota 32,659 35,697 39,501 3.7 3.9 3.7
South Dakota 31,609 30,429 35,166 3.5 3.3 3.3
Illinois 28,538 29,755 39,562 3.2 3.3 3.7
All Other States 304,839 281,485 322,409 34.1 30.9 30.3
Direct Statutory Premiums
Written $ 893,741 $ 911,512 $ 1,065,318
100.0 % 100.0 % 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, 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. 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 Part II, Item 8, Note 13 "Debt" for more information. Our share repurchase program was suspended inmid-March 2020 and restarted in the first quarter of 2021. Also, the Company maintained the payment of quarterly cash dividends during 2021 and 2022, with the dividends paid inNovember 2022 marking the 219th consecutive quarter of paying dividends sinceMarch 1968 . Stockholders' equity decreased to$740.1 million atDecember 31, 2022 , from$879.1 million atDecember 31, 2021 . The decrease is primarily attributable to the$138.1 million decrease in the net unrealized value from our fixed maturity securities, net of tax, shareholder dividends of$15.9 million , and offset by net income of$15.0 million . 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. The Company impaired all goodwill in 2020. The latest evaluation of other intangible assets was completed as ofDecember 31, 2022 and no impairments were deemed necessary. 30 -------------------------------------------------------------------------------- Table of Contents As ofDecember 31, 2022 , we intend to keep all assets currently leased and honor the terms of the contracts. Also, we have five lease contracts where we are the lessor which we evaluated for impairment. As ofDecember 31, 2022 , all payments on these contracts had been received and we fully expect to receive all future payments on time. The decline in certain sectors of the equity and bond markets in 2022 due to economic conditions did have a material impact on the fair value of our investments. The Company's investment philosophy, objectives, approach and program have not changed. During 2022 we had a decrease in the fair value of equity securities of$12.8 million and a decrease in value of our investments in limited liability partnerships of$7.9 million from the values reported atDecember 31, 2021 . The Company has a highly rated fixed maturity portfolio, with low credit risk. The Company recognized an increase in unrealized losses of$138.1 million , net of tax, atDecember 31, 2022 on its available-for-sale fixed maturity portfolio due to an increase in interest rates. In addition, we adopted new accounting guidance onJanuary 1, 2020 , which changes the measurement of credit losses for our investment in available-for-sale fixed maturities and our mortgage loans, and this also impacts our reinsurance receivables. The adoption of this new guidance resulted in an immaterial allowance for credit losses to be recorded for each of these assets on our balance sheet as ofDecember 31, 2022 . For more information on credit losses, please refer to Part II, Item 8, Note 1 "Summary of Significant Accounting Policies" and Note 2 "Summary of Investments" of this Annual Report on Form 10-K. 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. The following provides further explanation of the key measures management uses to evaluate our results: Catastrophe losses is an operational measure which utilizes the designations of theInsurance 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$25.0 million or more inU.S. industry-wide direct insured losses to property and that affect a significant number of insureds and insurers ("ISO catastrophe"). In addition to ISO catastrophes, we also include as catastrophes those events ("non-ISO catastrophes"), which may includeU.S. or international losses, that we believe are, or will be, material to our operations, either in amount or in number of claims made. Management, at times, may determine for comparison purposes of our financial results that it is more meaningful to exclude extraordinary catastrophe losses and resulting litigation. The frequency and severity of catastrophic losses we experience in any year affect our results of operations and financial position. In analyzing the underwriting performance of our property and casualty insurance business, we evaluate performance both including and excluding catastrophe losses. Portions of our catastrophe losses may be recoverable under our catastrophe reinsurance agreements. We include a discussion of the impact of catastrophes because we believe it is meaningful for investors to understand the variability in our periodic earnings. Years Ended December 31, (In Thousands) 2022 2021 2020 ISO catastrophes$ 73,342 $ 83,386 $ 141,425 Non-ISO catastrophes (1) 124 15,230 579 Total catastrophes$ 73,466 $ 98,616 $ 142,004
(1) Includes international assumed losses.
31 -------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS FOR THE YEARS ENDEDDECEMBER 31, 2022 , 2021 AND 2020 FINANCIAL HIGHLIGHTS Years Ended December 31, % Change 2022 2021 (In Thousands) 2022 2021 2020 vs. 2021 vs. 2020 Revenues Net premiums earned$ 951,541 $ 962,823 $ 1,055,082 (1.2) % (8.7) % Investment income, net of investment expenses 44,932 55,778 39,670 (19.4) 40.6 Net investment gains (losses) (15,892) 47,383 (32,395) (133.5) (246.3) Other income (295) 207 6,270 (242.5) (96.7) Total revenues$ 980,286 $ 1,066,191 $ 1,068,627 (8.1) % (0.2) % Benefits, losses and expenses Losses and loss settlement expenses$ 637,301 $ 652,155 $ 869,467 (2.3) % (25.0) % Amortization of deferred policy acquisition costs 213,075 203,432 210,252 4.7 (3.2) Other underwriting expenses 114,645 110,574 143,332 3.7 (22.9) Goodwill impairment - - 15,091 NM (100.0) Interest expense 3,188 3,187 - - -
Total benefits, losses and expenses
$ 1,238,142 (0.1) % (21.7) % Income (loss) before income taxes$ 12,077 $ 96,843 $ (169,515) (87.5) (157.1) % Federal income tax expense (benefit) (2,954) 16,249 (56,809) (118.2) (128.6) % Net income (loss)$ 15,031 $ 80,594 $ (112,706) (81.3) (171.5) % GAAP Ratios: Net underlying loss ratio (1) 59.2 % 64.4 % 71.2 % (8.1) % (9.6) % Catastrophes - effect on net loss ratio (1) 7.7 % 10.2 % 13.5 % (24.5) % (24.4) % Reserve development-effect on net loss ratio (1) 0.1 % (6.9) % (2.2) % (101.4) % 213.6 % Net loss ratio (2) 67.0 % 67.7 % 82.4 % (1.0) % (17.8) % Expense ratio (3) 34.4 % 32.6 % 33.5 % 5.5 % (2.7) % Combined ratio (4) 101.4 % 100.3 % 115.9 % 1.1 % (13.5) % NM = not meaningful (1) Net underlying loss ratio is defined as the net loss ratio less impacts of catastrophes and non-catastrophe prior year reserve development. (2) 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. (3) 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. (4) 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 2022, the decrease in net income compared to 2021 was primarily due to lower premiums earned, lower net investment income from a decrease in value of other long-term assets, and net investment losses from a decrease in the fair value of equity securities, as compared to net investment gains for the same period in 2021.
Net income reported in 2021 as compared to a net loss in 2020 was primarily due
to a decrease in losses and loss settlement expenses, a decrease in other
underwriting expenses, an increase in investment income and net investment
32 -------------------------------------------------------------------------------- Table of Contents gains from an increase in the fair value of equity securities, as compared to net investment losses for the same period in 2020. These were partially offset by a decrease in net premiums earned.
Premiums
The following table shows our premiums written and earned for 2022, 2021 and
2020:
% Change
(In Thousands) 2022 2021
Years ended December 31, 2022 2021 2020 vs. 2021 vs. 2020
Direct premiums written $ 893,741 $ 911,514 $ 1,065,318 (1.9) % (14.4) %
Assumed premiums written 190,215 130,375 34,371 45.9 279.3
Ceded premiums written (99,732) (100,541) (88,339) (0.8) 13.8
Net premiums written(1) $ 984,224 $ 941,348 $ 1,011,350 4.6 % (6.9) %
Less: change in unearned premiums (34,655) 25,112 40,317 (238.0) (37.7)
Less: change in prepaid reinsurance
premiums 1,972 (3,637) 3,415 154.2 (206.5)
Net premiums earned $ 951,541 $ 962,823 $ 1,055,082 (1.2) % (8.7) %
NM = not meaningful
(1) Net premiums written: 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 decreased$17.8 million in 2022 as compared to 2021 primarily due to our continued focus on improving profitability through non-renewal of under-performing accounts in our commercial auto line of business. Direct premiums written decreased$153.8 million in 2021 as compared to 2020 primarily due to our focus on improving profitability through non-renewal of under-performing accounts in our commercial auto line of business and our exit from the personal lines business which began inSeptember 2020 .
Assumed Premiums Written
Assumed premiums written increased$59.8 million in 2022 as compared to 2021 due to growth of our assumed book by the addition of new programs and cedant premium growth. Assumed premiums written increased$96.0 million in 2021 as compared to 2020 due to growth of our assumed book by the addition of new programs and cedant premium growth. 33
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Ceded Premiums Written Direct premiums written are reduced by the ceded premiums that we pay to reinsurers. For 2022, the ratio of ceded premiums to direct written premiums is nearly the same as it was in 2021, and thus ceded premiums written are only down as a reflection of decreased direct premiums written. For 2021, we ceded 13.8 percent more premiums to reinsurers related to the Fund's at Lloyd's agreement offset by a decrease in written premium for ICAT (International Catastophe), decrease in reinstatement premium paid for catastrophe events, and decreased placement of facultative reinsurance.
Losses and Loss Settlement Expenses
Climate Change and 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 and consider the impacts of climate change and the unpredictability of future trends in adjusting our geographic concentrations inthe United States . 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 ofthe United States , such as theGulf Coast andEast Coast , 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 theU.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 intend to 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. 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 34
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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 2022, our pre-tax catastrophe losses were$73.5 million , a decrease of$25.1 million compared to$98.6 million in 2021 and a decrease of$68.5 million as compared to$142.0 million in 2020. In 2022, our catastrophe losses included 45 events. Catastrophe losses in 2022 added 7.7 percentage points to the combined ratio, which is above our historical 10-year average of 7.0 percentage points. In 2021, our pre-tax catastrophe losses were$98.6 million , a decrease of$43.4 million compared to$142.0 million in 2020 and an increase of$34.2 million as compared to$64.4 million in 2019. In 2021, our catastrophe losses included 58 events. Catastrophe losses in 2021 added 10.2 percentage points to the combined ratio, which was above our historical 10-year average of 7.3 percentage points.
Catastrophe Reinsurance
In 2022, the company entered into a pillared loss occurrence program in addition
to the Excess of Loss ("XOL") ceded reinsurance program. Our catastrophe
reinsurance retention level was $15.0 million for the XOL ceded reinsurance
treaty and $5.0 million for the pillared loss occurrence program. We did not
experience any property catastrophe events that produced a reported loss to
either program. IBNR on certain catastrophe losses in 2022 have considered these
insurance programs.
In 2021 we exceeded our catastrophe reinsurance retention level of $20.0 million
with winter storm Uri which caused widespread freezing damages across multiple
states in February. Uri was a full retention loss, with losses in excess of our
stated reinsurance retention of $20.0 million . Total losses from this storm,
including assumed reinsurance, were $28.5 million with $7 million of reinsurance
recoveries. In 2021, we also exceeded our catastrophe reinsurance retention
level of $20.0 million from further loss development from the April 2020 Midwest
hail storm. A majority of the losses occurred in 2020, with the reinsurance
retention level reached in 2021.
The majority of the Company's catastrophe reinsurance programs renewed on
January 1, 2023 , including the XOL treaty, earthquake quota share and pillared
occurrence program. During the renewal period in 2022, reinsurance markets
hardened and the industry experienced increasing reinsurance pricing and lower
reinsurer capacity. The Company was able to renew previous programs and we
expect to have an increase in reinsurance costs of one to two percent of the
combined ratio, which we anticipate to offset with increases in direct premiums
written.
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-."
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The following table represents the primary reinsurers we utilize and their
financial strength ratings as of
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+ AA- Odyssey Re(2) A A Partner Re(1)(2) A+ A+QBE Reinsurance Corporation (1) A A+ R&V Versicherung AG(2) N/A A+ Renaissance Re A+ A+ SCOR Reinsurance Company(1)(2) A+ A+ Toa Re(1) A A Tokio Marine Kiln A++ A+ Transatlantic Re(1) A+ AA+ (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.
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. TRIPRA coverage is effective throughDecember 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 theU.S. Secretary of theTreasury , the Secretary of State and the Attorney General was$200.0 million for 2022 and remains the same for 2023. Our TRIPRA deductible was$132.6 million for 2022 and our TRIPRA deductible is expected to be$124.8 million for 2023. Our catastrophe and non-catastrophe reinsurance programs provide limited coverage for terrorism exposure excluding nuclear, biological and chemical-related claims.
2022 Results
In 2022, our losses and loss settlement expenses were 2.3 percent lower than 2021 and our net loss ratio decreased 0.7 points. The primary driver for the decline is a reduction of loss and loss settlement expenses of$27.0 million in personal lines related to our exit of that business. This was offset by an increase in reinsurance assumed related to our growth in that business from the prior year. Our commercial lines were down slightly and will be discussed in more detail in Net Loss Ratios by Line. In 2022, catastrophe losses were$73.5 million in both our direct business and assumed reinsurance business as compared to$98.6 million in 2021. 36
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2021 Results
In 2021, our losses and loss settlement expenses were 25.0 percent lower than 2020 and our net loss ratio decreased 14.7 points. The decrease in losses and loss settlement expenses was primarily due to a decrease in frequency and severity of commercial auto liability losses and comparatively lower catastrophe losses. In 2021, catastrophe losses were$98.6 million in both our direct business and assumed reinsurance business as compared to$142.0 million in 2020.
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 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, conservative case reserves, which we expect to result in some level of favorable development over the course of settlement.
2022 Development
The property and casualty insurance business experienced$12.9 million of unfavorable development in our net reserves for prior accident years for the twelve-month period endedDecember 31, 2022 . The two lines that contributed to the majority of the unfavorable development were commercial other liability with$47.8 million and commercial fire and allied with$24.8 million unfavorable development. This was offset partially by favorable development on commercial automobile which contributed$56.7 million . The unfavorable development in commercial other liability and commercial fire and allied was due to paid loss and loss adjustment expense ("LAE") which was greater than reductions in reserves for unpaid loss and LAE. The favorable development for commercial automobile was from both loss and LAE where reductions of reserves for unpaid liabilities were more than sufficient to offset actual paid loss and paid LAE. Reductions in reserves for IBNR claims also contributed favorable development.
2021 Development
The property and casualty insurance business experienced$48.9 million of favorable development in our net reserves for prior accident years for the twelve-month period endedDecember 31, 2021 . Two lines contributed the majority of favorable development with the largest contribution coming from commercial automobile which had$43.3 million favorable development, followed by workers' compensation which had$10.9 million favorable development. All other individual lines, with the exception of commercial other liability, experienced favorable development. Commercial other liability experienced$20.7 million of unfavorable development. The favorable 37 -------------------------------------------------------------------------------- Table of Contents development for commercial automobile was from both loss and LAE where reductions of reserves for unpaid liabilities were more than sufficient to offset actual paid loss and paid LAE. The favorable development for workers' compensation was from both loss and LAE and for loss the reductions in reserves for reported claims were more than sufficient to offset paid loss; reductions in reserves for IBNR claims also contributed favorable development in addition to LAE where reductions in reserves were more than sufficient to offset payments. Commercial other liability 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.
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 endedDecember 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 LAE where reductions in reserves were 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$0.8 million of favorable development. Reserve development amounts can vary significantly from year-to-year depending on a number of factors, including the number of claims settled and the settlement terms, and are subject to reallocation between accident years and lines of business. 38 -------------------------------------------------------------------------------- Table of Contents Net Loss Ratios by Line
The following table depicts our net loss ratios for 2022, 2021 and 2020:
Years ended December 31, 2022 2021 2020
Net Losses and Net Losses and Net Losses and
Net Premiums Loss Settlement Net Premiums Loss Settlement Net Premiums Loss Settlement
(In Thousands) Earned Expenses Incurred Net Loss Ratio Earned Expenses Incurred Net Loss Ratio Earned Expenses Incurred Net Loss Ratio Commercial lines Other liability 302,446$ 231,587 76.6 %$ 299,961 $ 184,794 61.6 %$ 316,098 $ 200,280 63.4 % Fire and allied lines 232,156 204,278 88.0 238,881 177,136 74.2 245,454 228,305 93.0 Automobile 208,398 114,296 54.8 248,135 181,119 73.0 296,444 290,891 98.1 Workers' compensation 56,015 27,545 49.2 61,690 43,790 71.0 75,953 29,463 38.8 Fidelity and surety 37,975 6,790 17.9 30,989 2,913 9.4 28,001 707 2.5 Other 1,081 821 75.9 1,313 251 19.1 1,530 261 17.1 Total commercial lines 838,071$ 585,317 69.8 %$ 880,969 $ 590,003 67.0 %$ 963,480 $ 749,907 77.8 % Personal lines Fire and allied lines$ 4,957 $ 2,959 59.7 %$ 14,604 $ 20,215 138.4 %$ 32,061 $ 66,815 208.4 % Automobile 1 (3,123) NM 7,144 5,784 81.0 27,976 21,535 77.0 Other 50 (1,009) NM 361 (216) NM 1,148 3,741 325.9 Total personal lines$ 5,008 $ (1,173) (23.4) %$ 22,109 $ 25,783 116.6 %$ 61,185 $ 92,091 150.5 % Reinsurance assumed$ 108,462 $ 53,157 49.0 %$ 59,745 $ 36,369 60.9 %$ 30,417 $ 27,469 90.3 % Total$ 951,541 $ 637,301 67.0 %$ 962,823 $ 652,155 67.7 %$ 1,055,082 $ 869,467 82.4 % 39
-------------------------------------------------------------------------------- Table of Contents Commercial Lines The net loss ratio in our commercial lines of business, excluding assumed reinsurance, was 69.8 percent in 2022 compared to 67.0 percent in 2021 and 77.8 percent in 2020. The net loss dollars for 2022 compared to 2021 are lower by 0.8 percent but the loss ratio increased due to the contraction of premiums in 2022. The net loss ratio in 2021 decreased compared to 2020 primarily due to comparatively lower catastrophe losses and a decrease in frequency and severity of commercial auto liability 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. The net loss ratio deteriorated 15.0 percentage points in 2022 compared to 2021. The increase in the loss ratio is related to an increase in severity. During 2022, a combination of deeper analytical insights and emerging claim experience has increased our view of potential exposure within this line which has led to reserve strengthening. Construction Defect Losses AtDecember 31, 2022 , we had$103.8 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 5,338 claims. In comparison, atDecember 31, 2021 , we had reserves of$86.8 million , excluding IBNR reserves, consisting of 4,496 claims. OurWest Coast region continues 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 inTexas ,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 ofColorado 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 ofMercer Insurance Group, Inc. in 2011, we added construction defect exposure in the states ofCalifornia ,Nevada andArizona .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 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 40 -------------------------------------------------------------------------------- Table of Contents 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 13.8 percentage points in 2022 compared to 2021.
The deterioration in 2022 is related to an increase in severity of
non-catastrophe claims.
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 under-insured motorists and the legal costs of defending the insured against lawsuits. The net loss ratio improved 18.2 percentage points in 2022 compared to 2021. The improvement is attributable to a decrease in frequency and severity of commercial auto losses, which is the direct result of our continued focus to increase the quality of our commercial auto book of business through non renewing underperforming accounts and rate increases.
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 improved 21.8 percentage points in 2022 compared to 2021. This line experienced improvement with lower frequency of losses, a decline in severity and favorable prior accident year reserve development.
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 8.5 percentage points in 2022 compared to 2021. This line continues to perform well with a low loss ratio of 17.9 percent as we expand this book of business. The deterioration is due to an increase in severity of losses in 2022 as compared to 2021. Personal Lines Our personal lines consist primarily of fire and allied lines (including homeowners) and automobile lines. The negative loss ratio is due to reserves developing favorably after our independent insurance agents transferred their personal lines policies toNationwide Mutual Insurance Company .
Assumed Reinsurance
Our assumed reinsurance portfolio is comprised of contracts that provide
reinsurance protection to insurance companies. We only reinsure companies with
attractive expected profitability, relevant materiality, and strong reputation.
Our reinsurance business focuses on long-term relationships.
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Net earned premium grew to$108.5 million in 2022 compared to$59.7 million in 2021. The net loss ratio improved 11.9 percentage points in 2022 compared to 2021. Results benefited from hardened reinsurance rates, as well as our disciplined approach to underwriting.
Underwriting Expense Ratio
Our underwriting expense ratio, which is a percentage of amortization of deferred policy acquisition costs and other underwriting expenses over net premiums earned, was 34.4 percent, 32.6 percent and 33.5 percent for 2022, 2021, and 2020, respectively. The increase in expense ratio in 2022 as compared to 2021 was primarily driven by the non-recurring benefit in 2021 resulting from the change in design of our employee post-retirement benefit plans. The decrease in the expense ratio in 2021 as compared to 2020 was primarily due to the change in the design of our employee post-retirement benefit plans and a decrease in the acceleration of the amortization of our deferred acquisition costs due to improved profitability in our commercial auto line of business.
Federal Income Taxes
We reported a federal income tax benefit on a consolidated basis of$3.0 million or (24.5) percent of pre-tax income in 2022. For 2022, the effective tax rate varied from the statutory federal income tax expense rate at 21.0 percent, due primarily to our portfolio of tax-exempt securities and general business tax credits. In 2021, federal income tax expense on a consolidated basis was$16.2 million or 16.8 percent of pre-tax income and federal income tax benefit on a consolidated basis was$56.8 million or 33.5 percent of pre-tax loss in 2020. Deferred tax assets are reduced by a valuation allowance when management believes it is more likely than not that some, or all, of the deferred taxes will not be realized. After considering all positive and negative evidence of taxable income in the carryback and carryforward periods and our tax planning strategy of holding debt securities with unrealized losses to maturity or recovery, we believe it is more likely than not that all the deferred assets will be realized. As a result, we have no valuation allowance atDecember 31, 2022 and 2021.
As of
INVESTMENTS Investment Environment Following a very successful 2021, most investors experienced a difficult year in 2022. Stock prices plummeted andU.S. bonds suffered their worst selloff ever, the combination of which had a chilling effect on capital markets more broadly. The IPO market endured a year of record low issuance, mergers and acquisition activity was relatively subdued, and most saw the value of their 401(k) account drop significantly. The S&P 500 fell 19.4% for the year, while the Dow Jones Industrial Average dropped 8.8%. The Nasdaq Composite Index plunged 33.1% as Technology shares felt the adverse effects of higher interest rates and prospects of a slowing economy. All threeU.S. indices logged their worst annual performance since 2008. The closing yield on 10-yearU.S. Treasuries climbed from 1.512% at the end of 2021 to as high as 4.244% in October before settling at 3.877% at year-end. Most major bond indices were down 15-20% for the year. There were many factors contributing to the narrative, but at the heart of 2022's performance was consumer and producer price inflation not seen in over forty years. What was originally believed to be "transitory" pricing pressures turned into a significant challenge for policy makers, which required extraordinary measures in response. Making matters more difficult wasRussia's invasion ofUkraine , which sent energy prices soaring in the first quarter and disrupted food and energy supply chains globally. However, even as oil and gas prices moderated and supply chains came into line, inflation remained stubbornly high. In response, theFederal Reserve initiated its most aggressive interest rate increases since the 1980s. By the end of 2022, policymakers had lifted the Fed Funds rate from 0% to 4.50%, with four consecutive 75 basis point increases from June to November. 42 -------------------------------------------------------------------------------- Table of Contents Tighter financial conditions led portfolio managers to flee the most popular investments from prior years. In a period of zero interest rates, which was the decade or so following the financial crisis of 2008, it cost very little to invest in growth stocks regardless of whether those companies were profitable. With short-term bonds and other cash-like investments now delivering yields not seen in several years, portfolio managers chose to rotate away from risky investments with uncertain prospects. Commodities were the big winner in 2022, with the Energy Sector of the S&P 500 returning 65.8%. Utilities placed a distant second, delivering 1.41% total return for the year. Fed officials have been steadfast in saying their work is far from over, but markets are positioning for a more dovish future state. Although wages have been increasing, they are not currently keeping pace with the overall level of inflation. Therefore, the consumer's true purchasing power is deteriorating, and this is one of the primary issues monetary policy is attempting to cure. Signs the economy is cooling began to appear in the fourth quarter. As we closed-out the year, yields on short- and long-term Treasuries seemed to be pricing for a less restrictive Fed, and not a central bank intent on keeping monetary policy tight for the foreseeable future. The economy and financial markets are set-up for a pivotal year in 2023, with a meaningful lack of clarity on the future path forward for investors. That said, there are reasonable scenarios to consider in the year ahead to both downside risk and upside opportunity.
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 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 supportsUnited Fire's strategic plan and risk appetite. The portfolio is structured 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 atDecember 31, 2022 totaled$1,844.9 million , compared to$2,064.7 million atDecember 31, 2021 , a decrease of$219.8 million . AtDecember 31, 2022 , fixed maturity securities and equity securities comprised 84.1 percent and 9.2 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, taxableU.S. government and government agency bonds and tax-exemptU.S. municipal bonds. Our overall investment strategy is to stay fully invested (i.e., minimize cash balances). If additional cash is needed, we have the 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
carrying value in the following table:
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Percent
(In Thousands) of Total
Fixed maturities:
Available-for-sale $ 1,551,336 84.0 %
Trading securities -
Equity securities 169,106 9.2
Mortgage loans 37,898 2.1
Other long-term investments 86,276 4.7
Short-term investments 275 -
Total $ 1,844,891 100.0 %
At December 31, 2022 and December 31, 2021 , our fixed maturities portfolio is
classified as available-for-sale. 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
convertible redeemable preferred debt securities and equity securities at fair
value, with any changes in fair value recognized in earnings.
As of
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 security portfolios by credit rating atDecember 31, 2022 and 2021. Information contained in the table is generally based upon the issue credit ratings provided by Moody's, unless the rating is unavailable, in which case we obtain it fromStandard & Poor's . (In Thousands) December 31, 2022 December 31, 2021 Rating Carrying Value % of Total Carrying Value % of Total AAA $ 540,485 34.8 % $ 670,222 39.0 % AA 482,369 31.1 586,426 34.1 A 232,668 15.0 209,076 12.2 Baa/BBB 278,247 17.9 241,547 14.0 Other/Not Rated 17,567 1.1 12,519 0.7$ 1,551,336 100.0 %$ 1,719,790 100.0 % 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 4.3 years at
The amortized cost and fair value of available-for-sale and trading fixed maturity securities atDecember 31, 2022 , 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. 44
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(In Thousands) Available-For-Sale
Amortized Fair
December 31, 2022 Cost Value
Due in one year or less $ 35,745 $ 35,549
Due after one year through five years 461,716
448,758
Due after five years through 10 years 539,189 501,171
Due after 10 years 361,171 335,136
Asset-backed securities 3,932 4,254
Mortgage-backed securities 20,450 17,700
Collateralized mortgage obligations 240,477 208,771
$ 1,662,680 $ 1,551,339
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 19.4 percent in 2022, compared with the
same period of 2021 and was primarily due to the change in the fair value of our
investments in limited liability partnerships. 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 versus
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, 2022 :
Rollforward of allowance for credit losses for available-for-sale fixed maturity securities:
As of
December 31, 2022
Beginning balance, January 1, 2022 $ -
Additions to the allowance for credit losses for which credit losses were not
previously recorded
3 Ending balance, December 31, 2022 $ 3 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 atDecember 31, 2022 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. 45
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Net Investment Income
In 2022, our investment income, net of investment expenses, decreased
in the fair value of our investments in limited liability partnerships.
In 2021, our investment income, net of investment expenses, increased
in the fair value of our investments in limited liability partnerships.
The following table summarizes the components of net investment income:
(In Thousands) Years Ended December 31, 2022 2021
2020
Investment income from operations: Interest on fixed maturities$ 48,702 $ 43,224 $
46,478
Dividends on equity securities 5,163 5,031
6,368
Income on other long-term investments - 0 0 Interest 4,742 4,481 1,890 Change in value (1) (7,930) 9,699 (9,633) Interest on mortgage loans 1,897 1,995 1,949 Interest on short-term investments 354 18
107
Interest on cash and cash equivalents 740 252
763
Other 780 152
205
Total investment income from operations$ 54,448 $ 64,852 $ 48,127 Less investment expenses 9,516 9,074 8,457 Net investment income$ 44,932 $ 55,778 $ 39,670
(1)Represents the change in value of our interests in limited liability
partnerships that are recorded on the equity method of accounting.
In 2022, 89.4 percent of our gross investment income originated from interest on
fixed maturities, compared to 66.7 percent and 96.6 percent in 2021 and 2020,
respectively.
The following table details our annualized yield on average invested assets for
2022 , 2021, and 2020, 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)
Average Investment Annualized Yield on
Years ended December 31, Invested Assets Income, Net Average Invested Assets
2022 $ 1,992,108 $ 44,932 2.3 %
2021 2,141,022 55,778 2.6 %
2020 2,169,220 39,670 1.8 %
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Net Investment Gains and Losses
The following table summarizes the components of our net investment gains or losses: (In Thousands) Years Ended December 31, 2022 2021 2020 Net investment gains (losses): Net gains (losses): Fixed maturities: Available-for-sale$ (1,397) $ (277) $ 1,787 Allowance for credit losses (3) 5 (5) Trading securities Change in fair value - - (3,314) Sales - - 2,950 Equity securities Available-for-sale Trading securities Change in fair value (12,802) 30,682 (6,875) Sales (1,767) 14,444 (26,906) Mortgage loans 109 5 (4) Other long-term investments (267) 2,780 - Short-term investments - - - Other-than-temporary-impairment charges: Fixed maturities - - - Equity securities - - - Cash equivalents - - - Real Estate 235 (256)$ (28)
Total net investment gains (losses)
Net Unrealized Investment Gains and Losses
As ofDecember 31, 2022 , net unrealized investment losses, after tax, totaled$88.4 million compared to unrealized gains of$49.8 million and unrealized gains of$83.1 million as ofDecember 31, 2021 and 2020, respectively. The net unrealized investment losses in 2022 was primarily the result of a change in the value of the fixed maturity portfolio due to higher interest rates during 2022. The decrease in net unrealized investment gains in 2021 was primarily the result of a decrease in fixed maturity securities held and a change in the value of the fixed maturity portfolio due to higher interest rates during 2021. 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 following table summarizes the change in our net unrealized investment gains (losses): (In Thousands) Years Ended December 31, 2022 2021 2020
Changes in net unrealized investment gains (losses):
Available-for-sale fixed maturity securities
$ (174,858) $ (42,159) $ 45,305 Income tax effect 36,720 8,858 (9,514) Total change in net unrealized investment gains (losses), net of tax$ (138,138) $ (33,301) $ 35,791 47
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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. 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 or recovery, 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 atDecember 31, 2022 . 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. 48
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Table of Contents December 31, 2022 -200 Basis -100 Basis +100 Basis + 200 Basis (In Thousands) Points Points Base Points Points AVAILABLE-FOR-SALE Fixed maturities Bonds U.S. Treasury$ 15,419 $ 15,041 $ 14,675 $ 14,320 $ 13,976 U.S. government agency 92,883 89,103 84,406 79,261 74,123 States, municipalities and political subdivisions General obligations: Midwest 62,705 61,957 61,113 59,630 57,536 Northeast 15,891 15,685 15,463 15,130 14,637 South 67,346 65,756 63,981 61,618 58,810 West 90,435 88,570 86,545 83,887 80,424 Special revenue: Midwest 108,418 105,531 102,266 97,596 91,568 Northeast 57,837 56,113 54,220 51,762 48,699 South 193,546 187,618 180,857 171,973 161,370 West 119,774 116,267 112,212 106,680 100,007 Foreign bonds 35,317 33,418 31,649 30,003 28,473 Public utilities 139,541 132,238 125,411 119,036 113,092 Corporate bonds Energy 36,141 34,640 33,209 31,845 30,551 Industrials 59,018 55,792 52,842 50,141 47,667 Consumer goods and services 101,099 95,282 89,941 85,031 80,515 Health care 32,286 29,812 27,592 25,597 23,802 Technology, media and telecommunications 66,701 63,160 59,940 56,998 54,301 Financial services 134,083 129,141 124,292 119,588 115,087 Mortgage backed securities 19,212 18,516 17,700 16,853 16,056 Collateralized mortgage obligations Government national mortgage association 93,704 89,286 84,548 79,822 75,352 Federal home loan mortgage corporation 86,861 83,050 78,838 74,554 70,501 Federal national mortgage association 48,775 47,231 45,386 43,451 41,550 Asset-backed securities 5,283 4,690 4,253 3,927 3,677
Total Available-For-Sale Fixed Maturities
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.
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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
(In Thousands) -10% Base
+10%
Estimated fair value of equity securities
Foreign Currency Exchange Rate Risk
Foreign currency exchange rate risk arises from the possibility that changes in
foreign exchange rates will impact our financial results. Foreign currency
exchange rate risk can occur as a result of investment holdings in foreign
currency, settlement of amounts due to or from foreign reinsurers or our
participation in FAL. 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 internalInvestment 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, 98.7 percent and 99.6 percent were rated "A" or above, and 95.2 percent and 96.0 percent were rated "AA" or above atDecember 31, 2022 and 2021, 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$7.7 million or 29.1 percent of our insured municipal securities atDecember 31, 2022 , as compared to$9.4 million or 29.8 percent atDecember 31, 2021 . Our five largest indirect exposures to financial guarantors accounted for$28.7 million and$35.6 million of our municipal securities atDecember 31, 2022 and 2021, 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 inthe United States . 50
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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. 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 2022, 2021 and 2020: Cash Flow Summary Years Ended December 31, (In Thousands) 2022 2021 2020 Cash provided by (used in) Operating activities$ (1,251) $ 29,917 $ 41,435 Investing activities (19,171) 31,731 (92,871) Financing activities (15,032) (17,492) 18,662 Net increase (decrease) in cash and cash equivalents$ (35,454) $ 44,156 $ (32,774) Our cash flows were sufficient to meet our current liquidity needs for the full-year periods endedDecember 31, 2022 , 2021 and 2020 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 Part II, Item 8, Note 13 "Debt" for more information. Operating Activities Net cash flows used in operating activities totaled$1.3 million in 2022, and provided by operating activities totaled$29.9 million and$41.4 million in 2021 and 2020, respectively. Our cash flows from operating activities were sufficient to meet our liquidity needs for 2022, 2021 and 2020.
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,
maturity portfolio will mature.
We invest funds required for short-term cash needs primarily in money market accounts, which are classified as cash equivalents. AtDecember 31, 2022 , our cash and cash equivalents included$31.3 million related to these money market accounts, compared to$43.4 million atDecember 31, 2021 . Net cash flows used in investing activities totaled$19.2 million in 2022 and net cash flows provided by investing activities totaled$31.7 million in 2021. Net cash flows used in investing activities totaled$92.9 million in 2020. In 2022, we had cash inflows from scheduled and unscheduled investment maturities, redemptions, prepayments, and sales of investments that totaled$280.4 million compared to$451.1 million and$376.2 million for the same period in 2021 and 2020, respectively.
Our cash outflows for investment purchases totaled
compared to
2020, respectively.
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Financing Activities
Net cash flows used in financing activities totaled$15.0 million in 2022 and$17.5 million in 2021. Net cash flow provided by financing activities totaled$18.7 million in 2020. The net cash flows used in financing activities in 2022 is primarily the payment of cash dividends of$15.0 million . The net cash flows used in financing activities in 2021 is primarily the payment of cash dividends of$15.1 million and share repurchases of$2.0 million . The net cash flows provided by financing activities in 2020 is primarily from borrowings of long term debt of$50.0 million offset by the payment of cash dividends of$28.5 million .
Contractual Obligations and Commitments
The following table shows our contractual obligations and commitments, including our estimated payments due by period atDecember 31, 2022 . Time periods of less than one year are considered short-term cash obligations and time periods greater than one year are considered long-term cash obligations. (In Thousands) Payments Due By Period Less Than One to Three to More Than Contractual Obligations Total One Year
Three Years Five Years Five Years
Loss and loss settlement expense reserves$ 1,497,274 $ 515,326 $ 544,605 $ 199,556 $ 237,787 Long term debt 107,378 3,188 6,376 6,376 91,438 Operating leases 28,353 8,452 13,445 6,456 - Profit-sharing commissions 13,701 13,701 - - - Total$ 1,646,706 $ 540,667 $ 564,426 $ 212,388 $ 329,225
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 onDecember 15, 2020 betweenUnited Fire & Casualty Company ,Federated Mutual Insurance Company , a mutual insurance company domiciled inMinnesota ("Federated Mutual"), andFederated Life Insurance Company , an insurance company domiciled inMinnesota ("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. Interest payments will be paid quarterly onMarch 15 ,June 15 ,September 15 andDecember 15 of each year (each such date, an "Interest Payment Date"). The interest rate will equal the rate that corresponds to theA.M. Best Co. (or its successor's) financial strength rating for members of theUnited Fire & Casualty Pooled Group as of the applicable Interest Payment Date. Interest expense totaled$3,188 for the year endedDecember 31, 2022 . 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 12 "Lease Commitments."
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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 2022, property and casualty agencies expect to
receive profit-sharing payments of
Commitments for Capital Expenditures
Dividends
Dividends paid to shareholders totaled
quarterly cash dividends, which we have paid every quarter since
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, underIowa 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 precedingDecember 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, atDecember 31, 2022 , our insurance company subsidiary,United Fire & Casualty , is able to make a maximum of$70.4 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 inAugust 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 2022, 2021 and 2020, pursuant to authorization by our Board of Directors, we repurchased 0, 67,651, and 70,467 shares of our common stock, respectively, which used cash totaling$0.0 million in 2022,$2.0 million in 2021 and$2.7 million in 2020. The Board of Directors reauthorized the share repurchase program inNovember 2022 throughAugust 2024 . AtDecember 31, 2022 , we were authorized to purchase an additional 1,719,326 shares of our common stock.
Credit Facilities
Information specific to our credit facilities is incorporated by reference from Note 13 "Debt" contained in Part II, Item 8. As ofDecember 31, 2022 , we were in compliance with all financial covenants of the Credit Agreement (the "Credit Agreement") withWells Fargo Bank, National Association ("Wells Fargo"), as 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"). 53
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Stockholders' Equity
Stockholders' equity decreased 15.8 percent to$740.1 million atDecember 31, 2022 , from$879.1 million atDecember 31, 2021 . The decrease is primarily attributed to a decrease in net unrealized value from our fixed maturity securities, net of tax, of$138.1 million , stockholder dividends of$15.9 million , and offset by net income of$15.0 million . As ofDecember 31, 2022 , the book value per share of our common stock was$29.36 , compared to$35.05 atDecember 31, 2021 .
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. AtDecember 31, 2022 , all of our insurance companies had capital well in excess of required levels.
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 throughJuly 10, 2030 to make capital contributions upon request of the partnerships. Our remaining potential contractual obligation was$40.1 million atDecember 31, 2022 . In addition, the Company invested$25,000 inDecember 2019 in a limited liability partnership investment fund which is subject to a 3-year lockup with a 60-day minimum notice, with four possible repurchase dates per year, after the 3-year lockup period is met. The fair value of the investment atDecember 31, 2022 was$25,187 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
percent of our total invested assets, at
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.
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
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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. AtDecember 31, 2022 and 2021, our DAC asset was$104.2 million and$91.4 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 endedDecember 31, 2022 , 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 endedDecember 31, 2022 :
Sensitivity Analysis - Impact of Changes in Projected Loss and Loss Settlement Expense Ratios
(In Thousands)
-10% -5% Base +5% +10%
Premium deficiency charge estimated $ - $ - $
889
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 costs in the period such changes in assumptions are made. The premium deficiency charge calculated for the quarter endedDecember 31, 2022 was$0.9 million compared to the premium deficiency charge of$2.9 million calculated for the same period of 2021.
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$1,497.3 million and$1,514.3 million atDecember 31, 2022 and 2021, respectively. We purchase reinsurance to mitigate the impact of large losses and catastrophic events. Loss and loss 55
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settlement expense reserves ceded to reinsurers were
recoverables, by line of business as of
Loss
Settlement
(In Thousands) Case Basis IBNR Expense Total Reserves
Commercial lines
Fire and allied lines $ 91,386 $ 44,211 $ 20,773 $ 156,370
Other liability 363,143 221,303 173,082 757,528
Automobile 245,140 35,021 32,233 312,394
Workers' compensation 113,652 8,765 16,497 138,914
Fidelity and surety 10,036 853 392 11,281
Miscellaneous 1,225 540 210 1,975
Total commercial lines $ 824,582 $ 310,693 $ 243,187 $ 1,378,462
Personal lines
Automobile $ 4,104 $ 22 $ 415 $ 4,541
Fire and allied lines 4,699 1,488 604 6,791
Miscellaneous 76 415 96 587
Total personal lines $ 8,879 $ 1,925 $ 1,115 $ 11,919
Reinsurance assumed 45,518 60,787 588 106,893
Total $ 878,979 $ 373,405 $ 244,890 $ 1,497,274
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 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
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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 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 actuarial staff and consultants perform a detailed analysis of IBNR reserves. This analysis uses various loss projection methods to provide several estimates of ultimate loss (or 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 actuarial team 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 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 actuarial team 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
57 -------------------------------------------------------------------------------- Table of Contents 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.
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
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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. 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, increased to$2.5 million from 2016 through 2021, and increased again to$3.0 million beginning in 2022.
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$1,497.3 million as ofDecember 31, 2022 , is 10.0 percent inadequate, we would experience a reduction in future pre-tax earnings of up to$149.7 million . This reduction could be recorded in one year or multiple years, depending on when we identify the deficiency. The deficiency would also affect our financial position in that our equity would be reduced by an amount equivalent to the reduction in net income. Any deficiency that would be recognized in our loss and loss settlement expense reserves usually does not have a material effect on our liquidity because the claims have not been paid. Conversely, if our estimates of ultimate unpaid loss and loss settlement expense reserves prove to be redundant, our future earnings and financial position would be improved. We believe our reserving philosophy, coupled with what we believe to be aggressive and successful claims management and loss settlement practices, has resulted in year-to-year redundancies in reserves. We believe our approach produces recorded reserves that are reasonable as to their relative position within a range of reasonable reserves from year-to-year. We are unable to reasonably quantify the impact of changes in our key assumptions utilized to establish individual case-basis reserves on our total reported reserves because the impact of these changes would be unique to each specific case-basis reserve established. However, based on historical experience, we believe that aggregate case-basis reserve volatility levels of 5.0 percent and 10.0 percent can be attributed to the ultimate development of our net case-basis reserves. The impact to pre-tax earnings would be a decrease if the reserves were to be adjusted upwards and an increase if the reserves were to be adjusted downwards. The table below details the impact of this development volatility on our reported net case-basis reserves atDecember 31, 2022 : 59 -------------------------------------------------------------------------------- Table of Contents (In Thousands) Change in level of net case-basis reserve development 5% 10% Impact on reported net case-basis reserves$ 39,399 $
78,797
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 atDecember 31, 2022 . 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
(In Thousands) Change in LAE paid to losses paid ratio 1% 2%
Impact due to change in LAE reserving assumptions
In 2022, we did not change the key method through which we develop our assumptions on which we based our reserving calculations. In estimating our 2022 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.
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.
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Our reserve for other liability claims atDecember 31, 2022 was$757.5 million and consisted of 4,860 claims, compared with$671.0 million , consisting of 5,113 claims atDecember 31, 2021 . Of the$757.5 million total reserve for other liability claims,$117.0 million is identified as defense costs and$56.1 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. 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. AtDecember 31, 2022 and 2021, we had$1.9 million and$2.5 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.
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 atDecember 31, 2022 was$138.9 million and consisted of 1,414 claims, compared with$167.1 million , consisting of 2,028 claims, atDecember 31, 2021 . 61
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The following reserve development section should be read in conjunction with the "Results of Operations for the Years EndedDecember 31, 2022 , 2021 and 2020" section of this Item 7.
In 2022, we recognized an unfavorable development in our net reserves for prior
accident years totaling
Unfavorable development in 2022 was driven by leveraging deeper data insights and emerging claim experience on longer tailed lines where the most uncertainty in the reserving process exists. Our actions were focused on other liability lines, including excess umbrella business and construction defect, where increased loss exposure in these longer tailed businesses are also subject to social and economic inflation. This was offset by continued favorable development in commercial auto which has seen consistent releases over the past two years. Other factors contributing to our development include: establishing reserves at their ultimate expected loss amount as soon as practicable after information becomes available, which produces, on average, conservative 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 EndedDecember 31, 2022 , 2021 and 2020" 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 Other liability$ (75,753) $ (37,876) $ 37,876 $ 75,753 Workers' compensation (13,891) (6,946) 6,946 13,891 Automobile (31,694) (15,847) 15,847 31,694 Hypothetical Reserve Development Volatility Levels -5% -3% +3% +5% Impact on loss and loss settlement expenses All other lines$ (14,195) $ (8,517) $ 8,517 $ 14,195 Independent Actuary We engage an independent actuarial firm to render an opinion as to the reasonableness of the statutory reserves that are established by management. During 2022 and 2021, 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 2023. 62
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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 reserves for losses and loss settlement expenses, net of reinsurance recoverables, as ofDecember 31, 2022 and 2021 were$1,350.4 million and$1,401.4 million , respectively. In 2022 and 2021, 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 benefit obligation atDecember 31, 2022 by$28.2 million while a 100 basis point increase in the rate would decrease the benefit obligation$22.9 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 endedDecember 31, 2022 by$2.2 million , while a 100 basis point increase in the rate would decrease benefit expense by$2.2 million , for the same period.
The post-retirement benefit obligation is
plan closure at the end of 2022.
Recently Issued Accounting Standards
Information specific to accounting standards that we adopted in 2022 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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