10-K 1 a2015123110k.htm 10-K 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2015
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________to __________________ 
Commission File Number: 0-10956
EMC INSURANCE GROUP INC.
(Exact name of registrant as specified in its charter)
Iowa
 
42-6234555
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
717 Mulberry Street, Des Moines, Iowa
 
50309
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code:       
 
(515) - 345 - 2902
Securities registered pursuant to Section 12(b) of the Act:
 
 
Common Stock, Par Value $1.00
 
The NASDAQ OMX Group, Inc.
(Title of Class)
 
(Name of each exchange on which registered)
Securities registered pursuant to Section 12 (g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act
 
o
Yes
 
ý
No
 
 
 
 
 
 
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act
 
o
Yes
 
ý
No
 
 
 
 
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
ý
Yes
 
o
No
 
 
 
 
 
 
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
ý
Yes
 
o
No
 
 
 
 
 
 
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
 
o
 
 
 
 
 
 
 
 
 
 
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).
 
 
 
 
 
 
Large accelerated filer   o
Accelerated filer   x
Non-accelerated filer   o
Smaller reporting company   o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
 
o
Yes
 
ý
No
The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2015 was $222,662,238.
The number of shares outstanding of the registrant's common stock, $1.00 par value, on February 29, 2016, was 20,831,163.

DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive proxy statement for the Annual Meeting of Stockholders to be held on May 19, 2016, and to be filed pursuant to Regulation 14A within 120 days after the registrant’s fiscal year ended December 31, 2015, are incorporated by reference under Part III.



TABLE OF CONTENTS

 
 
Page
Part I
 
 
Item 1.
 
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
 
Part II
 
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
 
 
Part III
 
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
 
Part IV
 
 
Item 15.

1


PART I
ITEM 1.
BUSINESS
GENERAL
EMC Insurance Group Inc. is an insurance holding company that was incorporated in Iowa in 1974 by Employers Mutual Casualty Company (Employers Mutual) and became a public company in 1982 following the initial public offering of its common stock.  EMC Insurance Group Inc. is approximately 57 percent owned by Employers Mutual, a multiple-line property and casualty insurance company organized as an Iowa mutual insurance company in 1911 that is licensed in all 50 states and the District of Columbia.  The term “Company” is used interchangeably to describe EMC Insurance Group Inc. (Parent Company only) and EMC Insurance Group Inc. and its subsidiaries.  Employers Mutual and all of its subsidiaries (including the Company) and an affiliate are referred to as the “EMC Insurance Companies.”
The Company conducts operations in property and casualty insurance and reinsurance through its subsidiaries.  The Company primarily focuses on the sale of commercial lines of property and casualty insurance to small and medium-sized businesses.  These products are sold through independent insurance agents who are supported by a decentralized network of branch offices.  Although the Company actively markets its insurance products in 41 states, the majority of its business is marketed and generated in the Midwest.
The Company conducts its insurance business through two business segments as follows:


2


Illinois EMCASCO was formed in Illinois in 1976 (and was re-domesticated to Iowa in 2001), Dakota Fire was formed in North Dakota in 1957 and EMCASCO was formed in Iowa in 1958, all for the purpose of writing property and casualty insurance.  EMC Reinsurance Company was formed in 1981 to assume reinsurance business from Employers Mutual.  The Company’s excess and surplus lines insurance agency, EMC Underwriters, LLC, was formed in Iowa in 1975 and was acquired by the Company in 1985.  Effective December 31, 1998, the excess and surplus lines insurance agency was converted to a limited liability company and the ownership was contributed to EMCASCO.
Property and casualty insurance is the most significant segment of the Company’s business, totaling 78 percent of consolidated premiums earned in 2015.  The property and casualty insurance operations are integrated with the property and casualty insurance operations of Employers Mutual through participation in a reinsurance pooling agreement.  Because the Company conducts its property and casualty insurance operations together with Employers Mutual through the reinsurance pooling agreement, the Company shares the same business philosophy, management, employees and facilities as Employers Mutual and offers the same types of insurance products.  For a discussion of the reinsurance pooling agreement and its benefits, please see “Organizational Structure – Property and Casualty Insurance” below.
Reinsurance operations are conducted through EMC Reinsurance Company and accounted for 22 percent of consolidated premiums earned in 2015.  The principal business activity of EMC Reinsurance Company is to assume, through a quota share reinsurance agreement, 100 percent of Employers Mutual's assumed reinsurance business, subject to certain exceptions.  EMC Reinsurance Company also writes a relatively small amount of assumed reinsurance business on a direct basis (outside the quota share reinsurance agreement).  For a discussion of the quota share reinsurance agreement and its benefits, please see “Organizational Structure – Reinsurance” below.
The Company’s insurance agency, EMC Underwriters, LLC, specializes in marketing excess and surplus lines of insurance.  The excess and surplus lines markets provide insurance coverage at negotiated rates for risks that are not acceptable to licensed insurance companies.  EMC Underwriters accesses this market by working through independent agents and functions as managing underwriter for excess and surplus lines insurance for the pool participants.  The Company derives income from this business based on the fees and commissions earned through placement of the business, as opposed to the underwriting of the risks associated with that business.

Organizational Structure
Property and Casualty Insurance
The Company’s three property and casualty insurance subsidiaries and two subsidiaries and an affiliate of Employers Mutual (Union Insurance Company of Providence, EMC Property & Casualty Company and Hamilton Mutual Insurance Company) are parties to reinsurance pooling agreements with Employers Mutual (collectively the “pooling agreement"). Under the terms of the pooling agreement, each company cedes to Employers Mutual all of its insurance business, and assumes from Employers Mutual an amount equal to its participation in the pool.  All premiums, losses, settlement expenses, and other underwriting and administrative expenses, excluding the voluntary reinsurance business assumed by Employers Mutual from nonaffiliated insurance companies, are prorated among the parties on the basis of participation in the pool.  Employers Mutual negotiates reinsurance agreements that provide protection to the pool and each of its participants, including protection against losses arising from catastrophic events.  The aggregate participation of the Company’s property and casualty insurance subsidiaries in the pool is 30 percent.
The Inter-Company Committees of the boards of directors of the Company and Employers Mutual approved a new inter-company reinsurance program between the Company's insurance subsidiaries in the property and casualty insurance segment and Employers Mutual for calendar year 2016. This reinsurance program is intended to reduce the volatility of the Company's quarterly results caused by excessive catastrophe and storm losses, and will provide protection from both the frequency and severity of such losses. The reinsurance program for 2016 will consist of two semi-annual aggregate catastrophe excess of loss treaties. The first treaty will be effective from January 1, 2016 through June 30, 2016, and will have a retention of $20.0 million and a limit of $24.0 million. The cost of this treaty will be approximately $6.3 million. The second treaty will be effective from July 1, 2016 through December 31, 2016, and will have a retention of $15.0 million and a limit of $12.0 million. The cost of this treaty will be approximately $1.5 million. All catastrophe and storm losses assumed by the property and casualty insurance subsidiaries (net of applicable reinsurance recoveries from external reinsurance protections purchased by the pool participants) will be subject to the terms of these treaties, and there is no co-participation provision.
All transactions occurring under the pooling agreement are based on statutory accounting principles. Certain adjustments are made to the statutory-basis amounts assumed by the Company's property and casualty insurance subsidiaries to bring the amounts into compliance with U.S. generally accepted accounting principles (GAAP).

3


Operations of the pool give rise to inter-company balances with Employers Mutual, which are generally settled during the subsequent month.  The investment and income tax activities of the pool participants are not subject to the pooling agreement.  The pooling agreement provides that Employers Mutual will make up any shortfall or difference resulting from an error in its systems and/or computation processes that would otherwise result in the required restatement of the pool participants’ financial statements.
The purpose of the pooling agreement is to spread the risk of an exposure insured by any of the pool participants among all of the companies.  The particular benefits that the Company’s property and casualty insurance subsidiaries realize from participating in the pooling agreement include the following:
the ability to produce a more uniform and stable underwriting result from year to year than might be experienced individually, by spreading the risks over a wide range of geographic locations, lines of insurance written, rate filings, commission plans and policy forms;
the ability to benefit from the capacity of the entire pool (representing $1.6 billion in direct premiums written in 2015 and $1.5 billion in statutory surplus as of December 31, 2015) rather than being limited to policy exposures of a size commensurate with each participant’s own surplus level;
the achievement of an “A” (Excellent) rating from A.M. Best Company on a “group” basis;
the ability to take advantage of a significant distribution network of independent agencies that the participants most likely could not access on an individual basis;
the ability to negotiate and purchase reinsurance from third-party reinsurers on a combined basis, thereby achieving larger retentions and better pricing; and
the ability to achieve and benefit from economies of scale in operations.
The amount of insurance a property and casualty insurance company writes under industry standards is commonly expressed as a multiple of its surplus calculated in accordance with statutory accounting practices.  Generally, a ratio of 3 or less is considered satisfactory by state insurance departments.  The ratios of the pool participants for the past three years are as follows:
 
 
Year ended December 31,
 
 
2015
 
2014
 
2013
Employers Mutual
 
0.74

 
0.74

 
0.75

EMCASCO (1)
 
1.54

 
1.57

 
1.59

Illinois EMCASCO (1)
 
1.52

 
1.52

 
1.54

Dakota Fire (1)
 
1.59

 
1.61

 
1.62

EMC Property & Casualty Company
 
0.65

 
0.64

 
0.63

Union Insurance Company of Providence
 
0.65

 
0.65

 
0.63

Hamilton Mutual Insurance Company
 
0.89

 
0.90

 
0.87

(1)       The ratios for these companies reflect the issuance of an aggregate $25.0 million of surplus notes to Employers Mutual. Surplus notes are considered to be a component of surplus for statutory reporting purposes; however, under GAAP, surplus notes are considered to be debt and are reported as a liability in the Company’s financial statements.

Reinsurance
The Company’s reinsurance subsidiary is party to a quota share reinsurance retrocessional agreement (the “quota share agreement”) and an excess of loss reinsurance agreement (the “excess of loss agreement”), with Employers Mutual.  Under the terms of the quota share agreement, the reinsurance subsidiary assumes 100 percent of Employers Mutual’s assumed reinsurance business, subject to certain exceptions.  Under the terms of the excess of loss agreement (covering both business assumed from Employers Mutual through the quota share agreement, as well as business obtained outside the quota share agreement), the reinsurance subsidiary retains the first $4.0 million of losses per event, and also retains 20.0 percent of any losses between $4.0 million and $10.0 million and 10.0 percent of any losses between $10.0 million and $50.0 million. The cost of the excess of loss reinsurance protection, which includes reimbursement for the cost of reinsurance protection purchased by Employers Mutual to protect itself from the assumption of excessive losses in the event of a major catastrophe, is 8.0 percent (9.0 percent in 2013) of the reinsurance subsidiary’s total assumed reinsurance premiums written.

4


The Inter-Company Committees of the boards of directors of the Company and Employers Mutual approved a change in the inter-company reinsurance program between the Company's reinsurance subsidiary and Employers Mutual for calendar year 2016. The reinsurance program for 2016 will consist of two treaties. The first is a per occurrence catastrophe excess of loss treaty with a retention of $10.0 million, a limit of $10.0 million, 20 percent co-participation, and no reinstatement. The cost of this treaty will be approximately $2.0 million. The second is an annual aggregate catastrophe excess of loss treaty with a retention of $20.0 million, a limit of $100.0 million, and 20 percent co-participation. The cost of this treaty will be approximately $3.1 million. Any losses recovered under the per occurrence treaty will inure to the benefit of the aggregate treaty. Only catastrophic events with total losses greater than $500,000 will be subject to the terms of the aggregate treaty. The reinsurance subsidiary will also purchase additional reinsurance protection (Industry Loss Warranties) in peak exposure territories from external parties in which coverage is triggered when losses experienced by the insurance industry from a catastrophic event exceed a specified threshold. Any reinsurance recoveries received from external parties will reduce the amount of losses ceded to Employers Mutual under the excess of loss agreement. The net cost of the external reinsurance protection is estimated to be approximately $4.0 million.
All transactions occurring under the quota share agreement and the excess of loss agreement are based on statutory accounting principles. Certain adjustments are made to the statutory-basis amounts assumed by the Company's reinsurance subsidiary to bring the amounts into compliance with GAAP.
The reinsurance subsidiary does not directly reinsure any of the insurance business written by Employers Mutual or the other pool participants; however, Employers Mutual assumes reinsurance business from the Mutual Reinsurance Bureau underwriting association (MRB), which provides a small amount of reinsurance protection to the members of the EMC Insurance Companies pooling agreement. As a result, the reinsurance subsidiary’s assumed exposures include a small portion of the EMC Insurance Companies’ direct business, after ceded reinsurance protections purchased by MRB are applied. In addition, the reinsurance subsidiary does not reinsure any “involuntary” facility or pool business that Employers Mutual assumes pursuant to state law. The reinsurance subsidiary assumes all foreign currency exchange gain/loss associated with contracts incepting on January 1, 2006 and thereafter that are subject to the quota share agreement.
Operations of the quota share and excess of loss agreements give rise to inter-company balances with Employers Mutual, which are generally settled during the month following the end of each quarter. The investment and income tax activities of the reinsurance subsidiary are not subject to the quota share agreement.
Under the terms of the quota share agreement, the reinsurance subsidiary receives reinstatement premium income that is collected by Employers Mutual from the ceding companies when reinsurance coverage is reinstated after a loss event; however, the cap on losses assumed per event contained in the excess of loss agreement is automatically reinstated without cost.  

Property and Casualty Insurance and Reinsurance
The Company does not have any employees of its own.  Employers Mutual performs all operations for all of its subsidiaries and affiliate.  Such services include data processing, claims, financial, actuarial, legal, auditing, marketing and underwriting.  Employers Mutual allocates a portion of the cost of these services to its subsidiaries that do not participate in the pooling agreement based upon a number of criteria, including usage of the services and the number of transactions.  The remaining costs are charged to the pooling agreement and each pool participant shares in the total cost in accordance with its pool participation percentage.
Investment expenses are based on actual expenses incurred by the Company plus an allocation of other investment expenses incurred by Employers Mutual, which is based on a weighted-average of total invested assets and number of investment transactions.

FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
For information concerning the Company’s revenues, results of operations and identifiable assets attributable to each of its industry segments over the past three years, see note 7 of Notes to Consolidated Financial Statements under Part II, Item 8 of this Form 10-K.


5


NARRATIVE DESCRIPTION OF BUSINESS
Principal Products
Property and Casualty Insurance
The Company’s property and casualty insurance subsidiaries and the other parties to the pooling agreement underwrite both commercial and personal lines of property and casualty insurance.  Those coverages consist of the following types of insurance:
Commercial Lines
Automobile - policies purchased by insureds engaged in a commercial activity that provide protection against liability for bodily injury and property damage arising from automobile accidents, and protection against loss from damage to automobiles owned by the insured.
Property - policies purchased by insureds engaged in a commercial activity that provide protection against damage or loss to property (other than autos) owned by the insured.
Workers’ Compensation - policies purchased by employers to provide benefits to employees for injuries incurred during the course of employment.  The extent of coverage is established by the workers’ compensation laws of each state.
Liability - policies purchased by insureds engaged in a commercial activity that provide protection against liability for bodily injury or property damage to others resulting from acts or omissions of the insured or its employees.
Other - includes a broad range of policies purchased by insureds engaged in a commercial activity that provide protection with respect to burglary and theft loss, aircraft, marine and other types of losses.  This category also includes fidelity and surety bonds issued to secure performance.
Personal Lines
Automobile - policies purchased by individuals that provide protection against liability for bodily injury and property damage arising from automobile accidents, and protection against loss from damage to automobiles owned by the insured.
Homeowners - policies purchased by individuals that provide protection against damage or loss to property (other than autos) owned by the individual. This category also includes umbrella policies purchased by individuals that provide protection against liability for bodily injury or property damage to others resulting from acts or omissions of the insured.
The following table sets forth the aggregate direct premiums written of all parties to the pooling agreement for the three years ended December 31, 2015, by line of business.
 
 
Year ended December 31,
 
 
2015
 
2014
 
2013
($ in thousands)
Line of business
 
Amount
 
Percent of total
 
Amount
 
Percent of total
 
Amount
 
Percent of total
Commercial lines:
 
 
 
 
 
 
 
 
 
 
 
 
Automobile
 
$
367,559

 
23.2
%
 
$
344,013

 
22.7
%
 
$
306,695

 
21.6
%
Property
 
403,567

 
25.5

 
387,408

 
25.5

 
355,723

 
25.1

Workers' compensation
 
309,654

 
19.6

 
293,140

 
19.3

 
276,921

 
19.5

Liability
 
329,045

 
20.8

 
311,516

 
20.5

 
285,121

 
20.1

Other
 
29,704

 
1.9

 
28,236

 
1.9

 
28,067

 
2.0

Total commercial lines
 
1,439,529

 
91.0

 
1,364,313

 
89.9

 
1,252,527

 
88.3

Personal lines:
 
 

 
 

 
 

 
 

 
 

 
 

Automobile
 
73,802

 
4.7

 
80,970

 
5.3

 
88,830

 
6.3

Homeowners
 
67,744

 
4.3

 
71,994

 
4.8

 
76,037

 
5.4

Total personal lines
 
141,546

 
9.0

 
152,964

 
10.1

 
164,867

 
11.7

Total
 
$
1,581,075

 
100.0
%
 
$
1,517,277

 
100.0
%
 
$
1,417,394

 
100.0
%


6


Reinsurance
As previously noted, the reinsurance subsidiary primarily assumes the voluntary reinsurance business written directly by Employers Mutual with unaffiliated insurance companies (subject to certain limited exceptions).  Employers Mutual writes both pro rata and excess of loss reinsurance for unaffiliated insurance companies.  Pro rata reinsurance is a form of reinsurance in which the reinsurer assumes a stated percentage of all premiums, losses and related expenses in a given class of business.  In contrast, excess of loss reinsurance provides coverage for a portion of losses incurred by an insurer which exceed predetermined retention limits.
The following table sets forth the net premiums written of the reinsurance subsidiary for the three years ended December 31, 2015, by line of business.  In 2015, three pro rata lines of business experienced unusual changes in net written premiums. The multiline line of business reflects a decline in business in a large German account, the liability line of business reflects a large increase in business produced by MRB, and the marine line of business reflects a large negative premium adjustment reported by the ceding company for the offshore energy and liability proportional account, as well as reduced participation in this account for the 2015 contract year. The 2014 pro rata property line of business reflects a $10.0 million reduction in the amount of earned but not reported (EBNR) premiums recognized upon the completion of a detailed review of the premium recognition period of all pro rata contracts. Eight percent (9.0 percent in 2013) of the reinsurance subsidiary’s assumed premiums written were ceded back to Employers Mutual in accordance with the terms of the excess of loss agreement.
 
 
Year ended December 31,
 
 
2015
 
2014
 
2013
($ in thousands)
Line of business
 
Amount
 
Percent of total
 
Amount
 
Percent of total
 
Amount
 
Percent of total
Pro rata reinsurance:
 
 
 
 
 
 
 
 
 
 
 
 
Multiline (primarily property)
 
$
5,610

 
4.5
%
 
$
9,463

 
8.0
%
 
$
8,415

 
6.5
%
Property
 
15,423

 
12.4

 
7,531

 
6.3

 
21,699

 
16.8

Liability
 
26,500

 
21.3

 
12,055

 
10.1

 
8,366

 
6.5

Marine
 
1,119

 
0.9

 
13,528

 
11.4

 
15,398

 
12.0

Total pro rata reinsurance
 
48,652

 
39.1

 
42,577

 
35.8

 
53,878

 
41.8

Excess of loss reinsurance
 
 

 
 

 
 

 
 

 
 

 
 

Property
 
63,542

 
51.0

 
64,768

 
54.5

 
64,011

 
49.6

Liability
 
12,310

 
9.9

 
11,558

 
9.7

 
11,139

 
8.6

Total excess of loss reinsurance
 
75,852

 
60.9

 
76,326

 
64.2

 
75,150

 
58.2

Total
 
$
124,504

 
100.0
%
 
$
118,903

 
100.0
%
 
$
129,028

 
100.0
%

Marketing and Distribution
Property and Casualty Insurance
The pool participants market a wide variety of commercial and personal lines insurance products through 16 branch offices, which actively write business through independent agents in 41 states.  The pool participants’ products are marketed exclusively through a network of 2,071 local independent agency relationships through 3,997 offices.  The pool participants primarily focus on the sale of commercial lines of property and casualty insurance to small and medium-sized businesses, which are considered to be policyholders that pay less than $100,000 in annual premiums.  The pool participants also seek to provide more than one policy to a given customer, because this “account selling” strategy diversifies risks and generally improves underwriting results.
The pool participants wrote approximately $1.6 billion in direct premiums in 2015, with 91 percent of this business coming from commercial lines products and 9 percent coming from personal lines products.  Although a majority of the pool participants’ business is generated by sales in the Midwest, Employers Mutual’s branch offices are located across the country to take advantage of local market conditions and opportunities, as well as to spread risk geographically.  Each branch office performs its own underwriting, claims, marketing and risk management functions according to policies and procedures established and monitored by the home office.  This decentralized network of branch offices allows the pool participants to develop marketing strategies, products and pricing that target the needs of individual marketing territories and take advantage of different opportunities for profit in each market.  This operating structure also enables the pool participants to develop close relationships with their agents and customers.

7


Although each branch office offers a slightly different combination of products, the branches generally target three customer segments:
a wide variety of small to medium-sized businesses, through a comprehensive package of property and liability coverages;
businesses and institutions eligible for the pool participants’ target market, safety dividend group and EMC Choice programs (described below), which offer specialized products geared to their members’ unique protection needs; and
individual consumers, through a number of personal lines products such as homeowners, automobile and umbrella coverages.
The pool participants write a number of target market, safety dividend group and EMC Choice programs throughout the country, and have developed a strong reputation for these programs within the marketplace.  These programs provide enhanced insurance protection to businesses or institutions that have similar hazards and exposures, and are willing to implement loss prevention programs.  These groups include public schools, small municipalities, petroleum marketers, contractors and mobile home parks.  As an example, the pool participants write coverage for approximately 1,500 school districts throughout the Midwest.  These programs have been successful because they offer risk management products and services that are targeted to the needs of the group members through a local independent agent.
The following table sets forth the geographic distribution of the aggregate direct premiums written by all parties to the pooling agreement for the three years ended December 31, 2015.
 
 
Year ended December 31,
 
 
2015
 
2014
 
2013
Illinois
 
4.2
%
 
4.3
%
 
4.2
%
Iowa
 
13.0

 
13.3

 
13.9

Kansas
 
8.5

 
9.2

 
9.7

Michigan
 
4.6

 
4.3

 
4.1

Minnesota
 
4.7

 
4.6

 
4.5

Nebraska
 
5.3

 
5.2

 
5.6

North Carolina
 
3.1

 
2.8

 
2.6

Pennsylvania
 
2.9

 
2.9

 
3.3

Texas
 
4.1

 
3.9

 
3.7

Wisconsin
 
5.6

 
5.4

 
5.3

Other *
 
44.0

 
44.1

 
43.1

 
 
100.0
%
 
100.0
%
 
100.0
%
* Includes all other jurisdictions, none of which accounted for more than 3 percent.

Reinsurance
The reinsurance subsidiary currently obtains 97 percent of its business from Employers Mutual through the quota share agreement, and writes 3 percent directly.  The reinsurance subsidiary relies on the financial strength of Employers Mutual to write reinsurance business, as well as the competitive advantage that Employers Mutual has by virtue of being licensed in all 50 states and the District of Columbia.  Reinsurance marketing is undertaken by Employers Mutual in its role as the direct writer of the reinsurance business; however, the reinsurance subsidiary is utilized in the marketing efforts to help differentiate the reinsurance business from the direct insurance business that is written by Employers Mutual and the other pool participants.
The reinsurance business is derived from two sources.  Approximately 83 percent of the reinsurance subsidiary’s assumed reinsurance premiums earned in 2015 were generated through the activities of Employers Mutual’s Home Office Reinsurance Assumed Department (also known as “HORAD”).  The reinsurance business written by HORAD is brokered through independent intermediaries.  As a result, the risks assumed by HORAD do not materially overlap with the risks assumed through MRB (discussed below).  The risks assumed through HORAD are directly underwritten by Employers Mutual.  As such, Employers Mutual has discretion with respect to the type and size of risks which it assumes and services through these activities.  Since the reinsurance subsidiary utilizes Employers Mutual’s underwriting personnel and systems to process its direct business, HORAD also includes the business written directly by the reinsurance subsidiary.

8


The remaining 17 percent of the reinsurance subsidiary’s assumed reinsurance premiums earned in 2015 were generated through Employers Mutual’s participation in MRB, an unincorporated association through which Employers Mutual and other unaffiliated insurance companies participate in a voluntary reinsurance pool to meet the reinsurance needs of small and medium-sized, unaffiliated mutual insurance companies.  Employers Mutual has participated in MRB since 1957.  MRB is controlled by a board of directors composed of the five member companies, including one representative designated by Employers Mutual.  As a member of this organization, Employers Mutual assumes its proportionate share of the risks ceded to MRB by unaffiliated insurers.  Since MRB is structured on a joint liability basis, Employers Mutual, and therefore the Company’s reinsurance subsidiary, would be obligated with respect to the proportionate share of risks assumed by the other participants in the event they were unable to perform.  MRB, which is operated by an independent management team, manages assumed risks through typical underwriting practices, including loss exposure controls provided through reinsurance coverage obtained for the benefit of MRB.  The reinsurance risks for MRB arise primarily from the Northeast and Midwest markets. Underwriting of risks and pricing of coverage is performed by MRB management under general guidelines established by Employers Mutual and the other participating insurers.  Except for this general oversight, Employers Mutual has only limited control over the risks assumed by, and the operating results of, MRB.  Because of the joint liability structure, MRB participating companies must generally maintain a rating of “A-” (Excellent) or above from A.M. Best Company, Inc. and meet certain other standards.  During 2012, the rating of one of the members was reduced to "B++".  The other participating companies continue to monitor the financial strength of this member, and have determined that removal of this member is not warranted at this time.
The following table sets forth the geographic distribution of the assumed premiums written of the reinsurance subsidiary (gross of the amount ceded to Employers Mutual in connection with the excess of loss agreement) for the three years ended December 31, 2015.
 
 
Year ended December 31,
 
 
2015
 
2014
 
2013
($ in thousands)
Domiciliary jurisdiction
 
Amount
 
Percent of total
 
Amount
 
Percent of total
 
Amount
 
Percent of total
Germany
 
$
3,672

 
2.7
%
 
$
6,444

 
5.0
%
 
$
7,000

 
4.9
%
Other foreign jurisdictions*
 
14,018

 
10.4

 
14,261

 
11.0

 
18,589

 
13.1

Domestic
 
117,641

 
86.9

 
108,537

 
84.0

 
116,200

 
82.0

Total
 
$
135,331

 
100.0
%
 
$
129,242

 
100.0
%
 
$
141,789

 
100.0
%
* Includes all other foreign jurisdictions, none of which accounted for more than 3 percent.

Employers Mutual emphasizes writing excess of loss reinsurance business in its HORAD operation and works to increase its participation on existing contracts that have had favorable terms and/or results.  Employers Mutual strives to be flexible in the types of reinsurance products it offers, but generally limits its writings to direct reinsurance business, rather than providing retrocessional covers.  The reinsurance marketplace tends to favor “across the board” participation on excess of loss reinsurance contracts.  As a result, reinsurance companies must be willing to participate on all layers offered under a specific contract in order to be considered viable reinsurers.
It is customary in the reinsurance business for the assuming company to compensate the ceding company for the acquisition expenses incurred in the generation of the business.  Commissions incurred by the reinsurance subsidiary under the quota share agreement with Employers Mutual amounted to $27.3 million in 2015.  During 2015, the reinsurance subsidiary ceded to Employers Mutual 8.0 percent of its total assumed reinsurance premiums written from all sources as premium for the excess of loss protection, which amounted to $10.8 million.  The reinsurance subsidiary also assumes all foreign currency exchange gain/loss associated with contracts incepting on January 1, 2006 and thereafter that are subject to the quota share agreement.  The net foreign currency exchange gain assumed by the reinsurance subsidiary in 2015 was $386,000.


9


Competition
Property and Casualty Insurance
The property and casualty insurance marketplace is very competitive.  The pool participants compete in the United States insurance market with numerous insurers, many of which have substantially greater financial resources.  Competition in the types of insurance in which the pool participants are engaged is based on many factors, including the perceived overall financial strength of the insurer, industry ratings, premiums charged, contract terms and conditions, services offered, speed of claim payments, reputation and experience.  Because the pool participants’ insurance products are marketed exclusively through independent agencies, they face competition to retain qualified agencies, as well as competition within the agencies. The pool participants also compete with direct writers, who utilize salaried employees and generally offer their products at a lower cost; exclusive agencies, who write insurance business for only one company; and to a lesser extent, internet-based enterprises.  Employers Mutual’s decentralized network of 16 branch offices allows the pool participants to enhance business relationships with agents and customers and develop products, marketing strategies and pricing parameters targeted to individual territories.  The pool participants also utilize a company-paid trip for qualified agents and a profit-sharing plan as incentives for the independent agencies to place high-quality insurance business with them.

Reinsurance
Employers Mutual, in writing reinsurance business through its HORAD operation, competes in the global reinsurance market with numerous reinsurance companies, many of which have substantially greater financial resources.  Competition for reinsurance business is based on many factors, including the perceived financial strength of the reinsurer, industry ratings, stability in products offered and licensing status.  There is a segment of the market that favors large, highly-capitalized reinsurance companies who are able to provide “mega” line capacity for multiple lines of business.
While reinsurer competition for national and regional company business is growing, the Company believes that MRB has a competitive advantage in the smaller mutual company market that it serves due to its low operating costs.  MRB understands the needs of the smaller company market and operates at a very low expense ratio, enabling it to offer reinsurance coverage (on business that generally presents less risk) to an under-served market at lower margins.  However, due to growth in the reinsurance intermediary marketplace, the size of this under-served market has declined.

A.M. Best Company, Inc. Ratings
Property and Casualty Insurance
A.M. Best Company, Inc. (A.M. Best) rates insurance companies based on their relative financial strength and ability to meet their contractual obligations.  During 2013, the Company’s property and casualty insurance subsidiaries' financial strength rating was raised from "A-" to “A” (Excellent) in their capacity as participants in the pooling agreement.  A.M. Best re-evaluates its ratings from time to time (normally on an annual basis) and there can be no assurance that the Company’s property and casualty insurance subsidiaries and the other pool participants will maintain their current rating in the future.  Management believes that an A.M. Best rating of “A-” (Excellent) or better is important to the Company’s business since many insureds require that companies with which they insure be so rated.  A.M. Best’s publications indicate that the “A“ (Excellent)  rating is assigned to companies that have achieved excellent overall performance and have a strong ability to meet their obligations over a long period of time.  A downgrade of the Company’s property and casualty insurance subsidiaries’ rating (particularly below "A-") would adversely affect the Company’s competitive position and make it more difficult for it to market its products, and retain its existing agents and policyholders.  A.M. Best’s ratings are based upon factors of concern to policyholders and insurance agents, and are not directed toward the protection of investors.
Reinsurance
The most recent A.M. Best Property Casualty Key Rating Guide gives the Company’s reinsurance subsidiary a financial strength rating of “A” (Excellent).  However, because the majority of the reinsurance business assumed by the reinsurance subsidiary is produced by Employers Mutual, the rating of the reinsurance subsidiary is not critical to the Company’s reinsurance operations.  The rating of Employers Mutual is, however, critical to the Company’s reinsurance operations, as the unaffiliated insurance companies that cede business to Employers Mutual view the rating as an indication of Employers Mutual’s ability to meet its obligations to those insurance companies.  Employers Mutual’s rating was increased from "A-" to "A" (Excellent) during 2013. This rating increase aids in marketing efforts because some insurance companies require a rating of “A” (Excellent) or higher.  A downgrade of Employers Mutual’s rating (particularly below "A-") would have a material adverse impact on the Company’s reinsurance subsidiary, as a downgrade would negatively impact Employers Mutual’s ability to write reinsurance business and, consequently, to cede that business to the Company’s reinsurance subsidiary.

10


Statutory Combined Trade Ratios
The following table sets forth the statutory combined trade ratios of the Company’s insurance subsidiaries, and the property and casualty insurance industry averages, for the five years ended December 31, 2015.  The combined trade ratios below are the sum of the following:  the loss and settlement expense ratio, calculated by dividing losses and settlement expenses incurred by net premiums earned, and the expense ratio, calculated by dividing underwriting expenses incurred by net premiums written and policyholder dividends by net premiums earned.  Generally, if the combined trade ratio is below 100 percent, a company has an underwriting profit; if it is above 100 percent, a company has an underwriting loss.
 
 
Year ended December 31,
 
 
2015
 
2014
 
2013
 
2012
 
2011
Property and casualty insurance (1)
 
 
 
 
 
 
 
 
 
 
Loss and settlement expense ratio
 
65.5
%
 
70.5
%
 
67.2
%
 
66.2
%
 
78.7
%
Expense ratio
 
33.4
%
 
32.0
%
 
35.0
%
 
35.3
%
 
36.1
%
Combined trade ratio
 
98.9
%
 
102.5
%
 
102.2
%
 
101.5
%
 
114.8
%
 
 
 
 
 
 
 
 
 
 
 
Reinsurance (1)
 
 

 
 

 
 

 
 

 
 

Loss and settlement expense ratio
 
64.1
%
 
73.9
%
 
59.0
%
 
68.4
%
 
96.6
%
Expense ratio
 
24.9
%
 
24.5
%
 
23.7
%
 
21.8
%
 
21.5
%
Combined trade ratio
 
89.0
%
 
98.4
%
 
82.7
%
 
90.2
%
 
118.1
%
 
 
 
 
 
 
 
 
 
 
 
Total insurance operations (1)
 
 

 
 

 
 

 
 

 
 

Loss and settlement expense ratio
 
65.2
%
 
71.2
%
 
65.2
%
 
66.7
%
 
82.8
%
Expense ratio
 
31.6
%
 
30.4
%
 
32.3
%
 
32.3
%
 
32.8
%
Combined trade ratio
 
96.8
%
 
101.6
%
 
97.5
%
 
99.0
%
 
115.6
%
 
 
 
 
 
 
 
 
 
 
 
Property and casualty insurance industry averages (2)
 
 

 
 

 
 

 
 

 
 

Loss and settlement expense ratio
 
70.4
%
 
69.3
%
 
67.7
%
 
73.4
%
 
77.9
%
Expense ratio
 
27.6
%
 
28.1
%
 
28.7
%
 
28.8
%
 
28.6
%
Combined trade ratio
 
98.0
%
 
97.4
%
 
96.4
%
 
102.2
%
 
106.5
%
(1)       Beginning in 2014, the expense ratios for the Company's property and casualty insurance subsidiaries reflect negative net periodic postretirement benefit costs allocated to them as a result of a plan amendment to Employers Mutual's postretirement medical plan, which created a large prior service credit that is being amortized into benefit expense over a period of 10 years. In addition, the service cost and interest cost components of the revised plan's net periodic benefit cost are significantly lower than those of the prior plan. The 2013 expense ratio and combined trade ratio for “reinsurance” and “total insurance operations” reflect $532,000 of negative premiums written (net of $53,000 reduction in the amount ceded to Employers Mutual under the excess of loss agreement) and $223,000 of negative commission expense that were recorded in connection with the change in Employers Mutual’s participation in MRB. Excluding these adjustments, the expense ratio and combined trade ratio for “reinsurance” would have been 23.8 percent and 82.8 percent, respectively, and for “total insurance operations” would have been unchanged at 32.3 percent and 97.5 percent, respectively. The 2012 expense ratio and combined trade ratio for “reinsurance” and “total insurance operations” reflect $3.1 million of negative premiums written (net of $341,000 reduction in the amount ceded to Employers Mutual under the excess of loss agreement) and $1.4 million of negative commission expense that were recorded in connection with the cancellation of a large pro rata account written by MRB.  Excluding these adjustments, the expense ratio and combined trade ratio for “reinsurance” would have been 22.4 percent and 90.8 percent, respectively, and for “total insurance operations” would have been 32.4 percent and 99.1 percent, respectively.  The 2011 expense ratio and combined trade ratio for “reinsurance” and “total insurance operations” reflect $921,000 of additional premiums written (net of $102,000 ceded to Employers Mutual under the excess of loss agreement) and $399,000 of commission expense that were recorded in connection with a change in Employers Mutual’s participation in MRB.  Excluding these adjustments, the expense ratio and combined trade ratio for “reinsurance” would have been 21.3 percent and 117.9 percent, respectively, and for “total insurance operations” would have been 32.7 percent and 115.5 percent, respectively.
(2)       As reported by A.M. Best.  The ratio for 2015 is an estimate; the actual combined trade ratio is not currently available.

11


Claims Management
Effective claims management is critical to the success of the pool participants.  To this end, the pool participants have adopted a customer-focused claims management process that is cost efficient, and delivers a high level of claims service that produces superior results.  The claims management process is focused on handling claims from their inception, accelerating communication to insureds and claimants, and compressing the cycle time of claims to control both loss costs and claims-handling costs.  This process provides quality service and results in the appropriate handling of claims, allowing the pool participants to cost-effectively pay valid claims and contest fraudulent claims.
The claims management operation includes adjusters, appraisers, special investigators, attorneys and claims administrative personnel.  The pool participants conduct their claims management operations out of 16 branch offices and four service offices located throughout the United States.  The home office claims group provides advice and counsel for branch claims staff in investigating, reserving and settling claims.  The home office claims staff also evaluates branch claims operations and makes recommendations for improvements in performance.  Additional home office services provided include: complex claim handling, physical damage and property review, medical case management, medical bill review, legal coverage analysis, a special investigative unit, litigation management and subrogation.  Management believes these home office services assist the branch claims personnel in producing greater efficiencies than can be achieved at the local level.
Each branch office is responsible for evaluating and settling claims within the authority provided by home office claims.  Authority levels within the branch offices are granted based upon an adjuster’s experience and expertise.  A branch office must request input from home office claims once a case exceeds its authority level.  The Senior Vice President of Claims participates in a claims committee that exists within the home office.  This committee meets on a weekly basis to assist the branches in evaluating and settling claims beyond their authority level.
The pool participants manage litigated claims arising from value disputes and questionable liability, and will defend appropriate denials of coverage.  The pool participants retain outside defense counsel to defend such matters; however, internal claims professionals manage the litigation process.  The pool participants have implemented an internally developed litigation management system that allows the claims staff to evaluate the quality and cost effectiveness of outside legal services.  Cases are constantly reviewed to adjust the litigation plan as necessary, and all cases going to trial are carefully reviewed to assess the value of a trial verses a settlement.

Loss and Settlement Expense Reserves
The Company's liabilities for losses and settlement expenses represent management's best estimates at a given point in time of ultimate unpaid losses and settlement expenses for both reported and unreported claims. The estimates of the liabilities for losses and settlement expenses include assumptions of future trends and claims severity, judicial theories of liability, historic loss emergence and other factors.  Because of the inherent uncertainties involved in the establishment of reserves for less mature accident years, management’s reserving methodology for the current and more recent accident years utilizes prudently conservative assumptions.  During the loss settlement period, which may cover many years in some cases, the inherent uncertainty associated with these accident years declines as the Company learns additional facts regarding individual claims and potential future claims, and consequently it often becomes necessary to refine and adjust its estimates of liability.  The Company reflects any adjustments to its liabilities for losses and settlement expenses in its operating results in the period in which the changes in estimates are made.
The amount of reserves for reported claims, known as “case reserves”, is primarily based upon a case-by-case evaluation of the specific type of claim, knowledge of the circumstances surrounding each claim and the policy provisions relating to the type of loss.  Case reserves on assumed reinsurance business are the amounts reported by the ceding companies.
The amount of reserves for unreported claims, known as “Incurred But Not Reported (IBNR) loss reserves”, is determined on the basis of statistical information for each line of insurance with respect to expected loss emergence arising from occurrences that have not yet been reported.  Established reserves (for both reported and unreported claims) are closely monitored and are frequently examined using a variety of formulas and statistical techniques for analyzing loss development, as well as other economic and social factors.
Settlement expense reserves are intended to cover the ultimate cost of investigating claims and defending lawsuits arising from claims.  These reserves are established each quarter based on previous periods’ experience to project the ultimate cost of settlement expenses.  To the extent that adjustments are required to be made in the amount of loss reserves each year, settlement expense reserves are correspondingly revised, if necessary.

12


The Company does not discount reserves.  Inflation is implicitly provided for in the reserving function through analysis of cost trends, reviews of historical reserving results and projections of future economic conditions.  Estimates of individual case loss reserves are monitored and reviewed on a regular basis by claim staff members.  Special attention is given to claims of $100,000 or greater, and long-term and lifetime medical claims.  Based on currently available information, individual case loss reserves are revised to reflect changes in estimated ultimate settlement values.
Despite the inherent uncertainties of estimating loss and settlement expense reserves, management believes that the Company’s reserves are being calculated in accordance with sound actuarial practices and, based upon current information, that the reserve for losses and settlement expenses at December 31, 2015 represents management’s best estimate of the Company’s overall liability.
Reserving Methodology
Property and Casualty Insurance
Management does not use accident year loss picks to establish the property and casualty insurance segment's carried reserves.  Case loss and IBNR loss reserves, as well as settlement expense reserves, are established independently of each other and added together to get the total loss and settlement expense reserve.  The property and casualty insurance segment's reserving methodology also includes bulk case loss reserves, which supplement the aggregate case loss reserves and are used by management to establish its best estimate of the liability for reported claims.  By establishing bulk (i.e. IBNR loss, bulk case loss, and settlement expense) reserves independently of the case loss reserves, management believes that it is able to appropriately estimate the property and casualty insurance segment's total loss and settlement expense exposures.
Case loss reserves are the individual reserves established based on the specific facts for each reported claim.  Individual case loss reserves are based on the probable, or most likely, outcome for each claim, with probable outcome defined as what is most likely to be awarded if the case were to be decided by a civil court in the applicable venue or, in the case of a workers’ compensation case, by that state’s Workers’ Compensation Commission.  Bulk case loss reserves are actuarially derived and are allocated to the various accident years on the basis of an annual study of indicated reserve adequacy by accident year maturity.
IBNR loss reserves are established by applying actuarially derived “IBNR factors” to the previous twelve months earned premiums.  The IBNR factors are determined for each line of business on an annual basis through an actuarial study of historic IBNR emergence relative to "on-level" premium.  The IBNR factors are adjusted on a quarterly basis for rate level changes, and may be further adjusted if the actuarial department recommends that a change in the overall reserve level is warranted.  The formula IBNR loss reserve established through this process is for all accident years combined, and the total is allocated to the various accident years by applying an allocation factor to the total formula IBNR amount.  The accident year allocation factors are determined by line-of-business, and are based on an annual study of indicated reserve adequacy by accident year maturity, as well as historic IBNR loss emergence. 
Other categories of the IBNR loss reserve, which are used to cover exposures associated with asbestos and environmental claims, storms, and catastrophic events, are established independently.  IBNR loss reserves associated with storms and catastrophic events are event-specific.  When a storm or catastrophic event occurs, the location of the event is overlaid over a map of the Company’s exposures.  Using this information and other factors (such as wind speed and the size of any hail), the affected branch office(s) are contacted and requested to develop a loss estimate based on projections of loss frequency and severity in their location.  To develop this loss estimate, large accounts located in the affected areas are contacted.  Based on this information and discussions with local agents, both the number and severity of estimated losses are projected by location.  Management then compiles and analyzes this information and calculates a total loss estimate.  The total loss estimate is generally established within two weeks of an event and is adjusted, if necessary, as the actual claims are inspected.  At each reporting date, the total amount of reported losses associated with each storm/catastrophic event is compared to the most recent total loss estimate for that event, and the difference is recorded as the storm/catastrophe IBNR loss reserve.
The IBNR loss reserves and settlement expense reserves are established jointly for asbestos and environmental liabilities as the available estimation methodologies require the consideration of both loss and loss settlement expense payments together. Management's internal ultimate loss and settlement expense evaluations consist of runoff scenarios based on recent payment activity and various future payout decay assumptions. The assumptions include published research on industry payout curves as well as reasonable alternative assumptions selected by Employers Mutual's actuaries. Company and industry survival ratios are also monitored to assist in validating assumptions underlying the payout scenarios.
Settlement expense reserves (other than for asbestos and environmental claims) are established by applying actuarially derived “settlement expense factors” to the loss reserves.  The settlement expense factors are determined for each line of business on a quarterly basis through an actuarial study of historical ratios of paid expenses to paid losses.  The settlement expense reserve established through this process is for all accident years combined, and the total is allocated to the various accident years proportional to the loss reserves.

13


Reinsurance
Reserves for the HORAD book of business are reviewed quarterly. The latest five contract years are typically reviewed during each of the first three quarters of any given year; while all contract years 1988 and subsequent are reviewed during the fourth quarter (detailed contract year information is not available prior to 1988). Accident years 1981-1987 are reviewed separately during the fourth quarter.
Premium, loss and settlement expense data is generally reported by ceding companies on a contract year basis; however, some loss and settlement expense data is reported on an accident year basis. Some ceding companies also report IBNR loss reserves. The reinsurance segment books these IBNR loss reserve amounts, and then deducts them from the indicated IBNR loss reserves calculated by Employers Mutual’s actuaries. The reinsurance segment may also book “additional case reserves” for ceding companies whose reported case reserves related to certain claims are believed to be less than adequate.
Using the reported data, excluding the reported IBNR loss reserves, Employers Mutual's actuaries develop an indicated ultimate loss, and corresponding IBNR loss reserve, by type of contract (property/casualty/excess/pro rata/multi-line) and by contract year. The actuaries employ the standard paid and incurred chain ladder (triangle) development methods and the Bornheutter-Furgeson "expected loss ratio" method to produce the indicated ultimate loss, and corresponding IBNR loss reserves. In addition, a loss ratio approach and judgment are applied to a few minor contract types which represent an insignificant portion of the total book of business.
For the major contract types, the reinsurance segment uses its own paid and incurred development data aggregated on a contract year basis. The reason for aggregating by contract year, rather than accident year, is to ensure an accurate aggregation, as ceding companies have not always provided sufficient detail to determine the proper accident year assignment. In addition, the reinsurance segment uses data from the Reinsurance Association of America (RAA) to assist in estimating reserve development for casualty excess contracts.
The "expected loss ratios" used in the Bornheutter-Ferguson method for the current contract year are calculated by contract type during the first quarter. Once established, the "expected loss ratios" for the various contract years are generally not revised. The "expected loss ratios" are calculated by dividing the "projected ultimate losses" for contract years having at least five years of maturity by the contract-year earned premium brought to the current rate-level. The current rate-level loss ratios are then trended to the current contract period. In addition, when large accounts are first written, there is generally some underwriting or reserving data available from which an "expected loss ratio" may be determined.
After establishing the ultimate loss, and corresponding IBNR loss reserve, by treaty type and contract year, an allocation must be made in order to book the IBNR loss reserve by accident year and line-of-business. This is accomplished by a historical study of the ultimate accident year distribution of reported losses and reported loss types (for those treaty types which may cover multiple lines of business). For the latest contract years, consideration is also given to the distribution of the contract effective dates and the expected earnings pattern of the contract types (occurrence vs. risks attaching contracts).
The reinsurance segment also books EBNR premiums on pro rata contracts, and accrued reinstatement premiums on catastrophe excess contracts. EBNR premium is estimated by applying selected earnings patterns to the expected ultimate contract year premium associated with each individual pro rata account, and netting the reported-to-date amount from the estimated earned-to-date amount. The account level earnings patterns are selected from an examination of all available information regarding distribution of risk attachment dates during the contract period and a review of each ceding company's historical reporting patterns. It is important to note that whenever EBNR premium is booked, there is an associated IBNR loss reserve established as well. Accrued reinstatement premiums are estimated by applying a historically selected ratio of "ultimate reinstatement premium to incurred losses" to the "expected ultimate" incurred catastrophe loss by contract year. Netting the reported reinstatement premiums-to-date from this ultimate produces the booked accrual.
Reported loss and IBNR loss reserves associated with the MRB book of business are established by that entity’s management, and booked by the reinsurance segment on a monthly basis. MRB claims files are audited annually by the member companies’ reinsurance claim departments, and the member company actuarial departments perform an annual reserve adequacy review. The reinsurance segment estimates and books a relatively small IBNR loss reserve and EBNR premium amount to account for a one month lag in reporting. The booking of the lag IBNR loss reserve may be suspended during periods when actuarial reviews indicate MRB's carried reserves are more than adequate to cover its liabilities.

14


Reserve Evaluation and Determination of Management’s Best Estimate of Overall Liability
Property and casualty insurance
Prior to the end of each quarter, Employers Mutual's actuaries utilize standard loss development methodologies to evaluate the adequacy of the previous quarter’s carried reserves.  The actuaries employ the use of the standard paid and incurred chain ladder (triangle) development methods to perform this evaluation.  The actuaries organize the paid and incurred losses on a “rolling” accident year basis, meaning that at any particular quarter-end, an accident year is defined by the most recent four quarters and will, therefore, cross calendar years except at year-end.  Using five different averaging periods to compute loss development factors, five separate point estimates of indicated reserves are developed for each paid and incurred triangle.  The high and low point estimates derived from this process establish the actuarial range of reasonable reserves.  An additional benchmark, referred to as the actuarial central estimate, is determined by calculating a separate point estimate using “selected paid” and “selected incurred” estimates.  This actuarial central estimate is deemed to be an action point in the evaluation of the property and casualty insurance segment's carried reserves.  If the prior quarter’s total carried reserves fall below this threshold, the actuarial department will recommend that an adjustment be made to the current quarter’s carried reserves.
A separate evaluation of the prior quarter’s case and bulk case loss reserves is also performed each quarter. The evaluation methodology utilized is similar to the review performed on total carried reserves, except that the accident year triangles include development on reported claims only.
The determination of management’s best estimate of the property and casualty insurance segment's overall liability at each quarterly reporting date begins with the actuarial department performing a comparison of the prior quarter’s total carried reserves to the actuarial range of reasonable reserves and actuarial central estimate (as described in the preceding paragraph) for such prior quarter.  Generally, if the prior quarter’s carried reserves are within a few percentage points of, but not below, the actuarial central estimate, and if the separate review of the case and bulk case loss reserves indicates that those reserves are within a few percentage points of the actuarial central estimate for the case reserves, the actuarial department will report that it is comfortable with the current quarter’s carried reserves, and the current quarter’s total carried reserves are deemed to be management’s best estimate of the property and casualty insurance segment's overall liability.  If the prior quarter’s total carried reserves fall outside of that quarter’s actuarial range of reasonable reserves, or if the review of the previous quarter’s total carried reserve and/or case and bulk case loss reserves indicates that those reserves are not within a few percentage points of their respective actuarial central estimate, the actuarial department will recommend that an adjustment be made to the current quarter’s total carried reserves.  Management reviews all recommendations submitted by the actuarial department and considers such recommendations in the determination of its best estimate of overall liability.

Reinsurance
The IBNR loss reserves for the HORAD book of business are determined and booked each quarter along with the ceding companies’ reported losses/reserves. The methodologies used to establish the IBNR loss reserves produce a range of indicated reserves for each contract type and contract year. Employers Mutual’s actuaries examine the reasonableness of each range, and then select a point estimate within those ranges. For the more recent contract years, the selected IBNR loss reserve estimate tends to be higher in the range, typically in the fourth quartile, due to the considerable uncertainty associated with these immature contract years. The IBNR loss reserve selected for the more mature contract years tends to be at, or slightly above, the midpoint of the range of reasonable reserves. In addition to the actuarially determined reserves, an additional IBNR loss reserve is established when large catastrophic events occur, based on an examination of impacted contracts/exposures and reported industry-wide loss estimates. In aggregate, the IBNR loss reserve selected using these methods and procedures, combined with reserves reported by the ceding companies, becomes management’s best estimate of the reinsurance segment’s overall liability.
The reported loss and IBNR loss reserves associated with the MRB book of business are established by that entity’s management, and the reinsurance segment books its share of those amounts on a monthly basis. The Company also estimates and books a relatively small IBNR loss reserve and EBNR premium accrual to the current accident year, to account for a one month lag in reporting. The booking of the lag IBNR loss reserve may be suspended during periods when actuarial reviews indicate MRB's carried reserves are more than adequate to cover its liabilities.

15


Reserve Development
Property and casualty insurance
There is an inherent amount of uncertainty involved in the establishment of insurance liabilities.  This uncertainty is greatest in the current and more recent accident years because a smaller percentage of the expected ultimate claims have been reported, adjusted and settled compared to more mature accident years.  For this reason, carried reserves for these accident years reflect prudently conservative assumptions.  As the carried reserves for these accident years run off, the overall expectation is that, more often than not, favorable development will occur.  However, there is also the possibility that the ultimate settlement of liabilities associated with these accident years will show adverse development, and such adverse development could be substantial.
As previously noted, the property and casualty insurance segment's bulk reserves (formula IBNR loss reserve, bulk case loss reserve and settlement expense reserve) are initially established for all accident years combined, and the total is then allocated to the various accident years. During this allocation process, a portion of the total bulk reserves may be reallocated from the current accident year to prior accident years, or from prior accident years to the current accident year, to achieve the actuarial department's desired reserve level by accident year. When reserves are moved to, or from, prior accident years, the change is reported as development on prior years' reserves. However, this type of development is "mechanical" in nature, and does not have an impact on earnings. This is due to the fact that such development is simply a mathematical by-product of the mechanical process used to reallocate bulk reserves to the various accident years.  Earnings are only impacted by changes in the total amount of carried reserves.

Reinsurance
There are inherent uncertainties involved in establishing reserves for assumed reinsurance business. Such uncertainties include the fact that a reinsurance company generally has less knowledge than the ceding companies about the underlying book of business and the ceding companies' reserving practices. For this reason, the carried reserves for the reinsurance segment are generally in the upper quartile of the range of actuarial reserve indications. As the carried reserves run off, the overall expectation is that, more often than not, favorable development will occur.  However, there is also the possibility that the ultimate settlement of liabilities will show adverse development, and such adverse development could be substantial.

16


The following table sets forth a reconciliation of beginning and ending reserves for losses and settlement expenses of the property and casualty insurance subsidiaries and the reinsurance subsidiary.  Amounts presented are on a net basis, with a reconciliation of beginning and ending reserves to the gross amounts presented in the consolidated financial statements.
 
 
Year ended December 31,
($ in thousands)
 
2015
 
2014
 
2013
Gross reserves at beginning of year
 
$
661,309

 
$
610,181

 
$
583,097

Re-valuation due to foreign currency exchange rates
 
(2,061
)
 
333

 
(2
)
Less ceded reserves at beginning of year
 
28,253

 
30,118

 
31,390

Net reserves at beginning of year
 
635,117

 
579,730

 
551,709

 
 
 
 
 
 
 
Incurred losses and settlement expenses related to:
 
 

 
 

 
 

Current year
 
405,850

 
406,266

 
346,072

Prior years
 
(35,114
)
 
(20,792
)
 
(12,785
)
Total incurred losses and settlement expenses
 
370,736

 
385,474

 
333,287

 
 
 
 
 
 
 
Paid losses and settlement expenses related to:
 
 

 
 

 
 

Current year
 
154,958

 
162,905

 
137,998

Prior years
 
193,123

 
167,182

 
167,268

Total paid losses and settlement expenses
 
348,081

 
330,087

 
305,266

 
 
 
 
 
 
 
Net reserves at end of year
 
657,772

 
635,117

 
579,730

Plus ceded reserves at end of year
 
23,477

 
28,253

 
30,118

Re-valuation due to foreign currency exchange rates
 
(2,475
)
 
(2,061
)
 
333

Gross reserves at end of year
 
$
678,774

 
$
661,309

 
$
610,181


The following table presents the reported amounts of favorable development experienced on prior years’ reserves and the portion of the reported development amounts that resulted solely from changes in the allocation of bulk reserves between the current and prior accident years (no impact on earnings).  The result is an approximation of the implied amount of favorable development that had an impact on earnings.
 
 
Year ended December 31,
($ in thousands)
 
2015
 
2014
 
2013
Reported amount of favorable development experienced on prior years' reserves
 
$
(35,114
)
 
$
(20,792
)
 
$
(12,785
)
Adjustment for (adverse) favorable development included in the reported development amount that had no impact on earnings
 
(618
)
 
2,151

 
6,526

Approximation of the implied amount of favorable development that had an impact on earnings
 
$
(35,732
)
 
$
(18,641
)
 
$
(6,259
)

Following is a detailed analysis of the development the Company has experienced on its prior accident years’ reserves during the past three years.  Care should be exercised when attempting to analyze the financial impact of the reported development amounts because, as previously noted, 1) the overall expectation is that, more often than not, favorable development will occur as the prior accident years’ reserves run off, and 2) development on prior years’ reserves resulting solely from changes in the allocation of bulk reserves between the current and prior accident years does not have an impact on earnings.


17


Year ended December 31, 2015
Property and casualty insurance segment
For the property and casualty insurance segment, the December 31, 2015 estimate of loss and settlement expense reserves for accident years 2014 and prior decreased $13.8 million from the estimate at December 31, 2014.  This decrease represents 3.0 percent of the December 31, 2014 carried reserves.  No changes were made in the key actuarial assumptions utilized to estimate loss and settlement expense reserves during 2015; however, the accident year allocation factors applied to IBNR loss reserves, bulk case loss reserves, and the defense and cost containment portion of settlement expense reserves were revised at December 31, 2015 as part of the annual review.  This change resulted in the movement of $423,000 of reserves from prior accident years to the current accident year, and hence, was reported as favorable development on prior years' reserves.
Reserves on previously reported claims developed favorably in 2015 by approximately $8.5 million.  This includes $514,000 of adverse development attributable to revised accident year allocation factors for bulk case loss reserves, which was offset by $7.5 million of favorable development experienced on prior years’ reported claims (exclusive of the bulk case loss reserve) and $1.5 million of favorable development from changes in the line of business distribution of the bulk case loss reserves.  Of the $8.5 million of favorable development, accident years 2012-2014 experienced favorable development of $7.0 million.  While all lines of business continued to experience very favorable development on claims which “closed” during 2015, adverse development on claims remaining “open” in the commercial auto liability line outpaced the favorable development experienced on "closed" claims by $6.5 million. Favorable development on the combined "case plus bulk case loss reserves" occurred in all lines of business except commercial auto liability, which experienced adverse development of $2.5 million, and homeowners, which experienced adverse development of $28,000 mostly attributable to a reallocation of the bulk case reserve. The following table displays the development experienced on previously reported claims, as well as the development amounts generated by the change in accident year allocation factors, by line of business:
($ in thousands)
Line of business
 
Development experienced on previously reported claims which closed during the year
 
Development experienced on previously reported claims remaining open at year end
 
Development associated with changes in bulk case loss reserve line of business distribution
 
Development associated with the change in bulk case loss reserve accident year allocation factors
 
Total development on previously reported claims
Personal auto liability
 
$
(1,303
)
 
$
1,110

 
$
(1,389
)
 
$
13

 
$
(1,569
)
Commercial auto liability
 
(4,773
)
 
11,279

 
(4,418
)
 
384

 
2,472

Auto physical damage
 
(1,376
)
 
(266
)
 
35

 
11

 
(1,596
)
Workers' compensation
 
(16,106
)
 
11,668

 
1,253

 
166

 
(3,019
)
Other liability
 
(12,938
)
 
12,432

 
(1,861
)
 
(60
)
 
(2,427
)
Commercial property
 
(6,743
)
 
1,168

 
3,946

 

 
(1,629
)
Homeowners
 
(987
)
 
80

 
935

 

 
28

Bonds
 
7

 
(761
)
 
16

 

 
(738
)
 
 
 
 
 
 
 
 
 
 
 
Total
 
$
(44,219
)
 
$
36,710

 
$
(1,483
)
 
$
514

 
$
(8,478
)

The favorable development of $8.5 million on previously reported claims during 2015 is an increase of $2.6 million over the $5.9 million of favorable development reported in 2014. Five of the eight lines of business contributed to the aggregate increase in favorable development. Commercial auto liability was the largest contributor, having $3.4 million less adverse development during 2015 compared to 2014. The four remaining contributing lines, and the increase in favorable development attributed to them, were; other liability ($1.8 million), commercial property ($954,000), all other lines (mostly surety bonds) ($472,000), and auto physical damage ($316,000). Personal auto liability experienced $3.0 million less favorable development during 2015 as the 2014 development was impacted by unusual reserve decreases on two very large unlimited personal injury protection claims reinsured through the Michigan Catastrophic Claims Association. Workers' compensation continued to experience favorable development; however, the development was $1.0 million less than in 2014. The $28,000 of adverse development experienced on the homeowners' line of business represents a $265,000 increase over the amount experienced during 2014. As previously stated, this was primarily caused by a line of business redistribution of the bulk case reserve.


18


While the adverse development experienced in commercial auto liability remains significant, the decline from the amount reported in 2014 is also significant. Similar to 2014, the adverse development is being driven by large claim amounts associated with a very small percentage (1.8 percent) of the total claims experiencing development of any type. The development associated with this group of claims increased 13.0 percent, which partially offset a 293.0 percent increase in favorable development on all other commercial auto claims experiencing development of any type in 2015. Internally monitored claims diagnostics, such as accident year ratios of average opened to average closed claims, appear to indicate continued strengthening of case reserves for claims reported during 2015 relative to 2014. Management continues to allocate a significant amount of time and resources on the commercial auto liability book of business, focusing on claims, underwriting and pricing processes.

IBNR loss reserves experienced $4.3 million of adverse development, which is attributable to higher than expected loss emergence ($5.5 million) and exposure growth ($1.9 million). These adverse development amounts were partially offset by favorable development from changes in the IBNR accident year allocation factors ($698,000), and reserve decreases taken as the result of scheduled reserve reviews ($2.0 million). Approximately $2.6 million of the $5.5 million of higher than expected loss emergence was due to IBNR loss reserve strengthening in the other liability line of business necessitated by the continuing emergence of asbestos claims at a rate not previously anticipated. Six of the eight reserving lines experienced adverse IBNR loss reserve development, with higher than expected loss emergence being the main driver for each. The lines experiencing adverse development included commercial property ($5.3 million), auto physical damage ($844,000), commercial auto liability ($443,000), workers' compensation ($420,000), homeowners ($381,000), and personal auto liability ($264,000). Adverse development on the property lines of business is not totally unexpected. Favorable development is consistently observed on reported property claims, therefore, lower levels of IBNR loss reserves are generally carried to offset perceived redundancies. Favorable development, generally driven by lower than expected emergence and decreases in carried reserves from scheduled reviews, was experienced in other liability ($2.8 million) and surety bonds ($596,000). The following table displays the development experienced on IBNR loss reserves from each of these factors, by line of business:
 
 
Development on IBNR loss reserves resulting from:
($ in thousands)
Line of business
 
Loss emergence different than expected
 
Actions taken as a result of scheduled reserve reviews
 
Change in underlying exposures
 
Change in accident year allocation factors
 
Change in line-of-business distribution
 
Total
Personal auto liability
 
$
359

 
$
(35
)
 
$
(49
)
 
$

 
$
(11
)
 
$
264

Commercial auto liability
 
890

 
(263
)
 
172

 
(336
)
 
(20
)
 
443

Auto physical damage
 
838

 
8

 
2

 
1

 
(5
)
 
844

Workers' compensation
 
769

 
(368
)
 
414

 
(414
)
 
19

 
420

Other liability
 
(2,102
)
 
(1,713
)
 
1,323

 
42

 
(302
)
 
(2,752
)
Commercial property
 
5,014

 
253

 
35

 
46

 
(59
)
 
5,289

Homeowners
 
363

 
29

 
(14
)
 
14

 
(11
)
 
381

Bonds
 
(593
)
 
62

 
21

 
(51
)
 
(35
)
 
(596
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
$
5,538

 
$
(2,027
)
 
$
1,904

 
$
(698
)
 
$
(424
)
 
$
4,293


Total settlement expense reserves developed favorably in 2015 by $7.9 million.  Approximately 73.0 percent of the favorable development is attributed to defense and cost containment expenses.  The reserves associated with these expenses were established in bulk, and were allocated to the various accident years in proportion to the accident year distribution of the underlying loss reserves.  During 2015, the underlying loss reserves experienced favorable development, which generated favorable development in the settlement expense reserves.  However, the portion of this reserve associated with asbestos and environmental claims experienced adverse development of $1.6 million due to additional reserve strengthening necessitated by the continuing emergence of asbestos claims at a rate not previously anticipated.  Changes in the IBNR loss reserve and bulk case loss reserve accident year allocation factors accounted for $239,000 of the favorable development in the defense and cost containment expense reserves.  The remaining 27.0 percent of favorable development was attributed to adjusting and other expenses (i.e., internal claims department, independent adjuster and miscellaneous settlement expenses). Differences in the allocation factors used to distribute the reserves for these expenses at year-end 2015 compared to year-end 2014 generated $234,000 of adverse development.  The majority of the remaining favorable development resulted from settlement expense payments that were lower than anticipated in the payment patterns used in the December 31, 2014 accident year allocations.

19


Prior accident years’ reserves for non-voluntary assumed business developed favorably by $464,000, attributed primarily to assigned risk pools.
The above results reflect prior accident year reserve development on a direct and assumed basis.  During 2015, ceded losses and settlement expenses for prior accident years increased $1.6 million.  This increase in reinsurance recoveries is reported as favorable development.

Reinsurance segment
For the reinsurance segment, the December 31, 2015 estimate of loss and settlement expense reserves for accident years 2014 and prior decreased $21.3 million from the estimate at December 31, 2014.  This decrease represents 10.8 percent of the December 31, 2014 carried reserves.  No changes were made in the key actuarial assumptions utilized to estimate loss and settlement expense reserves during 2015; however, the accident year allocation factors applied to IBNR loss reserves were revised during 2015.  This change resulted in the movement of $1.0 million of reserves from the current accident year to prior accident years, and hence, was reported as adverse development on prior years' reserves. The HORAD portion of the book experienced favorable development of approximately $18.1 million, while MRB experienced favorable development of approximately $3.2 million.  
The vast majority of HORAD’s favorable development occurred in four contract types; ocean marine pro rata ($8.5 million), casualty excess ($5.1 million), per risk excess ($3.3 million), and property pro rata with wind ($2.0 million). Approximately 15.0 percent of the favorable development experienced in ocean marine pro rata is attributable to a large negative premium adjustment (for contracts effective during the three previous years) reported by the ceding company for the offshore energy and liability proportional account, which reduced the amount of IBNR loss reserves carried for those years. In addition, as this particular set of contracts has matured, carried IBNR loss reserves have declined because emerged loss experience has been better than expected. The development in the remaining contract types experiencing favorable development is attributable to the reinsurance segment's prudently conservative reserving approach, and reflects a reduction in carried IBNR loss reserves that could no longer be justified. Three contract types experienced adverse development; property/casualty global pro rata ($3.0 million), property/casualty global excess ($389,000), and crop/hail pro rata ($86,000). For the property/casualty global contracts, increases in cedants’ reported losses exceeded the decrease in IBNR loss reserves. Significant IBNR loss reserves remain for these contract types, so the possibility for improved profitability on prior accident years still exists.
Historically, the MRB book of business has experienced very little development on prior years' loss and settlement expense reserves. The Company’s actuarial reviews of MRB's reported reserves have consistently indicated that those reserves challenge the upper level of the range of reasonable reserves. To address this issue, a negative bulk IBNR loss reserve was established in 2015 for this business. This negative IBNR loss reserve is responsible for approximately $3.0 million of the $3.2 million of favorable development reported on prior years’ reserves.
No changes were made in the "expected loss ratios" utilized for prior contract years. The "expected loss ratios" utilized for the 2015 contract year were based on an extensive actuarial analysis of trended historic ultimate loss ratios based on current-level earned premiums. Where applicable, new contract loss information or loss histories were also incorporated into the "expected loss ratio" selection process. Compared to the 2014 contract year selections, the 2015 contract year expected loss ratios for the per risk excess and casualty excess lines of business increased by 7.5 percentage points and 2.5 percentage points, respectively. The 2015 contract year expected loss ratio for the ocean marine pro rata line of business decreased 5.5 percentage points due to the favorable experience that has occurred during the previous three contract years.

Year ended December 31, 2014
Property and casualty insurance segment
For the property and casualty insurance segment, the December 31, 2014 estimate of loss and settlement expense reserves for accident years 2013 and prior decreased $8.1 million from the estimate at December 31, 2013.  This decrease represented 1.9 percent of the December 31, 2013 carried reserves.  No changes were made in the key actuarial assumptions utilized to estimate loss and settlement expense reserves during 2014; however, the accident year allocation factors applied to IBNR loss reserves, bulk case loss reserves, and the defense and cost containment portion of settlement expense reserves were revised at December 31, 2014 as part of the annual review.  This change resulted in the movement of $2.2 million of reserves from prior accident years to the current accident year, and hence, was reported as favorable development on prior years' reserves.

20


Reserves on previously reported claims developed favorably in 2014 by approximately $5.9 million.  This includes $432,000 of adverse development attributable to revised accident year allocation factors for bulk case loss reserves, which was offset by $5.0 million of favorable development experienced on prior years’ reported claims (exclusive of the bulk case loss reserve) and $1.3 million of favorable development from changes in the line of business distribution of the bulk case loss reserves.  Of the $5.9 million of favorable development, accident years 2011-2013 experienced adverse development of $3.6 million, while all remaining accident years experienced aggregate favorable development of $9.5 million.  While all lines of business continued to experience very favorable development on claims which “closed” during 2014, adverse development on claims remaining “open” in the commercial auto liability line outpaced the favorable development experienced on "closed" claims by $9.4 million. Favorable development on the combined "case plus bulk case loss reserves" occurred in all lines of business except Commercial Auto Liability, which experienced adverse development of $5.8 million. The following table displays the development experienced on previously reported claims, as well as the development amounts generated by the change in accident year allocation factors, by line of business:
($ in thousands)
Line of business
 
Development experienced on previously reported claims which closed during the year
 
Development experienced on previously reported claims remaining open at year end
 
Development associated with changes in bulk case loss reserve line of business distribution
 
Development associated with the change in bulk case loss reserve accident year allocation factors
 
Total development on previously reported claims
Personal auto liability
 
$
(1,184
)
 
$
(3,648
)
 
$
234

 
$
29

 
$
(4,569
)
Commercial auto liability
 
(2,000
)
 
11,415

 
(3,583
)
 

 
5,832

Auto physical damage
 
(1,145
)
 
(91
)
 
(45
)
 
1

 
(1,280
)
Workers' compensation
 
(15,116
)
 
12,051

 
(997
)
 

 
(4,062
)
Other liability
 
(8,462
)
 
8,029

 
(210
)
 

 
(643
)
Commercial property
 
(5,096
)
 
1,422

 
2,669

 
330

 
(675
)
Homeowners
 
(1,105
)
 
192

 
604

 
72

 
(237
)
Bonds
 
(40
)
 
(221
)
 
(5
)
 

 
(266
)
 
 
 
 
 
 
 
 
 
 
 
Total
 
$
(34,148
)
 
$
29,149

 
$
(1,333
)
 
$
432

 
$
(5,900
)

Approximately 98 percent of the favorable development experience for personal auto liability stemmed from reserve take-downs on two large Michigan Catastrophic Claims Association unlimited personal injury protection claims which were reported in 2002 and 2003. Similar to 2013, commercial auto liability’s adverse development is associated with a small number of previously reported claims which experienced very significant upwards revisions in carried reserves and payments. Of the total number of reported claims for this line, 1.8 percent developed adversely by more than $100,000, representing $11.2 million of adverse development. The development on the remaining 98.2 percent of commercial auto liability claims was a favorable $1.7 million. Management believes prior accident years underwent significant strengthening during 2014, and that the 2014 accident year is more adequately reserved than the 2013 accident year was at year-end 2013. Both workers' compensation and other liability, which experienced adverse development on combined open and closed previously reported claims at year-end 2013, exhibited favorable development as of year-end 2014, similar to year-end 2012. The remaining lines of business experienced favorable development, though somewhat less than in 2013 which had a larger favorable impact from the revision of the bulk case loss reserve accident year allocation factors.

21


IBNR loss reserves experienced $201,000 of adverse development, which is attributable to higher than expected emergence ($1.4 million) and exposure growth ($1.9 million). These items were almost completely offset by favorable development from changes in the IBNR accident year allocation factors ($1.8 million), and reserve decreases taken as the result of scheduled reserve reviews ($1.2 million). Four of the eight reserving lines experienced adverse IBNR loss reserve development, with higher than expected emergence being the main driver for each. The lines experiencing adverse development included commercial property ($3.4 million), auto physical damage ($970,000), homeowners ($886,000) and commercial auto liability ($291,000). Adverse development on the property lines of business is not totally unexpected. Favorable development is consistently observed on reported property claims, therefore, lower levels of IBNR loss reserves are generally carried to offset perceived redundancies. Favorable development, generally driven by lower than expected emergence and/or decreases in carried reserves from scheduled reviews, was experienced in other liability ($4.3 million), workers' compensation ($846,000), surety bonds ($250,000) and personal auto liability ($3,000). The following table displays the development experienced on IBNR loss reserves from each of these factors, by line of business:
 
 
Development on IBNR loss reserves resulting from:
($ in thousands)
Line of business
 
Loss emergence different than expected
 
Actions taken as a result of scheduled reserve reviews
 
Change in underlying exposures
 
Change in accident year allocation factors
 
Change in line-of-business distribution
 
Total
Personal auto liability
 
$
80

 
$
(23
)
 
$
(70
)
 
$
21

 
$
(11
)
 
$
(3
)
Commercial auto liability
 
658

 
(148
)
 
190

 
(434
)
 
25

 
291

Auto physical damage
 
950

 
(1
)
 
1

 
19

 
1

 
970

Workers' compensation
 
(531
)
 
(576
)
 
254

 

 
7

 
(846
)
Other liability
 
(4,028
)
 
(525
)
 
1,540

 
(1,226
)
 
(34
)
 
(4,273
)
Commercial property
 
3,354

 
69

 
32

 

 
(29
)
 
3,426

Homeowners
 
933

 
(15
)
 
(25
)
 
(10
)
 
3

 
886

Bonds
 
(43
)
 
(1
)
 
(2
)
 
(204
)
 

 
(250
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
$
1,373

 
$
(1,220
)
 
$
1,920

 
$
(1,834
)
 
$
(38
)
 
$
201


Total settlement expense reserves developed favorably in 2014 by $6.5 million.  Approximately 87 percent of the favorable development is attributed to defense and cost containment expenses.  The reserves associated with these expenses were established in bulk, and were allocated to the various accident years in proportion to the accident year distribution of the underlying loss reserves.  During 2014, the underlying loss reserves experienced favorable development, which generated favorable development in the settlement expense reserves.  However, the portion of this reserve associated with asbestos claims experienced adverse development of $1.2 million due to additional strengthening.  Changes in the IBNR loss reserve and bulk case loss reserve accident year allocation factors accounted for $749,000 of the favorable development in the defense and cost containment expense reserves.  The remaining 13 percent of favorable development was attributed to adjusting and other expenses (i.e., internal claims department, independent adjuster and miscellaneous settlement expenses). Differences in the allocation factors used to distribute the reserves for these expenses at year-end 2014 compared to year-end 2013 generated $716,000 of favorable development.  The majority of the remaining favorable development resulted from settlement expense payments that were lower than anticipated in the payment patterns used in the December 31, 2013 accident year allocations.
Prior accident years’ reserves for non-voluntary assumed business developed favorably by $346,000, attributed primarily to assigned risk pools.
The above results reflect prior accident year reserve development on a direct and assumed basis.  During 2013, ceded losses and settlement expenses for prior accident years decreased $4.2 million.  This decrease in reinsurance recoveries is reported as adverse development.


22


Reinsurance segment
For the reinsurance segment, the December 31, 2014 estimate of loss and settlement expense reserves for accident years 2013 and prior decreased $12.7 million from the estimate at December 31, 2013.  This decrease represented 6.9 percent of the December 31, 2013 carried reserves.  The HORAD portion of the book experienced favorable development of approximately $11.8 million, while MRB experienced favorable development of approximately $833,000.  MRB accident year 2013 experienced adverse development of $277,000.  This adverse development was more than offset by favorable development on accident years 2011 ($237,000) and 2009 ($638,000), plus favorable development on most of the remaining prior accident years.  For the HORAD book of business, accident years 2010 and prior accounted for approximately 80 percent of the favorable development, with less significant amounts of favorable development occurring in most of the remaining prior accident years.  Development for accident year 2013 was an adverse $1.8 million due to reserve strengthening. The increase in favorable development in the HORAD book of business in 2014 compared to 2013 was greater than expected, and was driven mostly by a reduction of IBNR loss reserves for accident years 2010 and prior because the amount previously carried was no longer indicated in the actuarial analysis.
No changes were made in the key actuarial assumptions utilized to estimate loss and settlement expense reserves during 2014, including the "expected loss ratios" utilized for prior contract years. The "expected loss ratios" utilized for the 2014 contract year were based on an extensive actuarial analysis of trended historic ultimate loss ratios based on current-level earned premiums. Where applicable, new contract loss information or loss histories were also incorporated into the selection process. Compared to the 2013 contract year selections, the property per risk "expected loss ratios" increased moderately. The casualty excess and property/casualty global pro rata "expected loss ratios" decreased slightly from the 2013 selections.

Year ended December 31, 2013
Property and casualty insurance segment
For the property and casualty insurance segment, the December 31, 2013 estimate of loss and settlement expense reserves for accident years 2012 and prior decreased $7.3 million from the estimate at December 31, 2012.  This decrease represented 1.8 percent of the December 31, 2012 carried reserves.  No changes were made in the key actuarial assumptions utilized to estimate loss and settlement expense reserves during 2013; however, the accident year allocation factors applied to IBNR loss reserves, bulk case loss reserves, and the defense and cost containment portion of settlement expense reserves were revised at December 31, 2013 as part of the annual review. This change resulted in the movement of $6.5 million of reserves from prior accident years to the current accident year, and hence, was reported as favorable development on prior years’ reserves.  
Reserves on previously reported claims developed favorably in 2013 by approximately $106,000.  This included $2.7 million of favorable development attributable to revised accident year allocation factors for bulk case loss reserves, which offset $1.0 million of adverse development experienced on prior years’ reported claims (exclusive of the bulk case loss reserve) and $1.6 million of adverse development from increases in the bulk case loss reserve.  Of the $106,000 of favorable development, accident years 2009, 2010 and 2012 experienced adverse development of $3.5 million, while all remaining accident years experienced aggregate favorable development of $3.6 million.  While all lines of business continued to experience very favorable development on claims which “closed” during 2013, adverse development (exclusive of bulk case loss reserve changes or accident year reallocation impacts) on claims remaining “open” outpaced the favorable development experienced on "closed" claims in four lines of business: personal auto liability ($56,000), commercial auto liability ($6.2 million), workers compensation ($931,000) and other liability ($1.5 million). Favorable development on the combined "case plus bulk case loss reserves" occurred in five of the eight major lines of business.  The lines experiencing adverse development included Personal Auto Liability ($114,000), Commercial Auto Liability ($4.6 million), and Other Liability ($2.5 million). The following table displays the development experienced on previously reported claims, as well as the development amounts generated by the change in accident year allocation factors, by line of business:

23


($ in thousands)
Line of business
 
Development experienced on previously reported claims which closed during the year
 
Development experienced on previously reported claims remaining open at year end
 
Development associated with changes in bulk case loss reserve line of business distribution
 
Development associated with the change in bulk case loss reserve accident year allocation factors
 
Total development on previously reported claims
Personal auto liability
 
$
(1,655
)
 
$
1,711

 
$
58

 
$

 
$
114

Commercial auto liability
 
(604
)
 
6,755

 
(2,290
)
 
703

 
4,564

Auto physical damage
 
(873
)
 
(186
)
 
4

 

 
(1,055
)
Workers' compensation
 
(15,902
)
 
16,833

 
(1,174
)
 

 
(243
)
Other liability
 
(6,739
)
 
8,209

 
820

 
177

 
2,467

Commercial property
 
(4,650
)
 
1,123

 
3,313

 
(2,935
)
 
(3,149
)
Homeowners
 
(1,388
)
 
145

 
855

 
(644
)
 
(1,032
)
Bonds
 
(232
)
 
(1,541
)
 
1

 

 
(1,772
)
 
 
 
 
 
 
 
 
 
 
 
Total
 
$
(32,043
)
 
$
33,049

 
$
1,587

 
$
(2,699
)
 
$
(106
)

Personal auto liability experienced adverse development stemming solely from a reserve increase on one 2003 Michigan Catastrophic Claims Association unlimited personal injury protection claim. If not for this increase, personal auto liability would have experienced favorable development similar to prior reporting periods. Commercial auto liability experienced adverse development on reported claims stemming from an approximate 50 percent increase in the number and dollar amount of claims having development in excess of $100,000. Although the number of claims involved represented slightly over one percent of the commercial auto liability claims having development of any amount, the dollar impact was significant. Other liability also experienced adverse development on reported claims, however, approximately 90 percent of that development was attributed to an unexpected judgment on a single liability claim. Compared to prior reporting periods, the decline in favorable development on the commercial property and homeowners lines of business were attributed to the property and casualty insurance segment experiencing far fewer storm related claims during 2012, as opposed to the record numbers incurred during 2011. Approximately 35 percent fewer prior year storm-related property claims remained open during 2013 versus 2012, and the decrease in associated commercial property and homeowners' favorable development between the two calendar years totaled $2.7 million.
Overall, IBNR loss reserves developed adversely by $5.9 million.  This adverse development was primarily attributed to higher than expected emergence ($6.8 million), increased exposures ($1.8 million), and the impact of changes in line-of-business distribution ($996,000). The adverse development was partially offset by favorable development stemming from changes in the IBNR accident year allocation factors ($2.7 million), and from IBNR loss reserve decreases taken as a result of scheduled reserve reviews ($880,000).  The commercial property line of business was responsible for approximately 85 percent ($5.0 million) of the adverse development, the vast majority of which was attributable to higher than expected IBNR emergence. Homeowners and auto physical damage also experienced adverse IBNR loss reserve development ($1.1 million and $871,000, respectively) attributable to higher than expected IBNR emergence. Adverse IBNR emergence on these lines was not totally unexpected as the property and casualty insurance segment carries slightly lower levels of IBNR loss reserves on the property lines of business due to the consistent strength of reserves carried on reported claims.  Other Liability experienced a small amount of adverse IBNR loss reserve development ($299,000). The remaining casualty lines developed favorably. Surety bonds experienced adverse IBNR loss reserve development of $1.9 million due mainly to an increase in carried formula IBNR loss reserves. The following table displays the development experienced on IBNR loss reserves from each of these factors, by line of business:

24


 
 
Development on IBNR loss reserves resulting from:
($ in thousands)
Line of business
 
Loss emergence different than expected
 
Actions taken as a result of scheduled reserve reviews
 
Change in underlying exposures
 
Change in accident year allocation factors
 
Change in line-of-business distribution
 
Total
Personal auto liability
 
$
(269
)
 
$
(18
)
 
$
(66
)
 
$

 
$
10

 
$
(343
)
Commercial auto liability
 
(1,474
)
 
(173
)
 
246

 
(442
)
 
11

 
(1,832
)
Auto physical damage
 
879

 

 
2

 
(2
)
 
(8
)
 
871

Workers' compensation
 
(123
)
 
(1,043
)
 
155

 

 
(101
)
 
(1,112
)
Other liability
 
1,593

 
(915
)
 
1,434

 
(2,046
)
 
233

 
299

Commercial property
 
4,942

 
(39
)
 
25

 

 
70

 
4,998

Homeowners
 
1,079

 
(10
)
 
(26
)
 
(8
)
 
113

 
1,148

Bonds
 
124

 
1,318

 
8

 
(231
)
 
668

 
1,887

 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
$
6,751

 
$
(880
)
 
$
1,778

 
$
(2,729
)
 
$
996

 
$
5,916


The commercial property line of business includes liability claims from business owners policies. Part of the adverse IBNR loss reserve development was attributed to four large business owners liability claims ($1.0 million policy limit for the pool) which emerged during 2013. For comparison, IBNR emergence for calendar year 2012 consisted mostly of property claims, of which the largest was significantly below $1.0 million. As noted above, since the property and casualty insurance segment normally experiences significant favorable development on reported claims, a lower level of IBNR loss reserves was carried for the property lines (commercial property, homeowners and auto physical damage). The adverse IBNR emergence observed on the other liability line of business was attributed to a single 2010 construction defect claim which generated $2.7 million of adverse development.
Total settlement expense reserves developed favorably in 2013 by $7.1 million.  Approximately 65 percent of the favorable development was attributed to defense and cost containment expenses.  The reserves associated with these expenses were established in bulk, and were allocated to the various accident years in proportion to the accident year distribution of the underlying loss reserves.  During 2013, the underlying loss reserves experienced favorable development, which generated favorable development in the settlement expense reserves.  However, the portion of this reserve associated with asbestos claims experienced adverse development of $1.1 million due to strengthening required to bolster the indicated survival ratio (ratio of loss and settlement expense reserves to the three-year average of loss and settlement expense payments), which had declined due to increased litigation costs.  Changes in the IBNR loss reserve and bulk case loss reserve accident year allocation factors accounted for $1.1 million of the favorable development in the defense and cost containment expense reserves.  The remaining 35 percent of favorable development was attributed to adjusting and other expenses (i.e., internal claims department, independent adjuster and miscellaneous settlement expenses). Differences in the allocation factors used to distribute the reserves for these expenses at year-end 2013 compared to year-end 2012 generated $781,000 of adverse development.  The majority of the remaining favorable development resulted from settlement expense payments that were lower than anticipated in the payment patterns used in the December 31, 2012 accident year allocations.
Prior accident years’ reserves for non-voluntary assumed business developed favorably by $152,000, attributed primarily to assigned risk pools.
The above results reflect prior accident year reserve development on a direct and assumed basis.  During 2013, ceded losses and settlement expenses for prior accident years increased $5.3 million.  This increase in reinsurance recoveries was reported as favorable development.


25


Reinsurance segment
For the reinsurance segment, the December 31, 2013 estimate of loss and settlement expense reserves for accident years 2012 and prior decreased $5.5 million from the estimate at December 31, 2012.  This decrease represented 3.2 percent of the December 31, 2012 carried reserves.  The HORAD portion of the book experienced favorable development of approximately $5.6 million, while MRB experienced adverse development of approximately $74,000.  MRB accident years 2012 and 2010 experienced adverse development of $997,000 and $110,000, respectively.  The adverse development was mostly offset by favorable development on accident years 2006 ($431,000) and 2008 ($259,000), plus favorable development on most of the remaining prior accident years.  For the HORAD book of business, accident years 2009-2012 accounted for approximately 85 percent of the favorable development, with less significant amounts of favorable development occurring in most of the remaining prior accident years. The decline in favorable development in the HORAD book of business in 2013 compared to 2012 was generally expected by management as the expected loss ratios used in the development methodologies applied to the 2012 contract year were somewhat lower than previous contact years due to an extensive actuarial study performed during 2012. Much of the favorable development experienced in 2013 was attributed to reported losses that were below December 2012 implicit projections for policy year 2012 in the property per risk, catastrophe excess, multi-line excess and property pro rata treaty types.
No changes were made in the key actuarial assumptions utilized to estimate loss and settlement expense reserves during 2013, including the "expected loss ratios" utilized for prior contract years. The "expected loss ratios" utilized for the 2013 contract year were based on an extensive actuarial analysis of trended historic ultimate loss ratios based on current-level earned premiums. Where applicable, new contract loss information or loss histories were also incorporated into the selection process. Compared to the 2012 contract year selections, the property excess "expected loss ratios" increased slightly, as did the ocean marine pro rata "expected loss ratios". The casualty excess "expected loss ratio" decreased very slightly. The addition of a large account with favorable loss history to the small casualty pro rata portfolio that previously existed significantly lowered the "expected loss ratio" applied to that contract type.
 
Calendar Year Development Table
The following table shows the calendar year development of the loss and settlement expense reserves of the property and casualty insurance subsidiaries and the reinsurance subsidiary.  Amounts presented are on a net basis with (i) a reconciliation of the net loss and settlement expense reserves to the gross amounts presented in the consolidated financial statements and (ii) disclosure of the gross re-estimated loss and settlement expense reserves and the related re-estimated reinsurance receivables.
The differences between the loss and settlement expense reserves reported on a GAAP basis compared to the statutory basis are primarily due to a reclassification of certain pension and postretirement benefit reserves.  For statutory reporting, a portion of the liability for pension and postretirement benefit obligations is included in the loss and settlement expense reserves.  For GAAP reporting, this classification is reversed and the entire liability for pension and postretirement benefit obligations is reported on a separate line in the balance sheet.  These differences, along with other smaller adjustments, are referred to in the following table as “GAAP Adjustments.”
In evaluating the table, it should be noted that each cumulative redundancy amount includes the effects of all changes in reserves for prior periods.  Conditions and trends that have affected development of the liability in the past, such as a time lag in the reporting of assumed reinsurance business, the high rate of inflation associated with medical services and supplies and the reform measures implemented by several states to control administrative costs for workers’ compensation insurance, may not necessarily occur in the future.  Accordingly, it may not be appropriate to project future development of reserves based on this table.

26


 
 
Year ended December 31,
($ in thousands)
 
2005
 
2006
 
2007
 
2008
 
2009
 
2010
 
2011
 
2012
 
2013
 
2014
 
2015
Statutory reserves for losses and settlement expenses
 
502,927

 
514,576

 
521,159

 
541,254

 
529,527

 
529,672

 
558,707

 
555,089

 
584,478

 
639,198

 
662,028

GAAP Adjustments
 
(1,526
)
 
(1,827
)
 
(2,032
)
 
(1,459
)
 
(1,712
)
 
(2,201
)
 
(2,249
)
 
(3,380
)
 
(4,748
)
 
(4,081
)
 
(4,256
)
Reserves for losses and settlement expenses
 
501,401

 
512,749

 
519,127

 
539,795

 
527,815

 
527,471

 
556,458

 
551,709

 
579,730

 
635,117

 
657,772

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Paid (cumulative) as of:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

One year later
 
125,043

 
137,265

 
140,127

 
149,229

 
132,655

 
146,193

 
163,034

 
167,268

 
167,182

 
193,123

 

Two years later
 
202,851

 
217,804

 
221,285

 
221,157

 
210,418

 
228,455

 
252,631

 
250,982

 
267,749

 

 

Three years later
 
257,114

 
268,933

 
266,267

 
271,762

 
262,742

 
283,406

 
304,697

 
308,779

 

 

 

Four years later
 
290,940

 
297,075

 
297,348

 
305,261

 
296,871

 
316,501

 
340,708

 

 

 

 

Five years later
 
309,532

 
316,320

 
320,676

 
328,652

 
316,313

 
340,597

 

 

 

 

 

Six years later
 
323,175

 
334,151

 
336,198

 
343,807

 
334,492

 

 

 

 

 

 

Seven years later
 
337,044

 
345,682

 
348,545

 
358,441

 

 

 

 

 

 

 

Eight years later
 
346,284

 
354,993

 
361,099

 

 

 

 

 

 

 

 

Nine years later
 
353,957

 
364,882

 

 

 

 

 

 

 

 

 

Ten years later
 
361,463

 

 

 

 

 

 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reserves re-estimated as of:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

End of year
 
501,401

 
512,749

 
519,127

 
539,795

 
527,815

 
527,471

 
556,458

 
551,709

 
579,730

 
635,117

 
657,772

One year later
 
459,485

 
474,011

 
483,819

 
491,173

 
477,066

 
494,372

 
530,725

 
538,924

 
558,938

 
600,003

 

Two years later
 
446,279

 
460,931

 
464,515

 
469,576

 
461,732

 
487,289

 
518,626

 
517,417

 
544,601

 

 

Three years later
 
437,589

 
449,500

 
447,685

 
459,076

 
457,524

 
487,045

 
497,591

 
509,781

 

 

 

Four years later
 
429,680

 
437,096

 
445,162

 
461,072

 
454,989

 
467,397

 
495,411

 

 

 

 

Five years later
 
423,365

 
436,838

 
445,272

 
458,614

 
439,428

 
467,726

 

 

 

 

 

Six years later
 
421,851

 
438,029

 
444,376

 
448,424

 
440,215

 

 

 

 

 

 

Seven years later
 
424,004

 
437,091

 
437,308

 
449,975

 

 

 

 

 

 

 

Eight years later
 
424,865

 
431,073

 
439,663

 

 

 

 

 

 

 

 

Nine years later
 
419,081

 
433,602

 

 

 

 

 

 

 

 

 

Ten years later
 
421,620

 

 

 

 

 

 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cumulative redundancy
 
79,781

 
79,147

 
79,464

 
89,820

 
87,600

 
59,745

 
61,047

 
41,928

 
35,129

 
35,114