10-K 1 a2016123110k.htm 10-K Document

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, 2016
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 Global Select Market
(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, 2016 was $256,645,260.
The number of shares outstanding of the registrant's common stock, $1.00 par value, on February 28, 2017, was 21,269,368.

DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive proxy statement for the Annual Meeting of Stockholders to be held on May 25, 2017, and to be filed pursuant to Regulation 14A within 120 days after the registrant’s fiscal year ended December 31, 2016, 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.
 
Item 16.

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 55 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, a large portion of its business is marketed and generated in the Midwest.
The Company conducts its insurance business through two business segments as follows:
businesssegments.jpg

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 77 percent of consolidated premiums earned in 2016.  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 23 percent of consolidated premiums earned in 2016.  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 provide protection from both the frequency and severity of such losses. The reinsurance program consists of two semi-annual aggregate catastrophe excess of loss treaties. The first treaty was effective from January 1, 2016 through June 30, 2016, and had a retention of $20.0 million and a limit of $24.0 million. The total cost of this treaty was approximately $6.3 million. The second treaty was effective from July 1, 2016 through December 31, 2016, and had a retention of $15.0 million and a limit of $12.0 million. The total cost of this treaty was 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) were subject to the terms of these treaties, and there was no co-participation provision.
All transactions occurring under the pooling agreement and the inter-company reinsurance program with Employers Mutual are based on statutory accounting principles. Certain adjustments are made to these amounts to bring them into compliance with U.S. generally accepted accounting principles (GAAP).

3


Operations of the pool and the inter-company reinsurance program 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 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 written1 in 2016 and $1.4 billion in statutory surplus as of December 31, 2016) 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.
1 Premiums written is an industry metric used to quantify the amount of insurance sold during a specified reporting period. Premiums earned is the recognition of the portion of premiums written directly related to the expired portion of an insurance policy for a given reporting period.
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,
 
 
2016
 
2015
 
2014
Employers Mutual1
 
0.81

 
0.74

 
0.74

EMCASCO2
 
1.44

 
1.54

 
1.57

Illinois EMCASCO2
 
1.44

 
1.52

 
1.52

Dakota Fire2
 
1.51

 
1.59

 
1.61

EMC Property & Casualty Company1
 
(0.27
)
 
0.65

 
0.64

Union Insurance Company of Providence1
 
(0.27
)
 
0.65

 
0.65

Hamilton Mutual Insurance Company
 
0.88

 
0.89

 
0.90

1 The ratios for these companies reflect changes in their pool participation percentages in 2016. Effective January 1, 2016, the pool participation rates for EMC Property & Casualty Company and Union Insurance Company of Providence declined to zero, while Employers Mutual's pool participation rate increased to 68 percent.
2 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.


4


Reinsurance
The Company’s reinsurance subsidiary is party to a quota share reinsurance retrocessional agreement (the “quota share 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.  EMC Reinsurance Company also writes a relatively small amount of assumed reinsurance business on a direct basis (outside the quota share reinsurance agreement).  
The Company's reinsurance subsidiary also has an inter-company reinsurance program in place with Employers Mutual, covering both business assumed from Employers Mutual through the quota share agreement, as well as business obtained outside the quota share agreement. 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 2016 reinsurance program consists of two treaties. The first was 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 total cost of this treaty was approximately $2.0 million. The second was 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 total cost of this treaty was approximately $3.1 million. Any losses recovered under the per occurrence treaty inure to the benefit of the aggregate treaty, and only catastrophic events with total losses greater than $500,000 are subject to the terms of the aggregate treaty. Prior to 2016, the reinsurance program with Employers Mutual consisted of a single excess of loss reinsurance agreement. Under the terms of that agreement, the reinsurance subsidiary retained the first $4.0 million of losses per event, and also retained 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 included 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, was 8.0 percent of the reinsurance subsidiary’s total assumed reinsurance premiums written in 2015 and 2014.
In connection with the change in the inter-company reinsurance program in 2016, the reinsurance subsidiary began purchasing additional reinsurance protection 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 reduces the amount of losses ceded to Employers Mutual under the inter-company reinsurance program. The net cost of this external reinsurance protection was approximately $3.5 million in 2016.
All transactions occurring under the quota share agreement and the inter-company reinsurance program 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 agreement and the inter-company reinsurance program 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.

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.

5


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.

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
Includes 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; and 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.

6


The following table sets forth the aggregate direct premiums written of all parties to the pooling agreement for the three years ended December 31, 2016, by line of business.
 
 
Year ended December 31,
 
 
2016
 
2015
 
2014
($ in thousands)
Line of business
 
Amount
 
Percent of total
 
Amount
 
Percent of total
 
Amount
 
Percent of total
Commercial lines:
 
 
 
 
 
 
 
 
 
 
 
 
Automobile
 
$
383,503

 
23.4
%
 
$
367,559

 
23.2
%
 
$
344,013

 
22.7
%
Property
 
421,792

 
25.8

 
403,567

 
25.5

 
387,408

 
25.5

Workers' compensation
 
327,663

 
20.0

 
309,654

 
19.6

 
293,140

 
19.3

Liability
 
340,337

 
20.8

 
329,045

 
20.8

 
311,516

 
20.5

Other
 
31,725

 
1.9

 
29,704

 
1.9

 
28,236

 
1.9

Total commercial lines
 
1,505,020

 
91.9

 
1,439,529

 
91.0

 
1,364,313

 
89.9


 
 

 
 

 
 

 
 

 
 

 
 

Personal lines
 
132,697

 
8.1

 
141,546

 
9.0

 
152,964

 
10.1

Total
 
$
1,637,717

 
100.0
%
 
$
1,581,075

 
100.0
%
 
$
1,517,277

 
100.0
%

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, 2016. During 2016, $5.1 million of premiums written were ceded to Employers Mutual in accordance with the terms of the revised inter-company reinsurance program and $5.1 million of premiums written were ceded to external parties. In contrast, during 2015 and 2014, $10.8 million and $10.3 million, respectively, of premiums written (representing 8.0 percent of the reinsurance subsidiary’s total assumed reinsurance premiums written for those years) were ceded to Employers Mutual in accordance with the terms of the prior inter-company reinsurance program. The premium associated with the 2016 inter-company reinsurance program was allocated entirely to the excess of loss line of business, while the premium associated with the 2015 and 2014 inter-company reinsurance programs was allocated to all lines of business.
 
 
Year ended December 31,
 
 
2016
 
2015
 
2014
($ in thousands)
Line of business
 
Amount
 
Percent of total
 
Amount
 
Percent of total
 
Amount
 
Percent of total
Pro rata reinsurance
 
$
52,996

 
40.4
%
 
$
48,652

 
39.1
%
 
$
42,577

 
35.8
%
Excess of loss reinsurance
 
78,034

 
59.6

 
75,852

 
60.9

 
76,326

 
64.2

Total
 
$
131,030

 
100.0
%
 
$
124,504

 
100.0
%
 
$
118,903

 
100.0
%


7


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.  Beginning in 2016, the accountability and responsibility for personal lines business was taken out of the branch offices and assigned to a new personal lines operation in the home office. The pool participants’ products are marketed exclusively through a network of 2,121 local independent agency relationships through 4,114 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 2016, with 92 percent of this business coming from commercial lines products and 8 percent coming from personal lines products.  Although a large portion 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.
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, and contractors.  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 loss control products and services that are targeted to the needs of the group members through a local independent agent.

8


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, 2016.
 
 
Year ended December 31,
 
 
2016
 
2015
 
2014
Illinois
 
4.2
%
 
4.2
%
 
4.3
%
Iowa
 
12.5

 
13.0

 
13.3

Kansas
 
8.0

 
8.5

 
9.2

Michigan
 
4.9

 
4.6

 
4.3

Minnesota
 
5.1

 
4.7

 
4.6

Nebraska
 
5.4

 
5.3

 
5.2

North Carolina
 
3.5

 
3.1

 
2.8

Texas
 
4.3

 
4.1

 
3.9

Wisconsin
 
5.9

 
5.6

 
5.4

Other *
 
46.2

 
46.9

 
47.0

 
 
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 95 percent of its business from Employers Mutual through the quota share agreement, and writes 5 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 84 percent of the reinsurance subsidiary’s assumed reinsurance premiums written in 2016 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 primarily generated through independent intermediaries.  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.
The remaining 16 percent of the reinsurance subsidiary’s assumed reinsurance premiums written in 2016 were generated through Employers Mutual’s participation in MRB, an unincorporated association through which Employers Mutual and four 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 assumed by MRB from 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 four 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.

9


The following table sets forth the geographic distribution of the assumed premiums written of the reinsurance subsidiary (gross of the amounts ceded to Employers Mutual in connection with the inter-company reinsurance program and, beginning in 2016, the cost of additional reinsurance protection from external parties) for the three years ended December 31, 2016.
 
 
Year ended December 31,
 
 
2016
 
2015
 
2014
($ in thousands)
Domiciliary jurisdiction
 
Amount
 
Percent of total
 
Amount
 
Percent of total
 
Amount
 
Percent of total
Germany
 
$
6,724

 
4.8
%
 
$
3,672

 
2.7
%
 
$
6,444

 
5.0
%
Other foreign jurisdictions1
 
13,749

 
9.7

 
14,018

 
10.4

 
14,261

 
11.0

Domestic
 
120,690

 
85.5

 
117,641

 
86.9

 
108,537

 
84.0

Total
 
$
141,163

 
100.0
%
 
$
135,331

 
100.0
%
 
$
129,242

 
100.0
%
1 Includes all other foreign jurisdictions, none of which accounted for more than 3 percent during any of the three years presented.

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 $27.4 million in 2016.  During 2016, the reinsurance subsidiary ceded to Employers Mutual $5.1 million of premiums under the inter-company reinsurance program.  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 through the quota share agreement in 2016 was $367,000.

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.

10


While reinsurer competition for national and regional company business is growing, management 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.

11


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, 2016.  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,
 
 
2016
 
2015
 
2014
 
2013
 
2012
Property and casualty insurance1
 
 
 
 
 
 
 
 
 
 
Loss and settlement expense ratio
 
64.6
%
 
65.5
%
 
70.5
%
 
67.2
%
 
66.2
%
Expense ratio
 
33.9
%
 
33.4
%
 
32.0
%
 
35.0
%
 
35.3
%
Combined trade ratio
 
98.5
%
 
98.9
%
 
102.5
%
 
102.2
%
 
101.5
%
 
 
 
 
 
 
 
 
 
 
 
Reinsurance1
 
 

 
 

 
 

 
 

 
 

Loss and settlement expense ratio
 
68.0
%
 
64.1
%
 
73.9
%
 
59.0
%
 
68.4
%
Expense ratio
 
24.4
%
 
24.9
%
 
24.5
%
 
23.7
%
 
21.8
%
Combined trade ratio
 
92.4
%
 
89.0
%
 
98.4
%
 
82.7
%
 
90.2
%
 
 
 
 
 
 
 
 
 
 
 
Total insurance operations1
 
 

 
 

 
 

 
 

 
 

Loss and settlement expense ratio
 
65.5
%
 
65.2
%
 
71.2
%
 
65.2
%
 
66.7
%
Expense ratio
 
31.8
%
 
31.6
%
 
30.4
%
 
32.3
%
 
32.3
%
Combined trade ratio
 
97.3
%
 
96.8
%
 
101.6
%
 
97.5
%
 
99.0
%
 
 
 
 
 
 
 
 
 
 
 
Property and casualty insurance industry averages2
 
 

 
 

 
 

 
 

 
 

Loss and settlement expense ratio
 
73.0
%
 
69.8
%
 
69.3
%
 
67.7
%
 
73.4
%
Expense ratio
 
27.7
%
 
28.5
%
 
28.1
%
 
28.7
%
 
28.8
%
Combined trade ratio
 
100.7
%
 
98.3
%
 
97.4
%
 
96.4
%
 
102.2
%
1 Beginning in 2014, the expense ratios for the Company's property and casualty insurance subsidiaries reflect net periodic postretirement benefit income 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 inter-company reinsurance program) 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 inter-company reinsurance program) 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.  
2 As reported by A.M. Best.  The ratio for 2016 is an estimate; the actual combined trade ratio is not currently available.

12


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 estimate 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 loss 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 loss reserves on assumed reinsurance business are the amounts reported by the ceding companies.
Beginning in 2016, the amount of reserves for unreported claims, known as “Incurred But Not Reported (IBNR) loss reserves”, is generally determined by subtracting paid loss amounts and the case loss reserves carried on reported claims from the estimated ultimate loss amounts established by line of business and accident year.  Prior to 2016, IBNR loss reserves were determined on the basis of statistical information for each line of insurance with respect to expected loss emergence arising from occurrences that had 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.  Reserves are established separately for expenses specifically associated with a claim (allocated) and expenses not specifically associated with a claim (unallocated).  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.

13


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, 2016 represents management’s best estimate of the Company’s overall liability.
Reserving Methodology and Determination of Management’s Best Estimate of Overall Liability
Property and casualty insurance
The property and casualty insurance segment establishes case loss, IBNR loss and settlement expense reserves separately for three categories of losses, which are (1) all claims other than those stemming from storms, catastrophic events, asbestos and environmental exposures (general claims), (2) storms and catastrophic events, and (3) asbestos and environmental claims. Case loss reserves are established on a common basis for all three categories 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. IBNR loss and settlement expense reserves are established differently for the three categories of losses as discussed below.
Reserves for General Claims
Effective September 30, 2016, IBNR loss reserves for general claims are calculated by subtracting paid loss amounts and the case loss reserves carried on reported claims from the estimated ultimate loss amounts established by line of business and accident year. Allocated settlement expense reserves are established in a similar manner, except that only paid expenses to date are subtracted from the estimated ultimates, as adjusters do not establish case-basis settlement expense reserves. Unallocated settlement expenses reserves are determined through a study of historical paid expenses compared to paid loses. The unallocated 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.
Lines of Business and Process Overview
Reserves are evaluated for adequacy on a quarterly basis, and are the end-product of a broader process by which management establishes estimated ultimate loss (net of salvage, subrogation and reimbursement recoveries) and allocated settlement expense amounts by line of business and accident year. At quarter-end, carried bulk reserves are established as the difference between management's estimated ultimate amounts, and the reported amounts incurred to date. At the highest level, the actuarial department establishes estimated ultimate loss and allocated settlement expense amounts by accident year for claims aggregated into eight reserving lines of business: personal auto liability, commercial auto liability, auto physical damage, workers' compensation, other liability, commercial property, homeowners, and an “all other” category, which consists mostly of fidelity and surety bonds.
For each line of business, the establishment of IBNR loss and allocated settlement expense reserves begins with a review of historical experience as of the end of the previous quarter. The actuarial department utilizes standard actuarial incurred and paid chain ladder (triangle) development methods, expected loss and settlement expense ratio methods, and various methodologies which blend the development and expected ratio methods, such as the Bornhuetter-Ferguson method. The actuarial department employs these methods using incurred and paid losses and paid allocated settlement expenses aggregated on both a calendar/accident year basis and an accident quarter basis. The calendar/accident year development triangles generated in this process contain thirty-five years of historic data, and provide the tail development factors used in the accident quarter development triangles, which only utilize ten years of historic data. The end result of the process is a separate set of estimated ultimate ratios to earned premiums for losses and allocated settlement expenses by reserving line of business and accident year/quarter. At the end of each quarter, the selected estimated ultimate ratios are applied to the corresponding calendar year/quarter earned premiums to produce the estimated ultimate dollar amounts, from which the amounts reported to date are subtracted to produce the IBNR loss reserves and allocated settlement expense reserves to be recorded.

14


Fifteen different averaging periods/methods are used in the incurred and paid chain ladder methods to produce development factors to ultimate, from which the five medial estimates are generally selected to produce the chain ladder ultimate estimates. Thus, using both the incurred and paid chain ladder methods, ten ultimate loss estimates are produced for each accident year and accident quarter. Since the pool participants do not establish settlement expense reserves on an individual claim basis, there is no corresponding incurred allocated settlement expense data upon which to apply the chain ladder method. Therefore, only five ultimate allocated settlement expense estimates are produced for each accident year and accident quarter as only the paid chain ladder method can be applied.
In addition to the accident year and accident quarter ultimate loss and allocated settlement expense estimates produced from the chain ladder methods, the actuarial department employs the following methodologies on an incurred and paid basis: Bornhuetter-Ferguson, Benktander (iterative Bornhuetter-Ferguson), Ultimate Frequency-Severity and Generalized Cape Cod. The actuarial department will also sometimes apply the Expected Loss Ratio Method for extremely immature accident years/quarters. For allocated settlement expenses, the actuarial department also produces ultimate estimates by applying the chain ladder approach to the ratio of paid allocated settlement expenses to paid losses. The ultimate factors from these paid-to-paid ratios are applied to the ultimate losses determined by the paid chain ladder method to produce ultimate allocated settlement expense dollar amounts.
Range of Reasonable Ultimates and Management's Best Estimate: Except for the Expected Loss Ratio Method, each of the above listed methods are employed, where applicable, using each of the five factors to ultimate from the incurred and paid chain ladder methods. This results in forty-five ultimate loss estimates and thirty-five ultimate allocated settlement expense estimates, exclusive of the special situations where the Expected Loss Ratio Method is also applied. The actuarial department examines the indicated ultimate amounts for each category (losses and allocated settlement expenses) and each accident year/quarter, and applies judgment and knowledge of each method’s biases (if any) to exclude unreasonable estimates. The maximum and minimum of the remaining estimates define the range of reasonable ultimates. The point estimates within the range are further scrutinized for evenness of spread or for evidence of clustering around specific estimates. A comparison is also made to previous estimates. For the latest accident years, management generally selects an estimate in the third, or possibly fourth, quartile of the reasonable range as the best estimate. For more mature years, the mean is generally selected to be management's best estimate.
The selected point estimate for each accident year/quarter is divided by its corresponding earned premiums to produce the expected ultimate loss and allocated settlement expense ratios. At quarter end, the ratios are applied to the corresponding calendar year/quarter earned premiums to produce the ultimate estimated dollar amounts, from which the amounts incurred to date are subtracted to produce the IBNR loss and allocated settlement expense reserves to be recorded.
Reserves for Storms and Catastrophic Events
IBNR loss reserves for storms and catastrophic events are established by the branch offices in conjunction with the home office claims department. IBNR loss reserves associated with storms and catastrophic events are event-specific.  The pool participants define a storm or catastrophic event as any event for which the Property Liability Research Bureau (PLRB) assigns an occurrence number. When a storm or catastrophic event occurs, the location of the event is overlaid with a map of the pool participants’ 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. Since the pool participants do not establish separate settlement expense reserves for individual storm and catastrophe claims, the reserving methodology for settlement expenses on these claims is included in the settlement expense reserving process for general claims.
Reserves for Asbestos and Environmental Claims
The IBNR loss and settlement expense reserves are established jointly for asbestos and environmental liabilities as the available estimation methodologies require the consideration of both loss and 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 the actuarial department. Internal and industry survival ratios are also monitored to assist in validating assumptions underlying the payout scenarios.


15


Reinsurance
The IBNR loss reserves for the HORAD book of business are determined and booked each quarter along with the ceding companies’ reported 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 next several paragraphs provide addition detail on the HORAD reserving process.
Reserves for the HORAD book of business are reviewed quarterly. Contract years 1988 and subsequent are reviewed every quarter, while accident years 1981-1987, for which detailed contract year information is not available, are reviewed separately during the fourth quarter. Management segregates claims data associated with specified catastrophe occurrences expected to exceed $2.0 million in losses, and establishes a catastrophe specific IBNR loss reserve based upon an evaluation of the exposed reinsurance contracts. Once established, catastrophe specific IBNR reserves are taken down as claims are reported, unless the ultimate expected loss is adjusted by management.
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 loss reserves” for ceding companies whose reported case loss 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-Furguson 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 totals.
For the major contract types, the reinsurance subsidiary 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 subsidiary uses Reinsurance Association of America (RAA) development triangles to assist in estimating reserves 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 premiums 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 reserves 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 patterns of the contract types (occurrence vs. risks attaching contracts).
The reinsurance subsidiary also books earned but not reported (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 premiums 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 recorded amount.

16


Reported case and IBNR loss reserves associated with the MRB book of business are established by that entity’s management, and booked by the reinsurance subsidiary on a monthly basis. MRB claims files are audited annually by the member companies’ reinsurance claim departments, and the member companies' actuarial departments perform an annual reserve adequacy review. The reinsurance subsidiary 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, and a negative bulk IBNR loss reserve may be booked, during periods when the Company's actuarial reviews indicate MRB's carried reserves are more than adequate to cover its liabilities.

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 and have a negative impact on the Company's financial condition and results of operations.

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 and have a negative impact on the Company's financial condition and results of operations.

See note 4 of Notes to Consolidated Financial Statements under Part II, Item 8 of this Form 10-K for a reconciliation of beginning and ending reserves for losses and settlement expenses for the three years ended December 31, 2016, as well as ten years of incurred and paid development information for each major line of business. 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 any impact on earnings.


17


Year ended December 31, 2016
Property and casualty insurance segment
For the property and casualty insurance segment, the December 31, 2016 estimate of loss and settlement expense reserves for accident years 2015 and prior decreased $30.0 million from the estimate at December 31, 2015.  This decrease represents 6.2 percent of the December 31, 2015 carried reserves.  During the third quarter of 2016, management implemented a new reserving methodology for the determination of direct bulk reserves in the property and casualty insurance segment. The new methodology produces specific line of business and accident year estimated ultimate loss and allocated settlement expense amounts based on explicit loss frequency and severity assumptions. The previous methodology used one process to determine the aggregate amount of IBNR loss and settlement expense reserves, and a separate process to allocate those reserves to the various accident years. The implementation of the new reserving methodology did not have a material impact on total carried reserves for the property and casualty insurance segment; however, there was some movement of allocated settlement expense reserves to IBNR loss reserves, and a reallocation of loss and allocated settlement expense reserves by accident year to align those reserves with the estimated ultimate loss and allocated settlement expense ratios. In connection with this reallocation of reserves by accident year, approximately $5.6 million of IBNR loss and allocated settlement expense reserves were moved from prior accident years to the current accident year in multiple lines of business. This reduction in prior accident years' reserves is reported as favorable development; however, this development is "mechanical in nature", and did not have any impact on earnings because the total amount of carried reserves did not change. The following table displays development on prior years' reserves by line of business and type of reserve.
($ in thousands)
Line of business
 
Reported and unreported loss reserves
 
Allocated settlement expense reserves
 
Unallocated settlement expense reserves
 
Total
Personal lines
 
$
(1,242
)
 
$
(302
)
 
$
(33
)
 
$
(1,577
)
Commercial auto liability
 
6,807

 
(3,236
)
 
(1,222
)
 
2,349

Auto physical damage
 
(1,850
)
 
(34
)
 
205

 
(1,679
)
Workers' compensation
 
(11,271
)
 
(4,205
)
 
(844
)
 
(16,320
)
Other liability
 
(2,709
)
 
(9,936
)
 
(523
)
 
(13,168
)
Commercial property
 
1,296

 
982

 
174

 
2,452

Other
 
(1,426
)
 
(163
)
 
(481
)
 
(2,070
)
 
 
 
 
 
 
 
 
 
Total
 
$
(10,395
)
 
$
(16,894
)
 
$
(2,724
)
 
$
(30,013
)

The favorable development reported for 2016 is generally attributed to lower explicit loss frequency and severity assumptions underlying the loss and allocated settlement expense reserves carried at year-end 2016 than the implicit assumptions underlying the reserves carried at year-end 2015. The favorable development associated with the loss and allocated settlement expense reserves total $27.3 million, with $10.4 million coming from favorable loss reserve development and $16.9 million coming from favorable allocated settlement expense reserve development.
Favorable development on loss and allocated settlement expense reserves represents 91 percent of the property and casualty insurance segment’s total reported favorable development of $30.0 million. The following table displays the development experienced in 2016 on reported and unreported loss reserves and allocated settlement expense reserves for the five most recent accident years, by line of business.

18


($ in thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Calendar
accident
year
 
Personal
lines
 
Commercial
auto
liability
 
Auto
physical
damage
 
Workers'
compensation
 
Other
liability
 
Commercial
property
 
Other
 
Total
Prior
 
$
(96
)
 
$
(490
)
 
$
(145
)
 
$
218

 
$
2,681

 
$
(158
)
 
$
(361
)
 
$
1,649

2011
 
(182
)
 
(277
)
 
(37
)
 
(770
)
 
(1,654
)
 
672

 
(83
)
 
(2,331
)
2012
 
(243
)
 
(67
)
 
(72
)
 
(1,910
)
 
(3,435
)
 
296

 
(200
)
 
(5,631
)
2013
 
(199
)
 
126

 
(116
)
 
(2,940
)
 
(495
)
 
557

 
(142
)
 
(3,209
)
2014
 
(211
)
 
1,129

 
(204
)
 
(3,643
)
 
(2,231
)
 
(332
)
 
(163
)
 
(5,655
)
2015
 
(613
)
 
3,150

 
(1,310
)
 
(6,431
)
 
(7,511
)
 
1,243

 
(640
)
 
(12,112
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
$
(1,544
)
 
$
3,571

 
$
(1,884
)
 
$
(15,476
)
 
$
(12,645
)
 
$
2,278

 
$
(1,589
)
 
$
(27,289
)

The property and casualty insurance segment's new bulk reserving methodology is based on explicit assumptions concerning the ultimate number (frequency) and average size (severity) of claims expected to be incurred. The prior methodology separated the calculation of the aggregate reserves from the allocation of those reserves to the various accident years, and thus did not utilize explicit claim frequency and severity assumptions. Under the new reserving methodology, management seeks to better align expected and actual development by line of business and accident year. As this is a transitional year, there are some discontinuities in the development amounts reported for 2016. The following comments are based on a comparison of the explicit assumptions underlying the December 31, 2016 carried reserves to the implicit assumptions underlying the December 31, 2015 carried reserves.
In the table above, five of the seven lines of business exhibited favorable development on a fairly consistent basis over the prior five accident years, those being personal lines, auto physical damage, workers’ compensation, other liability and other. For these lines of business, favorable development for most accident years was driven by decreases in the frequency and/or severity assumptions underlying the estimated ultimate accident year loss and allocated settlement expense ratios. The workers’ compensation line of business experienced adverse development on accident years prior to 2011, as management strengthened those reserves in response to increases in the severity assumptions for those years due to the expansion of the experience review period to thirty-five accident years.
The commercial auto liability line of business experienced adverse development in each of the latest three accident years. Comparing the explicit assumptions utilized at December 31, 2016 to the implicit assumptions underlying the December 31, 2015 reserves, the ultimate claim frequency and severity assumptions for accident year 2015 were underestimated by 1.8 percent and 9.7 percent, respectively. Using the same comparison, claims severity for accident year 2014 was underestimated by 3.4 percent, and for accident year 2013, claim frequency was slightly underestimated.
The commercial property line of business experienced the greatest number of development discontinuities by accident year in connection with the change in reserving methodology. Under the previous methodology, negative bulk case loss reserves were often carried in the commercial property line of business due to the perceived strength of the case loss reserves relative to the other lines of business. With the elimination of the bulk case loss reserves under the new methodology, the reserves for the commercial property line of business were reallocated in total and by accident year in accordance with the explicit claim frequency and severity assumptions developed during 2016. The implicit assumptions utilized at year-end 2015 underestimated claim frequency for each of the five most recent accident years, and underestimated loss severity for all of those years except 2014.
The Company increased asbestos and environmental IBNR loss and settlement expense reserves by $3.5 million during 2016, which is primarily reflected in the other liability line of business. The increase was in response to an indicated increase in the ultimate asbestos liability produced by internal payout decay models. Management also notes that A.M. Best increased the industry’s estimated ultimate liability by $15 billion during 2016. Newly reported asbestos claims have decreased slightly for the last two calendar years. Asbestos and environmental reserves constitute less than 3 percent of the property and casualty insurance segment’s total direct reserves.


19


Reinsurance segment
For the reinsurance segment, the December 31, 2016 estimate of loss and settlement expense reserves for accident years 2015 and prior decreased $10.9 million from the estimate at December 31, 2015.  This decrease represents 5.5 percent of the December 31, 2015 carried reserves.  Approximately $7.1 million of favorable development is attributable to the HORAD book of business, with the remaining $3.8 million of favorable development associated with MRB.
In the HORAD book of business, $7.4 million of favorable development occurred in the pro rata line of business and $0.3 million of adverse development occurred in the excess of loss line of business. The favorable development in the pro rata line of business primarily occurred in the 2015 accident year, with accident years 2012 - 2014 generating $1.4 million of adverse development and the remaining prior accident years experiencing little development in the aggregate. In the excess of loss line of business, the 2015 accident year experienced over $3.0 million of favorable development; however, this favorable development was more than offset by adverse development in many of the prior 21 accident years, with the greatest amount of adverse development concentrated in accident years 2005 - 2014.
The favorable development experienced on the MRB business is mostly attributed to an increase in the amount of negative bulk IBNR loss reserve carried on prior years' reserves. Recent actuarial reviews of MRB's reported reserves have consistently indicated that those reserves challenged the upper level of the range of reasonable reserves. To address this issue, a $2.0 million negative bulk IBNR loss reserve was established in 2015 for this business. During 2016, the negative bulk IBNR loss reserve was increased to $4.0 million, with $5.3 million of negative IBNR loss reserve carried on prior accident years and $1.3 million of positive lag IBNR loss reserve carried on the 2016 accident year. The recognition of the additional negative IBNR loss reserve accounts for $3.3 million of the $3.8 million of favorable development experienced during 2016.
During 2016, the expected loss ratios utilized for prior contract years remained unchanged, except for ocean marine pro rata business. The expected loss ratios associated with this contract type were decreased by approximately 2.5, 4.0 and 5.0 percentage points for contract years 2012, 2014 and 2015, respectively, from the ratios utilized during 2015. Additionally, the expected loss ratio for contract year 2013 was increased by approximately 2.0 percentage points relative to the 2015 value. These changes were made in response to reserving information supplied by the ceding company, a large writer of ocean marine pro rata business.
The expected loss ratios utilized for the 2016 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 reserving process. Compared to the 2015 contract year selections, the 2016 contract year expected loss ratios for per risk excess and casualty excess business increased by 2.5 percentage points, while the expected loss ratio for aggregate excess business decreased by 5.0 percentage points. The 2016 contract year expected loss ratio for ocean marine pro rata business increased approximately 2.5 percentage points above the initial 2015 contract year selection, but is now approximately 7.5 percentage points above the revised ratio.

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 represented 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:

20


($ 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 was 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 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 represented 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.
While the adverse development experienced in commercial auto liability remained significant, the decline from the amount reported in 2014 was also significant. Similar to 2014, the adverse development was 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, appeared to indicate continued strengthening of case loss reserves for claims reported during 2015 relative to 2014. Management continued 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 was attributed 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 was not totally unexpected. Favorable development was consistently observed on reported property claims, therefore, lower levels of IBNR loss reserves were 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:

21


 
 
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.
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 represented 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.  

22


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.  
Reserves on previously reported claims developed favorably in 2014 by approximately $5.9 million.  This included $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:

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
 
$
(1,184
)
 
$
(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.
IBNR loss reserves experienced $201,000 of adverse development, which was attributed 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:

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
 
$
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 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 $1.2 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 was reported as adverse development.

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.

25


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.
 
Asbestos and Environmental Claims
The Company has exposure to asbestos and environmental-related claims associated with the insurance business written by the parties to the pooling agreement and the reinsurance business assumed from Employers Mutual by the reinsurance subsidiary.  With regard to the assumed reinsurance business, however, all asbestos and environmental exposures related to 1980 and prior accident years are retained by Employers Mutual.
Estimating loss and settlement expense reserves for asbestos and environmental claims is very difficult due to the many uncertainties surrounding these types of claims.  These uncertainties exist because the assignment of responsibility varies widely by state and claims often emerge long after a policy has expired, which makes assignment of damages to the appropriate party and to the time period covered by a particular policy difficult.  In establishing reserves for these types of claims, management monitors the relevant facts concerning each claim, the current status of the legal environment, social and political conditions, and the claim history and trends within the Company and the industry.
The following table presents asbestos and environmental-related losses and settlement expenses incurred and reserves outstanding, net of reinsurance, for the Company:
 
 
Year ended December 31,
($ in thousands)
 
2016
 
2015
 
2014
Losses and settlement expenses incurred:
 
 
 
 
 
 
Asbestos:
 
 
 
 
 
 
Property and casualty insurance
 
$
3,475

 
$
3,584

 
$
1,614

Reinsurance
 

 

 

 
 
3,475

 
3,584

 
1,614

Environmental:
 
 

 
 

 
 

Property and casualty insurance
 
652

 
304

 
(42
)
Reinsurance
 

 

 

 
 
652

 
304

 
(42
)
Total losses and settlement expenses incurred
 
$
4,127

 
$
3,888

 
$
1,572

 
 
Year ended December 31,
($ in thousands)
 
2016
 
2015
 
2014
Loss and settlement expense reserves:
 
 
 
 
 
 
Asbestos:
 
 
 
 
 
 
Property and casualty insurance
 
$
11,134

 
$
9,248

 
$
7,587

Reinsurance
 
359

 
385

 
412

 
 
11,493

 
9,633

 
7,999

Environmental:
 
 

 
 

 
 

Property and casualty insurance
 
846

 
858

 
559

Reinsurance
 
666

 
686

 
738

 
 
1,512

 
1,544

 
1,297

Total loss and settlement expense reserves
 
$
13,005

 
$
11,177

 
$
9,296



26


The property and casualty insurance subsidiaries have exposure to asbestos and environmental claims arising primarily from the other liability line of business.  These exposures are closely monitored by management, and IBNR loss reserves have been established to cover estimated ultimate losses.  The loss and settlement expense reserves associated with asbestos claims have been increased each year for the last several years due to continued reporting of new claims at a rate not previously anticipated, as well as updated internal ultimate loss and settlement expense evaluations. In 2016, the loss and settlement expense reserves for asbestos claims were strengthened approximately $3.5 million.
Reserves for environmental claims are established in consideration of the implied three-year survival ratio.  Estimation of ultimate liabilities for these exposures is unusually difficult due to unresolved issues such as whether coverage exists, the definition of an occurrence, the determination of ultimate damages and the allocation of such damages to financially responsible parties. Therefore, any estimation of these liabilities is subject to greater than normal variation and uncertainty, and ultimate payments for losses and settlement expenses for these exposures may differ significantly from the carried reserves.
Based upon current facts, management believes the reserves carried for asbestos and environmental-related claims at December 31, 2016 are adequate.  Although future changes in the legal and political environment may result in adjustment to these reserves, management believes any adjustment will not have a material impact on the Company's financial condition or results of operations.

Reinsurance Ceded
Property and Casualty Insurance
The pool participants cede insurance in the ordinary course of business for the primary purpose of limiting their maximum loss exposure.  The pool participants also purchase catastrophe reinsurance to cover multiple losses arising from a single event.
All major reinsurance treaties, with the exception of the pooling agreement, the personal and commercial boiler treaties, the employment practices liability contract, and the data compromise, cyber liability and identity recovery contracts, are on an “excess of loss” basis whereby the reinsurer agrees to reimburse the pool participants for covered losses in excess of a predetermined amount, up to a stated limit.  The boiler treaties, data compromise, cyber liability and identity recovery contracts, and the employment practices liability contract provide for 100 percent reinsurance of the pool’s applicable direct exposures.  Facultative reinsurance from approved markets, which provides reinsurance on an individual risk basis and requires specific agreement of the reinsurer as to the limits of coverage provided, is purchased when coverage by an insured is required in excess of treaty capacity, where a high-risk type policy could expose the treaty reinsurance programs, or other reasons where the pool participants wish to reduce their net loss exposure from a particular risk.
Each type of reinsurance coverage is purchased in layers, and each layer may have a separate retention level.  Retention levels are determined according to reinsurance market conditions and the surplus position of the EMC Insurance Companies.  The pooling agreement aids efficient buying of reinsurance since it allows for higher retention levels and correspondingly decreased dependence on the reinsurance marketplace.

27


A summary of the reinsurance treaties benefiting the pool participants during 2016 is presented below.  Retention amounts reflect the accumulated retentions, co-participation and non-placed portions of all layers within a treaty. The retention amount for property catastrophe losses excludes a $10.0 million annual aggregate deductible that applies to losses after the initial $10.0 million retention in the first layer of coverage.
($ in thousands)
 
 
 
 
Type of reinsurance treaty
 
Retention
 
Limits
Property catastrophe
 
$
15,000

 
98 percent of $205,000
Property per risk
 
$
4,000

 
100 percent of $76,000
Casualty
 
$
4,000

 
100 percent of $36,000
Workers' compensation excess
 
$

 
$40,000 excess of $40,000
Fidelity
 
$
2,250

 
95 percent of $5,000
Surety
 
$
3,050

 
97 percent of $38,000
Boiler - commercial lines
 
$

 
100 percent of $100,000
Boiler - personal lines
 
$

 
100 percent of $50 ($100 starting 10/1)
Employment practices liability
 
$

 
100 percent of $1,000
Data compromise
 
$

 
100 percent of $1,000
Identity recovery
 
$

 
100 percent of $25
Cyber liability
 
$

 
100 percent of $250

Although reinsurance does not discharge the original insurer from its primary liability to its policyholders, it is the practice of insurers for accounting purposes to treat reinsured risks as risks of the reinsurer since the primary insurer would only re-assume liability in those situations where the reinsurer is unable to meet the obligations it assumes under the reinsurance agreements.  The ability to collect reinsurance is subject to the solvency of the reinsurers.
The major reinsurers in the pool participants’ reinsurance programs during 2016 are presented below.  The percentages represent the reinsurers’ share of the total reinsurance protection under all coverages.  Each type of coverage is purchased in layers, and an individual reinsurer may participate in more than one type of coverage and at various layers within these coverages.  All programs (except the boiler, data compromise, cyber liability, identity recovery, and employment practice liability programs, as well as the top layer of the property catastrophe program) are handled by reinsurance brokers.  The reinsurance of those programs is syndicated to 53 domestic and foreign reinsurers.
In formulating reinsurance programs, Employers Mutual is selective in its choice of reinsurers.  Employers Mutual selects reinsurers on the basis of financial stability and long-term relationships, as well as the price and coverage terms. Reinsurers are generally required to have an A.M. Best rating of “A” (Excellent) or higher and a minimum policyholders’ surplus of $500.0 million.

28


($ in thousands)
 
Percent of total reinsurance protection
 
A.M. Best rating
Property catastrophe, property per risk and casualty coverages
 
 
Underwriters at Lloyd's of London
 
26.4
%
 
 
A
Mutual Reinsurance Bureau
 
13.3
%
 
 
(1)
Hannover Ruckversicherung AG
 
9.0
%
 
 
A+
Swiss Reinsurance America Corporation
 
5.5
%
 
 
A+
R + V Versicherung AG
 
5.5
%
 
 
(2)
Renaissance Reinsurance US Inc.
 
4.8
%
 
 
A
Tokio Millennium Re Ltd.
 
4.0
%
 
 
A++
QBE Reinsurance Corporation
 
3.9
%
 
 
A
MAPFRE Re Compania De Reaseguros, SA
 
3.9
%
 
 
A
 
 
 
 
 
 
Fidelity and surety coverages
 
 

 
 
 
Transatlantic Reinsurance Company
 
31.6
%
 
 
A+
Hannover Ruckversicherung AG
 
20.7
%
 
 
A+
Axis Reinsurance Company
 
14.1
%
 
 
A+
Odyssey America Reinsurance Corp.
 
12.1
%
 
 
A
Everest Reinsurance Company
 
12.1
%
 
 
A+
Endurance Reinsurance Corporation of America
 
9.4
%
 
 
A
 
 
 
 
 
 
Boiler - commercial lines coverage
 
 

 
 
 
Hartford Steam Boiler Inspection and Insurance Company
 
100.0
%
 
 
A++
 
 
 
 
 
 
Boiler - personal lines coverage
 
 

 
 
 
Factory Mutual Insurance Company
 
100.0
%
 
 
A+
 
 
 
 
 
 
Employment practices liability coverage
 
 

 
 
 
Hartford Steam Boiler Inspection and Insurance Company
 
100.0
%
 
 
A++
 
 
 
 
 
 
Data compromise, cyber liability and identity recovery
 
 

 
 
 
Hartford Steam Boiler Inspection and Insurance Company
 
100.0
%
 
 
A++
(1)
MRB is composed of Employers Mutual and four other unaffiliated mutual insurance companies.  MRB is backed by the financial strength of the five member companies.  Three of the other member companies have an “A” (Excellent) rating and the fourth has a “B++” (Good) rating from A.M. Best.
(2)
R + V Versicherung AG is not rated by A.M. Best, but maintains an AA- rating from Standard & Poor’s.

The Terrorism Risk Insurance Program Reauthorization Act of 2015 (effective through December 31, 2020, referred to herein as the "TRIA Reauthorization Act") continues the Federal backstop on losses from certified terrorism events from foreign sources, and includes coverage for domestic terrorism as well.  The TRIA Reauthorization Act covers most direct commercial lines of business, including coverage for losses from nuclear, biological and chemical exposures if coverage was afforded by an insurer, but with exclusions for commercial automobile insurance, burglary and theft insurance, surety insurance, professional liability insurance, and farm owners multiple peril insurance.  

29


The program trigger threshold for federal participation in losses was $120.0 million in 2016, and increases $20.0 million per year until reaching $200.0 million on January 1, 2020. A loss must be $5.0 million or more to count towards the program trigger threshold. Each insurer has a deductible amount (20 percent of the prior year’s direct commercial lines premiums earned for the applicable lines of business) and a retention above the deductible (16 percent in 2016, increasing by one percentage point each year until reaching 20 percent on January 1, 2020). The TRIA Reauthorization Act caps losses at $100.0 billion annually; no insurer that has met its deductible will be liable for payment of any portion of losses above that amount. For the Company, the TRIA Reauthorization Act deductible is approximately $60.9 million.
Coverage for terrorism losses is included in the pool participants’ reinsurance programs for property and casualty risks (including coverage for the aggregation of property claims from catastrophic losses).  In summary, coverage under the property contracts includes both domestic and foreign terrorism, though it is restricted to exclude from coverage nuclear, biological, chemical and radiation (NBCR) losses.  Coverage under the casualty contracts also includes both domestic and foreign terrorism, though NBCR terrorism is covered for one limit per layer.

Reinsurance
In connection with the change in the inter-company reinsurance program in 2016, the reinsurance subsidiary began purchasing additional reinsurance protection 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 reduces the amount of losses ceded to Employers Mutual under the inter-company reinsurance program. The net cost of this external reinsurance protection was approximately $3.5 million in 2016.
The reinsurance subsidiary also assumes and cedes some selected reinsurance business through the quota share agreement in connection with “fronting” activities initiated by Employers Mutual whereby an agreed upon percentage of the selected assumed business is ceded to other reinsurer(s) on a pro rata basis.  Ceded earned premiums associated with this fronting activity amounted to $3.7 million during 2016.  The ceding of this reinsurance business through these fronting activities does not discharge the reinsurance subsidiary from its assumed liability to the original cedants, and the ability to collect reinsurance is subject to the solvency of the reinsurers.


30


Property and Casualty Insurance and Reinsurance
The Company’s portion of premiums written ceded (unaffiliated and excluding premiums ceded to mandatory pools) by the property and casualty insurance segment and the reinsurance segment for the year ended December 31, 2016 is presented below.  Reinsurance coverage for the property and casualty insurance segment is often purchased in layers, and an individual reinsurer may participate in more than one type of coverage and at various layers within the coverages.  Since each layer of coverage is priced separately, with the lower layers being more expensive than the upper layers, a reinsurer’s overall participation in a reinsurance program does not necessarily correspond to the amount of premiums it receives.  The premium amounts ceded by the reinsurance subsidiary reflect the purchase of additional reinsurance protection from external parties and fronting transactions handled through the quota share agreement, and excludes premiums written ceded to Employers Mutual under the inter-company reinsurance program.
 
 
Premiums written ceded
($ in thousands)
Reinsurer
 
Property and casualty insurance segment
 
Reinsurance segment
 
Total
Hartford Steam Boiler Inspection and Insurance Company
 
$
11,298

 
$

 
$
11,298

Underwriters at Lloyd's of London
 
1,358

 
2,887

 
4,245

Transatlantic Reinsurance Company
 
1,503

 
1,750

 
3,253

Country Mutual Insurance Company
 

 
2,995

 
2,995

Hannover Ruckversicherung AG
 
1,717

 

 
1,717

Tokio Millenium Re Ltd.
 
170

 
1,100

 
1,270

QBE Reinsurance Corporation
 
921

 

 
921

TOA Reinsurance Company of America
 
666

 

 
666

Navigators Insurance Company
 

 
650

 
650

Mutual Reinsurance Bureau
 
627

 
16

 
643

Other Reinsurers
 
5,041

 
728

 
5,769

Total
 
$
23,301

 
$
10,126

 
$
33,427


The property and casualty insurance segment also cedes reinsurance on a mandatory basis to state organizations in connection with various workers’ compensation and assigned risk programs. The Company’s portion of premiums written ceded to these organizations for the year ended December 31, 2016 is presented below.
($ in thousands)
Reinsurer
 
Property and casualty insurance segment
Michigan Catastrophic Claims Association
 
$
807

Other Reinsurers
 
238

Total
 
$
1,045



31


The following table presents amounts due to the Company from reinsurers for losses and settlement expenses, contingent commissions, and prepaid reinsurance premiums as of December 31, 2016.  This presentation differs from the presentation utilized in the consolidated financial statements, where all amounts flowing through the pooling and quota share agreements and inter-company reinsurance programs with Employers Mutual are reported as “affiliated” balances.
 
 
Amount recoverable
 
 
 
 
($ in thousands)
 
Property and casualty insurance segment
 
Reinsurance segment
 
Total
 
Percent of total
 
A.M. Best rating
Hartford Steam Boiler Inspection and Insurance Company
 
$
7,247

 
$

 
$
7,247

 
23.7
%
 
A++
Country Mutual Insurance Company
 

 
3,136

 
3,136

 
10.2

 
A+
Mutual Reinsurance Bureau
 
465

 
2,126

 
2,591

 
8.5

 
(1)
Wisconsin Compensation Rating Bureau
 
2,590

 

 
2,590

 
8.5

 
(2)
Michigan Catastrophic Claims Association
 
2,215

 

 
2,215

 
7.2

 
(2)
Hannover Ruckversicherung AG
 
1,350

 

 
1,350

 
4.4

 
A+
Underwriters at Lloyd's of London
 
354

 
976

 
1,330

 
4.3

 
A
Transatlantic Reinsurance Company
 
543

 
729

 
1,272

 
4.2

 
A+
Workers' Compensation Reinsurance Association of Minnesota
 
1,139

 

 
1,139

 
3.7

 
(2)
General Reinsurance Corporation
 
807

 

 
807

 
2.6

 
A++
Other Reinsurers
 
6,313

 
645

 
6,958

 
22.7

 
 
 
 
$
23,023

 
$
7,612

 
$
30,635

(3)
100.0
%
 
 
(1)
MRB is composed of Employers Mutual and four other unaffiliated mutual insurance companies.  MRB is backed by the financial strength of the five member companies.  Three of the other member companies have an “A” (Excellent) rating and the fourth has a “B++” (Good) rating from A.M. Best.
(2)
Amounts recoverable reflect the property and casualty insurance subsidiaries’ aggregate pool participation percentage of amounts ceded to these organizations by Employers Mutual in connection with its role as “service carrier.”  Under these arrangements, Employers Mutual writes business for these organizations on a direct basis and then cedes the business (typically at 100 percent) to these organizations.  Credit risk associated with these amounts is minimal as all companies participating in these organizations are responsible for the liabilities of such organizations on a pro rata basis.
(3)
The total amount recoverable at December 31, 2016 represents $20.7 million in unpaid losses and settlement expenses, $662,000 in unpaid contingent commissions, and $9.3 million in prepaid reinsurance premiums. Employers Mutual settles with the pool participants (monthly) and the reinsurance subsidiary (quarterly) ceded paid losses and settlement expenses under the reinsurance contracts and provides full credit for the ceded paid losses and settlement expenses generated during the period (not just the collected portion). As a result, Employers Mutual's recoverable for paid losses and settlement expenses represents, to the Company, an off-balance sheet arrangement with an unconsolidated entity that results in credit-risk exposure that is not reflected in the Company’s financial statements.  See note 1 of Notes to Consolidated Financial Statements under Part II, Item 8 of this Form 10-K for further discussion of off-balance sheet credit exposures.

32


Investments
The Company’s total invested assets at December 31, 2016 are summarized in the following table:
 
 
December 31, 2016
($ in thousands)
 
Amortized
cost
 
Fair
value
 
Percent of total
fair value
 
Carrying
value
Fixed maturity securities available-for-sale
 
$
1,189,525

 
$
1,199,699

 
81.7
%
 
$
1,199,699

Equity securities available-for-sale
 
147,479

 
213,839

 
14.6

 
213,839

Short-term investments
 
39,670

 
39,670

 
2.8

 
39,670

Other long-term investments
 
12,506

 
12,506

 
0.9

 
12,506

 
 
$
1,389,180

 
$
1,465,714

 
100.0
%
 
$
1,465,714


The Company’s investment strategy is to conservatively manage its investment portfolio by investing primarily in readily marketable, investment-grade fixed maturity securities and equity securities.  The board of directors of each of the Company’s insurance company subsidiaries has established investment guidelines and regularly reviews the portfolio for compliance with those guidelines.  The Company does not hold foreign denominated investments.  The Company does not purchase non-investment grade securities.  Any non-investment grade securities held are the result of rating downgrades that occurred subsequent to their purchase.  
At December 31, 2016, the portfolio of fixed maturity securities consisted of 0.7 percent U.S. Treasury, 21.0 percent government agency, 14.0 percent asset-backed, 26.9 percent municipal and 37.4 percent corporate securities.  As of December 31, 2016, the effective duration of the Company’s fixed maturity portfolio, excluding interest-only securities, was 5.2, and the effective duration of its liabilities was 3.1. At December 31, 2016, the Company held $3.0 million of non-investment grade fixed maturity securities in a net unrealized gain position of $50,000.
The Company has two separate common stock equity portfolios that are diversified across a large range of industry sectors and are managed for fees based on total assets under management (a large-cap blend equity portfolio managed by BMO Global Asset Management and a high dividend value equity portfolio managed by Schafer Cullen Capital Management).  As of December 31, 2016, the common stock equity portfolios were invested in the following industry sectors:
 
 
Percent of equity portfolio
Financial services
 
18.1
%
Information technology
 
15.8

Healthcare
 
12.8

Consumer staples
 
9.9

Consumer discretionary
 
11.5

Energy
 
9.9

Industrials
 
12.5

Other
 
9.5

 
 
100.0
%

The Company's other long-term investments consist of minority ownership interests in limited partnerships and limited liability companies.  During 2016 and 2015, the Company invested $4.9 million and $4.0 million, respectively, in a limited partnership that is designed to help protect the Company from a sudden and significant decline in the value of its equity portfolio (an equity tail-risk hedging strategy). This investment is carried under the equity method of accounting, with changes in the carrying value (from both expired hedging contracts and changes in the value of contracts that are still in effect) reported as realized gains or losses in the Company's financial statements. During 2016, the Company's reinsurance subsidiary invested approximately $6.6 million in a limited liability company designed to provide a return on investment through the receipt of renewable energy tax credits. After reductions for the utilization of the tax credits and a $209,000 impairment loss, the carrying value of this investment was approximately $2.0 million at December 31, 2016.

33


Employees
EMC Insurance Group Inc. and its subsidiaries have no employees.  The Company’s business activities are conducted by the approximately 2,250 employees of Employers Mutual.  EMC Insurance Group Inc., EMC Reinsurance Company and EMC Underwriters, LLC are charged their proportionate share of salary and employee benefit costs based on time allocations.  Costs not allocated to these companies, and other subsidiaries of Employers Mutual outside the pooling agreement, are charged to the pooling agreement.  The Company’s property and casualty insurance subsidiaries share the costs charged to the pooling agreement in accordance with their pool participation percentages.

Regulation
The Company’s insurance subsidiaries are subject to extensive regulation and supervision by their state of domicile, as well as those states in which they do business.  The purpose of such regulation and supervision is primarily to provide safeguards for policyholders, rather than to protect the interests of stockholders.  The insurance laws of the various states establish regulatory agencies with broad administrative powers, including the power to grant or revoke operating licenses and regulate trade practices, investments, premium rates, deposits of securities, the form and content of financial statements and insurance policies, accounting practices and the maintenance of specified reserves and capital for the protection of policyholders.
Premium rate regulation varies greatly among jurisdictions and lines of insurance.  In most states in which the Company’s subsidiaries and the other pool participants write insurance, premium rates for the various lines of insurance are subject to either prior approval or limited review upon implementation.  States require rates for property and casualty insurance that are adequate, not excessive, and not unfairly discriminatory.
Like other insurance companies, the pool participants are required to participate in mandatory shared-market mechanisms or state pooling arrangements as a condition for maintaining their insurance licenses to do business in various states.  The purpose of these state-mandated arrangements is to provide insurance coverage to individuals who, because of poor driving records or other underwriting reasons, are unable to purchase such coverage voluntarily provided by private insurers. These risks can be assigned to all insurers licensed in the state and the maximum volume of such risks that any one insurance company may be assigned typically is proportional to that insurance company’s annual premium volume in that state.  The underwriting results of this mandatory business traditionally have been unprofitable.
The Company’s insurance subsidiaries are required to file detailed annual reports with the appropriate regulatory agency in each state in which they do business based on applicable statutory regulations, which differ from U.S. generally accepted accounting principles.  Their business and accounts are subject to examination by such agencies at any time.  Since three of the Company’s four insurance subsidiaries and Employers Mutual are domiciled in Iowa, the State of Iowa exercises principal regulatory supervision, and Iowa law requires periodic examination.
State laws governing insurance holding companies also impose standards on certain transactions with related companies, which include, among other requirements, that all transactions be fair and reasonable and that an insurer’s surplus as regards policyholders be reasonable and adequate in relation to its liabilities.  Under Iowa law, dividends or distributions made by registered insurers are restricted in amount and may be subject to approval from the Iowa Commissioner of Insurance. “Extraordinary” dividends or distributions are subject to prior approval and are defined as dividends or distributions made within a 12 month period which exceed the greater of 10 percent of statutory surplus as regards policyholders as of the preceding December 31, or net income of the preceding calendar year on a statutory basis.  North Dakota imposes similar restrictions on the payment of dividends and distributions.  At December 31, 2016, $52.7 million was available for distribution to the Company in 2017 without prior approval.  See note 6 of Notes to Consolidated Financial Statements under Part II, Item 8 of this Form 10-K.
Under state insurance guaranty fund laws, insurance companies doing business in a state can be assessed for certain obligations of insolvent insurance companies to such companies’ policyholders and claimants.  Maximum assessments allowed in any one year generally vary between one percent and two percent of annual premiums written in that state, but it is possible that caps on such assessments could be raised if there are numerous or large insolvencies.  In most states, guaranty fund assessments are recoverable either through future policy surcharges or offsets to state premium tax liabilities.

34


The National Association of Insurance Commissioners (NAIC) utilizes a risk-based capital model to help state regulators assess the capital adequacy of insurance companies and identify insurers that are in, or are perceived as approaching, financial difficulty.  This model establishes minimum capital needs based on the risks applicable to the operations of the individual insurer.  The risk-based capital requirements for property and casualty insurance companies measure three major areas of risk:  asset risk, credit risk and underwriting risk.  Companies having less statutory surplus than required by the risk-based capital requirements are subject to varying degrees of regulatory scrutiny and intervention, depending on the severity of the inadequacy.  At December 31, 2016, the Company’s insurance subsidiaries had total adjusted statutory capital of $526.8 million, which is well in excess of the minimum risk-based capital requirement of $87.3 million.

AVAILABLE INFORMATION
The Company’s internet address is www.emcins.com.  The Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to these reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) are available free of charge through the Company’s website as soon as reasonably practicable after the filing or furnishing of such material with the Securities and Exchange Commission.

35


EXECUTIVE OFFICERS OF THE COMPANY
The Company’s executive officers, their positions and ages are shown in the table below:
NAME
 
AGE
 
POSITION
Melissa J. Appenzeller
 
50
 
Vice President-Chief Actuary of the Company and Employers Mutual effective in 2016. Assistant Vice President of Employers Mutual from 2009 to 2016. She has been employed by Employers Mutual since 1993.
 
 
 
 
 
Ian C. Asplund
 
36
 
Senior Vice President-Strategic Analytics of the Company and Employers Mutual effective in 2016. Vice President-Chief Actuary of the Company and Employers Mutual from 2015 to 2016. Assistant Vice President of Employers Mutual from 2012 to 2014. He has been employed by Employers Mutual since 2003.
 
 
 
 
 
Jason R. Bogart
 
55
 
Senior Vice President of the Company and Senior Vice President of Branch Operations of Employers Mutual since 2013. Vice President of the Company and Vice President of Branch Operations of Employers Mutual from 2010 to 2013.  Resident Vice President-Lansing Branch of Employers Mutual from 2003 until 2010.  He has been employed by Employers Mutual since 1993.
 
 
 
 
 
Bradley J. Fredericks
 
43
 
Vice President-Chief Investment Officer of the Company and Employers Mutual since 2014.  Assistant Vice President of Employers Mutual from 2013 to 2014. He has been employed by Employers Mutual since 2010.
 
 
 
 
 
Rodney D. Hanson
 
61
 
Senior Vice President-Information Technology of the Company and Employers Mutual since 2013. Vice President-Information Technology of the Company and Employers Mutual from 2003 to 2013. He has been employed by Employers Mutual since 1978.
 
 
 
 
 
Kevin J. Hovick
 
62
 
Executive Vice President and Chief Operating Officer of the Company and of Employers Mutual since 2011.  Senior Vice President-Business Development of the Company from 2004 until 2011 and Employers Mutual from 2001 until 2011.  Vice President-Marketing of Employers Mutual from 1997 to 2001.  He has been employed by Employers Mutual since 1979.
 
 
 
 
 
Scott R. Jean
 
45
 
Executive Vice President for Finance & Analytics of the Company and Employers Mutual since 2015. Senior Vice President-Chief Actuary of the Company and Employers Mutual in 2014. Vice President-Chief Actuary of the Company and of Employers Mutual from 2009 to 2014.  He has been employed by Employers Mutual since 1993.
 
 
 
 
 
Bruce G. Kelley
 
62
 
President and Chief Executive Officer of the Company and Employers Mutual since 1992. Reappointed Treasurer of the Company and Employers Mutual in 2014 (previously held that title for Employers Mutual from 1996 until 2000 and the Company from 1996 until 2001). President and Chief Operating Officer of the Company and Employers Mutual from 1991 to 1992 and Executive Vice President of the Company and Employers Mutual from 1989 to 1991.  He has been employed by Employers Mutual since 1985.
 
 
 
 
 
Robert L. Link
 
59
 
Senior Vice President and Assistant Secretary of the Company and Senior Vice President and Corporate Secretary-Administration of Employers Mutual since 2012. Vice President of the Company from 2007 to 2012 and Vice President and Corporate Secretary-Administration of Employers Mutual from 2005 to 2012. He has been employed by Employers Mutual since 1977.
 
 
 
 
 
Mick A. Lovell
 
54
 
Executive Vice President for Corporate Development of the Company and Employers Mutual since 2015. Senior Vice President for Corporate Development of the Company and Employers Mutual in 2014. Vice President of the Company and Vice President-Business Development of Employers Mutual from 2011 to 2014.  Assistant Vice President of the Company and Assistant Vice President-Director of Product Management of Employers Mutual from 2003 to 2011. He has been employed by Employers Mutual since 2003.
 
 
 
 
 

36


Elizabeth A. Nigut
 
47
 
Senior Vice President of the Company and Senior Vice President-Human Resources of Employers Mutual since 2014. Vice President of the Company and Vice President-Human Resources of Employers Mutual from 2010 to 2014.  She has been employed by Employers Mutual since 2010.
 
 
 
 
 
Larry W. Phillips
 
63
 
Senior Vice President-Business Development of the Company and Employers Mutual since 2015. Vice President-Underwriting of Employers Mutual from 2013 to 2015. He has been employed by Employers Mutual since 2012. Prior to joining Employers Mutual he was Executive Director of the Iowa Fair Plan from 2011 to 2012, and Vice President of Underwriting of Midwest Family Mutual Insurance Company from 2009 to 2011.
 
 
 
 
 
Mark E. Reese
 
59
 
Senior Vice President and Chief Financial Officer of the Company and of Employers Mutual since 2004.  Vice President of the Company and Employers Mutual from 1996 until 2004 and has been Chief Financial Officer of the Company and Employers Mutual since 1997.  He has been employed by Employers Mutual since 1984.
 
 
 
 
 
Lisa A. Simonetta
 
57
 
Senior Vice President-Claims of the Company and Employers Mutual since 2013.  Vice President Claims-Legal of the Company and Vice President of Employers Mutual from 2002 to 2013. She has been employed by Employers Mutual since 1992.
 
 
 
 
 
Todd A. Strother
 
48
 
Vice President-General Counsel and Secretary of the Company and Vice President-General Counsel of Employers Mutual upon his hiring in 2016.  Prior to joining Employers Mutual he was an attorney and shareholder with Bradshaw, Fowler, Proctor & Fairgrave, P.C. from 1999 to 2016.
 
 
 
 
 

37


ITEM 1A.    RISK FACTORS
Set forth below is a description of risk factors related to the Company’s business, provided to enable investors to assess, and be appropriately apprised of, certain risks and uncertainties the Company faces in conducting its bus