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INSURANCE LIABILITIES
 3 Months Ended
Mar. 31, 2017
LIABILITY FOR UNPAID CLAIMS AND CLAIMS ADJUSTMENT EXPENSE, FUTURE POLICY BENEFITS FOR LIFE AND ACCIDENT AND HEALTH INSURANCE CONTRACTS, AND POLICYHOLDER CONTRACT DEPOSITS  
LIABILITY FOR UNPAID CLAIMS AND CLAIMS ADJUSTMENT EXPENSE, FUTURE POLICY BENEFITS FOR LIFE AND ACCIDENT AND HEALTH INSURANCE CONTRACTS, AND POLICYHOLDER CONTRACT DEPOSITS

10. Insurance Liabilities

Liability for Unpaid Losses and Loss Adjustment Expenses (Loss Reserves)

Loss reserves represent the accumulation of estimates of unpaid claims, including estimates for claims incurred but not reported (IBNR) and loss adjustment expenses (LAE), less applicable discount. We regularly review and update the methods used to determine loss reserve estimates. Any adjustments resulting from this review are reflected currently in pre-tax income. Because these estimates are subject to the outcome of future events, changes in estimates are common given that loss trends vary and time is often required for changes in trends to be recognized and confirmed. Reserve changes that increase previous estimates of ultimate cost are referred to as unfavorable or adverse development or reserve strengthening. Reserve changes that decrease previous estimates of ultimate cost are referred to as favorable development.

Our gross loss reserves before reinsurance and discount are net of contractual deductible recoverable amounts due from policyholders of approximately $12.8 billion at both March 31, 2017 and December 31, 2016. These recoverable amounts are related to certain policies with high deductibles (in excess of high dollar amounts retained by the insured through self-insured retentions, deductibles, retrospective programs, or captive arrangements, each referred to generically as “deductibles”), primarily for U.S. commercial casualty business. With respect to the deductible portion of the claim, we manage and pay the entire claim on behalf of the insured and are reimbursed by the insured for the deductible portion of the claim. Thus, these recoverable amounts represent a credit exposure to us. At March 31, 2017 and December 31, 2016, we held collateral of approximately $9.8 billion and $9.7 billion, respectively, for these deductible recoverable amounts, consisting primarily of letters of credit and funded trust agreements.

The following table presents the roll forward of activity in Loss Reserves:

Three Months Ended March 31,
(in millions)20172016
Liability for unpaid loss and loss adjustment expenses, beginning of year$77,077$74,942
Reinsurance recoverable(15,532)(14,339)
Net Liability for unpaid loss and loss adjustment expenses, beginning of year61,54560,603
Foreign exchange effect(105)(160)
Dispositions(a)--
Retroactive reinsurance adjustment (net of discount)(b)(11,199)-
Total50,24160,443
Losses and loss adjustment expenses incurred:
Current year4,3004,912
Prior years, excluding discount25(66)
Prior years, discount charge (benefit)(25)(9)
Total losses and loss adjustment expenses incurred4,3004,837
Losses and loss adjustment expenses paid:
Current year(571)(580)
Prior years(4,753)(4,966)
Total losses and loss adjustment expenses paid(5,324)(5,546)
Reclassified to liabilities held for sale(c)(87)-
Liability for unpaid loss and loss adjustment expenses, end of period:
Net liability for unpaid losses and loss adjustment expenses49,13059,734
Reinsurance recoverable26,92014,212
Total$76,050$73,946

(a) Includes amounts related to dispositions through the date of disposition. Includes sale of UGC and Ascot.

(b) Includes discount on retroactive reinsurance in the amount of $1.7 billion.

(c) Represents change in loss reserves included in our pending sale of certain of our insurance operations to Fairfax for the three months ended March 31, 2017. Upon consummation of the sale, we may retain a portion of these reserves through reinsurance arrangements.

On January 20, 2017, we entered into an adverse development reinsurance agreement with NICO, a subsidiary of Berkshire, under which we transferred to NICO 80 percent of the reserve risk on substantially all of our U.S. Commercial long-tail exposures for accident years 2015 and prior. Under this agreement, we ceded to NICO 80 percent of the paid losses on subject business paid on or after January 1, 2016 in excess of $25 billion of net paid losses, up to an aggregate limit of $25 billion. At NICO’s 80 percent share, NICO’s limit of liability under the contract is $20 billion. We account for this transaction as retroactive reinsurance. We paid total consideration, including interest, of $10.2 billion. The consideration was placed into a collateral trust account as security for NICO’s claim payment obligations, and Berkshire has provided a parental guarantee to secure the obligations of NICO under the agreement.

Discounting of Loss Reserves

At March 31, 2017, the loss reserves reflect a net loss reserve discount of $1.9 billion, including tabular and non-tabular calculations based upon the following assumptions:

Certain asbestos claims are discounted when allowed by the regulator and when payments are fixed and determinable, based on the investment yields of the companies and the payout pattern for the claims. At December 31, 2016, the discount for asbestos reserves was fully amortized.

The tabular workers’ compensation discount is calculated based on a 3.5 percent interest rate and the mortality rate used in the 2007 U.S. Life Table.

The non-tabular workers’ compensation discount is calculated separately for companies domiciled in New York and Pennsylvania, and follows the statutory regulations (prescribed or permitted) for each state. For New York companies, the discount is based on a 5 percent interest rate and the companies’ own payout patterns. In 2012, for Pennsylvania companies, the statute has specified discount factors for accident years 2001 and prior, which are based on a 6 percent interest rate and an industry payout pattern. For accident years 2002 and subsequent, the discount is based on the payout patterns and investment yields of the companies.

In 2013, our Pennsylvania regulator approved use of a consistent discount rate (U.S. Treasury rate plus a liquidity premium) to all of our workers’ compensation reserves in our Pennsylvania-domiciled companies, as well as our use of updated payout patterns specific to our primary and excess workers compensation portfolios.

In the fourth quarter of 2016, our Pennsylvania and Delaware regulators approved an updated discount rate that we applied to our workers’ compensation loss reserves for the legal entities domiciled in those states.

The discount consists of $491 million of tabular discount and $1.5 billion of non-tabular discount for workers’ compensation. During the three-month periods ended March 31, 2017 and 2016, the benefit/(charge) from changes in discount of $25 million and $10 million, respectively, were recorded as part of the policyholder benefits and losses incurred in the Condensed Consolidated Statement of Income. For the three-month period ended March 31, 2017, the discount on workers’ compensation reserves decreased by $1.7 billion due to the impact of the adverse development reinsurance agreement with NICO.

During the first quarter of 2017, reserves were established for accident year 2017, which increased the discount by $32 million. In addition, the increase in the forward yield curve component of the discount rates resulted in a $57 million increase in the loss reserve discount. This increase was partially offset by a $64 million reduction for accident years 2016 and prior, primarily from accretion of discount on reserves for the first quarter of 2017. This resulted in an increase in the loss reserve discount of $25 million.

During the first quarter of 2016, reserves were established for accident year 2016, which increased the discount by $48 million. This increase was partially offset by a $27 million reduction for accident years 2015 and prior, primarily from accretion of discount on reserves for the first quarter of 2016. In addition, decreases in the forward yield curve component of the discount rates resulted in an $11 million decrease in the loss reserve discount, as Treasury rates generally decreased in the first quarter of 2016 along the payout pattern horizon as compared to the prior periods, partially offset by an increase in the credit spread. This resulted in an increase in the loss reserve discount of $10 million.

The following table presents the components of the loss reserve discount discussed above:

March 31, 2017December 31, 2016
Legacy PortfolioLegacy Portfolio
U.S. Liability- Property andU.S. Liability- Property and
andCasualty run-offandCasualty run-off
(in millions)Financial LinesInsurance LinesTotalFinancial LinesInsurance LinesTotal
U.S. workers' compensation$2,606$989$3,595$2,583$987$3,570
Retroactive reinsurance(1,655)-(1,655)---
Total reserve discount$951$989$1,940$2,583$987$3,570

The following table presents the net loss reserve discount benefit (charge):

Three Months Ended March 31,20172016
Legacy PortfolioLegacy Portfolio
U.S. Liability- Property andU.S. Liability- Property and
andCasualty run-offandCasualty run-off
(in millions)Financial LinesInsurance LinesTotalFinancial LinesInsurance LinesTotal
Current accident year$32$-$32$48$-$48
Accretion and other adjustments
to prior year discount(48)(16)(64)(14)(14)(28)
Effect of interest rate changes391857(8)(3)(11)
Net reserve discount
benefit (charge)2322526(17)9
Change in discount on loss reserves
ceded under retroactive reinsurance(1,655)-(1,655)---
Net change in total reserve
discount$(1,632)$2$(1,630)$26$(17)$9
Comprised of:
U.S. Workers' compensation$(1,632)$2$(1,630)$26$(16)$10
Asbestos$-$-$-$-$(1)$(1)