INSURANCE LIABILITIES

3 Months Ended

Mar. 31, 2018

LIABILITY FOR UNPAID CLAIMS AND CLAIMS ADJUSTMENT EXPENSE, FUTURE POLICY BENEFITS FOR LIFE AND ACCIDENT AND HEALTH INSURANCE CONTRACTS, AND POLICYHOLDER CONTRACT DEPOSITS

9. 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 $12.3 billion and $12.6 billion at March 31, 2018 and December 31, 2017, respectively. 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 both March 31, 2018 and December 31, 2017, we held collateral of approximately $9.5 billion 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)		2018		2017
Liability for unpaid loss and loss adjustment expenses, beginning of period	$	78,393	$	77,077
Reinsurance recoverable		(26,708)		(15,532)
Net Liability for unpaid loss and loss adjustment expenses, beginning of period		51,685		61,545
Losses and loss adjustment expenses incurred:
Current year		4,698		4,300
Prior years, excluding discount and amortization of deferred gain		(40)		63
Prior years, discount charge (benefit)		(205)		(25)
Prior years, amortization of deferred gain on retroactive reinsurance		(39)		(38)
Total losses and loss adjustment expenses incurred		4,414		4,300
Losses and loss adjustment expenses paid:
Current year		(610)		(571)
Prior years		(4,779)		(4,753)
Total losses and loss adjustment expenses paid		(5,389)		(5,324)
Other changes:
Foreign exchange effect		274		(105)
Retroactive reinsurance adjustment (net of discount)^(a)		(97)		(11,199)
Reclassified to liabilities held for sale^(b)		-		(87)
Total other changes		177		(11,391)
Liability for unpaid loss and loss adjustment expenses, end of period:
Net liability for unpaid losses and loss adjustment expenses		50,887		49,130
Reinsurance recoverable		27,211		26,920
Total	$	78,098	$	76,050

(a) Includes discount on retroactive reinsurance in the amount of $128 million and $1.7 billion for the three-month periods ended March 31, 2018 and 2017, respectively.

(b) Represents change in loss reserves included in our sale of certain of our insurance operations to Fairfax Financial Holdings Limited (Fairfax) for the three-month period ended March 31, 2017. Upon consummation of the sale, we retained a portion of these reserves through reinsurance arrangements.

On January 20, 2017, we entered into an adverse development reinsurance agreement with National Indemnity Company (NICO), a subsidiary of Berkshire Hathaway Inc. (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. The total paid claims subject to the agreement as of March 31, 2018 were below the attachment point.

Discounting of Loss Reserves

At March 31, 2018, 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. For the Pennsylvania companies, the statute specifies 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.

The discount consists of $622 million of tabular discount and $1.3 billion of non-tabular discount for workers’ compensation. During the three-month periods ended March 31, 2018 and 2017, the benefit/(charge) from changes in discount of $205 million and $25 million, respectively, were recorded as part of the policyholder benefits and losses incurred in the Consolidated Statement of Income.

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

	March 31, 2018						December 31, 2017
	North		Legacy Portfolio				North		Legacy Portfolio
	America		- General				America		- General
	Commercial		Insurance run-off				Commercial		Insurance run-off
(in millions)	Insurance		Insurance Lines			Total	Insurance		Insurance Lines			Total
U.S. workers' compensation	$	2,652	$	936	$	3,588	$	2,465	$	918	$	3,383
Retroactive reinsurance		(1,667)		-		(1,667)		(1,539)		-		(1,539)
Total reserve discount^*	$	985	$	936	$	1,921	$	926	$	918	$	1,844

* Excludes $177 million and $173 million of discount related to certain long tail liabilities in the United Kingdom at March 31, 2018 and December 31, 2017, respectively.

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

Three Months Ended March 31,	2018						2017
	North		Legacy Portfolio				North		Legacy Portfolio
	America		- General				America		- General
	Commercial		Insurance run-off				Commercial		Insurance run-off
(in millions)	Insurance		Insurance Lines			Total	Insurance		Insurance Lines			Total
Current accident year	$	19	$	-	$	19	$	32	$	-	$	32
Accretion and other adjustments
to prior year discount		45		(18)		27		(48)		(16)		(64)
Effect of interest rate changes		123		36		159		39		18		57
Net reserve discount
benefit (charge)		187		18		205		23		2		25
Change in discount on loss reserves
ceded under retroactive reinsurance		(128)		-		(128)		(1,655)		-		(1,655)
Net change in total reserve
discount^(a)	$	59	$	18	$	77	$	(1,632)	$	2	$	(1,630)

(a) Excludes $(5) million and $(1) million of discount related to certain long tail liabilities in the United Kingdom for the three-month periods ended March 31, 2018 and 2017, respectively.

During the first quarters of 2018 and 2017, effective interest rates increased due to an increase in the forward yield curve component of the discount rates reflecting an incline in U.S. Treasury rates along with the changes in payout pattern assumptions. This resulted in an increase in the loss reserve discount by $159 million in first quarter 2018 and $57 million in first quarter 2017.