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) are referred to as the “EMC Insurance Companies.”

On November 20, 2018, the Company announced receipt of a non-binding indicative proposal dated November 15, 2018 from Employers Mutual to purchase all the outstanding common stock of the Company not already owned by Employers Mutual, and the formation of a special committee of the Company's board of directors to consider the proposal. The proposal, which is subject to certain conditions, provides that the shares will be purchased at a price of $30 per share in cash. The special committee, which consists of the Company's four independent directors, has retained its own independent financial and legal advisors to assist it in considering the proposal. There can be no assurance that any definitive agreement will be finalized and executed or that the proposal transaction or any other transaction will be approved or consummated.

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:

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 2018 .  The property and casualty insurance operations are conducted through Illinois EMCASCO, Dakota Fire and EMCASCO and 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 2018 .  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 international 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 of Employers Mutual (Union Insurance Company of Providence and EMC Property & Casualty 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.

An inter-company reinsurance program is in place between the Company's insurance subsidiaries in the property and casualty insurance segment and Employers Mutual. 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 is effective each year from January 1 through June 30, and the second treaty is effective each year from July 1 through December 31. 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) are subject to the terms of these treaties, and there is no co-participation provision.

All transactions occurring under the pooling 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 property and casualty insurance subsidiaries to bring the amounts into compliance with U.S. generally accepted accounting principles (GAAP).

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 participating in the pool.  The particular benefits that the Company’s property and casualty insurance subsidiaries realize from participating in the pooling agreement include the following:

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 regulators.  The ratios of the pool participants for the past three years are as follows:

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. Effective January 1, 2018, Hamilton Mutual Insurance Company was merged into Employers Mutual. The balances for Employers Mutual reflect those of the merged entity as a 70 percent pool participant.

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.

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 international assumed reinsurance business on a direct basis (outside the quota share agreement).  

The Company's reinsurance subsidiary also has an inter-company reinsurance program in place with Employers Mutual that covers both business assumed from Employers Mutual through the quota share agreement, as well as business obtained outside the quota share agreement, and consists of two treaties. The first is a per occurrence catastrophe excess of loss treaty, and the second is an annual aggregate catastrophe excess of loss treaty. 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.

The reinsurance subsidiary, through Employers Mutual, purchases 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, net of the reinsurance subsidiary's 20 percent co-participation.

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 Mutual Re, 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 Mutual Re 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, as well as the purchase of the reinsurance protection from external parties, 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.  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 and its subsidiaries, 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.

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; however, on October 29, 2018, it was announced that a strategic decision had been made to exit personal lines business so that more time and resources could be dedicated to the commercial and reinsurance business.  The exit from personal lines of business is expected to be completed in early 2020. The coverages provided have consisted of the following types of insurance:

Commercial Lines

Personal Lines

The following table sets forth the aggregate direct premiums written of all parties to the pooling agreement for the three years ended December 31, 2018 , by line of business.

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, 2018 . During 2018 , 2017 and 2016 , $5.3 million , $4.9 million and $5.1 million , respectively, of premiums written were ceded to Employers Mutual in accordance with the terms of the inter-company reinsurance program, and $10.0 million , $10.2 million and $10.1 million , respectively, of premiums written were ceded to external parties, through Employers Mutual, in connection with the purchase of reinsurance and through fronting activities. The ceded premiums associated with the inter-company reinsurance program were allocated entirely to the excess of loss line of business.

Marketing and Distribution

Property and Casualty Insurance

The pool participants market a wide variety of commercial lines insurance products through 16 branch offices, which actively write business through independent agents in 41 states.  Since 2016, the oversight of personal lines business has been handled in the home office, with support provided by certain branch offices. The pool participants’ products are marketed exclusively through a network of more than 1,900 local independent agency relationships through more than 4,000 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 $1.8 billion in direct premiums in 2018 , 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 have generally targeted two customer segments:

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 local independent agents.

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, 2018 .

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

Reinsurance

The reinsurance subsidiary currently obtains 97 percent of its business from Employers Mutual through the quota share agreement, and writes 3 percent directly in certain foreign jurisdictions to comply with their regulatory requirements.  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 93 percent of the reinsurance subsidiary’s assumed reinsurance premiums written in 2018 was 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 international business written directly by the reinsurance subsidiary.

The remaining 7 percent of the reinsurance subsidiary’s assumed reinsurance premiums written in 2018 was generated through Employers Mutual’s participation in Mutual Re, 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 Mutual Re since 1957. Mutual Re 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 Mutual Re from unaffiliated insurers.  Since Mutual Re 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.  Mutual Re, 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 Mutual Re.  The reinsurance risks for Mutual Re arise primarily from the Northeast and Midwest markets. Underwriting of risks and pricing of coverage is performed by Mutual Re 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, Mutual Re. Because of the joint liability structure, Mutual Re participating companies must generally maintain a rating of “A-” (Excellent) or above from A.M. Best Company, Inc. and meet certain other standards. 

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 $30.0 million in 2018 .  During 2018 , the reinsurance subsidiary ceded to Employers Mutual $5.3 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 2018 was $266,000 .

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.

While reinsurer competition for national and regional company business is growing, management believes that Mutual Re has a competitive advantage in the smaller mutual company market that it serves due to its low operating costs.  Mutual Re 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.

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, 2018 .  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.

¹ 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 starting in 2014.

² As reported by A.M. Best.  The ratio for 2018 is an estimate; the actual combined trade ratio is not currently available.

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, utilizing enhanced claims solutions to improve outcomes and lower costs, 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, nurses 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-Chief Claims Officer 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 a stochastically derived risk load associated with the Company’s enterprise risk management practices.  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 established 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. 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.

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 claims staff members.  The home office claims group reviews and maintains a diary on files with reserves over $150,000, and also monitors catastrophic losses (fatalities, paraplegia, serious burns, etc.) regardless of claim size. Based on currently available information, individual case loss reserves are revised to reflect changes in the estimated average verdict value of the case in the applicable venue.

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, 2018 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

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 losses. 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. The actuarial department establishes estimated ultimate loss and allocated settlement expense amounts by accident year. During 2018, the number of line of business aggregations used in the actuarial reserving process was increased from eight to thirty-one in order to better align with pricing operations. For purposes of presentation, the finer line of business breakouts are 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 first or second month of the 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 a calendar/accident year basis. The calendar/accident year development triangles generated in this process contain thirty-five years of historic data. The 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. At the end of each quarter, the selected estimated ultimate ratios are applied to the corresponding calendar year 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.

Several different averaging periods/methods are used in the incurred and paid chain ladder methods to produce development factors to ultimate. 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.

In addition to the accident year 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. 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: Each of the above listed methods are employed to determine an unbiased actuarial central estimate of the ultimate loss or settlement expense ratio. The actuarial department examines the indicated ultimate amounts for each category (losses and allocated settlement expenses) and each accident year, and applies judgment and knowledge of each method’s biases (if any) to exclude unreasonable estimates and assign a weight to the remaining estimates. The weighted average of the included estimates becomes the “actuarial central estimate”, to which a risk load is applied to produce management’s best estimate. The maximum and minimum of the remaining estimates define the range of reasonable ultimates.

The selected point estimate for each accident year 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 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.

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.

Reported case and IBNR loss reserves associated with the Mutual Re book of business are established by that entity’s management, and booked by the reinsurance subsidiary on a monthly basis. Mutual Re 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 Mutual Re'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 quartiles 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, 2018 , 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, the overall expectation is that, more often than not, favorable development will occur as the prior accident years’ reserves run off.

Year ended December 31, 2018

Property and casualty insurance segment

For the property and casualty insurance segment, the December 31, 2018 estimate of loss and settlement expense reserves for accident years 2017 and prior decreased $15.3 million from the estimate at December 31, 2017 .  This decrease represents 3.0 percent of the December 31, 2017 gross carried reserves.  The following table displays development on prior years' reserves by line of business and type of reserve.

The favorable development reported for 2018 is generally attributed to lower loss severity assumptions underlying the loss and allocated settlement expense reserves carried at year-end 2018 than those underlying year-end 2017 reserves. The favorable development associated with the loss and allocated settlement expense reserves totaled $9.6 million, which consisted of $2.1 million of favorable loss reserve development and $7.5 million of favorable development from allocated settlement expense reserves.

The $9.6 million of favorable development on loss and allocated settlement expense reserves accounted for approximately 60 percent of the property and casualty insurance segment’s total reported favorable development of $15.3 million. The following table displays the development experienced in 2018 on reported case and IBNR loss reserves and allocated settlement expense reserves for the five most recent accident years, and all prior accident years, by line of business.

In the table above, five of the seven lines of business exhibited favorable development: personal lines, auto physical damage, other liability, commercial property and all other (surety). For these lines of business, favorable development for most accident years was driven by decreases in the severity assumptions underlying the estimated ultimate accident year loss and allocated settlement expense ratios.

Personal lines experienced favorable development in nearly every accident year due to better than expected development on prior reported claims and lower than anticipated emerged IBNR and settlement expenses.

The commercial auto liability line of business experienced adverse development in four of the latest five accident years. Ultimate loss ratios increased for accident years 2013 and 2017, while both ultimate loss and settlement expense ratios increased for accident years 2015 and 2016 due to increases in higher estimated ultimate severity.

Auto physical damage ultimate loss and settlement expense ratios decreased for accident years 2013-2016, as ultimate severity estimates decreased. However, the accident year 2017 ultimate loss ratio increased due to an increase in estimated ultimate frequency.

Reserves in the prior years (years prior to 2013) in workers' compensation experienced favorable development during 2018 after having been significantly strengthened during 2017. Two of the most recent five accident years experienced adverse development. An increase in ultimate estimated severity is the driver for the accident year 2015 development. Accident year 2017 saw a significant increase in ultimate frequency mainly due to a surge in claims associated with winter weather that occurred in late 2017.

The other liability line experienced favorable development from lower ultimate frequency and/or severity estimates on all years except accident year 2016, for which the ultimate severity estimate was increased four percent.

Commercial property’s favorable development in the latest five accident years is the result of reductions in estimated ultimate claim severities. The prior years (years prior to 2013) adverse development was impacted by a large businessowners liability claim from accident year 2012.

The “other” line of business consists mostly of fidelity and surety bonds. Favorable development on three of the latest five accident years was driven by decreases in estimated ultimate claim frequency and severity. The adverse development experienced for accident years 2014 and 2015 is from a reduction in the estimated ultimate reimbursement recoveries on surety bonds.

Reinsurance segment

For the reinsurance segment, the December 31, 2018 estimate of loss and settlement expense reserves for accident years 2017 and prior decreased $3.4 million from the estimate at December 31, 2017 .  This decrease represents 1.5 percent of the December 31, 2017 gross carried reserves.  Both the HORAD and the Mutual Re segments experienced favorable development.

The HORAD segment experienced favorable development of $3.2 million. The composition of the prior year development consisted of $2.7 million of favorable development from assumed operations, $5.2 million of favorable development from external reinsurance recoveries on accident year 2017 catastrophes, and $4.6 million of adverse development from the inter-company reinsurance program with Employers Mutual. The $2.7 million of favorable development from assumed operations was associated with lower estimated ultimate losses for casualty excess contracts for accident years 2008-2011 and 2016, nearly all contact types for accident year 2013, and catastrophe and per risk excess contracts for accident year 2017.

Operations attributable to Mutual Re experienced favorable development of $0.2 million. Actuarial reviews of the reserves assumed from Mutual Re have consistently indicated a level of adequacy which challenged the upper boundary of the range of reasonable reserves. To address this issue, the reinsurance segment currently maintains a $3.7 million negative bulk IBNR loss reserve to keep reserves within the reasonable range. The negative IBNR was reduced during 2018 from the $4.0 million carried at the end of 2017.

During 2018, the expected loss ratios utilized in the various reserving methodologies for prior contract years were unchanged except for one contract type. Based on conversations with and observed experience provided by a large cedant, the ocean marine pro rata expected loss ratios for contract years 2012 through 2017, excepting 2015, experienced reductions ranging from 2 points to 22 points. The expected loss ratios utilized in reserving methodologies for the 2018 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 2017 contract year selection, the 2018 contract year expected loss ratio for the property pro rata contract type increased 2.5 points. Compared to the 2017 contract year selection, the 2018 contract year expected loss ratio for the ocean marine pro rata contract type decreased 5.0 points. All other 2018 expected loss ratios were unchanged from what was used for contract year 2017.

Year ended December 31, 2017

Property and casualty insurance segment

For the property and casualty insurance segment, the December 31, 2017 estimate of loss and settlement expense reserves for accident years 2016 and prior decreased $15.7 million from the estimate at December 31, 2016 . This decrease represented 3.2 percent of the December 31, 2016 gross carried reserves.  The following table displays development on prior years' reserves by line of business and type of reserve.

The favorable development reported for 2017 was generally attributed to lower loss severity assumptions underlying the loss and allocated settlement expense reserves carried at year-end 2017 than those underlying year-end 2016 reserves. The favorable development associated with the loss and allocated settlement expense reserves totaled $12.5 million, which consisted of $14.6 million of favorable loss reserve development and $2.1 million of adverse development from allocated settlement expense reserves.

The $12.5 million of favorable development on loss and allocated settlement expense reserves accounted for approximately 80 percent of the property and casualty insurance segment’s total reported favorable development of $15.7 million. The following table displays the development experienced in 2017 on reported case and IBNR loss reserves and allocated settlement expense reserves for the five most recent accident years, and all prior accident years, by line of business.

In the table above, five of the seven lines of business exhibited favorable development; personal lines, auto physical damage, workers’ compensation, other liability and commercial property. For these lines of business, favorable development for most accident years was driven by decreases in the severity assumptions underlying the estimated ultimate accident year loss and allocated settlement expense ratios.

Personal lines experienced favorable development in nearly every accident year due to better than expected development on prior reported claims and lower than anticipated emerged IBNR.

The commercial auto liability line of business experienced adverse development in each of the latest five accident years. The severity assumption for accident year 2016 increased three percent over the assumption underlying the ultimate established at year-end 2016. For accident years 2012 through 2015, the severity assumption was increased between one and two percent.

Auto physical damage ultimate ratios were reduced for accident years 2016 and 2015, as claim severity estimates were lowered. Accident years 2014 and prior experienced little additional claim activity during 2017.

The workers’ compensation line of business experienced adverse development on accident years prior to 2012, as management strengthened those reserves in response to increases in the severity assumptions. During 2017, it became apparent that the severity assumption underlying the initial workers’ compensation ultimate ratio established for accident year 2016 was too conservative. The favorable development reported above was the result of using an updated assumption.

The other liability line of business experienced favorable development on all recent accident years due to lower severity estimates. The adverse development observed on accident years prior to 2012 was due to a settlement reached with a former insured, resulting in the Company recognizing $4.5 million (its share) of losses and settlement expenses to remove all past and future asbestos liability exposure related to that policyholder. Loss and settlement expense reserves for asbestos claims were also strengthened approximately $900,000. If not for this unanticipated asbestos settlement, development on prior accident years would have been favorable.

Commercial property’s favorable development was concentrated in accident years 2015 and 2016, as severity on reported and emerged claims was less than anticipated. Accident years 2014 and prior experienced minor fluctuations in claims activity with mostly offsetting changes in the ultimate severity assumptions.

The “other” line of business category consists almost exclusively of fidelity and surety bonds. Uncharacteristically, this line experienced adverse development stemming from unanticipated outcomes associated with two accident year 2015 claims.

Reinsurance segment

For the reinsurance segment, the December 31, 2017 estimate of loss and settlement expense reserves for accident years 2016 and prior decreased $3.9 million from the estimate at December 31, 2016.  This decrease represented 1.9 percent of the December 31, 2016 gross carried reserves.  All of the favorable development was attributable to the HORAD book of business, as the prior year development associated with Mutual Re was approximately zero in the aggregate.

In the HORAD book of business, $2.6 million of favorable development occurred in the pro rata line of business and $1.3 million of favorable development occurred in the excess of loss line of business. The favorable development in the pro rata line of business was driven by a change in loss development assumptions for property/casualty global pro rata contracts. Previously, ultimate losses for this contract type were determined by using a weighting of the reinsurance segment’s historical loss development experience with loss development factors from the Reinsurance Association of America (RAA). As the reinsurance segment’s exposure volume has increased over time, and as actual emerged losses have generally been significantly better than the weighted loss development history projections, the use of RAA factors was discontinued in favor of actual emerged loss development in the fourth quarter. In the excess of loss line of business, accident year 2015 was the greatest contributor to the favorable development, but was partially offset by reserve strengthening in accident year 2016 and several prior accident years.

As previously stated, Mutual Re experienced approximately zero development on prior accident years in aggregate. Actuarial reviews of the reserves assumed from Mutual Re have consistently indicated a level of adequacy which challenged the upper boundary of the range of reasonable reserves. To address this issue, the reinsurance segment maintained a $4.0 million negative bulk IBNR loss reserve to keep reserves within the reasonable range.

During 2017, the expected loss ratios utilized in the various reserving methodologies for prior contract years were unchanged. The expected loss ratios utilized in reserving methodologies for the 2017 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 2016 contract year selections, the 2017 contract year expected loss ratios for property pro rata and aggregate excess contract types decreased 2.5 points and 5.0 points, respectively, from the ratios established for contract year 2016. Additionally, the contract year 2017 expected loss ratio for casualty excess contracts was 2.5 points higher than what was used for contact year 2016. All other 2017 expected loss ratios were unchanged from what was used for contract year 2016.

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 .  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 was reported as favorable development; however, this development was "mechanical in nature", and did not have any impact on earnings because the total amount of carried reserves did not change. Excluding this adjustment, the implied amount of favorable development that had an impact on earnings was approximately 5.1 percent of the December 31, 2015 gross carried reserves.  The following table displays development on prior years' reserves by line of business and type of reserve.

The favorable development reported for 2016 was 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 represented 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 case and IBNR loss reserves and allocated settlement expense reserves for the five most recent accident years, and all prior accident years, by line of business.