Share-based Compensation

The fair value method of accounting is used for equity-based compensation plans. Under the fair value method, compensation cost is measured based on the fair value of the award at the measurement date and recognized over the requisite service period. We use the Black-Scholes model to estimate the fair values on the measurement date for share options and share appreciation rights (“SARs”). The Black-Scholes model uses several assumptions to value a share award. The volatility assumption is based on the historical change in our stock price over the previous five years preceding the measurement date. The risk-free rate of return assumption is based on the five-year U.S. Treasury constant maturity rate on the measurement date. The expected award life is based upon the average holding period over the history of the incentive plan. The expected dividend yield is based on our history and expected dividend payouts.

The following table summarizes the assumptions we used:



	For the Years Ended December 31,
	2018	2017	2016
Risk-free rate of return	2.61% to 2.96%	1.83% to 2.22%	1.00% to 2.02%
Expected dividend yields	1.71% to 1.87%	1.63% to 1.72%	1.62% to 1.70%
Expected award life (years)	4.48 to 4.49	4.48 to 4.49	4.50 to 4.61
Expected volatility	17.82% to 18.44%	18.13% to 18.70%	18.73% to 19.70%

All outstanding awards were adjusted to reflect the 15% stock dividend in 2018, resulting in a 15% increase to the number of awards outstanding and an 13.04% reduction in the exercise price.

All outstanding awards were adjusted to reflect the 10% stock dividend in 2016, resulting in a 10% increase to the number of awards outstanding and a 9.09% reduction in the exercise price.

We estimate forfeitures based on historical forfeitures patterns, thereby recognizing expense only for those awards that are expected to vest. The estimate of forfeitures is adjusted as actual forfeitures differ from our estimate, resulting in recognition of compensation expense only for those awards that actually vest.

The compensation expense recognized under all our share-based payment plans was $18.3 million ($16.5 million, net of tax), $12.3 million ($10.3 million, net of tax) and $19.8 million ($15.5 million, net of tax) for the years ended December 31, 2018, 2017 and 2016, respectively. The compensation expense is included in “Underwriting, acquisition and insurance expenses” in our Consolidated Statements of Income.

We present all tax benefits resulting from the exercise of stock options and vesting of non-vested shares as cash flows from operating activities. Excess tax benefits are realized tax benefits from tax deductions for exercised options and vested shares in excess of the deferred tax asset attributable to stock compensation costs for such options. Such tax benefits and cash flows were immaterial for all reporting periods.

Argo Group’s Long-Term Incentive Plans

In November 2007, our shareholders approved the 2007 Long-Term Incentive Plan (the “2007 Plan”), which provided for an aggregate of 4.5 million shares of our common stock that may be issued to executives, non-employee directors, and other key employees. As of May 2014, 1.5 million shares remained available for grant under the 2007 Plan. In May 2014, our shareholders approved the 2014 Long-Term Incentive Plan (the “2014 Plan”), which provides for an additional 2.8 million shares of our common stock to be available for issuance to executives, non-employee directors and other key employees. The share awards may be in the form of share options, SARs, restricted shares, restricted share awards, restricted share units awards, performance awards, other share-based awards and other cash-based awards. Shares issued under this plan may be shares that are authorized and unissued or shares that we reacquired, including shares purchased on the open market. Share options and SARs will count as one share for the purposes of the limits under the incentive plans; restricted shares, restricted share units, performance units, performance shares or other share-based incentive awards which settle in common shares will count as 2.75 shares for purpose of the limits under the 2014 Plan.

Share options may be in the form of incentive share options, non-qualified share options and restorative options. Share options are required to have an exercise price that is not less than the market value on the date of grant. We are prohibited from repricing the options. The term of the share options cannot exceed seven years from the grant date.

A summary of restricted share activity as of December 31, 2018 and changes during the year then ended is as follows:



	Shares		Weighted-Average Grant Date Fair Value
Outstanding at January 1, 2018	767,140		$	42.91
Granted	458,715		$	51.84
Vested and issued	(211,170	)	$	43.35
Expired or forfeited	(117,680	)	$	46.32
Outstanding at December 31, 2018	897,005		$	46.92

As of December 31, 2018, there was $27.8 million of total unrecognized compensation cost related to restricted share compensation arrangements granted by Argo Group. The weighted-average period over which this unrecognized expense is expected to be recognized is 1.8 years. The total fair value of shares vested during the year ended December 31, 2018 was $9.2 million.

A summary of stock-settled SARs activity as of December 31, 2018 and changes during the year then ended is as follows:



	Shares		Weighted-Average Exercise Price
Outstanding at January 1, 2018	1,494,458		$	30.85
Exercised	(665,875	)	$	27.00
Expired or forfeited	(17,824	)	$	36.51
Outstanding at December 31, 2018	810,759		$	33.88
Vested or expected to vest as of end of year	781,124		$	33.73
Exercisable at end of year	618,935		$	32.65

The stock-settled SARs vest over a one to four year period. Upon exercise of the stock-settled SARs, the employee is entitled to receive shares of our common stock equal to the appreciation of the stock as compared to the exercise price. For the year ended December 31, 2018, 665,875 stock-settled SARs were exercised resulting in 372,705 shares being issued. As of December 31, 2018, there was $0.3 million of total unrecognized compensation cost related to stock-settled SARs outstanding. The weighted-average period over which this unrecognized expense is expected to be recognized is 1.5 years. Aggregate intrinsic value of the stock-settled SARs at December 31, 2018 was $27.1 million. The remaining weighted average contractual term at December 31, 2018 was 2.48 years.

A summary of cash-settled SARs activity as of December 31, 2018 and changes during the year then ended is as follows:



	Shares		Weighted-Average Exercise Price
Outstanding at January 1, 2018	189,568		$	28.95
Exercised	(128,572	)	$	28.31
Expired or forfeited	(2,568	)	$	21.23
Outstanding at December 31, 2018	58,428		$	30.71

As of December 31, 2018, all the cash-settled SARs are fully vested. Upon exercise of the cash-settled SARs, the employee is entitled to receive cash payment for the appreciation in the value of our common stock over the exercise price. We account for the cash-settled SARs as liability awards, which require the awards to be revalued at each reporting period. For the year ended December 31, 2018, 128,572 cash-settled SARs were exercised resulting in $4.3 million in cash payments. Aggregate intrinsic value of the cash-settled SARs at December 31, 2018 was $2.1 million. The liability for cash-settled SARs was $2.1 million and $5.7 million at December 31, 2018 and 2017, respectively.

Included in the total shares outstanding at December 31, 2018 are 307,335 restricted shares whose vesting is contingent on the employee meeting defined performance conditions. Employees have a specified time period in which to meet the performance condition (typically one year) and forfeit the grant (on a pro rata basis) if the performance conditions are not met in the specified time frame. We evaluate the likelihood of the employee completing the performance condition and include this estimate in the determination of the forfeiture factor for the grants.

Employees Share Purchase Plans

We have established an employee stock purchase plan for eligible employees (Argo Group’s 2007 Employee Share Purchase Plan). Under this plan, newly issued shares of our common stock may be purchased over an offering period of three months at 85% of the lower of the market value on the first day of the offering period or on the designated purchase date at the end of the offering period. We have also established a Save As You Earn Plan for our United Kingdom employees. Under this plan, newly issued shares of our common stock may be purchased over an offering period of three or five years at 85% of the market value of the common shares on the first day of the offering period. Expense recognized under these plans for the years ended December 31, 2018, 2017 and 2016 was $0.4 million, $0.4 million and $0.3 million, respectively.