12.

Liability for Unpaid Losses and Loss Adjustment Expenses

Activity in the liability for unpaid losses and loss adjustment expenses is summarized as follows:


	Years Ended December 31,
(Dollars in thousands)	2013			2012		2011
Balance at beginning of period	$	879,114		$	971,377	$	1,052,743
Less: Ceded reinsurance receivables		240,566			283,652		407,195

Net balance at beginning of period		638,548			687,725		645,548
Incurred losses and loss adjustment expenses related to:
Current year		140,873			149,183		275,284
Prior years		(7,882	)		4,445		3,400

Total incurred losses and loss adjustment expenses		132,991			153,628		278,684

Paid losses and loss adjustment expenses related to:
Current year		50,732			52,164		78,340
Prior years		133,832			150,641		158,167

Total paid losses and loss adjustment expenses		184,564			202,805		236,507

Net balance at end of period		586,975			638,548		687,725
Plus: Ceded reinsurance receivables		192,491			240,566		283,652

Balance at end of period	$	779,466		$	879,114	$	971,377

When analyzing loss reserves and prior year development, the Company considers many factors, including the frequency and severity of claims, loss trends, case reserve settlements that may have resulted in significant development, and any other additional or pertinent factors that may impact reserve estimates.

During 2013, the Company reduced its prior accident year loss reserves by $7.9 million, which consisted of a $7.6 million decrease related to Insurance Operations and a $0.3 million decrease related to Reinsurance Operations.

During 2013, the Company reduced its prior accident year loss reserves for its Insurance Operations by $7.6 million, which primarily consisted of the following:

•

Property: A $9.2 million reduction primarily driven by better than expected development from accident years 2010, 2011, and 2012 related primarily to lower than expected non-catastrophe severity.

•

General Liability: A $6.7 million reduction primarily due to better than expected emergence in nearly all accident years between 2003 through 2011 partially offset by an increase to accident years 1998 through 2002 and 2012 due to higher than anticipated loss emergence.

•

Asbestos and Environmental: A $6.8 million increase primarily related to policies written prior to 1990.

•

Professional: A $0.7 million increase primarily driven by $2.2 million increase in aggregate from unexpected loss emergence in accident years 2006 to 2008 and 2010 offset by $1.5 million of favorable emergence from accident years 1998 and 2011.

•

Umbrella: A $1.1 million decrease primarily driven by better than expected loss emergence in accident years 2002 to 2010 offset by increases in 2011 and 2012.

•

Commercial Auto: A $0.9 million increase primarily related to accident year 2011.

•

Marine: A $0.9 million increase primarily related to accident years 2011 and 2012.

In 2013, the Company decreased its prior accident year loss reserves for its Reinsurance Operations by $0.3 million primarily due to better than anticipated loss emergence on property lines partially offset by adverse development on director and officer, general liability, automobile, and marine.

During 2012, the Company increased its prior accident year loss reserves by $4.4 million, which consisted of a $4.2 million decrease related to Insurance Operations and a $8.7 million increase related to Reinsurance Operations.

The $4.2 million decrease related to Insurance Operations primarily consisted of the following:

•

General liability: A $6.3 million reduction primarily due to favorable emergence of $4.7 million on small business binding and $3.3 million on casualty brokerage exposures primarily in accident years 2002 through 2005. Partially offsetting these reductions were increases of $2.0 million on construction defect reserves in accident year 2007. The Company also decreased its reinsurance allowance by $0.7 million in this line due to changes in its reinsurance exposure on specifically identified claims and general decreases in ceded reserves.

•

Umbrella: A $0.7 million reduction primarily due to continued favorable emergence. Umbrella coverage typically attaches to other coverage lines, so these net decreases follow the decreases in general liability above.

•

Property: A $1.2 million increase primarily related to accident year 2011 due to greater than expected loss emergence on a large sinkhole claim.

•

Auto liability: A $1.2 million increase primarily driven by continued loss emergence on casualty brokerage exposures.

The $8.7 million increase related to Reinsurance Operations primarily consisted of the following:

•

Workers’ Compensation: An $8.3 million increase in workers’ compensation lines primarily related to accident years 2009 and 2010 driven by increased frequency and severity. As a result of these increased losses, the Company recorded $6.0 million in additional premium related to these treaties.

•

Marine: A $2.7 million increase in marine lines primarily related to accident year 2011 primarily due to higher than expected reported losses.

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Automobile Liability: A $1.3 million increase in auto liability lines primarily related to accident year 2009 resulting from further unexpected development on non-standard auto treaties which were not renewed.

•

Property: A $3.4 million decrease in property lines primarily related to accident years 2009 and 2011 as a result of further development on worldwide catastrophe treaties.

During 2011, the Company increased its prior accident year loss reserves by $3.4 million, which consisted of a $9.7 million decrease related to Insurance Operations and a $13.1 million increase related to Reinsurance Operations.

The $9.7 million decrease related to Insurance Operations primarily consisted of the following:

•

General Liability: A $12.9 million reduction in general liability lines primarily consisted of net reductions of $25.5 million in accident years 2008 and prior due to continued favorable emergence. Incurred losses for these years have developed at a rate lower than the Company’s historical averages. The Company also decreased its reinsurance allowance by $1.3 million in this line due to changes in reinsurance exposure on specifically identified claims and general decreases in ceded reserves. Offsetting these decreases were increases of $13.9 million in accident years 2009 and 2010 primarily driven by loss emergence as well as revised exposure estimates for construction defect liability. Increased estimates for construction defect were primarily the result of a methodology change during the year, with some increases in recent years due to a slight increase in claim frequency in one of the reviewed segments. The Company has addressed profitability concerns by exiting certain classes of business within this line.

•

Property: A $2.5 million reduction in property lines primarily related to accident years 2009 and 2010 related to subrogation on a large equine mortality claim as well as favorable development on prior year catastrophe claims.

•

Umbrella: A $1.7 million reduction in umbrella lines primarily related to accident years 2010 and prior primarily due to continued favorable emergence. Umbrella coverage typically attaches to other coverage lines, so these net decreases follow the decreases in general liability above.

•

Professional Liability: A $5.7 million increase in professional liability lines primarily consisted of increases of $19.0 million related to accident years 1998, 2009 and 2010, offset partially by decreases of $13.2 million related to all other accident years. In 2011, the Company exited certain professional liability classes where the volume of premium was low and loss volatility was high. The Company is focused on writing business where it expects to realize profit that meets return on investment thresholds.

•

Auto Liability: A $1.8 million increase in auto liability lines is primarily related to accident year 2010 due to higher than expected severity.

The $13.1 million increase related to Reinsurance Operations primarily consisted of the following:

•

General Liability: An $8.7 million increase in general liability lines primarily related to accident years 2009 and 2010 due to loss emergence that was greater than expected.

•

Automobile Liability: A $3.1 million increase in automobile liability lines primarily related to accident year 2010 resulting from further unexpected development on non-standard auto treaties which were not renewed in 2011.

•

Property: A $1.5 million increase in property lines primarily related to accident year 2010 and is primarily related to loss emergence on a worldwide catastrophe treaty.

•

Workers’ Compensation: A $1.0 million increase in workers’ compensation lines primarily related to accident years 2009 and 2010 and is the result of expected losses recorded on adjustment premiums recorded in 2011.

•

Professional Liability: A $1.3 million decrease in professional liability lines primarily related to accident years 2009 and 2010 and is the result of better than expected development on certain treaties.

Prior to 2001, the Company underwrote multi-peril business insuring general contractors, developers, and sub-contractors primarily involved in residential construction that has resulted in significant exposure to construction defect (“CD”) claims. The Company’s reserves for CD claims ($70.5 million and $74.8 million as of December 31, 2013 and 2012, net of reinsurance, respectively) are established based upon management’s best estimate in consideration of known facts, existing case law and generally accepted actuarial methodologies. However, due to the inherent uncertainty concerning this type of business, the ultimate exposure for these claims may vary significantly from the amounts currently recorded.

The Company has exposure to asbestos & environmental (“A&E”) claims. The asbestos exposure primarily arises from the sale of product liability insurance, and the environmental exposure arises from the sale of general liability and commercial multi-peril insurance. In establishing the liability for unpaid losses and loss adjustment expenses related to A&E exposures, management considers facts currently known and the current state of the law and coverage litigation. Liabilities are recognized for known claims (including the cost of related litigation) when sufficient information has been developed to indicate the involvement of a specific insurance policy, and management can reasonably estimate its liability. In addition, liabilities have been established to cover additional exposures on both known and unasserted claims. Estimates of the liabilities are reviewed and updated regularly. Case law continues to evolve for such claims, and significant uncertainty exists about the outcome of coverage litigation and whether past claim experience will be representative of future claim experience. Included in net unpaid losses and loss adjustment expenses as of December 31, 2013, 2012, and 2011 were IBNR reserves of $18.2 million, $14.6 million, and $26.2 million, respectively, and case reserves of approximately $4.8 million, $5.5 million, and $3.6 million, respectively, for known A&E-related claims.

The following table shows the Company’s gross reserves for A&E losses:


	Years Ended December 31,
(Dollars in thousands)	2013		2012			2011
Gross reserve for A&E losses and loss adjustment expenses—beginning of period	$	44,767	$	50,601		$	49,151
Plus: Incurred losses and loss adjustment expenses—case reserves		2,154		7,687			2,005
Plus: Incurred losses and loss adjustment expenses—IBNR		5,961		(5,860	)		2,395
Less: Payments		2,727		7,661			2,950

Gross reserves for A&E losses and loss adjustment expenses—end of period	$	50,155	$	44,767		$	50,601

The following table shows the Company’s net reserves for A&E losses:


	Years Ended December 31,
(Dollars in thousands)	2013		2012			2011
Net reserve for A&E losses and loss adjustment expenses—beginning of period	$	20,134	$	25,285		$	30,333
Plus: Incurred losses and loss adjustment expenses—case reserves		1,351		6,934			1,873
Plus: Incurred losses and loss adjustment expenses—IBNR		3,506		(5,683	)		(4,926	)
Less: Payments		1,953		6,402			1,995

Net reserves for A&E losses and loss adjustment expenses—end of period	$	23,038	$	20,134		$	25,285

Establishing reserves for A&E and other mass tort claims involves more judgment than other types of claims due to, among other things, inconsistent court decisions, an increase in bankruptcy filings as a result of asbestos-related liabilities, and judicial interpretations that often expand theories of recovery and broaden the scope of coverage. The insurance industry continues to receive a substantial number of asbestos-related bodily injury claims, with an increasing focus being directed toward other parties, including installers of products containing asbestos rather than against asbestos manufacturers. This shift has resulted in significant insurance coverage litigation implicating applicable coverage defenses or determinations, if any, including but not limited to, determinations as to whether or not an asbestos-related bodily injury claim is subject to aggregate limits of liability found in most comprehensive general liability policies.

In 2009, one of the Company’s insurance companies was dismissed from a lawsuit seeking coverage from it and other unrelated insurance companies. The suit involved issues related to approximately 3,900 existing asbestos-related bodily injury claims and future claims. The dismissal was the result of a settlement of a disputed claim related to accident year 1984. The settlement is conditioned upon certain legal events occurring which may trigger financial obligations by the insurance company. One such event is the confirmation of a Plan involving an asbestos trust established under the bankruptcy code and funded in part by settlement proceeds. On February 24, 2014, the United States Bankruptcy Court for the Northern District of California (District Court) issued a Memorandum Re Confirmation of a Revised Plan following a remand from the Ninth Circuit Court of Appeals. The confirmation of the Revised Plan includes an injunction under 11 U.S.C. Section 524(g) (US bankruptcy code) related to the suit above. The injunction, also called a “channeling injunction,” precludes, among other things, non-settling insurers from asserting claims against one of the Company’s insurance companies and asbestos related claims by third parties against one of the Company’s insurance companies that are related to the named insured. The most recent ruling may be subject to an appeal by the non-settling insurer group. Management will continue to monitor the developments of the litigation to determine if any additional financial exposure is present.

As of December 31, 2013, 2012, and 2011, the survival ratio on a gross basis for the Company’s open A&E claims was 11.3 years, 11.3 years, and 8.9 years, respectively. As of December 31, 2013, 2012, and 2011, the survival ratio on a net basis for the Company’s open A&E claims was 6.7 years, 7.0 years, and 6.4 years, respectively. The survival ratio, which is the ratio of gross or net reserves to the 3-year average of annual paid claims, is a financial measure that indicates how long the current amount of gross or net reserves are expected to last based on the current rate of paid claims.