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INSURANCE LIABILITIES
 9 Months Ended
Sep. 30, 2017
LIABILITY FOR UNPAID CLAIMS AND CLAIMS ADJUSTMENT EXPENSE, FUTURE POLICY BENEFITS FOR LIFE AND ACCIDENT AND HEALTH INSURANCE CONTRACTS, AND POLICYHOLDER CONTRACT DEPOSITS  
LIABILITY FOR UNPAID CLAIMS AND CLAIMS ADJUSTMENT EXPENSE, FUTURE POLICY BENEFITS FOR LIFE AND ACCIDENT AND HEALTH INSURANCE CONTRACTS, AND POLICYHOLDER CONTRACT DEPOSITS

10. Insurance Liabilities

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

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

Our gross loss reserves before reinsurance and discount are net of contractual deductible recoverable amounts due from policyholders of approximately $12.4 billion and $12.8 billion at September 30, 2017 and December 31, 2016, respectively. These recoverable amounts are related to certain policies with high deductibles (in excess of high dollar amounts retained by the insured through self-insured retentions, deductibles, retrospective programs, or captive arrangements, each referred to generically as “deductibles”), primarily for U.S. commercial casualty business. With respect to the deductible portion of the claim, we manage and pay the entire claim on behalf of the insured and are reimbursed by the insured for the deductible portion of the claim. Thus, these recoverable amounts represent a credit exposure to us. At September 30, 2017 and December 31, 2016, we held collateral of approximately $9.5 billion and $9.7 billion, respectively, for these deductible recoverable amounts, consisting primarily of letters of credit and funded trust agreements.

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

Three Months Ended Nine Months Ended
September 30,September 30,
(in millions)2017201620172016
Liability for unpaid loss and loss adjustment expenses, beginning of period$76,422$74,143$77,077$74,942
Reinsurance recoverable(27,660)(14,520)(15,532)(14,339)
Net Liability for unpaid loss and loss adjustment expenses, beginning of period48,76259,62361,54560,603
Foreign exchange effect330(147)68853
Dispositions(a)----
Retroactive reinsurance adjustment (net of discount)(b)22-(11,438)-
Total49,11459,47650,79560,656
Losses and loss adjustment expenses incurred:
Current year7,5114,96016,02114,896
Prior years, excluding discount and amortization of deferred gain9012741,354214
Prior years, discount charge (benefit)4832283323
Prior years, amortization of deferred gain on retroactive reinsurance(c)(75)-(195)-
Total losses and loss adjustment expenses incurred8,3855,26617,46315,433
Losses and loss adjustment expenses paid:
Current year(1,634)(1,948)(3,342)(3,945)
Prior years(3,395)(3,779)(12,438)(13,129)
Total losses and loss adjustment expenses paid(5,029)(5,727)(15,780)(17,074)
Reclassified to liabilities held for sale(d)8(1,060)-(1,060)
Liability for unpaid loss and loss adjustment expenses, end of period:
Net liability for unpaid losses and loss adjustment expenses52,47857,95552,47857,955
Reinsurance recoverable27,60914,50127,60914,501
Total$80,087$72,456$80,087$72,456

(a) Includes amounts related to dispositions through the date of disposition. Includes sale of United Guaranty and Ascot Underwriting Holdings Limited, Ascot Corporate Name Limited and Ascot Employees Corporate Member Limited (Ascot).

(b) Includes discount on retroactive reinsurance in the amount of $53 million and $1.5 billion for the three- and nine-month periods ended September 30, 2017, respectively.

(c) Includes $6 million and $11 million for the 2011 retroactive reinsurance agreement with NICO covering U.S. asbestos exposures for the three- and nine-month periods ended September 30, 2017, respectively.

(d) Represents change in loss reserves included in our pending sale of certain of our insurance operations to Fairfax for the three- and nine-month periods ended September 30, 2017. Upon consummation of the sale, we may retain a portion of these reserves through reinsurance arrangements.

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

On June 14, 2017, a catastrophic fire occurred at Grenfell Tower, a 24-story residential housing block in London, UK, resulting in damage to the property and loss of lives. As of September 30, 2017, our net exposure to loss on this event was not estimable as the forensic investigation was incomplete and the list of potential insureds (and any potential liability) was unclear. There may also be other policyholders involved as the matter evolves.

Discounting of Loss Reserves

At September 30, 2017, the loss reserves reflect a net loss reserve discount of $1.8 billion, including tabular and non-tabular calculations based upon the following assumptions:

  • Certain asbestos claims are discounted when allowed by the regulator and when payments are fixed and determinable, based on the investment yields of the companies and the payout pattern for the claims. At December 31, 2016, the discount for asbestos reserves was fully amortized.
  • The tabular workers’ compensation discount is calculated based on a 3.5 percent interest rate and the mortality rate used in the 2007 U.S. Life Table.
  • The non-tabular workers’ compensation discount is calculated separately for companies domiciled in New York and Pennsylvania, and follows the statutory regulations (prescribed or permitted) for each state. For New York companies, the discount is based on a 5 percent interest rate and the companies’ own payout patterns. In 2012, for Pennsylvania companies, the statute has specified discount factors for accident years 2001 and prior, which are based on a 6 percent interest rate and an industry payout pattern. For accident years 2002 and subsequent, the discount is based on the payout patterns and investment yields of the companies.

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

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

The discount consists of $491 million of tabular discount and $1.3 billion of non-tabular discount for workers’ compensation. During the nine-month periods ended September 30, 2017 and 2016, the charge from changes in discount of $283 million and $321 million, respectively, were recorded as part of the policyholder benefits and losses incurred in the Condensed Consolidated Statement of Income. For the nine-month period ended September 30, 2017, the discount on workers’ compensation reserves decreased by $1.5 billion due to the impact of the adverse development reinsurance agreement with NICO.

During the nine-month period ended September 30, 2017, the forward yield curve component of the discount rates decreased reflecting a decline in the U.S. Treasury rates which resulted in a $138 million decrease in the loss reserve discount.

During the nine-month period ended September 30, 2016, the forward yield curve component of the discount rates decreased reflecting a decline in U.S. Treasury rates which resulted in a $295 million decrease in the loss reserve discount.

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

September 30, 2017December 31, 2016
Legacy PortfolioLegacy Portfolio
U.S. Liability- Property andU.S. Liability- Property and
andCasualty run-offandCasualty run-off
(in millions)Financial LinesInsurance LinesTotalFinancial LinesInsurance LinesTotal
U.S. workers' compensation$2,376$911$3,287$2,583$987$3,570
Retroactive reinsurance(1,494)-(1,494)---
Total reserve discount*$882$911$1,793$2,583$987$3,570

* Excludes $167 million and $181 million of discount related to certain long tail liabilities in the United Kingdom at September 30, 2017 and December 31, 2016, respectively.

The following tables present increase (decrease) in the net loss reserve discount:

Three Months Ended September 30,20172016
Legacy PortfolioLegacy Portfolio
U.S. Liability- Property andU.S. Liability- Property and
andCasualty run-offandCasualty run-off
(in millions)Financial LinesInsurance LinesTotalFinancial LinesInsurance LinesTotal
Current accident year$33$-$33$37$-$37
Accretion and other adjustments
to prior year discount(100)25(75)(43)(12)(55)
Effect of interest rate changes(7)1(6)(11)(3)(14)
Net reserve discount
benefit (charge)(74)26(48)(17)(15)(32)
Change in discount on loss reserves
ceded under retroactive reinsurance(a)53-53---
Net change in total reserve
discount(b)$(21)$26$5$(17)$(15)$(32)
Comprised of:
U.S. Workers' compensation$(21)$26$5$(17)$(15)$(32)
Asbestos$-$-$-$-$-$-
Nine Months Ended September 30,20172016
Legacy PortfolioLegacy Portfolio
U.S. Liability- Property andU.S. Liability- Property and
andCasualty run-offandCasualty run-off
(in millions)Financial LinesInsurance LinesTotalFinancial LinesInsurance LinesTotal
Current accident year$94$-$94$118$-$118
Accretion and other adjustments
to prior year discount(205)(34)(239)(104)(42)(146)
Effect of interest rate changes(96)(42)(138)(196)(99)(295)
Net reserve discount
benefit (charge)(207)(76)(283)(182)(141)(323)
Change in discount on loss reserves
ceded under retroactive reinsurance(1,494)-(1,494)---
Net change in total reserve
discount(c)$(1,701)$(76)$(1,777)$(182)$(141)$(323)
Comprised of:
U.S. Workers' compensation$(1,701)$(76)$(1,777)$(182)$(139)$(321)
Asbestos$-$-$-$-$(2)$(2)

(a) Included in the deferred gain from retroactive reinsurance reported in other liabilities.

(b) Excludes $(18) million and $4 million of discount related to certain long tail liabilities in the United Kingdom for the three-month period ended September 30, 2017 and 2016, respectively.

(c) Excludes $20 million and $(16) million of discount related to certain long tail liabilities in the United Kingdom for the nine-month period ended September 30, 2017 and 2016, respectively.