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INSURANCE LIABILITIES

6 Months Ended

Jun. 30, 2019

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, except to the extent such adjustment impacts a deferred gain under a retroactive reinsurance agreement, in which case the ceded portion would be amortized into pre-tax income in subsequent periods. 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 $12.0 billion and $12.3 billion at June 30, 2019 and December 31, 2018, 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 June 30, 2019 and December 31, 2018, we held collateral of approximately $9.0 billion and $9.2 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				Six Months Ended
	June 30,				June 30,
(in millions)		2019		2018		2019		2018
Liability for unpaid loss and loss adjustment expenses, beginning of period	$	82,496	$	78,098	$	83,639	$	78,393
Reinsurance recoverable		(31,784)		(27,211)		(31,690)		(26,708)
Net Liability for unpaid loss and loss adjustment expenses, beginning of period		50,712		50,887		51,949		51,685
Losses and loss adjustment expenses incurred:
Current year		4,795		4,452		9,600		9,130
Prior years, excluding discount and amortization of deferred gain		(132)		(26)		(147)		(65)
Prior years, discount charge (benefit)		244		9		741		(177)
Prior years, amortization of deferred gain on retroactive reinsurance^(a)		(56)		(69)		(142)		(108)
Total losses and loss adjustment expenses incurred		4,851		4,366		10,052		8,780
Losses and loss adjustment expenses paid:
Current year		(1,148)		(910)		(1,492)		(1,520)
Prior years		(4,562)		(4,635)		(10,682)		(9,414)
Total losses and loss adjustment expenses paid		(5,710)		(5,545)		(12,174)		(10,934)
Other changes:
Foreign exchange effect		(209)		(431)		7		(157)
Retroactive reinsurance adjustment (net of discount)^(b)		80		30		(110)		(67)
Total other changes		(129)		(401)		(103)		(224)
Liability for unpaid loss and loss adjustment expenses, end of period:
Net liability for unpaid losses and loss adjustment expenses		49,724		49,307		49,724		49,307
Reinsurance recoverable		31,333		27,406		31,333		27,406
Total	$	81,057	$	76,713	$	81,057	$	76,713

(a) Includes $6 million and $8 million for the retroactive reinsurance agreement with NICO covering U.S. asbestos exposures for the three-month periods ended June 30, 2019 and 2018, respectively, and $15 million and $13 million for the six-month periods ended June 30, 2019 and 2018, respectively.

(b) Includes change in discount on retroactive reinsurance of $(125) million and $(20) million for the three-month periods ended June 30, 2019 and 2018, respectively, and $(432) million and $108 million for the six-month periods ended June 30, 2019 and 2018, respectively.

On January 20, 2017, we entered into an adverse development reinsurance agreement with National Indemnity Company (NICO), a subsidiary of Berkshire Hathaway Inc. (Berkshire), under which we transferred to NICO 80 percent of the reserve risk on substantially all of our U.S. Commercial long-tail exposures for accident years 2015 and prior. Under this agreement, we ceded to NICO 80 percent of the paid losses on subject business paid on or after January 1, 2016 in excess of $25 billion of net paid losses, up to an aggregate limit of $25 billion. At NICO’s 80 percent share, NICO’s limit of liability under the contract is $20 billion. We account for this transaction as retroactive reinsurance. We paid total consideration, including interest, of $10.2 billion. The consideration was placed into a collateral trust account as security for NICO’s claim payment obligations, and Berkshire has provided a parental guarantee to secure the obligations of NICO under the agreement. The total paid claims subject to the agreement as of June 30, 2019 were below the attachment point.

Discounting of Loss Reserves

At June 30, 2019, the loss reserves reflect a net loss reserve discount of $1.8 billion, including tabular and non-tabular calculations based upon the following assumptions:

The discount for asbestos reserves has been fully amortized.

The tabular workers’ compensation discount is calculated based on a 3.5 percent interest rate and the mortality rate used in the 2007 U.S. Life Table.

The non-tabular workers’ compensation discount is calculated separately for companies domiciled in New York and Pennsylvania, and follows the statutory regulations (prescribed or permitted) for each state. For New York companies, the discount is based on a 5 percent interest rate and the companies’ own payout patterns. For the Pennsylvania companies, the statute specifies discount factors for accident years 2001 and prior, which are based on a 6 percent interest rate and an industry payout pattern. For accident years 2002 and subsequent, the discount is based on the payout patterns and investment yields of the companies.

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

The discount consists of $603 million of tabular discount and $1.2 billion of non-tabular discount for workers’ compensation as of June 30, 2019. During the six-month periods ended June 30, 2019 and 2018, the benefit (charge) from changes in discount of $(685) million and $219 million, respectively, were recorded as part of the policyholder benefits and losses incurred in the Condensed Consolidated Statement of Income.

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

	June 30, 2019						December 31, 2018
	North						North
	America						America
	Commercial			Legacy			Commercial			Legacy
(in millions)	Insurance			Portfolio		Total	Insurance			Portfolio		Total
U.S. workers' compensation	$	2,258	$	812	$	3,070	$	2,782	$	973	$	3,755
Retroactive reinsurance		(1,288)		-		(1,288)		(1,720)		-		(1,720)
Total reserve discount^*	$	970	$	812	$	1,782	$	1,062	$	973	$	2,035

*Excludes $188 million and $163 million of discount related to certain long tail liabilities in the United Kingdom at June 30, 2019 and December 31, 2018, respectively.

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

Three Months Ended June 30,	2019						2018
	North						North
	America						America
	Commercial			Legacy			Commercial			Legacy
(in millions)	Insurance			Portfolio		Total	Insurance			Portfolio		Total
Current accident year	$	32	$	-	$	32	$	23	$	-	$	23
Accretion and other adjustments
to prior year discount		8		(11)		(3)		(133)		(12)		(145)
Effect of interest rate changes		(170)		(71)		(241)		96		40		136
Net reserve discount
benefit (charge)		(130)		(82)		(212)		(14)		28		14
Change in discount on loss reserves
ceded under retroactive reinsurance		125		-		125		20		-		20
Net change in total reserve
discount^(a)	$	(5)	$	(82)	$	(87)	$	6	$	28	$	34

Six Months Ended June 30,	2019						2018
	North						North
	America						America
	Commercial			Legacy			Commercial			Legacy
(in millions)	Insurance			Portfolio		Total	Insurance			Portfolio		Total
Current accident year	$	56	$	-	$	56	$	42	$	-	$	42
Accretion and other adjustments
to prior year discount		(243)		(24)		(267)		(88)		(30)		(118)
Effect of interest rate changes		(337)		(137)		(474)		219		76		295
Net reserve discount
benefit (charge)		(524)		(161)		(685)		173		46		219
Change in discount on loss reserves
ceded under retroactive reinsurance		432		-		432		(108)		-		(108)
Net change in total reserve
discount^(b)	$	(92)	$	(161)	$	(253)	$	65	$	46	$	111

(a) Excludes $(9) million and $7 million discount related to certain long tail liabilities in the United Kingdom for the three-month periods ended June 30, 2019 and 2018, respectively.

(b) Excludes $26 million and $3 million discount related to certain long tail liabilities in the United Kingdom for the six-month periods ended June 30, 2019 and 2018, respectively.

During the six-month period ended June 30, 2019, effective interest rates declined due to a decrease in the forward yield curve component of the discount rates. This decrease reflects a decline in U.S. Treasury rates.

During the six-month period ended June 30, 2018, effective interest rates increased due to an increase in the forward yield curve component of the discount rates. This increase reflects an incline in U.S. Treasury rates.