UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
| ☒ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended Fiscal Year Ended December 31, 2018
OR
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ______ to ______
Commission file number number: 0-5534
(Exact nameName of registrantRegistrant as specifiedSpecified in its charter)Its Charter)
Indiana | 35-0160330 | |
| (State or Incorporation or Organization) | (I.R.S. Employer Identification No.) | |
111 Congressional Boulevard, Carmel, Indiana | 46032 | |
| (Address of | (Zip Code) |
Registrant's telephone number, including area code: (317) 636-9800
Securities registered pursuant to Section 12(b) of the Act:
(Title of class) | Name of Each Exchange on which Registered | |
| Class A Common Stock, No Par Value | The Nasdaq Stock Market LLC | |
| Class B Common Stock, No Par Value | The Nasdaq Stock Market LLC |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes -☐___ No ☒✓
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes -☐___ No ☒✓
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes -✓☒ No ___☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ✓☒ No__No ☐
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐-
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer", "accelerated filer", "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐ | Accelerated filer ☒ |
Non-accelerated filer ☐ | Smaller reporting company ☐ |
Emerging growth company ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ______☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes -☐___ No ☒✓
The aggregate market value of Class A and Class B Common Stock held by non-affiliates of the Registrant as of June 30, 2017,29, 2018, based on the closing trade prices on that date, was approximately $266,182,000.$265,014,000.
The number of shares outstanding of each of the issuer's classes of common stock as of March 1, 2018:2019:
| Common Stock, No Par Value: | Class A (voting) | 2,615,339 | |
| Class B (nonvoting) | 12,234,130 | ||
| 14,849,469 |
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Shareholders to be held on May 8, 20187, 2019 are incorporated by reference into Part III of this Annual Report on Form 10-K.
FORWARD-LOOKING STATEMENTS
The disclosures in this Form 10-K contain "forward-looking statements" (within the meaning of the Private Securities Litigation Reform Act of 1995). All statements, trend analyses and other information contained in this Form 10-K relative to markets for our products and trends in our operations or financial results, as well as other statements including words such as "may," "target," "anticipate," "believe," "plan," "estimate," "expect," "intend," "project," and other similar expressions, constitute forward-looking statements.
Investors are cautioned that such forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from such forward-looking statements,, many of which are difficult to predict and generally beyond our control. Investors are cautioned not to place undue reliance on these forward-looking statements that speak only as of the date hereof. Investors are also urged to carefully review and consider the various disclosures made by us, which attempt to advise interested parties of the factors that affect our business, including "Risk Factors""Risk Factors" set forth in Part I, Item 1A hereof and our reports filed with the U.S. Securities and Exchange Commission, or SEC, from time to time. Except to the extent otherwise required by federal securities laws, we do not undertake any obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof.
Factors that could contribute to these differences include, among other things:
| ● | general economic conditions, including weakness of the financial markets, prevailing interest rate levels and stock and credit market performance, which may affect or continue to affect (among other things) our ability to sell our products and to collect amounts due to us, our ability to access capital resources and the costs associated with such access to capital and the market value of our investments; |
| ● | our ability to obtain adequate premium rates and manage our growth strategy; |
| ● | increasing competition in the sale of our insurance products and services resulting from the entrance of new competitors into, or the expansion of the operations of existing competitors in, our markets and our ability to retain existing customers; |
| ● | other changes in the markets for our insurance products; |
| ● | the impact of technological advances, including those specific to the transportation industry; |
| ● | changes in the legal or regulatory environment, which may affect the manner in which claims are adjusted or litigated, including loss and loss adjustment expense; |
| ● | legal or regulatory changes or actions, including those relating to the regulation of the sale, underwriting and pricing of insurance products and services and capital requirements; |
| ● | the impact of a downgrade in our financial strength rating; |
| ● | technology or network security |
| ● | adequacy of insurance reserves; |
| ● | availability of reinsurance and ability of reinsurers to pay their obligations; |
| ● | our ability to attract and retain qualified |
| ● | tax law and accounting changes; and |
| ● | legal actions brought against us. |
Some of the significant risks and uncertainties that could cause actual results to differ materially from our expectations and projections are described more fully in Part I, Item 1A, ""Risk Factors"Factors" of this report.Annual Report on Form 10-K. You should read that information in conjunction with ""Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of this reportAnnual Report on Form 10-K and our Consolidated Financial Statementsconsolidated financial statements and related notes in Part II, Item 8 of this report.
Annual Report on Form 10-K.
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PART I
Item 1. BUSINESS
Protective Insurance Corporation (formerly Baldwin & Lyons, Inc.) (referred to herein as "B&L""Protective") was incorporated under the laws of the State of Indiana in 1930. Through its subsidiaries, B&LProtective engages in marketing and underwriting property, liability and workers' compensation coverage for trucking and public transportation fleets, as well as coverage for trucking industry independent contractors. In addition, B&LProtective offers workers' compensation coverage for a variety of operations outside the transportation industry.
Protective’s principal subsidiaries are:
| 1. | Protective Insurance Company |
| 2. | Protective Specialty Insurance Company (referred to herein as "Protective Specialty"), which is currently approved for excess and surplus lines business by insurance authorities in 48 states and the District of Columbia and licensed in Indiana; |
| 3. | Sagamore Insurance Company |
| 4. | B&L Brokerage Services, Inc. (referred to herein as "BLBS"), an |
| 5. | B&L Insurance, Ltd. (referred to herein as "BLI"), which is domiciled and licensed in Bermuda. |
Protective Insurance Co., Protective Specialty, Sagamore and BLI are collectively referred to herein as the "Insurance Subsidiaries." The "Company", "we", "us" and "our", as used herein, refersrefer to B&LProtective and all of its subsidiaries unless the context clearly indicates otherwise.
As is a common practice in the property and casualty insurance industry, the Insurance Subsidiaries share or "cede" portions of their gross premiums written with several non-affiliated reinsurers under excess of loss and quota-share treaties covering predetermined groups of risks and by facultative (individual(individual policy-by-policy) placements. Reinsurance is ceded to spread the risk of loss from individual claims or groups of claims among several reinsurers and is an integral part of the Company's business.
In 2017,2018, the Insurance Subsidiaries primarily served the fleet transportationcommercial automobile market, although the Insurance Subsidiaries continue to support previously written policies in specialty markets for which the Company has discontinued operations. Continuingwriting business and these operations andare in run-off. The Company expects targeted growth are expected to occur in ourits core business of fleet transportationcommercial automobile and workers' compensation.
The Company determined that its business constituted one reportable property and casualty insurance segment as of January 1, 2017. During 2016 and prior years, the Company had two reportable segments – property and casualty insurance and reinsurance. The Company moved to a single reportable segment based on how its operating results are regularly reviewed by the Company'sits chief operating decision maker when making decisions about how resources are to be allocated to the segment and assessing its performance. The prior year segment information throughout this Annual Report on Form 10-K was updated to conform to the current year presentation.
Product Lines
Commercial Automobile
The Insurance Subsidiaries provide coverage for larger companies in the motor carrier industry that retain substantial amounts of self-insurance, for independent contractors utilized by trucking companies, for medium-sized and small trucking companies on a first dollar or deductible basis, and for public livery concerns, principally covering fleets of commercial buses and taxis. This group of products is collectively referred to as fleet transportation.commercial automobile. Large fleet trucking products are marketed both directly to fleet transportationcommercial automobile clients and also through relationships with non-affiliated brokers and specialized agents. Products for small and intermediate fleets and independent contractors are marketed through relationships with non-affiliated brokers and specialized agents. In some cases, the Insurance Subsidiaries will provide customized product offerings to specific markets through partnerships with brokers or program administrators. In most cases, the Company's fleet transportationcommercial automobile policies are written on an "occurrence" basis (i.e. webasis. This means that the Company may be liable for claims that occurred when ourits policy was in place with an insured, regardless of when those claims are reported to us;the Company, and it may take months or even years for claims to be reported to us).the Company.
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The principal types of fleet transportationcommercial automobile insurance marketed by the Insurance Subsidiaries are:
| ● | Commercial motor vehicle liability, physical damage and general liability |
| ● | Workers' compensation |
● | Specialized accident (medical and indemnity) insurance for independent contractors in the trucking |
| ● | Non-trucking motor vehicle liability insurance for independent |
| ● | Fidelity and surety |
| ● | Inland Marine insurance consisting principally of cargo insurance. |
The Insurance Subsidiaries also perform a variety of additional services, primarily for the Company's insureds, including risk surveys and analyses, safety program design and monitoring, government compliance assistance, loss control and cost studies and research, development, and consultation in connection with new insurance programs, including development of systems to assist customers in monitoring their accident data. B<he Company also provides claims handling services, primarily to excess clients with self-insurance programs.
Workers' Compensation
The Insurance Subsidiaries provide workers' compensation insurance for the fleet transportationcommercial automobile industry, primarily to employees of motor carriers or independent contractors providing services in the transportation industry. In 2017, the Company began marketing workers' compensation coverage was marketed beyond fleet transportationcommercial automobile clients to a variety of non-transportation operations, such as light manufacturing, restaurants, retailers, and professional services on both a first-dollar and deductible basis. Non-transportation workers' compensation insurance is marketed through relationships with non-affiliated brokers and specialized agents. In addition, we havethe Company has developed customized non-transportation workers' compensation programs, which are marketed through non-affiliated agent partners. In most cases, the Company's workers' compensation policies are written on an "occurrence" basis (i.e. webasis. This means that the Company may be liable for claims that occurred when ourits policy was in place with an insured, regardless of when those claims are reported to us;the Company, and it may take months or even years for claims to be reported to us).the Company.
Discontinued Products
| ● | Reinsurance Assumptions |
In the first quarter of 2016, the Company discontinued its reinsurance assumed professional liability line of products. These products are in run-off but continued earning premiums in 2017.2017 and 2018. Prior to that, the Company accepted cessions and retrocessions from selected insurance and reinsurance companies, providing reinsurance coverage for both property and casualty events. Participation in reinsurance markets fluctuated based on market conditions for these products. The Company's reinsurance assumed policies were written on both an "occurrence" basis and a "claims-made" basis. Under claims-made policies, the Company was generally only liable for claims when a policy was in place with its insured; however, the Company was potentially liable for claims reported to it, even if the claim event occurred before it had a policy in place with the insured.
| ● | Professional Liability |
In the fourth quarter of 2016, the Company discontinued its professional liability line of products. Prior to that, the Company marketed a variety of professional liability products through wholesale and retail agents on both an admitted and surplus lines basis throughout the United States, specializing in smaller insureds. Some professional liability policies renewed in 2017 as required by state regulations and existing policies remained inforce through 2017. In most cases, the Company's professional liability policies were written on a "claims-made" basis. Under claims-made policies, the Company was generally only liable for claims when a policy was in place with our insured, however we were potentially liable for claims reported to us, even if the claim event occurred before we had a policy in place with the insured.
Losses and Loss Adjustment Expenses
Losses and loss adjustment expenses incurred on average comprise approximately two-thirds of the Company's operating expenses.
The Company's consolidated balance sheets as of December 31, 20172018 and 20162017 set forth in Part II, Item 8 of this Annual Report on Form 10-K include the estimated liability for unpaid losses and loss adjustment expenses ("LAE") of the Insurance Subsidiaries before the application of reinsurance credits (gross reserves). The liabilities for losses and LAE are determined using case basis evaluations and statistical projections and represent estimates of the Company's ultimate exposure for all unpaid losses and LAE incurred through December 31 of each year. These estimates are subject to the effects of trends in claim severity and frequency and are continually reviewed and, as experience develops and new information becomes known, the liability is adjusted as necessary. Such adjustments, either positive or negative, are reflected in current operations as recorded.
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The Company's reserves for losses and loss expenses are determined based on evaluations of individual reported claims and by actuarial estimation processes using historical experience, current economic information and, when necessary, available industry statistics. "Case basis" loss reserves are evaluated on an individual case-by-case basis by experienced claims adjusters using established Company guidelines and are monitored by claims management. Additionally, "bulk" reserves are established for (1) those losses which have occurred but have not yet been reported to the Company ("incurred but not reported" claims), (2) provisions for any possible deficiencies in the case reserving process and (3) the expected external and internal costs to fully settle each claim, also referred to as LAE. Common actuarial methods are employed in the establishment of bulk reserves using Company historical loss data, consideration of changes in the Company's business and study of current economic trends affecting ultimate claims costs. Loss adjustment expenseLAE reserves include amounts ultimately allocable to individual claims as well as amounts required for the general overhead of the claims handling operation whichthat are not specifically allocable to individual claims. Historical analyses of the ratio of loss adjusting expensesLAE to losses paid on prior closed claims and study of current economic trends affecting loss settlement costs are used to estimate the loss adjustmentLAE reserve needs relative to the established loss reserves. Each of these reserve categories containcontains elements of uncertainty, which assureassures variability when compared to the ultimate costs to settle the underlying claims for which the reserves are established. For a more detailed discussion of the three categories of reserves, see "Loss"Loss and Loss Expense Reserves" under the caption, "Critical"Critical Accounting Policies" notedPolicies" in Part II, Item 7, "Management's"Management's Discussion and Analysis of Financial Condition and Results of Operations," of this Annual Report on Form 10-K.
After giving effect to treaty and facultative reinsurance arrangements, the Company's maximum exposure to loss from a single occurrence for the vast majority of risks insured (those with policy limits of $5 million or less) is approximately:
| ● | $0.25 million to $1.3 million for policies written |
| ● | $0.8 million to $4.1 million for policies written on or after July 3, 2017. |
However, for certain losses (those with policy limits up to $10 million) the maximum exposure could be as high as:
| ● | $2.5 million for policies written |
| ● | $8.0 million for policies written on or after July 3, 2017. |
The change in the Company's single occurrence loss exposure described above (from a range of $0.25 million to $2.5 million in 2016, to a range of $0.8 million to $8.0 million in 2017) is offset by a change in the reinsurance structure for these risks. As of July 3, 2017, the Company no longer utilizes sliding scale ceding premium provisions in its reinsurance arrangements for these risks, instead utilizing a flat ceding premium percentage.
The economic exposure from a single claim occurrence remains relatively consistent year over year;year-over-year; however, under the current flat ceding premium provision, more of the economic exposure will flow through loss expense moving forward, whereas in prior periods, utilizing the sliding scale ceding premium provisions, more of the economic exposure was reflected in lower net premiums earned. For both periods discussed above, the Company'sCompany has limited economic exposure for losses occurring in treaty years that have loss and allocated loss adjustment expenseLAE ratios greater than approximately 86.5%83.0%.
The Company is a cedent under numerous reinsurance treaties covering its product lines. Treaties are typically written on an annual basis, each with its own renewal date. However, treaty terms may occasionally be agreed to for periods beyond one year. Treaty renewals are expected to largely continue to occur annually in the foreseeable future. Because losses from certain of the Company's products can experience delays in being reported and can take years to settle, losses reported to the Company in the current year may be covered by a number of older reinsurance treaties with higher or lower net loss exposures than those provided by current treaty provisions.
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The table below sets forth a reconciliation of beginning and ending loss and LAE liability balances for 2018, 2017 2016 and 2015.2016. This table includes reserves, net of reinsurance recoverable, to correspond with our income statementthe presentation in the Company's consolidated statements of operations, but also includes a reconciliation of beginning and ending loss and LAE liability, gross of reinsurance recoverable, as presented in the Company's consolidated balance sheet.sheets. All amounts are shown net of reinsurance, unless otherwise indicated.
| 2018 | 2017 | 2016 | ||||||||||
| Reserves, gross of reinsurance recoverable, at the beginning of the year | $ | 680,274 | $ | 576,330 | $ | 513,596 | ||||||
| Reinsurance recoverable on unpaid losses at the beginning of the year | 308,143 | 251,563 | 211,843 | |||||||||
| Reserves at the beginning of the year | 372,131 | 324,767 | 301,753 | |||||||||
| Provision for losses and loss expenses: | ||||||||||||
| Claims occurring during the current year | 329,078 | 228,303 | 172,645 | |||||||||
| Claims occurring during prior years | 16,786 | 19,215 | 13,836 | |||||||||
| Total incurred losses and loss expenses | 345,864 | 247,518 | 186,481 | |||||||||
| Loss and loss expense payments: | ||||||||||||
| Claims occurring during the current year | 84,738 | 67,234 | 54,239 | |||||||||
| Claims occurring during prior years | 143,853 | 132,920 | 109,228 | |||||||||
| Total paid | 228,591 | 200,154 | 163,467 | |||||||||
| Reserves at the end of the year | 489,404 | 372,131 | 324,767 | |||||||||
| Reinsurance recoverable on unpaid losses at the end of the year | 375,935 | 308,143 | 251,563 | |||||||||
| Reserves, gross of reinsurance recoverable, at the end of the year | $ | 865,339 | $ | 680,274 | $ | 576,330 | ||||||
| 2017 | 2016 | 2015 | ||||||||||
| Reserves, gross of reinsurance | ||||||||||||
| recoverable, at the beginning of the year | $ | 576,330 | $ | 513,596 | $ | 506,102 | ||||||
| Reinsurance recoverable on unpaid losses at the beginning of the year | 251,563 | 211,843 | 210,519 | |||||||||
| Reserves at the beginning of the year | 324,767 | 301,753 | 295,583 | |||||||||
| Provision for losses and loss expenses: | ||||||||||||
| Claims occurring during the current year | 228,303 | 172,645 | 165,812 | |||||||||
| Claims occurring during prior years | 19,215 | 13,836 | (10,062 | ) | ||||||||
| Total incurred losses and loss expenses | 247,518 | 186,481 | 155,750 | |||||||||
| Loss and loss expense payments: | ||||||||||||
| Claims occurring during the current year | 67,234 | 54,239 | 56,710 | |||||||||
| Claims occurring during prior years | 132,920 | 109,228 | 92,870 | |||||||||
| Total paid | 200,154 | 163,467 | 149,580 | |||||||||
| Reserves at the end of the year | 372,131 | 324,767 | 301,753 | |||||||||
| Reinsurance recoverable on unpaid losses at the end of the year | 308,143 | 251,563 | 211,843 | |||||||||
| Reserves, gross of reinsurance | ||||||||||||
| recoverable, at the end of the year | $ | 680,274 | $ | 576,330 | $ | 513,596 | ||||||
The reconciliation above shows the Company's estimate of net losses on 20162017 and prior accidentsaccident years is approximately $19.2$16.8 million higher at December 31, 20172018 than was provided in loss reserves at December 31, 20162017 (referred to as a "reserve deficiency"). This compares to a $13.8$19.2 million reserve deficiency on prior accident years in 20162017 and a $10.0$13.8 million reserve savingsdeficiency reported in 20152016 related to prior accident years.
The following table is a summary of the
| Years in Which Losses Were Incurred | Reserve at December 31, 2016 | (Savings) Deficiency Recorded During 2017 1 | % (Savings) Deficiency | Reserve at December 31, 2017 | (Savings) Deficiency Recorded During 2018 (1) | % (Savings) Deficiency | ||||||||||||||||||
| 2017 | $ | 161,069 | $ | (8,902 | ) | (5.5 | )% | |||||||||||||||||
| 2016 | $ | 118,406 | $ | (8,561 | ) | (7.2 | %) | 66,652 | 4,259 | 6.4 | % | |||||||||||||
| 2015 | 69,463 | (3,863 | ) | (5.6 | %) | 34,530 | 9,707 | 28.1 | % | |||||||||||||||
| 2014 | 50,739 | 3,688 | 7.3 | % | 30,129 | 11,970 | 39.7 | % | ||||||||||||||||
| 2013 | 22,186 | 17,418 | 78.5 | % | 22,423 | (1,382 | ) | (6.2 | )% | |||||||||||||||
| 2012 | 16,414 | 6,234 | 38.0 | % | ||||||||||||||||||||
| 2011 & Prior | 47,559 | 4,299 | 9.0 | % | ||||||||||||||||||||
| 2012 and prior | 57,328 | 1,134 | 2.0 | % | ||||||||||||||||||||
| $ | 324,767 | $ | 19,215 | 5.9 | % | $ | 372,131 | $ | 16,786 | 4.5 | % | |||||||||||||
| (1) | Consists of development on cases known at December 31, 2017, losses reported which were previously unknown at December 31, 2017 (incurred but not reported), unallocated loss expense paid related to accident years 2017 and prior changes in the reserves for incurred but not reported losses and loss expenses. |
The savings shown in accident years 2015 and 2016year 2017 in the table above reflect favorable loss development in both short-tail lines of business, such as physical damage, and the Company's independent contractor products (including non-trucking liability, occupational accident and workers' compensation). The deficiencies in accident years 2014 and prior2014-2016 are largely the result of discontinued lines (professional liability and general property based in Florida) and several infrequent, but severe transportation losses. The Company took action in all accident years to reflect new trends in loss development for commercial autoautomobile products that have emerged over the last twothree years. These actions included case reserving reviews, as well as actuarial product reviews, and resulted in the reserve strengthening noted during 2017.the last three years.
Bulk loss reserves are established to provide for potential future adverse development on cases known to the Company and for cases unknown at the reserve date. Changes in the reserves for incurred but not reported losses and loss expenses occur based upon information received on known and newly reported cases during the current year and the effect of that development on the application of standard actuarial methods used by the Company.
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The Company continues to incorporate more recent loss development data into its loss reserving formulae; however, the dynamic nature of losses associated with the fleet transportationcommercial automobile business, as well as the timing of settlement of large claims, increases the likelihood of variability in loss developments from period to period. As discussed elsewhere, the Company has historically experienced savings in its loss developments owing to, among other things, its long-standing policy of reserving for the ultimate value of losses quickly and realistically and a willingness to settle claims based upon a seasoned evaluation of its exposures. While the Company's basic assumptions have remained consistent, we continuethe Company continues to update loss data to reflect changing trends, which can be expected to result in fluctuations in loss developments over time.
Management's goal is to produce an overall estimate of reserves which is sufficient and as close to expected ultimate losses as possible. The $19.2 million in net deficiency developed during 2017 represents 5.9% of December 31, 2016 net loss and LAE reserves, which is within an acceptable range of variation for the Company's diverse and complex book of business. 2017 was the first calendar year in which reserve deficiencies were more than 5% of the prior year's loss position since 1985. The Company constantly monitors changes in trends related to the numbersnumber of claims incurred relative to correlative variances with premium volume, average settlement amounts, numbersnumber of claims outstanding at period ends and the average value per claim outstanding and adjusts actuarial assumptions as necessary to accommodate observed trends.
The table below presents the development of U.S. generally accepted accounting principles ("GAAP") balance sheet insurance reserves for each year-end from 20072008 through 2016,2017, as of December 31, 2017,2018, net of all reinsurance credits.
ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT--GAAP BASIS
(Dollars in thousands)
| ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT--GAAP BASIS | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Year Ended December 31 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Year Ended December 31 | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Liability for Unpaid Losses | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| and Loss Adjustment | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Expenses 1 | $ | 244,500 | $ | 231,633 | $ | 203,253 | $ | 218,629 | $ | 290,092 | $ | 289,236 | $ | 288,088 | $ | 295,583 | $ | 301,753 | $ | 324,767 | $ | 372,131 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Liability for Unpaid Losses and Loss Adjustment Expenses (1) | $ | 231,633 | $ | 203,253 | $ | 218,629 | $ | 290,092 | $ | 289,236 | $ | 288,088 | $ | 295,583 | $ | 301,753 | $ | 324,767 | $ | 372,131 | $ | 489,404 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Liability Reestimated | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
as of: 2 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Liability Reestimated as of: (2) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| One Year Later | 227,423 | 222,049 | 194,430 | 208,933 | 280,217 | 283,673 | 277,734 | 285,521 | 315,589 | 343,982 | 222,049 | 194,430 | 208,933 | 280,217 | 283,673 | 277,734 | 285,521 | 315,589 | 343,982 | 388,917 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Two Years Later | 216,730 | 208,702 | 198,220 | 201,745 | 272,285 | 282,381 | 268,757 | 303,540 | 340,361 | 208,702 | 198,220 | 201,745 | 272,285 | 282,381 | 268,757 | 303,540 | 340,361 | 369,670 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Three Years Later | 206,445 | 210,562 | 188,110 | 204,243 | 276,525 | 279,685 | 288,862 | 332,175 | 210,562 | 188,110 | 204,243 | 276,525 | 279,685 | 288,862 | 332,175 | 361,791 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Four Years Later | 210,170 | 205,519 | 192,195 | 202,078 | 268,299 | 291,332 | 313,909 | 205,519 | 192,195 | 202,078 | 268,299 | 291,332 | 313,909 | 343,898 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Five Years Later | 208,132 | 208,398 | 187,792 | 198,518 | 275,517 | 298,861 | 208,398 | 187,792 | 198,518 | 275,517 | 298,861 | 313,662 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Six Years Later | 210,446 | 205,986 | 181,547 | 200,922 | 276,812 | 205,986 | 181,547 | 200,922 | 276,812 | 299,996 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Seven Years Later | 209,288 | 200,460 | 181,998 | 203,692 | 200,460 | 181,998 | 203,692 | 279,598 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Eight Years Later | 205,179 | 200,808 | 184,122 | 200,808 | 184,122 | 204,769 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Nine Years Later | 205,248 | 202,565 | 202,565 | 183,693 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Ten Years Later | 205,784 | 201,673 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Cumulative Redundancy (Deficiency) (3) | $ | 29,960 | $ | 19,560 | $ | 13,860 | $ | 10,494 | $ | (10,760 | ) | $ | (25,574 | ) | $ | (48,315 | ) | $ | (60,038 | ) | $ | (44,903 | ) | $ | (16,786 | ) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Cumulative Redundancy (Deficiency) 3 | $ | 38,716 | $ | 29,068 | $ | 19,131 | $ | 14,937 | $ | 13,280 | $ | (9,625 | ) | $ | (25,821 | ) | $ | (36,592 | ) | $ | (38,608 | ) | $ | (19,215 | ) | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Cumulative Amount of | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Liability Paid | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Through: 4 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Cumulative Amount of Liability Paid Through: (4) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| One Year Later | $ | 76,970 | $ | 84,777 | $ | 74,182 | $ | 72,393 | $ | 94,003 | $ | 103,941 | $ | 92,275 | $ | 92,870 | $ | 109,228 | $ | 132,920 | $ | 84,777 | $ | 74,182 | $ | 72,393 | $ | 94,003 | $ | 103,941 | $ | 92,275 | $ | 92,870 | $ | 109,228 | $ | 132,920 | $ | 143,853 | ||||||||||||||||||||||||||||||||||||||||||||||||
| Two Years Later | 124,870 | 120,628 | 107,413 | 109,382 | 156,271 | 162,087 | 159,282 | 166,642 | 195,951 | 120,628 | 107,413 | 109,382 | 156,271 | 162,087 | 159,282 | 166,642 | 195,951 | 217,376 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Three Years Later | 145,857 | 142,731 | 125,038 | 133,507 | 193,566 | 205,452 | 166,642 | 222,295 | 142,731 | 125,038 | 133,507 | 193,566 | 205,452 | 166,642 | 222,295 | 250,924 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Four Years Later | 157,724 | 152,679 | 137,460 | 147,462 | 214,873 | 202,803 | 234,158 | 152,679 | 137,460 | 147,462 | 214,873 | 202,803 | 234,158 | 258,576 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Five Years Later | 164,877 | 161,834 | 143,461 | 158,172 | 227,359 | 241,533 | 161,834 | 143,461 | 158,172 | 227,359 | 241,533 | 251,696 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Six Years Later | 170,554 | 166,290 | 148,101 | 166,112 | 234,578 | 166,290 | 148,101 | 166,112 | 234,578 | 252,648 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Seven Years Later | 174,190 | 170,126 | 152,375 | 168,524 | 170,126 | 152,375 | 168,524 | 241,383 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Eight Years Later | 177,275 | 173,867 | 153,999 | 173,867 | 153,999 | 173,015 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Nine Years Later | 180,569 | 174,902 | 174,902 | 157,297 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Ten Years Later | 180,701 | 177,677 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (1) | Represents the estimated liability for unpaid losses and LAE recorded at the balance sheet date for each of the indicated years. This liability represents the estimated amount of losses and LAE for claims arising in all prior years that were unpaid at the respective balance sheet date, including incurred but not reported ("IBNR") losses, to the Company. |
| (2) | Represents the re-estimated amount of the previously recorded liability based on additional information available to the Company as of the end of each succeeding year. The estimate is increased or decreased as more information becomes known about the frequency and severity of individual claims and as claims are settled and paid. |
| (3) | Represents the aggregate change in the estimates of each calendar year-end reserve through December 31, 2018. |
| (4) | Represents the cumulative amount paid with respect to the previously recorded calendar year-end liability as of the end of each succeeding year. The payment patterns shown in this table demonstrate the "long-tail" nature of much of the Company's business, whereby portions of claims, principally in workers' compensation coverages, do not fully pay out for more than ten years. |
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Readers should note the table above does not present accident or policy year development data, which they may be more accustomed to analyzing. Rather, this table is intended to present an evaluation of the Company's ability to establish its liability for losses and loss expenses at a given balance sheet date. In reviewing this information, it is important to understand that this method of presentation causes some development experience to be duplicated. For example, the amount of any redundancy or deficiency related to losses settled in 2010,2011, but incurred in 2007,2008, will be included in the cumulative development amount for each of the years ending December 31, 2007, 2008, 2009, and 2009.2010. It is also important to note that conditions and trends that have affected development of the liability in the past may not necessarily occur in the future. Accordingly, it would not be appropriate to extrapolate future redundancies or deficiencies based on this table.
The table presented below presents loss development data on a gross (before consideration of reinsurance) basis for the same ten year period December 31, 20072008 through December 31, 2016,2017, as of December 31, 2017,2018, with a reconciliation of the data to the net amounts shown in the table above.
| (Dollars in thousands) | ||||||||||||||||||||||||||||||||||||||||||||
| Year Ended December 31 | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | |||||||||||||||||||||||||||||||||
| Direct and Assumed: | ||||||||||||||||||||||||||||||||||||||||||||
| Liability for Unpaid Losses and Loss | ||||||||||||||||||||||||||||||||||||||||||||
| Adjustment Expenses | $ | 378,616 | $ | 389,558 | $ | 359,030 | $ | 344,520 | $ | 421,556 | $ | 455,454 | $ | 474,470 | $ | 506,102 | $ | 513,596 | $ | 576,330 | $ | 680,274 | ||||||||||||||||||||||
| Liability Reestimated as of | ||||||||||||||||||||||||||||||||||||||||||||
| December 31, 2017 | 316,914 | 311,512 | 303,058 | 322,142 | 414,550 | 476,593 | 532,456 | 590,685 | 608,357 | 601,543 | ||||||||||||||||||||||||||||||||||
| Cumulative Redundancy (Deficiency) | $ | 61,702 | $ | 78,046 | $ | 55,972 | $ | 22,378 | $ | 7,006 | $ | (21,139 | ) | $ | (57,986 | ) | $ | (84,583 | ) | $ | (94,761 | ) | $ | (25,213 | ) | |||||||||||||||||||
| Ceded: | ||||||||||||||||||||||||||||||||||||||||||||
| Liability for Unpaid Losses and Loss | ||||||||||||||||||||||||||||||||||||||||||||
| Adjustment Expenses | $ | 134,116 | $ | 157,925 | $ | 155,777 | $ | 125,891 | $ | 131,464 | $ | 166,218 | $ | 186,382 | $ | 210,519 | $ | 211,843 | $ | 251,563 | $ | 308,143 | ||||||||||||||||||||||
| Liability Reestimated as of | ||||||||||||||||||||||||||||||||||||||||||||
| December 31, 2017 | 111,130 | 108,947 | 118,936 | 118,450 | 137,738 | 177,732 | 218,547 | 258,510 | 267,996 | 257,561 | ||||||||||||||||||||||||||||||||||
| Cumulative Redundancy (Deficiency) | $ | 22,986 | $ | 48,978 | $ | 36,841 | $ | 7,441 | $ | (6,274 | ) | $ | (11,514 | ) | $ | (32,165 | ) | $ | (47,991 | ) | $ | (56,153 | ) | $ | (5,998 | ) | ||||||||||||||||||
| Net: | ||||||||||||||||||||||||||||||||||||||||||||
| Liability for Unpaid Losses and Loss | ||||||||||||||||||||||||||||||||||||||||||||
| Adjustment Expenses | $ | 244,500 | $ | 231,633 | $ | 203,253 | $ | 218,629 | $ | 290,092 | $ | 289,236 | $ | 288,088 | $ | 295,583 | $ | 301,753 | $ | 324,767 | $ | 372,131 | ||||||||||||||||||||||
| Liability Reestimated as of | ||||||||||||||||||||||||||||||||||||||||||||
| December 31, 2017 | 205,784 | 202,565 | 184,122 | 203,692 | 276,812 | 298,861 | 313,909 | 332,175 | 340,361 | 343,982 | ||||||||||||||||||||||||||||||||||
| Cumulative Redundancy (Deficiency) | $ | 38,716 | $ | 29,068 | $ | 19,131 | $ | 14,937 | $ | 13,280 | $ | (9,625 | ) | $ | (25,821 | ) | $ | (36,592 | ) | $ | (38,608 | ) | $ | (19,215 | ) | |||||||||||||||||||
ANALYSIS OF LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT--GAAP BASIS
(Dollars in thousands)
| Year Ended December 31 | ||||||||||||||||||||||||||||||||||||||||||||
| 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | ||||||||||||||||||||||||||||||||||
| Direct and Assumed: | ||||||||||||||||||||||||||||||||||||||||||||
| Liability for Unpaid Losses and Loss Adjustment Expenses | $ | 389,558 | $ | 359,030 | $ | 344,520 | $ | 421,556 | $ | 455,454 | $ | 474,470 | $ | 506,102 | $ | 513,596 | $ | 576,330 | $ | 680,274 | $ | 865,339 | ||||||||||||||||||||||
| Liability Reestimated as of December 31, 2018 | 312,965 | 289,679 | 301,700 | 395,271 | 450,713 | 519,189 | 599,457 | 633,660 | 647,807 | 709,523 | ||||||||||||||||||||||||||||||||||
| Cumulative Redundancy (Deficiency) | $ | 76,593 | $ | 69,351 | $ | 42,820 | $ | 26,285 | $ | 4,741 | $ | (44,719 | ) | $ | (93,355 | ) | $ | (120,064 | ) | $ | (71,477 | ) | $ | (29,249 | ) | |||||||||||||||||||
| Ceded: | ||||||||||||||||||||||||||||||||||||||||||||
| Liability for Unpaid Losses and Loss Adjustment Expenses | $ | 157,925 | $ | 155,777 | $ | 125,891 | $ | 131,464 | $ | 166,218 | $ | 186,382 | $ | 210,519 | $ | 211,843 | $ | 251,563 | $ | 308,143 | $ | 375,935 | ||||||||||||||||||||||
| Liability Reestimated as of December 31, 2018 | 111,292 | 105,986 | 96,931 | 115,673 | 150,717 | 205,527 | 255,559 | 271,869 | 278,137 | 320,606 | ||||||||||||||||||||||||||||||||||
| Cumulative Redundancy (Deficiency) | $ | 46,633 | $ | 49,791 | $ | 28,960 | $ | 15,791 | $ | 15,501 | $ | (19,145 | ) | $ | (45,040 | ) | $ | (60,026 | ) | $ | (26,574 | ) | $ | (12,463 | ) | |||||||||||||||||||
| Net: | ||||||||||||||||||||||||||||||||||||||||||||
| Liability for Unpaid Losses and Loss Adjustment Expenses | $ | 231,633 | $ | 203,253 | $ | 218,629 | $ | 290,092 | $ | 289,236 | $ | 288,088 | $ | 295,583 | $ | 301,753 | $ | 324,767 | $ | 372,131 | $ | 489,404 | ||||||||||||||||||||||
| Liability Reestimated as of December 31, 2018 | 201,673 | 183,693 | 204,769 | 279,598 | 299,996 | 313,662 | 343,898 | 361,791 | 369,670 | 388,917 | ||||||||||||||||||||||||||||||||||
| Cumulative Redundancy (Deficiency) | $ | 29,960 | $ | 19,560 | $ | 13,860 | $ | 10,494 | $ | (10,760 | ) | $ | (25,574 | ) | $ | (48,315 | ) | $ | (60,038 | ) | $ | (44,903 | ) | $ | (16,786 | ) | ||||||||||||||||||
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Readers are reminded the gross data presented above requires significantly more subjectivity in the estimation of IBNR and loss expense reserves because of the high limits provided by the Company to its fleet transportationcommercial automobile and workers' compensation customers, some of which has been covered by excess of loss and facultative reinsurance. This is particularly true of excess of loss treaties where in which the Company retains risk in only the lower, more predictable, layers of coverage. Accordingly, one would generally expect more variability in development on a gross basis than on a net basis. The Company's consolidated financial statements reflect ourits financial results net of reinsurance.
Environmental Matters:
Given that one of the Company's core businesses is insuring fleet transportationcommercial automobile companies, on occasion claims involving a commercial automobile accident which has resulted in the spill of a pollutant are made. Certain of the Company's policies may cover these situations on the basis that they were caused by an accident that resulted in the immediate and isolated spill of a pollutant. These claims are typically reported, evaluated and fully resolved within a short period of time.
In general, establishing reserves for environmental claims, other than those associated with "sudden and accidental" losses, is subject to uncertainties that are greater than those represented by other types of claims. Factors contributing to those uncertainties include a lack of historical data, long reporting delays, uncertainty as to the number and identity of insureds with potential exposure, unresolved legal issues regarding policy coverage, and the extent and timing of any such contractual liability. Courts have reached different and sometimes inconsistent conclusions as to when the loss occurred and what policies provide coverage, what claims are covered, whether there is an insured obligation to defend, how policy limits are determined, how policy exclusions are applied and interpreted, and whether cleanup costs represent insured property damage.
Very few environmental claims have historically been reported to the Company. In addition, a review of the businesses of ourthe Company's past and current insureds indicates that exposure to claims of an environmental nature is limited because the vast majority of the Company's accounts are not currently, and have not in the past been, involved in the hauling of hazardous substances. Also, the revision of the pollution exclusion in the Company's policies since 1986 has, and is expected to, further limit exposure to such claims from that point forward.
The Company does not expect to have any significant environmental claims relating to asbestos exposure.
The Company's reserves for unpaid losses and loss expenses at December 31, 20172018 did not include significant amounts for liability related to environmental damage claims. The Company does not foresee significant future exposure to environmental damage claims and accordingly has established no reserve for IBNR environmental losses at December 31, 2017.
Marketing
Historically, the Insurance Subsidiaries have primarily focused their fleet transportationcommercial automobile marketing efforts on large and medium trucking fleets, with their biggest market share in larger trucking fleets (over 150 power units). The largest of these fleets (over 250 power units) generally self-insure a significant portion of their risk, and self-insured retention plans are a specialty of the Company. The indemnity contract provided to such customers is designed to cover all aspects of fleet transportationcommercial automobile liability, including third partythird-party liability, property damage, physical damage and cargo, whether arising from vehicular accident or other casualty loss. The self-insured program is supplemented with large deductible workers' compensation policies in states which do not allow for self-insurance of this coverage. Fleets with fewer than 250 power units typically purchase full insurance coverage or retain deductibles on each claim. The Company's fleet transportationcommercial automobile offerings also include public livery risks, principally large and medium-sized operators of bus fleets and taxis, work-related accident insurance, on a group or individual basis, to independent contractors under contract to a fleet sponsor, as well as workers' compensation coverage to employees of independent contractor fleet owners. Large fleet trucking products are marketed both directly to fleet transportationcommercial automobile clients and also through relationships with non-affiliated brokers and specialized independent agents.
In addition, the Company offers a program of coverages for "small fleet" trucking concerns (owner-operators generally with one to six power units) and "medium fleet" trucking concerns (7-150(7 to 150 power units). Products for small and medium fleets, independent contractors, and non-trucking entities are marketed through relationships with non-affiliated brokers and specialized agents.
In some cases, the Company will provide specific product offerings to specialized markets through partnerships with brokers and program administrators. As we grow, ourthe Company grows, its distribution strategy has moved toward utilization of non-affiliated agents and brokers to place new business for small and intermediate fleet transportationcommercial automobile (including independent contractor products) and non-transportation workers' compensation. In addition, we havethe Company has developed customized commercial autoautomobile liability and workers' compensation programs, which are marketed through non-affiliated agent partners. These customized programs can include a suite of products selected for ourits targeted customer base, including commercial autoautomobile liability, general liability, non-trucking liability, cargo, occupational accident, or workers' compensation coverages.
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Investments
The Company's investment portfolio is notionally divided between (1) funds which are considered necessary to support insurance underwriting activities and (2) excess capital funds. Management believes the funds invested in fixed maturityincome and short-term securities are more than sufficient to cover underwriting operations while equity securities and limited partnerships are utilized to invest excess capital funds to achieve higher long-term returns. The following discussion will concentrate on the different investment strategies for these two major categories.
At December 31, 20172018, the market value of the Company's consolidated investment portfolio was approximately $854.6$878.6 million, consisting of fixed maturities,income securities, equity securities, investments in limited partnershippartnerships, commercial mortgage loans and short-term and other investments and includes $59.2$156.9 million of short-term funds classified as cash equivalents.
A comparison of the allocation of assets within the Company's consolidated investment portfolio, using market value as a basis, is as follows as of December 31:
| 2017 | 2016 | |||||||
| Fixed maturities: | ||||||||
| Agency collateralized mortgage obligations | 1.9 | % | 0.8 | % | ||||
| Agency mortgage-backed securities | 3.2 | 0.6 | ||||||
| Asset-backed securities | 5.1 | 6.0 | ||||||
| Bank loans | 2.3 | 1.4 | ||||||
| Certificates of deposit | 0.4 | 0.4 | ||||||
| Collateralized mortgage obligations | 0.8 | 1.2 | ||||||
| Corporate securities | 23.2 | 19.0 | ||||||
| Mortgage-backed securities | 2.8 | 3.3 | ||||||
| Municipal obligations | 11.3 | 17.3 | ||||||
| Non-U.S. government obligations | 4.4 | 3.3 | ||||||
| U.S. government obligations | 5.7 | 12.3 | ||||||
| Total fixed maturities | 61.1 | 65.6 | ||||||
| Short-term | 0.1 | 0.2 | ||||||
| Cash equivalents | 6.9 | 8.0 | ||||||
| Total fixed maturities and short-term | 68.1 | 73.8 | ||||||
| Limited partnerships (equity basis) | 8.3 | 10.2 | ||||||
| Equity securities: | ||||||||
| Consumer | 5.5 | 4.3 | ||||||
| Energy | 1.2 | 1.7 | ||||||
| Financial | 5.3 | 4.2 | ||||||
| Industrial | 3.0 | 2.8 | ||||||
| Technology | 1.5 | 1.2 | ||||||
| Funds (e.g. mutual funds, closed end funds, ETFs) | 5.9 | 0.9 | ||||||
| Other | 1.2 | 0.9 | ||||||
| Total equity securities | 23.6 | 16.0 | ||||||
| 100.0 | % | 100.0 | % | |||||
| 2018 | 2017 | |||||||
| Fixed income securities | 67.5 | % | 61.1 | % | ||||
| Short-term | 0.1 | 0.1 | ||||||
| Cash equivalents | 17.8 | 6.9 | ||||||
| Total fixed income securities and short-term | 85.4 | 68.1 | ||||||
| Limited partnerships (equity basis) | 6.3 | 8.3 | ||||||
| Commercial mortgage loans (amortized cost basis) | 0.8 | 0.0 | ||||||
| Equity securities | 7.5 | 23.6 | ||||||
| 100.0 | % | 100.0 | % | |||||
Fixed MaturityIncome and Short-Term Investments
Fixed maturityincome and short-term securities comprised 68.1%85.4% of the market value of the Company's consolidated investment portfolio of $854.6$878.6 million at December 31, 2017.2018. The fixed maturityincome portfolio is widely diversified with no concentrations in any single industry, geographic location or municipality. The largest amount invested in any single issuer was $7.5$3.5 million (0.9%(0.4% of the Company's consolidated investment portfolio). The Company's fixed maturityincome portfolio has a short duration compared to the duration of its insurance liabilities and, accordingly, the Company does not actively trade fixed maturityincome securities but typically holds such investments until maturity. Exceptions exist in instances where the underlying credit for a specific issue is deemed to be diminished. In such cases, the security will be considered for disposal prior to maturity. In addition, fixed maturityincome securities may be sold when realignment of the portfolio is considered beneficial (e.g., moving from taxable to non-taxable issues) or when valuations are considered excessive compared to alternative investments.
| 2017 | 2016 | |||||||
| Less than one year | 19.5 | % | 27.7 | % | ||||
| 1 to 5 years | 53.4 | 52.7 | ||||||
| 5 to 10 years | 13.0 | 9.7 | ||||||
| More than 10 years | 14.1 | 9.9 | ||||||
| 100.0 | % | 100.0 | % | |||||
| Average contractual life of portfolio (years) | 4.9 | 4.5 | ||||||
The market value of the consolidated fixed maturityincome portfolio included $7.9 million of net unrealized losses at December 31, 2018 compared to $0.8 million of net unrealized gains at December 31, 2017 compared to $2.7 million of net unrealized losses at December 31, 2016.2017. The Company analyzes fixed maturityincome securities for other-than-temporary impairment ("OTTI") in accordance with the Financial Accounting Standards Board ("FASB") OTTI guidance. As has been the Company's consistent policy, OTTI is considered for any individual issue which has sustained a decline in current market value of at least 20% below original or adjusted cost, and the decline is ongoing for more than six months, regardless of the evaluation of the creditworthiness of the issuer or the specific issue. Additionally, the Company takes into account any known subjective information in evaluating for impairment without consideration of the Company's 20% threshold. The current net unrealized gainloss on fixed maturityincome securities consists of $5.7$10.8 million of gross unrealized gainslosses and $4.8$2.9 million of gross unrealized losses.gains. The gross unrealized losses equal approximately 0.9%1.8% of the cost of all fixed maturityincome securities. See also ""Critical Accounting Policies" in Part II, Item 7 of this Annual Report on Form 10-K for additional details of ourthe Company's investment valuation. valuation.
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Equity Securities
Because of the large amount of high qualityhigh-quality fixed maturityincome investments owned, relative to the Company's loss and loss expense reserves (net of reinsurance recoverables) and other liabilities, amounts invested in equity securities are not needed to fund current operations and, accordingly, can be committed for longer periods of time. Equity securities comprised 23.6%7.5% of the market value of the Company's consolidated investment portfolio of $854.6$878.6 million at December 31, 2017.2018. The Company's equity securities portfolio consists of various securities with diversification from large to small capitalization issuers and among several industries. The largest single equitysingle-equity issue owned had a market value of $6.8$3.2 million at December 31, 2017 (0.8%2018 (0.4% of the Company's consolidated investment portfolio).
As of January 1, 2018, the Company adopted Accounting Standards Update ("ASU") 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, or ASU 2016-01. The amendments in ASU 2016-01 changed the accounting for non-consolidated equity investments that are not accounted for under the equity method of accounting by requiring changes in fair value to be recognized in income. Previously, the Company's equity securities may be sold when realignmentwere classified as available-for-sale and changes in fair value were recognized in accumulated other comprehensive income (loss) as a component of shareholders' equity.
During 2018, the Company's external investment managers and the Board of Directors' Investment Committee determined that reallocation of the Company's equity portfolio is consideredwould be beneficial or when valuations are considered excessive comparedand sold $149.2 million of its equity portfolio, resulting in a gain on sale of $51.9 million. The majority of these gains were included in unrealized gains within other comprehensive income (loss) at December 31, 2017 and, as a result of the adoption of ASU 2016-01, were reclassified to alternative investments. Salesretained earnings as of January 1, 2018 and were therefore not recognized in the consolidated statement of operations for the year ended December 31, 2018. These equity sales further solidified the conservative nature of its high quality, short-duration investment portfolio; opportunistically utilized the new lower corporate tax rate of 21%, which was beneficial given the low tax basis of many of these equity positions; and were accretive to income, given the increase in yields at the shorter end of the yield curve. Realized losses related to the sale of equity securities during 2017 generated both gains and losses but netted to a realized gain2018 recognized in the consolidated statement of $8.1operations for the year ended December 31, 2018 were $3.1 million before taxes.
Limited Partnerships
The Company invests in various limited partnerships engaged in long-short equities, private equity, country focusedcountry-focused funds and real estate development as an alternative to direct equity investments. The funds used for these investments are part of the Company's excess capital strategy. At December 31, 2017,2018, the aggregate carrying value was $70.8$55.0 million, comprising 8.3%6.3% of the market value of the Company's consolidated investment portfolio.
As a group, these investments increaseddecreased in value during 2017,2018, with the aggregate of the Company's share of such gainslosses reported by the limited partnerships totaling approximately $12.5$9.3 million.
The Company follows the equity method of accounting for its limited partnership investments and, accordingly, records the total change in value as a component of net unrealized gains or losses(losses) on equity securities and limited partnership investments. Readers are cautioned that reported increases and decreases in equity value of the Company's limited partnerships can be subsequently reduced or eliminatedchange quickly byas a result of volatile market conditions. Limited partnerships also are highly illiquid investments, and the Company's ability to withdraw funds is generally subject to significant restrictions.
Investment Yields
Pre-tax net investment income increased $3.6$3.9 million, or 25%22%, during 2017, 2018, reflecting higher interest rates for shorter duration securities, increased dividends and increased invested assets from continuing positive cash flow from operations.operations. A comparison of consolidated investment yields, before consideration of investment management expenses, is as follows:
| 2017 | 2016 | 2018 | 2017 | |||||||||||||
| Before federal tax: | ||||||||||||||||
| Investment income | 3.2 | % | 2.9 | % | 3.0 | % | 3.2 | % | ||||||||
| Investment income plus investment gains | 6.2 | 6.8 | ||||||||||||||
| Investment income plus investment gains (losses) | (0.1 | ) | 6.2 | |||||||||||||
| After federal tax: | ||||||||||||||||
| Investment income | 2.3 | 2.2 | 2.7 | 2.3 | ||||||||||||
| Investment income plus investment gains | 5.4 | 6.1 | ||||||||||||||
| Investment income plus investment gains (losses) | (0.6 | ) | 5.4 | |||||||||||||
See also "Results of Operations" in Part II, Item 7 of this Annual Report on Form 10-K for additional details of ourthe Company's investment operations. operations.
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Regulatory Framework
The Insurance Subsidiaries are currently subject to insurance industry regulation by each of the jurisdictions in which they are licensed. In addition, minor portions of the Insurance Subsidiaries' business are subject to regulation by Bermudian and Canadian federal and provincial authorities. As an insurance holding company, B&LProtective is also subject to oversight from the Indiana Department of Insurance. There can be no assurance that laws and regulations will not be changed by one or more of these regulatory bodies in ways that will require the Company to modify its business models and objectives. In particular, the United States federal government continuously reviews the regulation and supervision of financial institutions, including insurance companies, as well as tax laws and regulation, which could impact the Company's operations and performance. The Company will also be impacted from changes to state and federal tax laws, including the U.S. Tax Cuts and Jobs Act of 2017 (the "U.S. Tax Act").
Additionally, changes in laws and regulations governing the insurance industry could have an impact on the Company's ability to generate historical levels of income from its insurance operations. We areThe Company is obligated to comply with numerous complex and varied governmental regulations in order to maintain its authority to write insurance business. While the Company has continuously maintained each of its licenses without exception, failure to maintain compliance could result in governmental regulators temporarily preventing the Company from writing new business, thus having a detrimental effect on the Company. Also, the ability of the Insurance Subsidiaries to modify certain insurance rates, specifically workers' compensation rates, is heavily regulated for significant portions of our business, and such rate increases are often denied or delayed for substantial periods by regulators.
Investments made by the Company's domestic Insurance Subsidiaries are regulated by guidelines promulgated by the NAIC, which are designed to provide protection for both policyholders and shareholders. The statutory capital of each of the Insurance Subsidiaries substantially exceeds the minimum risk- basedrisk-based capital requirements set by the NAIC. State regulatory authorities prescribe calculations of the minimum amount of statutory capital and surplus necessary for each insurance company to remain authorized. These computations are referred to as Risk Based Capital ("RBC")risk-based capital requirements and are based on a number of complex factors, taking into consideration the quality and nature of assets, the historical adequacy of recorded liabilities and the specific nature of business conducted. At December 31, 2017,2018, the minimum statutory capital and surplus requirements of the Insurance Subsidiaries was $104,913.$117.4 million. Actual consolidated statutory capital and surplus at December 31, 20172018 exceeded this requirement by $316,750.$278.5 million.
Employees
As of December 31, 2017,2018, the Company had 528535 employees, an increase of 737 employees from the prior year end.year-end.
Revenue Concentration
The Company derives a significant percentage of its direct premium volume from certain FedEx Corporation subsidiaries and operating companies ("FedEx"), and from insurance coverage provided to FedEx's contracted service providers. FedEx represented approximately $16.2 million, $18.5 million $18.3 million and $17.8$18.3 million of the Company's consolidated gross premiums written in 2018, 2017 2016 and 2015,2016, respectively. An additional $174.7 million, $189.4 million and $202.2 million in 2018, 2017 and $209.4 million in 2017, 2016, and 2015, respectively, was placed with the Company by a non-affiliated broker on behalf of contracted service providers of FedEx, but this additional business was not dependent upon the Company's direct business with FedEx.
Competition
Insurance underwriting is highly competitive. The Insurance Subsidiaries compete with other stock and mutual companies and inter-insurance exchanges (reciprocals). There are numerous insurance companies offering the lines of insurance which are currently written or may in the future be written by the Insurance Subsidiaries. Many of these companies have been in business for longer periods of time, have significantly larger volumes of business, offer more diversified lines of insurance coverage and have significantly greater financial resources than the Company. In many cases, competitors are willing to provide coverage for rates lower than those charged by the Insurance Subsidiaries. Many potential clients self-insure workers' compensation and other risks for which the Company offers coverage, and some have organized "captive" insurance companies as subsidiaries through which they insure their own operations. Some states have workers' compensation funds that preclude private companies from writing this business in those states. Federal law also authorizes the creation of "Risk Retention Groups," which may write insurance coverages similar to those offered by the Company.
The Company believes it has a competitive advantage in its major lines of business as the result of its management and staff, its service and products, its willingness to custom build insurance programs for its customers, its centralized location with ready access to skilled employees, its extensive proprietary databases and the use of technology with respect to its insureds and independent agent force. However, the Company is not "top-line" oriented and will readily sacrifice premium volume during periods of unrealistic rate competition.insureds. Accordingly, should competitors determine to "buy" market share with unprofitable rates, the Insurance Subsidiaries will generally experience a decline in business until pricing returns to profitable levels.
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Availability of Documents
The Company is an accelerated filer as defined in Rule 12b-2 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and is required, pursuant to Item 101 of Regulation S-K, to provide certain information regarding its website and the availability of certain documents filed with or furnished to the U.S. Securities and Exchange Commission (the "SEC"). The Company's Internet website is www.baldwinandlyons.com.www.protectiveinsurance.com. The Company has included its Internet website address throughout this Annual Report on Form 10-K as a textual reference only. The information contained on, or accessible through, the Company's Internet website is not incorporated by reference into this Annual Report on Form 10-K.
The Company makes available, free of charge, by mail or through its Internet website, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after it electronically files such material with or furnishes it to the SEC. The Company also includes on its Internet website its Code of Business Conduct and the charter of each standingpermanent committee of its Board of Directors (the "Board"). In addition, the Company intends to disclose on its Internet website any amendments to, or waivers from, its Code of Business Conduct that are required to be publicly disclosed pursuant to rules of the SEC and the Nasdaq Stock Market, LLC ("Nasdaq").
Shareholders may obtain, without charge, a copy of this Annual Report on Form 10-K, including the consolidated financial statements and schedules thereto, without the accompanying exhibits, upon written request to Baldwin & Lyons, Inc.,Protective Insurance Corporation, 111 Congressional Boulevard, Carmel, Indiana 46032, Attention: Investor Relations. A list of exhibits is included in this Annual Report on Form 10-K, and exhibits are available from the Company upon payment to the Company of the cost of furnishing the exhibits.
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Item 1A. RISK FACTORS
The following is a description of the risk factors that could cause the Company'sour actual results to differ materially from those contained in forward-looking statements made in this Annual Report on Form 10-K and presented elsewhere by management from time to time. Such factors may have a material adverse effect on the Company'sour business, financial condition and results of operations, and you should carefully consider them before deciding to invest in, or retain, shares of the Company'sour common stock. These risk factors do not identify all risks that the Company faces; itswe face; our operations could also be affected by factors that are not presently known to the Companyus or that the Companywe currently considersconsider to be immaterial to itsour operations. Due to risks and uncertainties, known and unknown, the Company'sour past financial results may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods.
We compete with a large number of companies in the insurance industry for underwriting revenues.
We compete with a large number of other companies in our selected lines of business. During periods of intense competition for premium, we are vulnerable to the actions of other companies who may seek to write business without what we believe to be an appropriate regard for ultimate profitability. During these times, it is very difficult to grow or maintain premium volume without sacrificing underwriting discipline and income.
Insurance underwriting is highly competitive. We compete with other stock and mutual companies and inter-insurance exchanges (reciprocals). There are numerous insurance companies offering the lines of insurance which are currently written or may in the future be written by us. Many of these companies have been in business for longer periods of time, have significantly larger volumes of business, offer more diversified lines of insurance coverage and have significantly greater financial resources than us. In many cases, competitors are willing to provide coverage for rates lower than those charged by us. Many potential clients self-insure workers' compensation and other risks for which we offer coverage, and some have organized "captive" insurance companies as subsidiaries through which they insure their own operations. Some states have workers' compensation funds that preclude private companies from writing this business in those states. Federal law also authorizes the creation of "Risk Retention Groups," which may write insurance coverages similar to those offered by us.
We may incur increased costs in competing for underwriting revenues as we seek to expand our business. Increased costs associated with attracting and writing new clients may negatively impact underwriting revenue. If we are unable to compete effectively, our underwriting revenues may decline, as well as our overall business results.
New competition could cause the supply and/or demand for insurance or reinsurance to change, which could affect our ability to price our coverages at attractive rates and thereby adversely affect our underwriting results.
Changes in laws and regulations governing the insurance industry could have a negative impact on our ability to generate income from our insurance operations.
One or more of our Insurance Subsidiaries are regulated and/or licensed in all 50 of the United States, the District of Columbia, all Canadian provinces, Puerto Rico and Bermuda. We are obligated to comply with numerous complex and varied governmental regulations in order to maintain our authority to write insurance business. Failure to maintain compliance could result in governmental regulators preventing us from writing new business, which would have a material adverse impact on us, our results of operations and our financial condition. Further, the ability forof our Insurance Subsidiaries to adjust insurance rates and other product offerings is regulated for significant portions of our business and needed rate adjustments can be denied or delayed for substantial periods by regulators.regulators, which could have a material adverse effect on our results of operations and our financial condition.
A material decline in our financial strength rating could adversely affect our position in the insurance market and cause a significant reduction in our premiums and earnings.
Our main insurance subsidiary, Protective Insurance Co., currently has a financial strength rating of "A+" (Superior)“A” (Excellent) with a negative outlook by A.M. Best.Best, which represents a downgrade from the “A+” (Superior) financial strength rating with a negative outlook Protective Insurance Co. had prior to November 20, 2018. Financial ratings are an important factor influencing the competitive position of insurance companies. A.M. Best ratings, which are commonly used in the insurance industry, currently range from "A+“A++"” (Superior) to "F"“F” (In Liquidation). The objective of A.M. Best'sBest’s rating system is to provide potential policyholders and other interested parties with an expert independent opinion of an insurer'sinsurer’s financial strength and ability to meet ongoing obligations, including paying claims. This rating is subject to periodic review and may be revised downward, upward or revoked at the sole discretion of A.M. Best. A future downgrade in ratingby A.M. Best could result in the loss of a number of insurance contracts we write and in a substantial loss of business to other competitors, which would have a material adverse effect on our results of operations.
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We have two classes of common stock with unequal voting rights andthat are effectively controlled by our principal shareholders and management, which limits other shareholders'shareholders’ ability to influence our operations.
Our principal shareholders, directors and executive officers and their affiliates control approximately 50% of the outstanding shares of voting Class A common stockCommon Stock and approximately 23% of the outstanding shares of non-voting Class B common stock.Common Stock. These parties effectively control us, direct our affairs, and exert significant influence in the election of directors and approval of significant corporate transactions. The interests of these shareholders may conflict with those of other shareholders, and this concentration of voting power may limit the marketability of our stock and has the potential to delay, defer or prevent a change in control that other shareholders may believe to be in their best interests.
We are subject to credit risk relating to our ability to recover amounts due from reinsurers.
We limit our risk of loss from policies of insurance issued by our Insurance Subsidiaries through the purchase of reinsurance coverage from other insurance companies. Such reinsurance does not relieve us of our responsibility to policyholders should the reinsurers be unable to meet their obligations to us under the terms of the underlying reinsurance agreements. While we have not experienced any significant reinsurance losses for over 25 years, in the past, a small number of our less significant reinsurance carriers have experienced deteriorating financial conditions or have been downgraded by rating agencies, and provisions for potential uncollectible balances from these reinsurers have been established. If we are unable to collect the amounts due to us from reinsurers, any unreserved credit losses could adversely affect our results of operations, equity, business and insurer financial strength rating.
We may incur additional losses if our loss reserves are inadequate.
A large portion of our provision for losses recorded is composed of estimates of future loss payments to be made. Such estimates of future loss payments may prove to be inadequate. Loss and loss expense reserves represent our best estimate at a given point in time but are not an exact calculation of ultimate liability. Rather, they are complex estimates derived by utilizing a variety of reserve estimation techniques from numerous assumptions and expectations about future events, many of which are highly uncertain, such as estimates of claims severity, frequency of claims, inflation, claims handling, case reserving policies and procedures, underwriting and pricing policies, changes in the legal and regulatory environment and the lag time between the occurrence of an insured event and the time of its ultimate settlement. Many of these uncertainties are not precisely quantifiable and require significant judgment on our part. As trends in underlying claims develop, particularly in so-called "long tail"“long tail” lines wherein which the adjudication of claims can take many years and which have seen an increase in claim severity, management is sometimes required to revise reserves. This results in a charge to our earnings in the amount of the adjusted reserves, recorded in the period the change in estimate is made. These charges can be substantial and can potentially have a material impact, either positively or negatively, on results of operations and shareholders'shareholders’ equity.
The loss of our major customer could severely impact our revenue and earnings potential and A.M. Best rating.
We derive a significant percentage of our direct premium volume from certain FedEx, subsidiaries and related entities, and from insurance coverage provided to FedEx'sFedEx’s contracted service providers. The loss of this major customer would likely materially adversely impact our revenue and earnings potential, as well as our A.M. Best rating. Insurance programs provided to FedEx and programs provided to the contracted service providers are not necessarily dependent upon one another, and therefore can be viewed as separate entities.another.
Our collateral held may prove to be insufficient.
We require collateral from our large insureds covering the insureds'insureds’ obligations for self-insured retentions or deductibles related to policies of insurance provided. Should we, as surety, become responsible for such insured obligations, the collateral held may prove to be insufficient. In this regard, FedEx utilizes significant self-insured retentions and deductibles under policies of insurance provided by us. In the case of FedEx, we have determined that the financial strength of the customer is sufficient to allow for holding only partial collateral at this time. Should we become responsible for this customer'scustomer’s entire self-insured retention and deductible obligations, the collateral held would be insufficient, and we would sustain a significant operating loss.
A material drop in interest rates, or disruption in the fixed income markets, could have an adverse impact on our earnings and, potentially, our financial position.
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Our investment portfolio is subject to market and credit risks, which could affect our financial results and ability to conduct business.
We have a large portfolio of securities and limited partnership investments which can fluctuate in value with a wide variety of market conditions. A decline in the aggregate value of the securities and limited partnership investments would result in a commensurate decline in our shareholders'shareholders’ equity, either through the income statement or directly to equity. The resultant decline could, at least temporarily, materially adversely affect our results of operations, equity, business and insurer financial strength ratings.
Technological advances, including those specific to the transportation industry, could present us with added competitive risks.
An increase in accident prevention technologies and the growth of autonomous or partially autonomous vehicles could reduce the amount of accidents over time and shift the liability from the owner of the vehicle to the manufacturer, which would cause automobile insurance to become a smaller portion of our overall property and casualty insurance book of business. Innovations in telematics and the increase in usage-based information have become more important and will likely change the way premiums are determined in the future. These advances in technology could materially change the way products in the transportation industry are designed, priced and underwritten, and it will take time for usif we fail to adjust to these changes.changes in a timely manner, our business and results of operations could be materially adversely affected.
We rely upon ourcomplex and expensive information technology systems and other operational systems and on the integrity and timeliness of our data to run our businesses, and service our customers. These information technology and other systems could be subject to physical or electronic break-ins, unauthorized tampering or other cyber security breaches, resulting in a failure to maintain the security, confidentiality or privacy of sensitive data, including personal information relating to customers, or in theft of intellectual property or proprietary information. A failure to maintain proper security, confidentiality or privacy of sensitive data residing on such systems could delay or disrupt our ability to do business and service customers, harm our reputation, subject us to litigation, regulatory fines, a loss of customers and revenues or otherwise adversely affect our business.
In September 2018, we learned of suspicious activity occurring within two employee email accounts. In response, we launched an investigation and began working with third-party forensic experts to determine the full nature and scope of this incident. A review of the impacted email accounts determined that such disruptions occur,certain types of personal information may have been accessible for a small number of individuals, although no assurance can be given that we will not identify additional information that was accessed or obtained. We are working with the impacted clients and are in the process of notifying the individuals, and any implicated state regulators, pursuant to applicable law. We cannot ensure that we will be able to identify, prevent or contain the effects of any additional cyber attacks or other cybersecurity incidents in the future that bypass our security measures or disrupt our information technology systems or business. Any failure to maintain proper security, confidentiality or privacy of sensitive data residing on our information technology and other operational systems could delay or disrupt our ability to do business and service clients, harm our reputation, require us to incur significant remediation costs, subject us to litigation, regulatory fines, a loss of customers and revenues or otherwise have a material adverse effect on our business, operating results of operations and financial condition could be materially and adversely affected resulting in a possible loss of business.condition.
Changes in current accounting practices and future pronouncements may materially impact our reported financial results.
Developments in accounting practices may require us to incur considerable additional expenses to comply with such developments, particularly if we are required to prepare information relating to prior periods for comparative purposes or to apply the new requirements retroactively. The impact of changes in current accounting practices and future pronouncements cannot be predicted but may affect the calculation of net income, net equity and other historical financial statement line items that are important to users of our financial statements. Changes could also introduce significant volatility in our results of operations, equity, business and insurer financial strength rating.
We may be unable to attract and retain qualified employees.employees and successfully execute our Chief Executive Officer transition.
We depend on our ability to attract and retain qualified executive officers, experienced underwriters, claims professionals and other skilled employees who are knowledgeable about our specialty lines of business. If we are unable to attract and retain such individuals, we may be unable to maintain our current competitive position in the specialty markets in which we operate and may be unable to achieve our growth strategy.
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Item 1B. UNRESOLVED STAFF COMMENTS
None.
Item 2. PROPERTIES
The Company owns its home office building and the adjacent real estate in Carmel, Indiana, approximately 14 miles from downtown Indianapolis.Indiana. The home office building contains a total of 181,000 usable square feet of usable space, and the Company currently occupies approximately 72%74% of this space, with the remainder being leased to non-affiliated entities on short-term leases expiring through 2023.
The Company also owns a building and the adjacent real estate in Indianapolis, approximately nine miles from its main office in Carmel. The building contains approximately 15,000 square feet of usable space, and is used primarily for off-site data storage and as a contingent back upback-up and disaster recovery site.
The Company's entire operations are conducted from these two facilities. The current facilities are expected to be adequate for the Company's operations for the near future.
Item 3. LEGAL PROCEEDINGS
In the ordinary, regular and routine course of theirits business, the Company and its Insurance Subsidiaries areis frequently involved in various matters of litigation relating principally to claims for insurance coverage provided. No currently pending matter is deemed by management to be material to the Company or outside the ordinary course of business.
Item 4. MINE SAFETY DISCLOSURES
Not applicable.
- 2017 -
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDERSTOCKHOLDER MATTERS AND ISSUER PURCHASE OF EQUITY SECURITIES
| Cash | ||||||||||||||||||||
| Class A | Class B | Dividends | ||||||||||||||||||
| High | Low | High | Low | Declared | ||||||||||||||||
| 2017: | ||||||||||||||||||||
| Fourth Quarter | $ | 24.36 | $ | 21.95 | $ | 24.70 | $ | 22.30 | $ | .27 | ||||||||||
| Third Quarter | 23.85 | 21.41 | 24.90 | 21.20 | .27 | |||||||||||||||
| Second Quarter | 26.95 | 23.15 | 25.40 | 23.45 | .27 | |||||||||||||||
| First Quarter | 26.04 | 22.73 | 25.45 | 22.60 | .27 | |||||||||||||||
| 2016: | ||||||||||||||||||||
| Fourth Quarter | 26.10 | 23.21 | 27.70 | 23.45 | .26 | |||||||||||||||
| Third Quarter | 26.50 | 23.04 | 27.25 | 24.43 | .26 | |||||||||||||||
| Second Quarter | 24.90 | 22.50 | 25.28 | 23.33 | .26 | |||||||||||||||
| First Quarter | 24.02 | 22.00 | 25.10 | 22.11 | .26 | |||||||||||||||
The Company has paid quarterly cash dividends continuously since 1974. The current regularCompany paid a quarterly dividend rate of $.27 per share, effective February 2017, was increased to $.28 per share effective Februaryduring 2018. In the first quarter of 2019, the Company declared a dividend of $.10 per share. The Company expects to continue its policy of paying regular cash dividends, although there is no assurance as to future dividends because they are dependent on future earnings, capital requirements and financial conditions and are subject to regulatory restrictions. At December 31, 2017, $104.92018, $117.4 million, or 25.1%33.0% of shareholders' equity, represented net assets of the Company's Insurance Subsidiaries which, at that time, could not be transferred in the form of dividends, loans or advances to the parent companyProtective because of minimum statutory capital requirements. However, management believes that these restrictions do not currently pose any material dividend payment concerns for the Company. The Board intends to address the subject of dividends at each of its future meetings and will consider the Company's earnings, returns on investments and its capital needs.
The following table presents information regarding the Company's repurchases of its Common Stock for the periods indicated:
Period | Total number of shares purchased | Average price paid per share | Total number of shares purchased as part of publicly announced plans or programs (1) | Maximum number of shares that may yet be purchased under the plans or programs (1) | ||||||||||||
| October 1 - October 31, 2018 | 72,108 | $ | 22.64 | 72,108 | 2,194,666 | |||||||||||
| November 1 - November 30, 2018 | 15,085 | 22.79 | 15,085 | 2,179,581 | ||||||||||||
| December 1 - December 31, 2018 | - | - | - | 2,179,581 | ||||||||||||
| Total | 87,193 | 87,193 | ||||||||||||||
(1) On August 31, 2017, the Company's Board of Directors authorized the reinstatement of itsthe Company's share repurchase program for up to 2,464,209 shares of the Company's Class A or Class B Common Stock. On August 7, 2018, the Company's Board of Directors reaffirmed the Company's share repurchase program, but also provided that the aggregate dollar amount of shares of the Company's Common Stock that may be repurchased under the share repurchase program through August 8, 2019 may not exceed $25.0 million. The repurchases may be made in the open market or through privately negotiated transactions, from time to time, and in accordance with applicable laws, rules and regulations. Pursuant to this share repurchase program, the Company entered into a Rule 10b5-1 plan on September 24, 2018, which authorized the repurchase of up to $12.0 million of the Company's outstanding common stock.shares at various pricing thresholds, in accordance with guidelines specified under Rule 10b5-1 of the Exchange Act. The Rule 10b5-1 plan expired on November 8, 2018. No duration has been placed on the Company's share repurchase program, and the Company mayreserves the right to amend, suspend or discontinue it at any time. The share repurchase program does not commit the Company to repurchase any shares of its Common Stock. The Company has funded, and intends to continue to fund, the share repurchase program at any time.from cash on hand.
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Corporate Performance
The following graph shows a five yearfive-year comparison of cumulative total return for the Company's Class B common shares,Common Stock, the Russell 2000 Index and the Company's peer group as determined by management (the "BWINB"PTVCB Peer Group"). The basis of comparison is a $100 investment at December 31, 2012,2013, in each of (i) Baldwin & Lyons, Inc.,Protective, (ii) the Russell 2000 Index and (iii) the BWINBPTVCB Peer Group. All dividends are assumed to be reinvested.
| Period Ending | Year Ended December 31 | |||||||||||||||||||||||||||||||||||||||||||||||
| Index | 12/31/12 | 12/31/13 | 12/31/14 | 12/31/15 | 12/31/16 | 12/31/17 | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | ||||||||||||||||||||||||||||||||||||
| Baldwin & Lyons, Inc. | 100.00 | 119.26 | 117.09 | 113.91 | 124.49 | 123.93 | ||||||||||||||||||||||||||||||||||||||||||
| Protective Insurance Corporation | $ | 100.00 | $ | 98.17 | $ | 95.51 | $ | 104.38 | $ | 103.91 | $ | 75.93 | ||||||||||||||||||||||||||||||||||||
| Russell 2000 Index | 100.00 | 138.82 | 145.62 | 139.19 | 168.85 | 193.58 | 100.00 | 104.89 | 100.26 | 121.63 | 139.44 | 124.09 | ||||||||||||||||||||||||||||||||||||
| Peer Group | 100.00 | 160.92 | 167.94 | 182.04 | 219.76 | 238.34 | ||||||||||||||||||||||||||||||||||||||||||
| PTVCB Peer Group | 100.00 | 104.36 | 113.12 | 136.57 | 148.11 | 154.20 | ||||||||||||||||||||||||||||||||||||||||||
| Amerisafe, Inc. | HCI Group, Inc. | |
| Heritage Insurance Holdings, Inc. | ||
| James River Group Holdings, Ltd. | ||
| NMI Holdings, Inc. | ||
| Safety Insurance Group, Inc. | ||
| United Insurance Holdings Corp. | ||
| Universal Insurance Holdings, Inc. | ||
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Item 6. SELECTED FINANCIAL DATA
The table below provides selected consolidated financial data of the Company. The information has been derived from our consolidated financial statements for each of the years in the five yearfive-year period ended December 31, 2017.2018. You should read this selected consolidated financial data in conjunction with the audited consolidated financial statements and notes as of and for the year ended December 31, 20172018 included in Part II, Item 8 "Financial Statements and Supplementary Data", and Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in this Annual Report on Form 10-K.
| Year Ended December 31 | ||||||||||||||||||||
| 2018 | 2017 | 2016 | 2015 | 2014 | ||||||||||||||||
| (Dollars in thousands, except per share data) | ||||||||||||||||||||
| Gross premiums written | $ | 582,500 | $ | 504,737 | $ | 403,004 | $ | 383,553 | $ | 382,388 | ||||||||||
| Net premiums earned | 432,880 | 328,145 | 276,011 | 263,335 | 261,627 | |||||||||||||||
| Net investment income | 22,048 | 18,095 | 14,483 | 12,498 | 9,055 | |||||||||||||||
| Net realized and unrealized gains (losses) on investments | (25,691 | ) | 19,686 | 23,228 | (1,261 | ) | 14,930 | |||||||||||||
| Losses and loss expenses incurred | 345,864 | 247,518 | 186,481 | 155,750 | 159,596 | |||||||||||||||
| Net income (loss) | (34,075 | ) | 18,323 | 28,945 | 23,283 | 29,717 | ||||||||||||||
Earnings (loss) per share -- net income (loss) (1) | (2.28 | ) | 1.21 | 1.92 | 1.55 | 1.98 | ||||||||||||||
| Cash dividends per share | 1.12 | 1.08 | 1.04 | 1.00 | 1.00 | |||||||||||||||
Investment portfolio (2) | 878,638 | 854,595 | 749,501 | 729,877 | 757,421 | |||||||||||||||
| Total assets | 1,490,131 | 1,357,016 | 1,154,137 | 1,085,771 | 1,144,247 | |||||||||||||||
| Shareholders' equity | 356,082 | 418,811 | 404,345 | 394,498 | 399,496 | |||||||||||||||
| Book value per share | 23.95 | 27.83 | 26.81 | 26.25 | 26.67 | |||||||||||||||
| (1) | Earnings (loss) per share are adjusted for the dilutive effect of restricted stock outstanding for 2014-2017. |
| Year Ended December 31 | ||||||||||||||||||||
| 2017 | 2016 | 2015 | 2014 | 2013 | ||||||||||||||||
| (Dollars in thousands, except per share data) | ||||||||||||||||||||
| Gross premiums written | $ | 504,737 | $ | 403,004 | $ | 383,553 | $ | 382,388 | $ | 369,476 | ||||||||||
| Net premiums earned | 328,145 | 276,011 | 263,335 | 261,627 | 252,743 | |||||||||||||||
| Net investment income | 18,095 | 14,483 | 12,498 | 9,055 | 8,770 | |||||||||||||||
| Net realized gains (losses) on investments | 19,686 | 23,228 | (1,261 | ) | 14,930 | 23,515 | ||||||||||||||
| Losses and loss expenses incurred | 247,518 | 186,481 | 155,750 | 159,596 | 150,701 | |||||||||||||||
| Net income | 18,323 | 28,945 | 23,283 | 29,717 | 36,588 | |||||||||||||||
Earnings per share -- net income 1 | 1.21 | 1.92 | 1.55 | 1.98 | 2.45 | |||||||||||||||
| Cash dividends per share | 1.08 | 1.04 | 1.00 | 1.00 | 1.00 | |||||||||||||||
Investment portfolio 2 | 854,595 | 749,501 | 729,877 | 757,421 | 703,259 | |||||||||||||||
| Total assets | 1,357,016 | 1,154,137 | 1,085,771 | 1,144,247 | 1,072,270 | |||||||||||||||
| Shareholders' equity | 418,811 | 404,345 | 394,498 | 399,496 | 381,724 | |||||||||||||||
Book value per share 1 | 27.83 | 26.81 | 26.25 | 26.67 | 25.57 | |||||||||||||||
| (2) | Includes money market instruments classified as cash equivalents in the consolidated balance sheets. |
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Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The term “Protective,” as used throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), refers to Protective Insurance Corporation, the parent company. The terms the “Company,” “we,” “us” and our,” as used throughout this M&DA, refer to Protective and all of its subsidiaries unless the context clearly indicates otherwise. The term “Insurance Subsidiaries,” as used throughout this MD&A, refers to Protective Insurance Company, Protective Specialty Insurance Company, Sagamore Insurance Company and B&L Insurance, Ltd.
Effective January 1, 2017, we determined that itsour business constituted one reportable property and casualty insurance segment as of January 1, 2017.segment. During 2016, and prior years, the Companywe had two reportable segments – property and casualty insurance and reinsurance. The CompanyWe moved to a single reportable segment based on how itsour operating results are regularly reviewed by the Company'sour chief operating decision maker when making decisions about how resources are to be allocated to the segment and assessing its performance. The prior year segment information throughout this Annual Report on Form 10-K was updated to conform to the current year presentation.
Effective August 1, 2018, we changed our name to Protective Insurance Corporation to better align our holding company's and Insurance Subsidiaries' identities and to reflect our position within the insurance industry.
Effective January 1, 2018, we adopted Accounting Standards Update ("ASU") 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, or ASU 2016-01, resulting in a cumulative-effect adjustment of $71.0 million ($46.2 million, net of tax). This adjustment moved our historical unrealized gains and losses, net of tax, on our equity portfolio from accumulated other comprehensive income (loss) to retained earnings, but had no impact on overall shareholders' equity. In addition, for 2018 and forward, the change in fair value for equity securities is required to be recognized in net earnings rather than in other comprehensive income (loss). The impact to our consolidated statements of operations will vary depending upon the level of volatility in the performance of the securities held in our equity portfolio and the overall market.
On December 22, 2017, the U.S. Tax CutsCut and Jobs Act of 2017 (the "U.S. Tax Act") was signed into law. The U.S. Tax Act lowered the U.S. corporate income rate from 35% to 21% effective January 1, 2018. GAAP requires the impact of tax legislation to be recognized in the period in which the law was enacted. As a result, of the U.S. Tax Act, the Companywe recorded a tax benefit of $9.6 million related to the re-measurementremeasurement of itsour deferred tax assets and liabilities during the fourth quarter of 2017. As of December 31, 2017, the IRS had not yet published all of the detailed regulations resulting from the enactment of the U.S. Tax Act; therefore, while we had not completed our accounting for the tax effects, we made a reasonable estimate of the tax effects on our existing deferred tax balances at December 31, 2017. We finalized our accounting for the tax effects of the U.S. Tax Act during 2018. No material adjustments to income tax expense (benefit) were recorded during 2018.
On July 13, 2018, A.M. Best Company, Inc. ("A.M. Best") affirmed our financial strength rating of "A+" (Superior). At the same time, A.M. Best revised its outlook to negative based on their monitoring of our growth strategy and the potential for adverse loss development in certain lines of business.
On November 20, 2018, A.M. Best downgraded our financial strength rating to "A" (Excellent) from "A+" (Superior), citing three consecutive years of material adverse loss development. A.M. Best continues to categorize our balance sheet as "very strong" and our operating performance as "adequate," but its outlook remains negative.
Liquidity and Capital Resources
The primary sources of the Company'sour liquidity are (1) funds generated from insurance operations, including net investment income, (2) proceeds from the sale of investments, and (3) proceeds from maturing investments.
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On August 31, 2017, the Company'sour Board of Directors authorized the reinstatement of itsour share repurchase program for up to 2,464,209 shares of the Company'sour Class A or Class B Common Stock. On August 7, 2018, our Board of Directors reaffirmed our share repurchase program, but also provided that the aggregate dollar amount of shares of our common stock. stock that may be repurchased under the share repurchase program through August 8, 2019 may not exceed $25.0 million. The repurchases may be made in the open market or through privately negotiated transactions, from time-to-time, and in accordance with applicable laws, rules and regulations. On September 21, 2017, the Company24, 2018, we entered into a stock repurchase plan for the purpose of repurchasing up to $17.5$12.0 million of shares of itsour common stock, at various pricing thresholds, in accordance with guidelines specified under Rule 10b5-1 of the Securities Exchange Act of 1934, as amended (the "Rule 10b5-1 Plan"). The Rule 10b5-1 Plan was established pursuant to, and as part of, the Company'sour share repurchase program and permittedpermits shares to be repurchased in accordance with pre-determined criteria when repurchases would otherwise be prohibited, such as during self-imposed blackout periods, or under insider trading laws. The Rule 10b5-1 Planplan expired on March 5,November 8, 2018. The Company's share repurchase program may be amended, suspended or discontinued at any time and does not commit the Companyus to repurchase any shares of itsour common stock. The Company hasWe have funded, and intendsintend to continue to fund, the share repurchase program from cash on hand. The actual number and value of the shares to be purchased will depend on the performance of the Company'sour stock price, market volume and other market conditions. ForDuring the year ended December 31, 2017, the Company2018, we paid $1.9$4.6 million to repurchase 84,9607,770 shares of itsClass A and 191,898 shares of Class B common stockCommon Stock under itsthe share repurchase program.
For several years, the Company'sour investment philosophy has emphasized the purchase of short-term bonds with high quality and liquidity. Our fixed income investment portfolio continues to emphasize shorter-duration bonds. As flat yield curves have not provided an incentiveinstruments. If there was a hypothetical increase in interest rates of 100 basis points, the price of our bonds at December 31, 2018 would be expected to lengthen maturities in recent years, the Company has continued to maintain itsfall by approximately 2.8%. The credit quality of our fixed maturity portfolio at short-term levels.income securities remains high with a weighted average rating of AA-, including cash. The average contractual life of the Company'sour fixed maturityincome and short-term investment portfolio increased slightlyto 5.5 years at December 31, 2018 compared to 4.9 years during 2017 from 4.5 years during 2016.at December 31, 2017. The average duration of the Company'sour fixed maturityincome portfolio remains much shorter than both the contractual maturity average and the duration of the Company'sour liabilities. Our investmentsWe also remain an active participant in the equity markets reflect a conservative, value driven approach, which has been implemented through partnerships, advisors and the Investment Committee.securities market, allocating capital in excess of amounts considered necessary to fund our current operations. The long-term horizon for the Company'sour equity investments allows itus to invest in positions where ultimate value, and not short-term market fluctuation, is the primary focus. Investments made by the Company'sour domestic property/casualty Insurance Subsidiaries are regulated by guidelines promulgated by the NAIC,National Association of Insurance Commissioners (the "NAIC"), which are designed to provide protection for both policyholders and shareholders.
Net cash flows from operations increased $61.3$3.0 million to $93.7$100.7 million for full year 20172018 from $32.4$97.7 million in 2016.2017. The increase in operating cash flow was primarily related to higher premium volume in 2018 compared to 2017. Net cash flows from operations decreased $5.8increased $65.3 million to $97.7 million for 2017 compared to $32.4 million for full year 2016 compared to $38.2 million in 2015.2016. The decrease2017 increase in operating cash flow resulted mainly from increased loss and loss adjustment expensesflows was related to higher premium volume in 2017 compared to 2016.
Net cash provided by investing activities was $23.7 million for 2018 compared to net cash used in investing activities of $74.3 million in 2017. The $98.0 million change was primarily related to higher proceeds from sales of fixed income and equity securities and lower purchases of equity securities and fixed income investments. These increases were partially offset by lower proceeds from maturities of our fixed income securities and lower distributions from limited partnerships during 2018, in addition to the purchase of $10.0 million of company-owned life insurance in the first quarter of 2018. Net cash used in investing activities increased $47.0 million towas $74.3 million for full year 2017 as compared to $27.4 million in 2016. The increase of $46.9 million in cash used in investing activities was the resultprimarily related to higher purchases of the normal timingequity securities and fixed income investments and lower proceeds from sales of purchasesequity and sales and maturities in our investment portfolio,fixed income securities. These increases were partially offset by higher distributions from limited partnership investments and higher proceeds from maturities of fixed income securities in 2017. Net cash used in investing activities increased $14.5 million to $27.4 million for full year 2016 compared to $12.8 million in 2015. The increase in cash used in investing activities was also the result of the normal timing of purchases and sales and maturities in our investment portfolio.
Net cash used in financing activities for full year2018 consisted of regular cash dividend payments to shareholders of $16.8 million ($1.12 per share) and $4.6 million to repurchase 199,668 shares of our common stock. Financing activities for 2017 consisted of regular cash dividend payments to shareholders of $16.3 million ($1.08 per share) and $1.9 million to repurchase 84,960 shares of the Company'sour Class B common stock.Common Stock. Financing activities for full year 2016 and 2015 consisted solely of the regular cash dividend payments to shareholders of $15.8 million ($1.04 per share) and $15.0 million ($1.00 per share), respectively..
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We previously maintained a revolving line of credit with a $40.0 million limit andthat had an expiration date of September 23, 2018. Interest on this line of credit was referenced to the London Interbank Offered Rate ("LIBOR") and could be fixed for periods of up to one year at our option. Outstanding drawings on this line of credit were $20.0 million at December 31, 2017. On August 9, 2018, we entered into a credit agreement providing a revolving credit facility with a $40.0 million limit, with the option for up to an additional $35.0 million in incremental loans at the discretion of the lenders. This credit agreement, which has an expiration date of August 9, 2022, replaced our line of credit that was to expire on September 23, 2018. Interest on this credit facility is referenced to LIBOR and can be fixed for periods of up to one year at the Company'sour option. Outstanding drawings on this line ofrevolving credit facility were $20.0 million as of December 31, 2017 and December 31, 2016.2018. At December 31, 2017,2018, the effective interest rate was 2.65%. The Company3.61%, and we had $20.0 million remaining unused under the revolving credit facility. The current outstanding borrowings were used to repay the previous line of credit. Our revolving credit at December 31, 2017. The Company's revolving line of creditfacility has threetwo financial covenants, each of which were met as of December 31, 2017. The three financial covenants relate2018, requiring us to have a minimum GAAPU.S. Generally Accepted Accounting Principles ("GAAP") net worth a minimum statutory surplus and a minimum A.M. Best rating.maximum consolidated leverage ratio of 0.35 to 1.00.
Consolidated shareholders' equity is composed largely of GAAP shareholders' equity of our Insurance Subsidiaries. As such, there are statutory restrictions on the transfer of substantial portions of this equity to Protective. At December 31, 2017, $104.9 million, or 25.1% of shareholders' equity, represented net assets of the Company's Insurance Subsidiaries which, at that time, could not be transferred in the form of dividends, loans or advances to the parent company because of minimum statutory capital requirements. At December 31, 2017, $59.12018, $64.1 million may be transferred by dividend or loan to the parent companyProtective without approval by, or prior notification to, regulatory authorities. An additional $256.4$213.1 million of shareholders' equity of theour Insurance Subsidiaries could be advanced or loaned to the parent companyProtective with prior notification to, and approval from, regulatory authorities, although transfers of this size would not be practical. The Company believes that We believe these restrictions do not currently pose anyno material liquidity concerns tofor us. We also believe the Company. We expect financial strength and stability of theour Insurance Subsidiaries towould permit access by the parent companyProtective to short-term and long-term sources of credit when needed. The parent companyProtective had cash and marketable securities valued at $26.5$15.2 million at December 31, 2017.2018.
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Non-GAAP Measures
We believe investors’ understanding of our performance is enhanced by our disclosure of underwriting income (loss), which is a measure that is not calculated in accordance with GAAP. Underwriting income (loss) represents the pre-tax profitability of our insurance operations and is derived by subtracting net realized and unrealized gains (losses) on investments and net investment income from income (loss) before federal income tax expense (benefit). For 2018, we also had a goodwill impairment charge, which has also been excluded from the calculation of underwriting income (loss). We use underwriting income (loss) as an internal performance measure in the management of our operations because we believe it gives us and users of our financial information useful insight into our results of operations, our underlying business performance and our ongoing operating trends. Underwriting income (loss) should not be viewed as a substitute for income (loss) before federal income tax expense (benefit) calculated in accordance with GAAP, and other companies may define underwriting income (loss) differently. In addition, for 2018, the goodwill impairment charge has been excluded from other operating expenses when calculating our expense ratio and our combined ratio, as these ratios are intended to depict our underlying business performance and ongoing operating trends. We also believe that the exclusion of this goodwill impairment charge improves the comparability of our expense ratio and our combined ratio with our ratios in prior years.
| 2018 | 2017 | 2016 | ||||||||||
| Income (loss) before federal income tax expense (benefit) | $ | (43,872 | ) | $ | 10,122 | $ | 43,054 | |||||
| Less: Net realized and unrealized gains (losses) on investments | (25,691 | ) | 19,686 | 23,228 | ||||||||
| Less: Net investment income | 22,048 | 18,095 | 14,483 | |||||||||
| Less: Goodwill impairment charge included in other operating expenses (see below) | (3,152 | ) | – | – | ||||||||
| Underwriting income (loss) | $ | (37,077 | ) | $ | (27,659 | ) | $ | 5,343 | ||||
| Other operating expenses | $ | 137,177 | $ | 113,594 | $ | 89,462 | ||||||
| Less: Goodwill impairment charge | 3,152 | – | – | |||||||||
| Other operating expenses, excluding goodwill impairment charge | $ | 134,025 | $ | 113,594 | $ | 89,462 | ||||||
| Ratios | ||||||||||||
| Losses and loss expenses incurred | $ | 345,864 | $ | 247,518 | $ | 186,481 | ||||||
| Net premiums earned | 432,880 | 328,145 | 276,011 | |||||||||
| Loss ratio | 79.9 | % | 75.4 | % | 67.6 | % | ||||||
| Other operating expenses | $ | 137,177 | $ | 113,594 | $ | 89,462 | ||||||
| Less: Commissions and other income | 9,932 | 5,308 | 5,275 | |||||||||
| Other operating expenses, less commissions and other income | 127,245 | 108,286 | 84,187 | |||||||||
| Net premiums earned | 432,880 | 328,145 | 276,011 | |||||||||
| Expense ratio | 29.4 | % | 33.0 | % | 30.5 | % | ||||||
| Impact of goodwill impairment charge | (0.7 | )% | – | – | ||||||||
| Expense ratio, excluding goodwill impairment charge | 28.7 | % | 33.0 | % | 30.5 | % | ||||||
| Combined ratio | 109.3 | % | 108.4 | % | 98.1 | % | ||||||
| Combined ratio, excluding goodwill impairment charge | 108.6 | % | 108.4 | % | 98.1 | % | ||||||
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Results of Operations
2018 Compared to 2017
| 2018 | 2017 | Change | % Change | |||||||||||||
| Gross premiums written | $ | 582,500 | $ | 504,737 | $ | 77,763 | 15.4 | % | ||||||||
| Ceded premiums written | (138,102 | ) | (151,348 | ) | 13,246 | (8.8 | )% | |||||||||
| Net premiums written | $ | 444,398 | $ | 353,389 | $ | 91,009 | 25.8 | % | ||||||||
| Net premiums earned | $ | 432,880 | $ | 328,145 | $ | 104,735 | 31.9 | % | ||||||||
| Net investment income | 22,048 | 18,095 | 3,953 | 21.8 | % | |||||||||||
| Commissions and other income | 9,932 | 5,308 | 4,624 | 87.1 | % | |||||||||||
| Net realized and unrealized gains (losses) on investments | (25,691 | ) | 19,686 | (45,377 | ) | (230.5 | )% | |||||||||
| Total revenue | 439,169 | 371,234 | ||||||||||||||
| Losses and loss expenses incurred | 345,864 | 247,518 | 98,346 | 39.7 | % | |||||||||||
| Other operating expenses | 137,177 | 113,594 | 23,583 | 20.8 | % | |||||||||||
| Total expenses | 483,041 | 361,112 | ||||||||||||||
| Income (loss) before federal income tax benefit | (43,872 | ) | 10,122 | (53,994 | ) | |||||||||||
| Federal income tax benefit | (9,797 | ) | (8,201 | ) | (1,596 | ) | ||||||||||
| Net income (loss) | $ | (34,075 | ) | $ | 18,323 | $ | (52,398 | ) | ||||||||
Gross premiums written for 2018 increased $77.8 million (15.4%), while net premiums earned increased $104.7 million (31.9%), as compared to 2017. The higher gross premiums written and net premiums earned were the result of continued growth in our commercial automobile and workers' compensation products in both our retail and program distribution channels. The difference in the percentage change for premiums written compared to earned was reflective of the normal differences in the financial statement recognition of earned premiums compared to written, as well as differences in reinsurance ceding rates on the mix of business in-force.
Premiums ceded to reinsurers on our insurance business averaged 23.7% of gross premiums written for 2018 compared to 30.0% for 2017. The percentage of premiums ceded to reinsurance decreased as a result of changes in our reinsurance structure. In the third quarter of 2017, we lowered the quota share rate on our workers' compensation premiums to reflect growing profitability and confidence in this book of business. We also restructured our commercial automobile reinsurance treaty, moving away from variable premium ceded rates (based on loss performance) to a flat ceding arrangement with no material changes to the economic risks taken for these products (i.e., ceded losses will decrease by a similar amount as ceded premiums). The impact of these changes to our reinsurance structure was partially offset by reserve strengthening in 2018 that resulted in ceding an additional $17.3 million in premium from prior treaty years related to variable premium adjustment provisions in our historical reinsurance treaties. Our historical commercial automobile reinsurance treaties cause an adjustment to premiums ceded when the ultimate loss estimate changes for a reinsurance treaty year. Reserve strengthening in 2017 also resulted in ceding an additional $13.7 million in premium related to these variable premium adjustment provisions in 2017.
Losses and loss expenses incurred during 2018 increased $98.3 million (39.7%) to $345.9 million compared to $247.5 million in 2017. The loss ratio also increased to 79.9% for 2018 compared to a loss ratio of 75.4% for 2017. The loss ratio is calculated as the percentage of losses and loss expenses incurred to net premiums earned. The increased losses and loss expenses and loss ratio in 2018 reflected reserve adjustments of $16.8 million related to unfavorable prior accident year loss development in commercial automobile coverages. These unfavorable loss developments were the result of increased claim severity due to a more challenging litigation environment, as well as an unexpected increase in the time to settle claims leading to an unfavorable change in claim settlement patterns. The 2018 loss ratio also reflected an increase in current accident year losses driven by severe commercial automobile losses, including continued emergence of severity. The 2017 loss ratio also reflected a $19.2 million reserve strengthening related to prior accident year deficiencies that developed as a result of unfavorable loss development from commercial automobile coverages, particularly from severe transportation loss events that occurred primarily during the first six months of 2017 and higher than expected loss development for discontinued lines of business.
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Commercial automobile products covered by our reinsurance treaties are subject to an aggregate stop-loss provision. Once this aggregate stop-loss level is reached, for every $100 of additional loss, we are responsible only for our $25 retention. The following table illustrates the financial impact of a further 5% or 10% increase in ultimate losses for the five most recent reinsurance treaty years (2013-2017) covering these commercial automobile products:
| 5% Increase in Ultimate Loss Ratio | 10% Increase in Ultimate Loss Ratio | |||||||
| Gross loss expense from further strengthening current reserve position | $ | 34.3 | $ | 68.7 | ||||
| Net financial loss | $ | 9.0 | $ | 17.6 | ||||
| $/share (after tax) | $ | 0.48 | $ | 0.94 | ||||
Net investment income for 2018 increased 21.8% to $22.0 million compared to $18.1 million for 2017. The increase reflected an increase in average funds invested resulting from positive cash flow, as well as higher interest rates, which led to higher reinvestment yields for our short-duration fixed income portfolio. After-tax investment income increased by 39.4% to $17.7 million during 2018, compared to $12.7 million during 2017, reflecting the aforementioned higher interest rates and reinvestment yield environment.
Net realized and unrealized losses on investments of $25.7 million during 2018 were driven by $9.7 million in unrealized losses on equity securities during the period, which are now recorded in the consolidated statements of operations in conjunction with our adoption of ASU 2016-01, a $9.3 million decrease in the value of our limited partnership investments and net realized losses on sales of fixed income and equity securities of $6.6 million. During 2018, we sold $149.2 million in equity securities resulting in a gain on sale of $51.9 million. The majority of this gain was included in unrealized gains within other comprehensive income (loss) at December 31, 2017 and, as a result of the adoption of ASU 2016-01, was reclassified to retained earnings as of January 1, 2018 and not recognized in the consolidated statements of operations for 2018. These equity sales further solidified the conservative nature of our high quality, short-duration investment portfolio; opportunistically utilized the new lower corporate tax rate of 21%, which was beneficial given the low tax basis of many of these equity positions; and were accretive to income, given the increase in yields at the shorter end of the yield curve. Comparative 2017 net realized investment gains were $19.7 million, consisting primarily of $12.5 million in gains reported from our investments in limited partnerships and $7.4 million in net realized gains from sales of securities. Realized investment gains and losses result from decisions regarding overall portfolio realignment as well as the sale of individual securities, including the change in aggregate value of limited partnerships and, as such, should not be expected to be consistent from period to period.
Other operating expenses for 2018 increased $23.6 million, or 20.8%, to $137.2 million compared to 2017. The increase in other operating expenses was primarily due to increased commission expenses as a result of increased premiums written and higher salary and benefit expense and a non-cash impairment charge of $3.2 million recorded in the fourth quarter of 2018 to write off our entire goodwill balance. See Note M for further discussion. The ratio of consolidated other operating expenses less commissions and other income to net premiums earned (the "expense ratio") was 29.4% during 2018, or 28.7% excluding the impact of the goodwill impairment charge, compared to 33.0% for 2017. The decrease in the expense ratio was primarily related to the leveraging effect of higher net premiums earned in 2018 compared to 2017.
Federal income tax benefit was $9.8 million for 2018 compared to income tax benefit of $8.2 million in 2017. The effective tax rate for 2018 was 22.3% compared to (81.0%) in 2017. The effective federal income tax rate in 2018 differed only slightly from the normal statutory rate primarily as a result of tax-exempt investment income. In the fourth quarter of 2017, we recorded a benefit of $9.6 million related to the remeasurement of deferred tax assets and liabilities pursuant to the U.S. Tax Act, which impacted our effective federal income tax rate for 2017.
As a result of the factors discussed above, net loss for 2018 was $34.1 million compared to net income of $18.3 million in 2017, a change of $52.4 million.
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2017 Compared to 2016
| 2017 | 2016 | Change | % Change | |||||||||||||
| Gross premiums written | $ | 504,737 | $ | 403,004 | $ | 101,733 | 25.2 | % | ||||||||
| Ceded premiums written | (151,348 | ) | (131,252 | ) | (20,096 | ) | 15.3 | % | ||||||||
| Net premiums written | $ | 353,389 | $ | 271,752 | $ | 81,637 | 30.0 | % | ||||||||
| Net premiums earned | $ | 328,145 | $ | 276,011 | $ | 52,134 | 18.9 | % | ||||||||
| Net investment income | 18,095 | 14,483 | 3,612 | 24.9 | % | |||||||||||
| Commissions and other income | 5,308 | 5,275 | 33 | 0.6 | % | |||||||||||
| Net realized and unrealized gains (losses) on investments | 19,686 | 23,228 | (3,542 | ) | (15.2 | )% | ||||||||||
| Total revenue | 371,234 | 318,997 | ||||||||||||||
| Losses and loss expenses incurred | 247,518 | 186,481 | 61,037 | 32.7 | % | |||||||||||
| Other operating expenses | 113,594 | 89,462 | 24,132 | 27.0 | % | |||||||||||
| Total expenses | 361,112 | 275,943 | ||||||||||||||
| Income before federal income tax expense (benefit) | 10,122 | 43,054 | (32,932 | ) | ||||||||||||
| Federal income tax expense (benefit) | (8,201 | ) | 14,109 | (22,310 | ) | |||||||||||
| Net income | $ | 18,323 | $ | 28,945 | $ | (10,622 | ) | |||||||||
Gross premiums written for 2017 totaled $504.7 million, an increase ofincreased $101.7 million (25.2%) from 2016. Net, while net premiums earned totaled $328.1 million for 2017 compared to $276.0 million for 2016, an increase ofincreased $52.1 million (18.9%)., as compared to 2016. The increase in net premiums written and earned was primarily due to an increase of $60.8 million in net premiums earned related to commercial automobile products and $3.7 million in higher net premiums earned related to workers' compensation products, which were consistent with the Company'sour growth strategy. These increases were partially offset by $8.1 million of lower premiums generated by reinsurance products, reflective of management'sour decision to completely withdraw from the property catastrophe reinsurance market,and professional liability reinsurance markets, and a decrease of $3.9 million in premiums earned from personal automobile products. The difference in the percentage change for premiums written compared to earned is reflective of the normal differences in the financial statement recognition of earned premiums compared to written, as well as differences in reinsurance ceding rates on the mix of business in-force.
Premiums ceded to reinsurers averaged 30.0% of gross premiums written for 2017, compared to 32.6% for 2016. The percentage of premiums ceded to reinsurance decreased as a result of changes in our reinsurance structure in the Company's reinsurance structure.third quarter of 2017. The change in net premiums earned, compared to growth in gross premiums written, was a function of premium adjustment provisions in the Company'sour historical commercial automobile reinsurance treaties. This historical reinsurance structure, which was revised in the latestJuly 2017 reinsurance renewal, causes an adjustment for ceded premiums when the ultimate loss estimate changes for a reinsurance treaty year.year. This resulted in ceding an additional $13.7 million in premium in connection with our reserve strengthening in 2017.
Net investment income for 2017 increased 24.9% higher thanto $18.1 million compared to $14.5 million for 2016, primarily due to higher interest rates leading to higher reinvestment yields for core fixed income securities, increased dividends from equity securities and an increase in average funds invested resulting from positive cash flow. After-tax investment income of $12.7 million increased 23.0% during 2017 compared to the prior year reflecting the above factors, as well as the mix between taxable and tax-exempt investment income.
Net realized and unrealized gains on investments before taxes, totaled $19.7 million in 2017 compared to $23.2 million during 2016. Direct trading gains during 2017 were $8.2 million lower compared to the prior year. Other-than-temporary impairmentsimpairment of $0.4 million, netted with gains of $1.6 million on previously impaired available-for-sale securities that were sold in 2017, are included in the net gains stated above. Investments in limited partnerships produced gains of $12.5 million in 2017, compared to gains of $2.5 million during the prior year.2016. Limited partnership investments utilized by the Companyus are primarily engaged in long-short equities, private equity, country focusedcountry-focused funds and real estate development as an alternative to direct equity investments. The aggregate of the Company'sour share of gains and losses in these entities represented a 16.3% appreciation in value for 2017, compared to a 3.3% increase in value for 2016.
| 2017 | 2016 | |||||||
| Fleet transportation | 73.9 | % | 63.4 | % | ||||
| All other | 94.0 | 95.5 | ||||||
| All lines | 75.4 | 67.6 | ||||||
Other operating expenses for 2017 increased $24.1 million (27.0%) to $113.6 million from $89.5 million in 2016. This increase was due primarily to an increase in commission expense as a result of the increase in premiums written and higher salary and salary relatedsalary-related expenses, reflective of the Company'sour increased workforce in response to the continued expansion of the Company'sour products and services. Reinsurance ceded credits, included as an offset to other operating expenses, were 30.8% lower in 2017, resulting primarily from ceding a lower percentage of workers' compensation premium to reinsurers in our most recent reinsurance treaty.
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Income tax benefit was $8.2 million for full year 2017 compared to income tax expense of $14.1 million in 2016. The CompanyWe recorded a benefit of $9.6 million related to the re-measurementremeasurement of deferred tax assets and liabilities in the fourth quarter of 2017 pursuant to the U.S. Tax Act. The Company'sOur effective federal tax rate for 2017 was (81.0%) as compared to 32.8% in 2016. The effective tax rate for 2017 was affected primarily by the impact of the U.S. Tax Act discussed above.
| 2016 | 2015 | |||||||
| Fleet transportation | 63.4 | % | 55.7 | % | ||||
| All other | 95.5 | 96.4 | ||||||
| All lines | 67.6 | 59.2 | ||||||
Critical Accounting Policies
The Company's significant accounting policies whichthat are material and/or subject to significant degrees of judgment are highlighted below.
Investment Valuation
All marketable securities are included in the Company's balance sheets at current fair market value.
Approximately 64%59% of the Company's assets are composed of investments at December 31, 2017.2018. Approximately 92% of these investments are publicly-traded, owned directly and have readily-ascertainable market values. The remaining 8% of investments are composed primarily of minority interests in several limited partnerships. These limited partnerships are engaged in long-short equities, private equity, country focusedcountry-focused funds and real estate development as an alternative to direct equity investments. These partnerships themselves, do not have readily-determinable market values.values themselves. Rather, the values recorded are those provided to the Company by the respective partnerships based on the underlying assets of the limited partnerships. While a substantial portion of the underlying assets are publicly-traded securities, those which are not publically-tradedpublicly-traded have been valued by the respective limited partnerships using their experience and judgment.
Under FASBFinancial Accounting Standards Board ("FASB") guidance, if a fixed maturityincome security is in an unrealized loss position and the Company has the intent to sell the security, or it is more likely than not that the Company will have to sell the security before recovery of its amortized cost basis, the decline in value is deemed to be other-than-temporary and is recorded to net realized lossesgains (losses) on investments in the consolidated statements of income.operations. For impaired fixed maturityincome securities that the Company does not intend to sell or it is more likely than not that the Company will not have to sell such securities, but the Company expects that it will not fully recover the amortized cost basis, the credit component of the other-than-temporary impairment is recognized in net realized lossesgains (losses) on investments in the consolidated statements of incomeoperations and the non-credit component of the other-than-temporary impairment is recognized directly in shareholders' equity (accumulatedwithin accumulated other comprehensive income)income (loss).
In determining if and when anconjunction with the adoption of ASU 2016-01, unrealized gains or losses on equity security's decline in market value below cost is other-than-temporary, we first make an objective analysis of each individual equity security where current market value is less than cost. For any equity security where the unrealized loss exceeds 20% of original or adjusted cost and, where that decline has existed for a period of at least six months, the decline is treated as an other-than-temporary impairment, without any subjective evaluation as to possible future recovery. For individual issues where the decline in value is less than 20% but the amount of the decline is considered significant, wesecurities will also evaluate the market conditions, trends of earnings, price multiples and other key measures for the securities to determine if it appears that the decline is other-than-temporary. In those instances, the Company also considers its intent and ability to hold equity investments until recovery can be reasonably expected. Additionally, for any equity security where the decline has existed for a period of at least one year, the decline is treated as an other-than-temporary impairment. For any decline which is considered to be other-than-temporary, we recognize an impairment lossrecognized in the current period earnings as an investment loss. Declines whichconsolidated statements of operations and are considered to be temporary are recorded as a reduction in shareholders' equity, net of related federal income tax benefits.no longer evaluated for other-than-temporary declines.
It is important to note that all available for saleavailable-for-sale securities included in the Company's consolidated financial statements are valued at current fair market values. The evaluation process for determination of other-than-temporary decline in value of investments, as described above, does not change these valuations but, rather, determines when a decline in value will be recognized in the income statementconsolidated statements of operations (other-than-temporary decline), as opposed to a charge to shareholders' equity (temporary decline). This evaluation process is subject to risks and uncertainties sincebecause it is not always clear what has caused a decline in value of an individual security or sincebecause some declines may be associated with general market conditions or economic factors, which relate to an industry in general, but not necessarily to an individual issue. The Company has attempted to minimize many of these uncertainties by adopting a largely objective evaluation process as described above. However, to the extent that certain declines in value are reported as unrealized at December 31, 2017,2018, it is possible that future earnings charges will result should the declines in value increase or persist or should the security actually be disposed of while market values are less than cost. At December 31, 2017,2018, the total gross unrealized loss included in the Company's investmentfixed income portfolio was approximately $7.1$10.8 million. No individual issue constituted a material amount of this total. Had this entire amount been considered other-than-temporary at December 31, 2017,2018, there would have been no impact on total shareholders' equity or book value since the decline in value of these securities was previously recognized as a reduction to shareholders' equity.
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Reinsurance Recoverable
Reinsurance ceded transactions were as follows for the years ended December 31 (dollars in thousands):
| 2017 | 2016 | 2015 | 2018 | 2017 | 2016 | |||||||||||||||||||
| Reinsurance recoverable | $ | 318,331 | $ | 255,024 | $ | 215,888 | $ | 392,436 | $ | 318,331 | $ | 255,024 | ||||||||||||
| Premium ceded (reduction to premium earned) | 145,201 | 130,012 | 128,697 | 131,080 | 145,201 | 130,012 | ||||||||||||||||||
| Losses ceded (reduction to losses incurred) | 128,086 | 108,656 | 75,581 | 148,285 | 128,086 | 108,656 | ||||||||||||||||||
| Reinsurance ceded credits (reduction to operating expenses) | 23,187 | 33,512 | 28,956 | 23,124 | 23,187 | 33,512 | ||||||||||||||||||
A discussion of the Company's reinsurance strategies is presented in Part I, Item 1, "Business"Business", of this Annual Report on Form 10-K.
Amounts recoverable under the terms of reinsurance contracts comprised approximately 24%26% of total Company assets as of December 31, 2017.2018. In order to be able to provide the high limits required by the Company's insureds, the Company shares a significant amount of the insurance risk of the underlying contracts with various insurance entities through the use of reinsurance contracts. Some reinsurance contracts provide that a loss will be shared among the Company and its reinsurers on a predetermined pro-rata basis ("quota-share"), while other contracts provide that the Company will keep a fixed amount of the loss, similar to a deductible, with reinsurers taking all losses above this fixed amount ("excess of loss"). Some risks are covered by a combination of quota-share and excess of loss contracts. The computation of amounts due from reinsurers is based upon the terms of the various contracts and follows the underlying estimation process for loss and loss expense reserves, as described below. Accordingly, the uncertainties inherent in the loss and loss expense reserving process also affect the amounts recorded as recoverable from reinsurers. Estimation uncertainties are greatest for claims which have occurred but which have not yet been reported to the Company. Further, the high limits provided by certain of the Company's insurance policies for fleet transportationcommercial automobile liability, workers' compensation and professional liability risks provide more variability in the estimation process than lines of business with lower coverage limits.
It should be noted, however, that a change in the estimate of amounts due from reinsurers on unpaid claims will not, in itself, result in charges or credits to losses incurred. This is because any change in estimated recovery follows the estimate of the underlying loss. Thus, it is the computation of the gross underlying loss that is critical.
As with any receivable, credit risk exists in the recoverability of reinsurance. This may be even more pronounced than in normal receivable situations since recoverable amounts are not generally due until the loss is settled which, in some cases, may be many years after the contract was written. If a reinsurer is unable, in the future, to meet its financial commitments under the terms of the contracts, the Company would be responsible to satisfy the reinsurer's portion of the loss. The financial condition of each of the Company's reinsurers is vetted upon the execution of a given treaty, and only reinsurers with superior credit ratings are utilized. However, as noted above, reinsurers are often not called upon to satisfy their obligations for several years and changes in credit worthiness can occur in the interim period. Reviews of the current financial strength of each reinsurer are made frequently and, should impairment in the ability of a reinsurer be determined to exist, current year operations would be charged in amounts sufficient to provide for the Company's additional liability. Such charges are included in other operating expenses, rather than losses and loss expenses incurred, since the inability of the Company to collect from reinsurers is a credit loss rather than a deficiency associated with the loss reserving process.
Loss and Loss Expense Reserves
The Company's reserves for losses and loss expenses ("reserves") are determined based on complex estimation processes using historical experience, current economic information and available industry statistics. The Company's claims range from routine "fender benders" to the highly complex and costly third partythird-party bodily injury claims involving large tractor-trailer rigs. Reserving for each class of claims requires a set of assumptions based upon historical experience, knowledge of current industry trends and seasoned judgment. The high limits provided in many of the Company's policies provide for greater volatility in the reserving process for more serious claims. Court rulings, legislative actions and trends in jury awards also play a significant role in the estimation process of larger claims. The Company continuously reviews and evaluates loss developments subsequent to each measurement date and adjusts its reserve estimation assumptions, as necessary, in an effort to achieve the best possible estimate of the ultimate remaining loss costs at any point in time. Changes to previously established loss and loss expense reserve amounts are charged or credited to losses and loss expenses incurred in the accounting periods in which they are determined. See Note C to the consolidated financial statements for additional information relating to loss and loss expense reserve development.
The Company's methods for determining loss and loss expense reserves are essentially identical for interim and annual reporting periods.
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A detailed analysis and discussion for each of the above basic reserve categories follows:
Reserves for known losses (Case reserves)
Each known claim, regardless of complexity, is handled by a claims adjuster experienced with claims of thisa similar nature, and a "case" reserve appropriate for the individual loss occurrence is established. For routine "short-tail" claims, such as physical damage, the Company records an initial reserve that is based upon historical loss settlements adjusted for current trends. As information regarding the loss occurrence is gathered in the claim handling process, the initial reserve is adjusted to reflect the anticipated ultimate cost to settle the claim. For more complex claims, which can tend toward being "long-tail" in nature, an experienced claims adjuster will review the facts and circumstances surrounding the loss occurrence to make a determination of the reserve to be established. Many of the more complex claims involve litigation and necessitate an evaluation of potential jury awards, in addition to the factual information, to determine the value of each claim. Each claim is frequently monitored and the recorded reserve is increased or decreased relative to information gathered during the settlement life cycle.
Reserves for IBNRincurred but not reported losses
The Company uses both standard actuarial techniques common to most insurance companies as well as proprietary techniques developed by the Company in connection with its specialty business products. For its short-tail lines of business, the Company uses predominantly the incurred or paid loss development factor methods. The Company has found that the use of accident quarter loss development triangles, rather than those based upon accident year, are most responsive to claim settlement trends and fluctuations in premium exposure for its short-tail lines. A minimum of 12 running accident quarters is used to project the reserve necessary for IBNRincurred but not reported ("IBNR") losses for its short-tail lines.
The Company also uses the loss development factor approach for its long-tail lines of business. A minimum of 15 accident years is included in the loss development triangles used to calculate link ratios and the selected loss development factors used to determine the reserves for IBNR losses. A minimum of 20 accident years is used for long-tail workers' compensation reserve projections. Significant emphasis is placed on the use of tail factors for the Company's long-tail lines of business.
For the Company's fleet transportationcommercial automobile risks, which are covered by regularly changing reinsurance agreements and which contain wide-ranging self-insured retentions ("SIR"), traditional actuarial methods are supplemented by other methods, as described below, in consideration of the Company's exposures to loss. In situations where the Company's reinsurance structure, the insured's SIR selections, policy volume, and other factors are changing, current accident period loss exposures may not be homogenous enough with historical loss data to allow for reliable projection of future developed losses. Therefore, the Company supplements the above-described actuarial methods with loss ratio reserving techniques developed from the Company's extensive, proprietary databases to arrive at the reserve for IBNR losses for the calendar/accident period under review. As losses for a given calendar/accident period develop with the passage of time, management evaluates such development on a monthly and quarterly basis and adjusts reserve factors, as necessary, to reflect current judgment with regard to the anticipated ultimate incurred losses. This process continues until all losses are settled for each period subject to this method.
Reserves for loss adjustment expenses
While certain of the Company's products involve case basis reserving for allocated loss adjustment expenses, the majority of such reserves are determined on a bulk basis. The Company uses historical analysis of the ratios of allocated loss adjustment expenses paid to losses paid on closed claims to arrive at the expected ultimate incurred loss adjustment expense factors applicable to each affected product. Once developed, the factors are applied to the expected ultimate incurred losses, including IBNR, on all open claims. The resulting ultimate incurred allocated loss adjustment expense is then reduced by amounts paid to date on all open claims to arrive at the reserve for allocated loss adjustment expenses to be incurred in the future for the handling of specific claims.
For those loss adjustment expenses not specific to individual claims (general claims handling expenses referred to as unallocated loss adjustment expenses), the Company uses a variation of the standard industry loss adjustment expenses paid to losses paid (net of reinsurance) ratio analysis that equally weighs paid and incurred losses to establish the necessary reserves. The selected factors are applied to 100% of IBNR reserves and to case reserves, with consideration given for that portion of loss adjustment expense already paid at the reserve measurement date. Such factors are monitored and revised, as necessary, on a quarterly basis.
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Sensitivity Analysis - Potential impact on reserve volatility from changes in key assumptions
Management is aware of the potential for variation from the reserves established at any particular point in time. Savings or deficiencies could develop in future valuations of the currently established loss and loss expense reserve estimates under a variety of reasonably possible scenarios. The Company's reserve selections are developed to be a "best estimate" of unpaid losses at a point in time and, due to the unique nature of ourits exposures, particularly in the large fleet transportationcommercial automobile excess product, ranges of reserve estimates are not established during the reserving process. However, basic assumptions that could potentially impact future volatility of ourthe Company's valuations of current loss and loss expense reserve estimates include, but are not limited to, the following:
| ● | Consistency in the individual case reserving processes; |
| ● | The selection of loss development factors in the establishment of bulk reserves for incurred but not reported losses and loss expenses; |
| ● | Projected future loss trend; and |
| ● | Expected loss ratios for the current book of business, particularly the Company's commercial automobile products, where the number of accounts insured, selected SIRs, policy limits and reinsurance structures may vary widely from period to period. |
Under reasonably possible scenarios, it is conceivable that the Company's selected loss estimates could be 10% or more redundant or deficient. The majority of the Company's reserves for losses and loss expenses, on a net of reinsurance basis, relate to its fleet transportationcommercial automobile products. Perhaps the most significant example of sensitivity to variation in the key assumptions is the loss ratio selection for the Company's fleet transportationcommercial automobile products for policies subject to certain major reinsurance treaties. The following table presents the approximate impacts on gross and net loss reserves of both a hypothetical 10 percentage point and a hypothetical 20 percentage point increase or decrease in the loss factors actually utilized in the Company's reserve determination at December 31, 20172018 for the prior six treaty periods, which covers exposures earned on policies written between July 3, 20112012 and December 31, 2017.2018. The Company's selection of the range of values presented should not be construed as the Company's prediction of future events, but rather simply an illustration of the impact of such events, should they occur.
The variation in impact from loss ratio increases and decreases is attributable to minimum and maximum premium rate factors included in the various reinsurance contracts. In between the minimum and maximum ceded premium provisions within the treaty terms, net premiums earned can be increased or decreased based on a change in loss expectation. The total impact to profitability in the same scenarios is shown below ($ in millions):
| 10% Loss Ratio Increase | 10% Loss Ratio Decrease | 20% Loss Ratio Increase | 20% Loss Ratio Decrease | 10% Loss Ratio Increase | 10% Loss Ratio Decrease | 20% Loss Ratio Increase | 20% Loss Ratio Decrease | |||||||||||||||||||||||||
| Gross Reserves | $ | 61.1 | $ | (48.4 | ) | $ | 122.3 | $ | (82.0 | ) | $ | 72.0 | $ | (72.0 | ) | $ | 144.1 | $ | (144.1 | ) | ||||||||||||
| Net Reserves | $ | 17.9 | $ | (14.0 | ) | $ | 34.3 | $ | (24.2 | ) | $ | 18.0 | $ | (19.5 | ) | $ | 36.0 | $ | (49.5 | ) | ||||||||||||
| Net premiums earned | $ | (27.2 | ) | $ | 31.0 | $ | (29.6 | ) | $ | 62.0 | $ | (0.4 | ) | $ | 16.5 | $ | (0.4 | ) | $ | 41.1 | ||||||||||||
| Cumulative Net Underwriting Income (Loss) | $ | (45.1 | ) | $ | 45.0 | $ | (63.9 | ) | $ | 86.2 | $ | (18.4 | ) | $ | 36.0 | $ | (36.4 | ) | $ | 90.6 | ||||||||||||
Federal Income Tax Considerations
The liability method is used in accounting for federal income taxes. Using this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The provision for deferred federal income tax is based on items of income and expense that are reported in different years in the consolidated financial statements and tax returns and are measured at the tax rate in effect in the year the difference originated.
On December 22, 2017, the U.S. Tax Act was signed into law. The U.S. Tax Act lowered the U.S. corporate income tax rate from 35% to 21% effective January 1, 2018. GAAP requires the impact of tax legislation to be recognized in the period in which the law was enacted. As a result of the U.S. Tax Act, the Company recorded a tax benefit of $9.6 million related to the re-measurementremeasurement of its deferred tax assets and liabilities during the fourth quarter of 2017. As of December 31, 2017, the IRS had not yet published all of the detailed regulations resulting from the enactment of the U.S. Tax Act; therefore, while the Company had not completed its accounting for the tax effects, it made a reasonable estimate of the tax effects on its existing deferred tax balances at December 31, 2017. The Company finalized its accounting for the tax effects of the U.S. Tax Act during 2018. No material adjustments to income tax expense (benefit) were recorded in 2018.
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Net deferred tax liabilities reported at December 31 are as follows (dollars in thousands):
| 2017 | 2016 | 2018 | 2017 | |||||||||||||
| Total deferred tax liabilities | $ | (23,836 | ) | $ | (24,969 | ) | $ | (12,906 | ) | $ | (23,836 | ) | ||||
| Total deferred tax assets | 9,478 | 13,557 | 19,168 | 9,478 | ||||||||||||
| Net deferred tax liabilities | $ | (14,358 | ) | $ | (11,412 | ) | ||||||||||
| Net deferred tax assets (liabilities) | $ | 6,262 | $ | (14,358 | ) | |||||||||||
Deferred tax assets at December 31, 2017 include2018 included approximately $6.8$10.0 million related to the timing of deductibility of loss and loss expense reserves, the majority of which relate to policy liability discounts required by the Internal Revenue Code of 1986, as amended, which are perpetual in nature and, in the absence of the termination of the Company's business, will not, in the aggregate, reverse to a material degree in the foreseeable future. $3.5 million of deferred tax assets are related to the results of the Company's limited partnership investments. Unearned premiums discount and deferred ceding commissions represent $2.3 million and $1.2 million of deferred tax assets, respectively. An additional $0.8$0.6 million relates to impairment adjustments made to investments, as required by accounting regulations. The sizable unrealized gains in the Company's investment portfolios would allow for the recovery of this deferred tax at any time. Unearned premiums discount and deferred ceding commissions represent $1.8 million and $0.6 million of deferred tax assets, respectively. The balance of deferred tax assets consists of various normal operating expense accruals and is not considered to be material. As a result of its analysis, management has determined that no valuation allowance is necessary at December 31, 2017.2018.
FASB provides guidance for recognizing and measuring uncertain tax positions and prescribes a threshold condition that a tax position must meet for any of the benefit of the uncertain tax position to be recognized in the consolidated financial statements. Based on this guidance, management regularly analyzes tax positions taken or expected to be taken in a tax return based on the threshold condition prescribed. Tax positions that do not meet or exceed this threshold condition are considered uncertain tax positions. Interest related to uncertain tax positions, if any, would be recognized in income tax expense. Penalties, if any, related to uncertain tax positions would be recorded in income tax expenses. expense (benefit).
Impact of Inflation
To the extent possible, the Company attempts to recover the impact of inflation on loss costs and operating expenses by increasing the premiums it charges. Within the fleet transportationcommercial automobile business, a majority of the Company's accounts are charged as a percentage of an insured's gross revenue, mileage or payroll. As these charging bases increase with inflation, premium revenues are immediately increased. The remaining premium rates charged are adjustable only at periodic intervals and often require state regulatory approval. Such periodic increases in premium rates may lag far behind cost increases.
To the extent inflation influences yields on investments, the Company is also affected. The Company's short-term and fixed investment portfolios are structured in direct response to available interest rates over the yield curve. As available market interest rates fluctuate in response to the presence or absence of inflation, the yields on the Company's investments are impacted. Further, as inflation affects current market rates of return, previously committed investments might increase or decline in value depending on the type and maturity of investment (seeinvestment. For additional comments ininformation, see Part II, Item 7A, "Quantitative and Qualitative Disclosures about Market Risk", in this Annual Report on Form 10-K).10-K.
Inflation must also be considered by the Company in the creation and review of loss and loss adjustment expense reserves, as portions of these reserves are expected to be paid over extended periods of time. The anticipated effect of inflation is implicitly considered when estimating liabilities for losses and loss adjustment expenses.
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Contractual Obligations
The table below sets forth the amounts of the Company's contractual obligations at December 31, 2017.2018.
| Payments Due by Period | Payments Due by Period | |||||||||||||||||||||||||||||||||||||||
| Total | Less than 1 year | 1 - 3 Years | 3 - 5 Years | More Than 5 Years | Total | Less than 1 year | 1 - 3 Years | 3 - 5 Years | More Than 5 Years | |||||||||||||||||||||||||||||||
| (dollars in millions) | (dollars in millions) | |||||||||||||||||||||||||||||||||||||||
| Loss and loss expense reserves | $ | 680.3 | $ | 238.1 | $ | 224.5 | $ | 81.6 | $ | 136.1 | $ | 865.3 | $ | 302.9 | $ | 285.6 | $ | 103.8 | $ | 173.0 | ||||||||||||||||||||
| Investment commitment | 1.4 | 1.4 | - | - | - | 1.3 | 1.3 | – | – | – | ||||||||||||||||||||||||||||||
| Operating leases | 0.7 | 0.3 | 0.4 | - | - | 0.5 | 0.4 | 0.1 | – | – | ||||||||||||||||||||||||||||||
| Borrowings | 20.0 | 20.0 | - | - | - | 20.0 | 20.0 | – | – | – | ||||||||||||||||||||||||||||||
| Total | $ | 702.4 | $ | 259.8 | $ | 224.9 | $ | 81.6 | $ | 136.1 | $ | 887.1 | $ | 324.6 | $ | 285.7 | $ | 103.8 | $ | 173.0 | ||||||||||||||||||||
The Company's loss and loss expense reserves do not have contractual maturity dates, and the exact timing of the payment of claims cannot be predicted with certainty. However, based upon historical payment patterns, the above table presents an estimate of when wethe Company might expect ourits direct loss and loss expense reserves (without the benefit of reinsurance recoveries) to be paid. Timing of the collection of the related reinsurance recoverable, estimated to be $318.3$392.4 million at December 31, 2017,2018, or 47%45% of the amounts presented in the above table, would approximate that of the above projected direct reserve payout but could lag behind such payments by several months in some instances.
The investment commitment in the above table relates to a maximum unfunded capital obligation for a limited partnership investment at December 31, 2017.2018. The actual call dates for such funding could vary from that presented.
Borrowings made under the Company's line of credit can be called by the bank,lender, under certain circumstances, with short notice. The Company'sCompany entered into a new line of credit has a currenton August 9, 2018 with an expiration date of September 23, 2018; however, management expects that this line of credit will be renewed for a multi-year period prior to maturity.August 9, 2022.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements.
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Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK