The Company uses the estimated annual effective tax rate method for calculating its tax provision in interim periods, which represents the Company’s best estimate of the effective tax rate expected for the full year based on projected annual taxable income (loss). The effective tax rate can fluctuate throughout the year because estimates used in the quarterly tax provision are updated as more information becomes available throughout the year.
(9) Stock-Based Compensation:
The Company issues shares of restricted Class B Common Stock to the Company's outside directors as part of their annual retainer compensation. The shares are distributed to the outside directors on the vesting date, which, with the exception of pro-rated annual retainers granted to outside directors, is one year following the date of grant. On May 17, 2019, the Company granted shares of restricted Class B Common Stock in connection with the election of a new outside director, reflecting such director’s pro-rated annual retainer compensation, which shares will vestvested and bewere distributed on May 7, 2020. Additionally, effective May 22, 2019, John D. Nichols, Jr. ceased serving as the Company's Interim Chief Executive Officer and principal executive officer, but continued to serve as Chairman of the Company's Board of Directors. On May 22, 2019, the Company granted shares of restricted Class B Common Stock to Mr. Nichols in connection with this transition, reflecting his pro-rated annual retainer compensation, which shares will also vestvested and bewere distributed on May 7, 2020. The table below provides detail of the restricted stock issuances to directors for 20192020 and 2020:2021:
Grant Date | | Number of Shares Issued | | Vesting Date | Service Period | | Grant Date Fair Value Per Share | | | Number of Shares Issued | | Vesting Date | | Service Period | | Grant Date Fair Value Per Share |
5/8/2018 | | 19,085 | | 5/8/2019 | 7/1/2018 - 6/30/2019 | | $ | 23.05 | | |
| | | | | | | | |
5/7/2019 | | 29,536 | | 5/7/2020 | 7/1/2019 - 6/30/2020 | | $ | 16.25 | | | 29,536 | | 5/7/2020 | | 7/1/2019 - 6/30/2020 | | $ | 16.25 |
| | | | | | | | | | | | | | | | |
5/17/2019 | | 3,591 | | 5/7/2020 | 7/1/2019 - 6/30/2020 | | $ | 16.25 | | | 3,591 | | 5/7/2020 | | 7/1/2019 - 6/30/2020 | | $ | 16.25 |
| | | | | | | | | | | | | | | | |
5/22/2019 | | 3,541 | | 5/7/2020 | 7/1/2019 - 6/30/2020 | | $ | 16.25 | | | 3,541 | | 5/7/2020 | | 7/1/2019 - 6/30/2020 | | $ | 16.25 |
| | | | | | | | | | |
5/5/2020 | | | 42,220 | | 5/5/2021 | | 7/1/2020 - 6/30/2021 | | $ | 14.21 |
| | | | | | | | | | |
Compensation expense related to the above stock grants is recognized over the period in which the directors render services.
In March 2018, the Company's Compensation Committee, granted equity-based awards pursuant tonow known as the Long-Term Incentive Plan. Certain participants under the Long-Term Incentive Plan were granted equity awardsCompensation and Human Capital Committee (the "2018 LTIP Awards""Committee"), with the number of shares of Class B Common Stock earned pursuant to such awards determined by applying a performance matrix consisting of a measurement of the combined results of the Company's 2018 growth in gross premiums earned and the Company's 2018 combined ratio. The combined ratio is calculated as a ratio of (A) losses and loss expenses incurred, plus other operating expenses, less commission and other income to (B) net premiums earned. No 2018 LTIP Awards were earned based on the Company's performance in 2018, and therefore no shares were issued pursuant to the 2018 LTIP Awards. In addition to the 2018 LTIP Awards, in March 2018 the Company's Compensation Committee also granted Value Creation Incentive Plan awards (the "2018 VCIP Awards") to certain participants under the Company's Long-Term Incentive Plan.Plan (the "Long-Term Incentive Plan"). The 2018 VCIP Awards arewere performance-based equity awards that willcould be earned based on the Company's cumulative operating income as defined above, over a three-year performance period from January 1, 2018 through December 31, 2020 relative to a cumulative operating income goal for the period set by the Compensation Committee in March 2018. Any 2018 VCIP Awards that arewere earned will bewould have been paid in unrestricted shares of the Company's Class B Common Stock at the end of the three-year performance period, but no later than March 15, 2021. NoNaN shares are eligible to be issuedwere earned under the 2018 VCIP Awards as of Marchfor the three-year performance period ended December 31, 2020.
On November 13, 2018, the Company entered into an employment agreement with its Interim Chief Executive Officer, John D. Nichols, Jr. Pursuant to the terms of this employment agreement, on November 13, 2018, Mr. Nichols was granted 85,000 restricted shares of the Company's Class B Common Stock (the "Nichols Stock Grant"), of which 42,500 shares vested as of October 17, 2019; 21,250 shares will vestvested as of October 17, 2020, and 21,250 shares will vest as of October 17, 2021. The Company incurred $14$183 of expense during the three months ended March 31, 20202021 related to the Nichols Stock Grant.
In March 2019, the Company's Compensation Committee granted equity-based awards pursuant to the Long-Term Incentive Plan. Certain participants under the Long-Term Incentive Plan were granted equity awards (the "2019 LTIP Awards"), with the number of shares of Class B Common Stock earned pursuant to such awards determined by applying a performance matrix consisting of a corporate performance component as well as a personal performance component. The corporate performance component of the 2019 LTIP Awards was determined based on the Company's achievement of 2019 underwriting income compared to the plan target. The Company's underwriting income was calculated as income (loss) before federal income tax expense (benefit), less net realized and unrealized gains (losses) on investments, less net investment income. The personal performance component of the 2019 LTIP Awards was determined based on the achievement of personal goals that alignaligned with departmental and corporate objectives for 2019. 2019 LTIP Awards earned were paid in shares of restricted Class B Common Stock in early 2020. One-third of such shares will vest annually over the three-year period beginning one year from the date of issue. The Company incurred $35$30 of expense during the three months ended March 31, 20202021 related to the 2019 LTIP Awards.
On May 22, 2019, the Company entered into an employment agreement with its new Chief Executive Officer, Jeremy D. Edgecliffe-Johnson. Pursuant to the terms of this employment agreement, on May 22, 2019, Mr. Edgecliffe-Johnson was granted 70,000 restricted shares of the Company's Class B Common Stock (the "Edgecliffe-Johnson Stock Grant"), of which 35,000 shares will vest as of June 1, 2022, 21,000 shares will vest as of June 1, 2023, and 14,000 shares will vest as of June 1, 2024. The Company incurred $39$399 of expense during the three months ended March 31, 20202021 related to the Edgecliffe-Johnson Stock Grant.
On November 5, 2019, the Board of the Company, upon the recommendation of the Compensation Committee, approved equity compensation awards to be granted to seven7 members of senior management as of November 12, 2019 under the Company’s Long-Term Incentive Plan. The Board approved a total of $1,100 in grants of restricted shares of the Company’s Class B Common Stock, which will vest on January 1, 2023, subject to the recipient’s continued employment with the Company through the vesting date. The Company incurred $88$52 of expense during the three months ended March 31, 20202021 related to this grant.
On July 6, 2020, the Committee granted a total of 101,400 restricted shares of the Company's Class B Common Stock to certain members of senior management under the Long-Term Incentive Plan. These 101,400 restricted shares will vest on July 1, 2023, subject to the recipient’s continued employment with the Company through the vesting date. The Company incurred $328 of expense during the three months ended March 31, 2021 related to this grant.
(10) Litigation, Commitments and Contingencies:
In the ordinary, regular and routine course of their business, the Company and its Insurance Subsidiaries are 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, other than as noted below.
Personnel Staffing Group Litigation
In July 2019, Protective Insurance Company (“Protective”) was named as a defendant in an action brought by a former insured, Personnel Staffing Group d/b/a MVP Staffing (“PSG”), in the U.S. District Court for the Central District of California (the “California Action”) alleging that Protective had breached its workers’ compensation insurance policy and had breached the duties of good faith and fair dealing. Protective provided workers’ compensation insurance to PSG from January 1, 2017 through June 30, 2018, which was subject to a $500 per claim deductible to be paid by PSG. NoNaN specific damages were included in the complaint. In August 2019, Protective filed a motion to dismiss or stay the action. On April 28, 2020, Protective's motion to dismiss the California Action was granted without prejudice on grounds that Indiana is the more appropriate forum. On May 4, 2020, PSG filed a notice of appeal in the 9th Circuit Court of Appeals, challenging the order of dismissal in the California Action. On April 15, 2021, the 9th Circuit Court of Appeals reversed and remanded, finding that dismissal is unavailable, because transfer to another federal district court is possible. Protective filed a petition for rehearing with the 9th Circuit on April 26, 2021, which was denied on April 27, 2021.
In August 2019, Protective filed a lawsuit against PSG in Marion County Superior Court, in Indianapolis, Indiana (the “Indiana Court”) alleging breach of contract, breach of the parties' collateral agreement, breach of the parties' indemnity agreement, and seeking a declaratory judgment regarding PSG’s obligation to fund its ongoing claim deductible obligations and adequately collateralize Protective’s current and ongoing claims exposure pursuant to terms of the parties' agreements (the “Indiana Action”). In October 2019, Protective amended the complaint to include allegations of misrepresentation as to source of coverage, negligent misrepresentation, fraud and racketeering and seeking injunctive relief. In November 2019, PSG filed a motion to dismiss the Indiana Action on the basis of comity with the California Action, claiming that California was the proper forum for Protective’s claims.
In February 2020, the Indiana Court issued an order dismissing the Indiana Action without prejudice; the Indiana Court declined to rule on the legal effect of the forum selection clause in the parties’ agreements, finding that any interpretation should be addressed by the court in the California Action. On April 28, 2020,Following the court's granting of Protective’s motion to dismiss in the California Action, was granted without prejudice on grounds that Indiana is the more appropriate forum. On May 4, 2020, PSG filed a notice of appeal of the order of dismissal in the California Action. On May 1, 2020, Protective filed a motion with the Indiana Court to re-open the Indiana Action.Action, which was denied on September 23, 2020. On December 22, 2020, Protective moved for reconsideration of its Motion to Re-Open the Indiana Action, which the Indiana Court granted on February 5, 2021. On February 18, 2021, PSG moved for further reconsideration and for hearing, which was held on March 2, 2021. On March 31, 2021, the Indiana Court ruled that Protective had shown good cause to reinstate the Indiana Action, premised on the California Action remaining dismissed. Protective intends to vigorously pursue its claims against PSG, however, the ultimate outcome cannot be presently determined.
Pursuant to the terms of the workers’ compensation policies, Protective has a duty to adjust and pay claims arising under the policies regardless of whether PSG makes payments to Protective for deductible obligations under the policies. Under its contractual obligations to Protective, PSG is required to maintain a “loss fund” for the payment of claims, the balance of which is to remain at or above $4,000; in addition, PSG is required to provide collateral in an amount equal to 110% of Protective’s current open case reserves on workers’ compensation claims arising under the policies.
As of March 31, 2020,2021, Protective had approximately $14,680$24,068 in deductible receivables on claims arising under PSG’s workers’ compensation policies and had exhausted all collateral provided by PSG. Protective continues to pay claims settlements under the policies without reimbursement from PSG. For the past six months, the average monthly deductible invoices have been approximately $1,300.$778. PSG’s estimated ultimate obligation under the agreements is approximately $44,600$47,000 as of March 31, 20202021 (inclusive of the $14,680$24,068 in deductible receivables noted above). At March 31, 2020,2021, based on the Company's assessment that PSG will continue to operate as a business and that the terms of the agreement with PSG will be legally enforceable, the Company believes that it will fully collect all current and future amounts due from PSG relating to this matter.
The Company includedconsidered this matter in its assessment of measuring credit losses under the impact of adopting ASU 2016-13, the newCECL guidance for measuring CECL, which is discussed in Note 1. A1 by applying a probability-of-default methodology was applied to projected estimated cash flows to estimate the allowance for expected credit losses for this matter. The Company considered the delay in reimbursement for claims paid as well as probability of default assumptions when analyzing the credit loss related to this matter. As of January 1, 2020, in conjunction with the adoption of ASU 2016-13, the Company recorded an allowance for expected credit losses of $15,000 ($11,850, net of tax). There was no change as a reduction to equity. During the third quarter of 2020, the Company performed an update to its CECL allowance calculation related to the PSG matter. As noted above, there have been further delays in the litigation process, which have extended the estimated cash flow timing. As a result of these delays and an increase in the estimated ultimate obligation, the Company recorded an additional allowance of $1,500 ($1,185, net of tax) within other operating expenses in the condensed consolidated statement of operations during the third quarter of 2020. No additional allowance was recorded in the fourth quarter of 2020 or the first quarter of 2020, as2021. In the event of a situation that results in no recovery from PSG, the Company would incur an estimated charge to the consolidated statement of operations of $30,500 ($24,095, net of tax), which represents the estimated ultimate obligation and projected cash flows had not materially changed since January 1, 2020 whendiscussed above less the initial measurement of the credit risk was conducted.CECL allowance.
(11) Shareholders' Equity:
On August 31, 2017, the Company's Board of Directors authorized the reinstatement of its share repurchase program for up to 2,464,209 shares of the Company's Class A or Class B Common Stock. On August 6, 2019, the Company's Board of Directors reaffirmed its 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 between August 6, 2019 and August 6, 2020 may not exceed $25,000, including a limit of up to $6,250 per quarter. No duration has been placed on the Company's share repurchase program, and the Company reserves 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.
During the three months ended March 31, 2020,2021, the Company paid $1,782 todid 0t repurchase 126,764any shares of Class B Common Stock under the share repurchase program. No share repurchases have been made since March 20, 2020.
- 18 -The following table illustrates changes in accumulated other comprehensive income (loss) by component for the three months ended March 31, 2021:
| | Foreign Currency | | | Unrealized Holding Gains (Losses) on Available-for-sale Securities | | | Total | |
Beginning balance at December 31, 2020 | | $ | (245 | ) | | $ | 22,004 | | | $ | 21,759 | |
| | | | | | | | | | | | |
Other comprehensive income (loss) before reclassifications | | | 88 | | | | (8,580 | ) | | | (8,492 | ) |
Amounts reclassified from accumulated other comprehensive income (loss) | | | 0 | | | | (501 | ) | | | (501 | ) |
| | | | | | | | | | | | |
Net current-period other comprehensive income (loss) | | | 88 | | | | (9,081 | ) | | | (8,993 | ) |
| | | | | | | | | | | | |
Ending balance at March 31, 2021 | | $ | (157 | ) | | $ | 12,923 | | | $ | 12,766 | |
The following table illustrates changes in accumulated other comprehensive income (loss) by component for the three months ended March 31, 2020:
| | Foreign Currency | | | Unrealized Holding Gains (Losses) on Available-for-sale Securities | | | Total | | | Foreign Currency | | | Unrealized Holding Gains (Losses) on Available-for-sale Securities | | | Total | |
Beginning balance at December 31, 2019 | | $ | (494 | ) | | $ | 9,863 | | | $ | 9,369 | | | $ | (494 | ) | | $ | 9,863 | | | $ | 9,369 | |
| | | | | | | | | | | | | | | | | | | | | |
Other comprehensive income (loss) before reclassifications | | (687 | ) | | (20,256 | ) | | (20,943 | ) | | | (687 | ) | | | (20,256 | ) | | | (20,943 | ) |
Amounts reclassified from accumulated other comprehensive income (loss) | | | – | | | | (605 | ) | | | (605 | ) | | | 0 | | | | (605 | ) | | | (605 | ) |
| | | | | | | | | | | | | | | | | | | | | |
Net current-period other comprehensive income (loss) | | | (687 | ) | | | (20,861 | ) | | | (21,548 | ) | | | (687 | ) | | | (20,861 | ) | | | (21,548 | ) |
| | | | | | | | | | | | | | | | | | | | | |
Ending balance at March 31, 2020 | | $ | (1,181 | ) | | $ | (10,998 | ) | | $ | (12,179 | ) | | $ | (1,181 | ) | | $ | (10,998 | ) | | $ | (12,179 | ) |
The following table illustrates changes in accumulated other comprehensive income (loss) by component for the three months ended March 31, 2019:
| | Foreign Currency | | | Unrealized Holding Gains (Losses) on Available-for-sale Securities | | | Total | |
Beginning balance at December 31, 2018 | | $ | (1,139 | ) | | $ | (6,208 | ) | | $ | (7,347 | ) |
| | | | | | | | | | | | |
Other comprehensive loss before reclassifications | | | 307 | | | | 7,671 | | | | 7,978 | |
Amounts reclassified from accumulated other comprehensive income (loss) | | | – | | | | 785 | | | | 785 | |
| | | | | | | | | | | | |
Net current-period other comprehensive income (loss) | | | 307 | | | | 8,456 | | | | 8,763 | |
| | | | | | | | | | | | |
Ending balance at March 31, 2019 | | $ | (832 | ) | | $ | 2,248 | | | $ | 1,416 | |
(12) Related Parties:
The Company utilizes the services of an investment firm of which one1 director of the Company is a partial owner. This investment firm manages equity securities and fixed income portfolios held by the Company with an aggregate market value of approximately $6,698$8,857 at March 31, 2020.2021. Total commissions and net fees earned by this investment firm and its affiliates on these portfolios were $37$8 and $34$37 for the three months ended March 31, 20202021 and 2019.2020.
(13) Subsequent Events:
On May 5, 2020,4, 2021, the Company's Board of Directors declared a regular quarterly dividend of $0.10 per share on the Company's Class A and Class B Common Stock. The dividend per share will be payable June 2, 20201, 2021 to shareholders of record on May 19, 2020.18, 2021.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Protective Insurance Corporation is a property-casualty insurer specializing 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. We operate as one reportable property and casualty insurance segment, offering a range of products and services, the most significant being commercial automobile and workers' compensation insurance products.
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 MD&A, 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.
Expected Credit Losses Standard (CECL) AdoptionSpecial Committee and Contingent Sale Agreement
On May 5, 2020, the Board of Directors (the “Board”) of Protective formed a special committee of independent directors (the “Special Committee”) to evaluate a Stockholder Support and Contingent Sale Agreement (the “Contingent Sale Agreement”) entered into by and among certain prospective third party purchasers (the “Offering Parties”), certain of Protective’s shareholders and the other parties thereto. The Contingent Sale Agreement was amended and restated on August 17, 2020.
In June 2020, Protective announced that the Board determined the transactions contemplated by the Contingent Sale Agreement were not in the best interests of Protective and our stakeholders. As part of this evaluation, the Board determined that it would also recommend against the potential tender offer contemplated by the Contingent Sale Agreement if it were commenced, and that if the transactions contemplated by the Contingent Sale Agreement were consummated, it expected to take the necessary actions to redeem all or certain of the Class A shares of Protective purchased by the Offering Parties pursuant to Protective’s Code of By-laws. Protective also announced that the Special Committee of the Board was exploring, with the assistance of its independent financial and legal advisors, strategic alternatives that may be available to Protective.
Proposed Merger with The Progressive Corporation
Merger Agreement
On January 1, 2020, weFebruary 14, 2021, Protective entered into an Agreement and Plan of Merger (the “Merger Agreement”) with The Progressive Corporation, an Ohio corporation (“Progressive”), and Carnation Merger Sub Inc., an Indiana corporation and wholly-owned indirect subsidiary of Progressive (“Merger Sub”). The Merger Agreement provides for, subject to the satisfaction or waiver of specified conditions, the merger of Merger Sub with and into Protective (the “Merger”), whereupon the separate existence of Merger Sub will cease and Protective will continue as the surviving corporation and as a wholly-owned indirect subsidiary of Progressive.
The Board, at the unanimous recommendation of the Special Committee, unanimously determined that the Merger Agreement and the transactions contemplated thereby, including the Merger, are advisable and fair to, and in the best interests of, Protective and its shareholders, and approved, adopted and declared advisable the provisionsMerger Agreement and the transactions contemplated thereby. The Merger is expected to close in June or July of ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement2021. At the effective time of Credit Losses on Financial Instruments,the Merger, each issued and outstanding share of common stock, without par value, of Protective (other than each share of Protective's common stock that is owned by Protective as treasury stock or ASU 2016-13. ASU 2016-13 introducedby any subsidiary of Protective and each share of Protective's common stock owned by Progressive, Merger Sub or any other subsidiary of Progressive immediately prior to the effective time of the Merger) will be automatically canceled and converted into the right to receive $23.30 in cash, without interest, for a current expected credit loss ("CECL") model for measuring expected credit losses fortotal transaction value of approximately $338 million.
The Merger Agreement contains various customary representations and warranties from each of Protective, Progressive and Merger Sub. Protective has also agreed to various customary covenants, including but not limited to conducting its business in the ordinary course and not engaging in certain types of financial instruments heldtransactions during the period between the execution of the Merger Agreement and the closing of the Merger. However, the Merger Agreement permits Protective to continue to pay regular quarterly dividends not to exceed $0.10 per share of its common stock. The Hart-Scott-Rodino Antitrust Improvements Act of 1976 waiting period expired April 5, 2021. In addition, at the reporting date requiring significant judgment in application basedspecial meeting of Protective’s shareholders held on historical experience, current conditionsMay 5, 2021, Protective’s Class A shareholders approved the Merger Agreement, the Merger and reasonable supportable forecasts, but is not prescriptive aboutthe other transactions contemplated by the Merger Agreement. The Merger remains subject to legal and regulatory approvals including from the Indiana Department of Insurance, as well as other customary closing conditions.
For additional information regarding the risks associated with the Merger, please see Part II, Item 1A, "Risk Factors," of this Quarterly Report on Form 10-Q and Part I, Item 1A, "Risk Factors," of our Annual Report on Form 10-K for the year ended December 31, 2020.
Voting and Support Agreement
On February 14, 2021, Protective also entered into a Voting and Support Agreement (the “Voting Agreement”) with Progressive and certain aspects of estimating expected losses. We adoptedProtective's shareholders. The Voting Agreement required that the guidance using a modified retrospective approach as of January 1, 2020 and recognized a cumulative effect adjustment of $15.5 million ($12.3 million net of tax),Protective shareholders party to the opening balance of retained earnings. The adjustment was primarily related to estimating credit losses on our accounts receivable balances, reinsurance recoverable balances and commercial mortgage loansVoting Agreement: (i) appear at the datemeeting of adoption. We did not recordthe holders of Protective's Class A common stock held on May 5, 2021 to consider resolutions to approve the Merger Agreement and the Merger or otherwise cause their shares of Protective's common stock to be counted as present for purposes of calculating a quorum, and (ii) vote their shares (a) in favor of the adoption of the Merger Agreement, the Merger and the other transactions contemplated thereby and any significant additional impactaction reasonably requested by Progressive or the Board in furtherance of the foregoing, (b) against any action or agreement that would result in a material breach of any covenant, representation or warranty or other obligation or agreement of Protective contained in the Merger Agreement and (c) against any takeover proposal or superior proposal (provided, that if the Board had changed its recommendation with respect to the statementMerger, any shares of operationsClass A common stock owned by such shareholders in excess of approximately 35% of the outstanding shares of Class A common stock would have been voted in the same proportion as those shares of Class A common stock voted by the holders of Protective's Class A common stock that were not party to the Voting Agreement). The Protective shareholders party to the Voting Agreement voted their shares in favor of the Merger Agreement and the Merger at the special meeting of Protective's shareholders held on May 5, 2021, in accordance with the terms of the Voting Agreement.
During the first quarter of 2020.
The updated guidance2021, we incurred $3.5 million ($2.7 million, net of tax) of expenses in ASU 2016-13 also amendedconjunction with the previous other-than-temporary impairment ("OTTI") model for available-for-sale fixed income securities by requiringactivities of the recognition of impairments relating to credit losses through an allowance account and limits the amount of credit lossSpecial Committee related to the difference between a security’s amortized cost basis and its fair value. In addition, the length of time a security has been in an unrealized loss position will no longer impact the determination of whether a credit loss exists. We adopted the guidance related to available-for-sale fixed income securities on January 1, 2020 using a prospective transition approach for available-for-sale fixed income securities that were purchasedMerger with credit deterioration or had recognized an OTTI write-down prior to the effective date. The effect of the prospective transition approach was to maintain the same amortized cost basis before and after the effective date. As of March 31, 2020, we intended to sell one security in an unrealized loss position and, in accordance with the new guidance, recorded a write down to earnings of less than $0.1 million. We reviewed our remaining fixed income securities in an unrealized loss position as of March 31, 2020 and determined that the losses were primarily the result of non-credit factors, such as the increase in market volatility due to the recent disruption in global financial markets as a result of the novel coronavirus COVID-19 ("COVID-19") pandemic and responses to it. We currently do not intend to sell nor do we expect to be required to sell these securities before recovery of their amortized cost. Based on the above factors, we did not record any allowance for credit losses under the new guidance related to our available-for-sale securities under the new guidance in the first quarter of 2020.Progressive discussed above.
COVID-19 Impacts
Beginning in March 2020 and continuing through the date of this Quarterly Report on Form 10-Q, the global pandemic associated with COVID-19the novel coronavirus ("COVID-19") and related economic conditions began to impacthave impacted the global economy and our results of operations. WhileWe saw improvements in net premiums earned during the third and fourth quarters of 2020 within our commercial automobile products that continued through the first quarter of 2021. However, net premiums earned within our public transportation products were negatively impacted due to a reduction in miles driven, which is the basis for premiums we did not see a material impact on our underwriting income (loss),receive, as defined below,well as an overall reduction in public transportation units insured. Additionally, during the fourth quarter of 2020, given ongoing profitability challenges, we discontinued writing new public transportation business. However, losses and loss expenses incurred during the three months ended March 31, 2020, we did incur net realized and unrealized losses on investments of $27.8 million during the period, primarily driven by the impact of changes in fair value on our equity investments2021 reflected favorable impacts within all commercial automobile products as a result of the recent disruptiondeclines in global financial markets. accident frequency due to lower traffic density. Additionally, insurance departments throughout the country have issued bulletins and regulations urging or requiring insurers to extend grace periods for the payment of policy premiums and to refrain from canceling or non-renewing policies for the non-payment of policy premiums for policyholders adversely affected by COVID-19; however, we have not seen a material decrease or slowdown in premium collection to date. We have also taken additional steps including a temporary freeze on hiringOur liquidity and share repurchasescapital resources were not materially impacted by COVID-19 and reductions to discretionary spending in response to COVID-19. related economic conditions during the first three months of 2021. For further discussion regarding the potential impacts of COVID-19 and related economic conditions on the Company,our results, see "Part II,Part I, Item 1A, "Risk Factors," of this Quarterlyour Annual Report on Form 10-Q.
10-K for the year ended December 31, 2021.
Liquidity and Capital Resources
The primary sources of our 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.
We generally experience positive cash flow from operations. Premiums are collected on insurance policies in advance of the disbursement of funds for payment of claims. Operating costs of our property/casualty Insurance Subsidiaries, other than loss and loss expense payments and commissions paid to related agency companies, average less than one-third of net premiums earned on a consolidated basis, and the remaining amount is available for investment for varying periods of time depending on the type of insurance coverage provided and the timing of the claim payments. Because losses are often settled in periods subsequent to when they are incurred, operating cash flows may, at times, become negative as loss settlements on claim reserves established in prior years exceed current revenues. Our cash flow relating to premiums is significantly affected by reinsurance programs in effect, whereby we cede both premium and risk to other insurance and reinsurance companies. These programs vary significantly among products, and certain contracts call for reinsurance payment patterns, which do not coincide with the collection of premiums by us from our insureds.
On August 31, 2017, our Board of Directors authorized the reinstatement of our share repurchase program for up to 2,464,209 shares of our Class A or Class B Common Stock. On August 6, 2019, our Board of Directors reaffirmed our share repurchase program, but also provided that the aggregate dollar amount of shares of our common stock that may be repurchased under the share repurchase program between August 6, 2019 and August 6, 2020 may not exceed $25.0 million and added a limit of no more than $6.25 million in repurchases per quarter. 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. The share repurchase program may be amended, suspended or discontinued at any time and does not commit us to repurchase any shares of our common stock. We have funded, and intend 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 our stock price, market volume and other market conditions. During the three months ended March 31, 2020,2021, we paid $1.8 million todid not repurchase 126,764any shares under the share repurchase program. No share repurchases have been made since March 20, 2020. Additionally, in connection with the Merger Agreement with Progressive discussed above, we are prohibited from repurchasing any of our Class A or Class B Common Stock under the share repurchase program.
For several years, our 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 instruments. If there was a hypothetical increase in interest rates of 100 basis points, the price of our fixed income portfolio, including cash, at March 31, 20202021 would be expected to fall by approximately 2.5%2.9%. The credit quality of our fixed income securities remains high with a weighted average rating of AA-, including cash. The average contractual life of our fixed income and short-term investment portfolio was 6.96.8 years and 7.1 years at both March 31, 20202021 and December 31, 2019.2020. The average duration of our fixed income portfolio remains shorter than the average duration of our liabilities. We also remain an active participant in the equity securities market,markets, using capital in excess of amounts considered necessary to fund our current operations. The long-term horizon for our equity investments allows us to invest in positions where ultimate value, and not short-term market fluctuation, is the primary focus. Investments made by our domestic property/casualty Insurance Subsidiaries are regulated by guidelines promulgated by the National Association of Insurance Commissioners (the "NAIC"), which are designed to provide protection for both policyholders and shareholders.
Net cash used inprovided by operating activities was $1.3$20.9 million during the three months ended March 31, 20202021 compared to net cash flows from operationsused in operating activities of $11.4$1.3 million for the three months ended March 31, 2019.2020. The decreaseincrease in operating cash flows was primarily related to lower premium volume as well as the timing of payments required under our reinsurance treaties, partially offset by higher investment income from our fixed income securities during the three months ended March 31, 20202021 compared to the same period in 2019.of 2020 reflected higher premium volume, partially offset by lower net investment income.
Net cash provided by investing activities was $17.1 million for the three months ended March 31, 2021 compared to $16.5 million for the three months ended March 31, 2020 compared to cash used in investing activities of $47.3 million for the three months ended March 31, 2019.2020. The $63.8 million change was primarily due to a decrease in the investment of cash and cash equivalent investments into fixed income securities and an increase in netreflected higher proceeds from maturities and sales of fixed income and equity securities, partially offset by $2.6$14.4 million less in limited partnership distributions and $10.1 million higher purchases of fixed income and equity securities during the three months ended March 31, 20202021 when compared to the same period in 2019.2020.
Net cash used in financing activities for the three months ended March 31, 2021 consisted of regular cash dividend payments to shareholders of $1.4 million ($0.10 per share). Financing activities for the three months ended March 31, 2020 consisted of regular cash dividend payments to shareholders of $1.4 million ($0.10 per share) and $1.8 million to repurchase shares of our Class B Common Stock. Financing activities for the three months ended March 31, 2019 consisted of regular cash dividend payments to shareholders of $1.5 million ($0.10 per share) and $0.5 million to repurchase shares of our Class A and B Common Stock.
Our assets at March 31, 20202021 included $69.5$87.0 million of investments included within cash and cash equivalents on the condensed consolidated balance sheet that are readily convertible to cash without market penalty and an additional $97.5$97.0 million of fixed income investments maturing in less than one year. We believe these liquid investments, plus the expected cash flow from premium collections, are sufficient to provide for projected claim payments and operating cost demands. In the event competitive conditions produce inadequate premium rates and we choose to further restrict volume or our premiums are further restricted due to market conditions, including related to the impact of COVID-19, we believe the liquidity of our investment portfolio would permit us to continue to pay claims as settlements are reached without requiring the disposal of investments at a loss, regardless of interest rates in effect at the time. In addition, our reinsurance program is structured to avoid significant cash outlays that accompany large losses.
We maintain 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, which has an expiration date of August 9, 2022. Interest on this revolving credit facility is referenced to the London Interbank Offered Rate and can be fixed for periods of up to one year at our option. Outstanding drawings on this revolving credit facility were $20.0 million as of March 31, 2020.2021. At March 31, 2020,2021, the effective interest rate was 2.03%1.21% and we had $20.0 million remaining under the revolving credit facility. The current outstanding borrowings were used to repay our previous line of credit. Our revolving credit facility has two financial covenants, each of which were met as of March 31, 2020.2021. These covenants require us to have a minimum U.S. generally accepted accounting principles ("GAAP") net worth and a maximum consolidated debt to equity ratio of 0.35.
Annualized net premiums written by our Insurance Subsidiaries for the first quarter of 20202021 equaled approximately 130% of the combined statutory surplus of these subsidiaries. According to the NAIC, acceptable ranges for the ratio of net premiums written to statutory surplus include results of up to 300%. This ratio is designed to measure our ability to absorb above-average losses and our financial strength. Additionally, the statutory capital of each of our Insurance Subsidiaries substantially exceeded minimum risk-based capital requirements set by the NAIC as of March 31, 2020.2021. As a result, we have the ability to increase our business without seeking additional capital to meet regulatory guidelines.
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 March 31, 2020, $61.92021, $68.6 million may be transferred by dividend or loan to Protective during the remainder of 20202021 without approval by, or prior notification to, regulatory authorities. An additional $140.4$158.1 million of shareholders' equity of our Insurance Subsidiaries could be advanced or loaned to Protective with prior notification to, and approval from, regulatory authorities, although transfers of this size would not be practical. We believe these restrictions pose no material liquidity concerns for us. We also believe the financial strength and stability of our Insurance Subsidiaries would permit access by Protective to short-term and long-term sources of credit when needed. Protective had cash and marketable securities valued at $14.7$7.8 million at March 31, 2020.
2021.
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 or loss 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 the three months ended March 31, 2021, we also excluded corporate charges incurred in conjunction with the Board's review of the Merger Agreement, the Voting Agreement and the Merger discussed above from the calculation of underwriting income (loss). We believe the exclusion of these corporate charges more accurately reflects our operational results. 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.
The ratio of consolidated other operating expenses, less commissions and other income, to net premiums earned, or our expense ratio, and the ratio of losses and loss expenses incurred, plus other operating expenses, less commissions and other income, to net premiums earned, or our combined ratio, are measures of our profitability that we believe increase the period-to-period comparability of our operational results. For the three months ended March 31, 2021, we also excluded the corporate charges discussed above 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 the exclusion of these charges improves the comparability of our expense and combined ratios with our ratios in prior years. Our management uses these ratios to evaluate performance, allocate resources and forecast future operating periods. While expense ratios and combined ratios are widely used within our industry, our use of such ratios may not be directly comparable to similarly titled measures reported by other companies.
| | Three Months Ended | | | Three Months Ended | |
| | March 31 | | | March 31 | |
(dollars in thousands) | | 2020 | | | 2019 | | | 2021 | | | 2020 | |
Income (loss) before federal income tax expense (benefit) | | $ | (25,139 | ) | | $ | 3,514 | | | $ | 16,353 | | | $ | (25,139 | ) |
Less: Net realized and unrealized gains (losses) on investments | | (27,756 | ) | | 6,028 | | | | 10,509 | | | | (27,756 | ) |
Less: Net investment income | | | 7,236 | | | | 6,232 | | | | 5,306 | | | | 7,236 | |
Underwriting loss | | $ | (4,619 | ) | | $ | (8,746 | ) | |
Less: Corporate charges included in other operating expenses 1 | | | | (3,474 | ) | | | - | |
Underwriting income (loss) | | | $ | 4,012 | | | $ | (4,619 | ) |
| | | | | | | | | | | | | | |
Other operating expenses | | | | 41,855 | | | | 34,110 | |
Less: Corporate charges 1 | | | | 3,474 | | | | - | |
Other operating expenses, excluding corporate charges | | | | 38,381 | | | | 34,110 | |
| | | | | | | | | | | | | | |
Ratios | | | | | | | | | | | | | | |
Losses and loss expenses incurred | | $ | 81,831 | | | $ | 87,122 | | | $ | 82,318 | | | $ | 81,831 | |
Net premiums earned | | | 109,659 | | | | 110,013 | | | | 122,853 | | | | 109,659 | |
Loss ratio | | 74.6 | % | | 79.2 | % | | | 67.0 | % | | | 74.6 | % |
| | | | | | | | | | | | | | |
Other operating expenses | | $ | 34,110 | | | $ | 33,701 | | | $ | 41,855 | | | $ | 34,110 | |
Less: Commissions and other income | | | 1,663 | | | | 2,064 | | | | 1,858 | | | | 1,663 | |
Other operating expenses, less commissions and other income | | 32,447 | | | 31,637 | | | | 39,997 | | | | 32,447 | |
Net premiums earned | | | 109,659 | | | | 110,013 | | | | 122,853 | | | | 109,659 | |
Expense ratio | | 29.6 | % | | 28.8 | % | | | 32.6 | % | | | 29.6 | % |
| | | | | | | | | | | | | | |
Impact of corporate charges | | | | (2.9 | )% | | | - | |
Expense ratio, excluding corporate charges | | | | 29.7 | % | | | 29.6 | % |
| | | | | | | | | |
Combined ratio | | 104.2 | % | | 108.0 | % | | | 99.6 | % | | | 104.2 | % |
Combined ratio, excluding corporate charges | | | | 96.7 | % | | | 104.2 | % |
1 Represents the corporate charges incurred in conjunction with the activities of the Special Committee related to the Merger with Progressive discussed above.
Results of Operations
Comparison of First Quarter 20202021 to First Quarter 2019 2020(in thousands)
| | 2020 | | | 2019 | | | Change | | | % Change | | | 2021 | | | 2020 | | | Change | | | % Change | |
Gross premiums written | | $ | 134,006 | | | $ | 148,893 | | | $ | (14,887 | ) | | (10.0 | )% | | $ | 145,056 | | | $ | 134,006 | | | $ | 11,050 | | | | 8.2 | % |
Ceded premiums written | | | (24,772 | ) | | | (33,571 | ) | | | 8,799 | | | (26.2 | )% | | | (26,229 | ) | | | (24,772 | ) | | | (1,457 | ) | | | 5.9 | % |
Net premiums written | | $ | 109,234 | | | $ | 115,322 | | | $ | (6,088 | ) | | (5.3 | )% | | $ | 118,827 | | | $ | 109,234 | | | $ | 9,593 | | | | 8.8 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net premiums earned | | $ | 109,659 | | | $ | 110,013 | | | $ | (354 | ) | | (0.3 | )% | | $ | 122,853 | | | $ | 109,659 | | | $ | 13,194 | | | | 12.0 | % |
Net investment income | | 7,236 | | | 6,232 | | | 1,004 | | | 16.1 | % | | | 5,306 | | | | 7,236 | | | | (1,930 | ) | | | (26.7 | )% |
Commissions and other income | | 1,663 | | | 2,064 | | | (401 | ) | | (19.4 | )% | | | 1,858 | | | | 1,663 | | | | 195 | | | | 11.7 | % |
Net realized and unrealized gains (losses) on investments | | | (27,756 | ) | | | 6,028 | | | | (33,784 | ) | | (560.5 | )% | | | 10,509 | | | | (27,756 | ) | | | 38,265 | | | | (137.9 | )% |
Total revenue | | 90,802 | | | 124,337 | | | | | | | | | | 140,526 | | | | 90,802 | | | | | | | | | |
Losses and loss expenses incurred | | 81,831 | | | 87,122 | | | (5,291 | ) | | (6.1 | )% | | | 82,318 | | | | 81,831 | | | | 487 | | | | 0.6 | % |
Other operating expenses | | | 34,110 | | | | 33,701 | | | | 409 | | | 1.2 | % | | | 41,855 | | | | 34,110 | | | | 7,745 | | | | 22.7 | % |
Total expenses | | | 115,941 | | | | 120,823 | | | | | | | | | | 124,173 | | | | 115,941 | | | | | | | | | |
Income (loss) before federal income tax expense (benefit) | | (25,139 | ) | | 3,514 | | | (28,653 | ) | | | | | | 16,353 | | | | (25,139 | ) | | | 41,492 | | | | | |
Federal income tax expense (benefit) | | | (2,983 | ) | | | 766 | | | | (3,749 | ) | | | | | | 3,415 | | | | (2,983 | ) | | | 6,398 | | | | | |
Net income (loss) | | $ | (22,156 | ) | | $ | 2,748 | | | $ | (24,904 | ) | | | | | $ | 12,938 | | | $ | (22,156 | ) | | $ | 35,094 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Gross premiums written during the first quarter of 2020 decreased $14.92021 increased $11.1 million (10.0%(8.2%), while net premiums earned decreased $0.4increased $13.2 million (0.3%(12.0%), as compared to the first quarter of 2019.2020. The lowerhigher net premiums earned in the first quarter of 20202021 were primarily the result of declines inincreased premiums associated with lower retention rates as we continuerelated to take actions to improve profitability, including rate increases, and non-renewal of certain risks, partially offset by rate increasesgrowth in existing business lines and new business policies sold.sold primarily in our commercial automobile line of business. This increase was partially offset by declines in premiums within our public transportation commercial automobile products as a result of a reduction in miles driven, which is the basis for premiums we receive, as well as an overall reduction in public transportation units insured, both due to the impact of COVID-19. Additionally, during the fourth quarter of 2020, given ongoing profitability challenges, we discontinued writing new public transportation business. 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 18.5%18.1% of gross premiums written for the first quarter of 20202021 compared to 22.5%18.5% in the first quarter of 2019.2020. The decrease in the percentage of premiums ceded was primarily due to a mix shift toward more commercial automobile business (specifically Independent Contractor linesthe result of higher growth in certain products that carry noare not reinsured and an increase in the percentage of premium earning in under the 2020 reinsurance coverage) and less workers' compensation business.treaty year which had lower ceding participation than the previous treaty.
Losses and loss expenses incurred during the first quarter of 2020 decreased $5.32021 increased $0.5 million (6.1%(0.6%) compared to the first quarter of 2019,2020, resulting in a loss ratio of 67.0% during the first quarter of 2021 compared to a loss ratio of 74.6% during the first quarter of 2020 compared to a loss ratio of 79.2% during the first quarter of 2019.2020. The loss ratio is calculated as the percentage of losses and loss expenses incurred to net premiums earned. The lower losses and loss expenses and lower loss ratio in the first quarter of 20202021 reflected results of our underwriting actions, including non-renewal of unprofitable business as well as significant rate increases in commercial automobile. Additionally, losses and loss expenses incurred reflected favorable impacts from COVID-19 within several of our commercial automobile products as a result of declines in accident frequency due to lower traffic density.
Net investment income for the first quarter of 2020 increased 16.1%2021 decreased 26.7% to $7.2$5.3 million compared to $6.2$7.2 million for the first quarter of 2019.2020. The increasedecrease reflected lower interest rates earned on cash and cash equivalent balances and lower interest rates on reinvestment in the first quarter of 2021, partially offset by an increase in average funds invested resulting from positive cash flows from operations compared to the first quarter of 2019,2020.
Net realized and unrealized gains on investments of $10.5 million during the first quarter of 2021 were primarily driven by $7.8million in unrealized gains on equity securities during the period and $2.3 million in realized gains on sales of securities as well asa result of continued improvement in the continued reallocation from equityglobal financial markets. Additionally, we saw a $0.4 million increase in the value of our limited partnership investments in limited partnerships and cash and cash equivalent investments into short-duration, high-quality bonds.
Netthe first quarter of 2021. These gains were partially offset by impairments on our fixed income securities of $0.1 million recognized during the period. Comparative first quarter 2020 net realized and unrealized losses on investments of $27.8 million during the first quarter of 2020 were primarily driven by $22.3 million in unrealized losses on equity securities, which were largely attributable to disruptions in the financial markets related to COVID-19, $4.8 million in net realized losses on sales of securities, excluding impairment losses, and a $0.7 million decrease in the value of our limited partnership investments. Comparative first quarter 2019 net realized and unrealized gains on investments of $6.0 million were primarily driven by $6.0 million in unrealized gains on equity securities and a $0.4 million increase in the value of our limited partnership investments, partially offset by impairments on our fixed income securities of $0.3 million recognized during the period. Realized investment gains and losses result from decisions regarding overall portfolio realignment as well as the sale of individual securities, including the change in the aggregate value of limited partnerships and, as such, should not be expected to be consistent from period to period.
Other operating expenses for the first quarter of 20202021 increased $0.4$7.7 million, or 1.2%22.7%, to $41.9 million compared to $34.1 million compared tofor the first quarter of 2019. 2020. The increase was driven primarily by higher commission expenses as a result$3.5 million of the mix of premium writtencorporate charges incurred during the first quarter of 2020 partially offset by lower salary2021 for third party advisors to the Special Committee in connection with the Merger with Progressive, as discussed above, and benefit expenses duringhigher variable costs related to the period. The expense ratio was 29.6%premiums earned during the first quarter of 20202021. The expense ratio was 32.6% during the first quarter of 2021, or 29.7% excluding the corporate charges discussed above, compared to 28.8%29.6% for the first quarter of 2019. The increase in the expense ratio was primarily related to the higher commission expenses noted above as well as the decrease in net premiums earned during the period.2020.
Federal income tax benefitexpense was $3.0$3.4 million for the first quarter of 20202021 compared to a $3.0 million federal income tax expense of $0.8 millionbenefit for the first quarter of 2019.2020. The effective tax rate on consolidated income for the first quarter of 20202021 was an 11.9% tax benefit20.9% compared to a 21.8% tax expense in11.9% on consolidated loss for the first quarter of 2019. The pre-tax loss for the three months ended March 31, 2020 makes these interim period effective tax rates less comparable year over year.2020. The difference in the effective federal income tax rate from the normal statutory rate was primarily related to the recording of a valuation allowance in the current period on our deferred tax assets, in addition to the effects of tax-exempt investment income and the dividends received deduction. In assessingThe effective tax rate for the valuationfirst quarter of deferred tax assets, we considered whether it is more likely than not that some portion or all2020 was impacted by the recording of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income or availability to carryback the losses to taxable income during the period in which those temporary differences become deductible. We considered several factors when analyzing the need for a valuation allowance including our current three year cumulative loss through March 31, 2020, the increase in deferred tax assets due to the adoption of CECL at January 1, 2020 discussed above, the change in unrealized gains and losses and the loss of a high taxable income year from the carryback period. The three year cumulative loss limits our ability to use projected income beyond 2020 in the analysis. Based on this analysis, we have concluded that a valuation allowance is necessary for our deferred tax assets not supported by either carryback availability or future reversals of existing taxable temporary differences and recorded a valuation allowance of $4.9 million for the three months ended March 31, 2020,on our deferred tax assets, of which $2.3 million was recorded in the condensed consolidated statement of operations and the balance was recorded in shareholders' equity within accumulated other comprehensive income (loss). in the prior period. We recognized thisdid not record a valuation allowance entirelyon our deferred tax assets in the first quarter of 2020 as it relates to realized and unrealized capital losses during the quarter that are treated as a discrete item.2021. The effective tax rate can fluctuate throughout the year because estimates used in the quarterly tax provision are updated as more information becomes available throughout the year.
As a result of the factors mentioned above, net income decreased $24.9increased $35.1 million to a$12.9 million during the first quarter of 2021 compared to net loss of $22.2 million during the first quarter of 2020 compared to net income of $2.7 million during the first quarter of 2019.2020.
Sensitivity Analysis
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 majority of our reserves for losses and loss expenses, on a net of reinsurance basis, relate to our commercial automobile products. Perhaps the most significant example of sensitivity to variation in the key assumptions is the loss ratio selection for our commercial automobile products for policies subject to certain major reinsurance treaties.
Commercial automobile products covered by our reinsurance treaties from July 3, 2013 through JuneJuly 2, 2019 are subject to an unlimited aggregate stop-loss provision. Currently, each of these treaty years is reserved at or above the attachment level of these treaties. For every $100 of additional loss, we are responsible only responsible for our $25 retention.
Commercial automobile products covered by our reinsurance treaty from July 3, 2019 through JuneJuly 2, 2020 are also subject to an unlimited aggregate stop-loss provision. Once the aggregate stop-loss level is reached, for every $100 of additional loss, we are responsible for our $65 retention. This increase in our retention compared to recent years reflects the combination of (1) a decreased need for stop-loss reinsurance protection resulting from a significant decrease in our commercial automobile subject limits profile, (2) a higher cost for this covercoverage and (3) our confidence in profitability improvements given the limit reductions and rate increases on our commercial automobile products. In 2020, due to continued rate achievement in our commercial automobile products, improvements in our mix of business and reductions to our average policy loss limits, we decided to non-renew the annual aggregate deductible treaty for policies written on and after July 3, 2020.
Forward-Looking Information
The disclosures in this Quarterly Report on Form 10-Q 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 Quarterly Report on Form 10-Q 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" set forth in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 20192020 and in Part II, Item 1A of this Quarterly Report on Form 10-Q and our reports filed with the U.S. Securities and Exchange Commission from time to time.10-Q. 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 continued weaknessvolatility 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; |
| ● | the risks related to our proposed Merger with Progressive, and Merger Sub described above, including: |
our inability to complete the proposed Merger due to the failure to satisfy any of the conditions to completion of the proposed Merger, including that a governmental entity may prohibit, delay or refuse to grant approval for the consummation of the Merger;
• uncertainty as to the timing of completion of the proposed Merger; the occurrence of any event, change or other circumstances that could give rise to the termination of the Merger Agreement;
risks related to disruption of management’s attention from our ongoing business operations due to the proposed Merger;
the effect of the announcement of the proposed Merger on our relationships with our clients, operating results and business generally; and
the outcome of the pending legal proceedings initiated against us and the members of our Board of Directors related to the proposed Merger and the outcome of any other legal proceedings initiated against us, Progressive or others related to the proposed Merger;
| ● | the effects of the COVID-19 pandemic and associated government actions on our operating and financial performance; |
| ● | 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; |
| ● | the effects of the COVID-19 pandemic and associated government actions on our operations and financial performance;
|
| ● | technology or network security disruptions or breaches; |
| ● | adequacy of insurance reserves; |
| ● | availability of reinsurance and ability of reinsurers to pay their obligations; |
| ● | our ability to attract and retain qualified employees; |
| ● | 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 II, Item 1A, "Risk Factors," of this Quarterly Report on Form 10-Q and in Part I, Item 1A, "Risk Factors," in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.2020. You should read that information in conjunction with this "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our unaudited condensed consolidated financial statements and related notes in Part I, Item 1 of this Quarterly Report on Form 10-Q.
Critical Accounting Policies
A summary of our significant accounting policies that we consider to be the most dependent on the application of estimates and assumptions can be found in the Management’s Discussion and Analysis section of our Annual Report on Form 10-K for the year ended December 31, 2019. Changes in 2020 to2020. As of March 31, 2021, our significantcritical accounting policies which are dependent uponand estimates and assumptions, include the adoption of new accounting guidance for the recognition of credit losses. For discussion of the new guidance and the related changes tohave not changed from those described in our accounting policy, see Accounting Policies within Note 1 - Summary of Significant Accounting Policies of this QuarterlyAnnual Report on Form 10-Q.10-K for the year ended December 31, 2020.
Concentrations of Credit Risk
Our Insurance Subsidiaries cede portions of their gross premiums to numerous reinsurers under quota share and excess of loss treaties, as well as facultative placements. These reinsurers assume commensurate portions of the risk of loss covered by the contracts. As losses are reported and reserved, portions of the gross losses attributable to reinsurers are established as receivable assets and losses incurred are reduced. At March 31, 2020,2021, amounts due from reinsurers on paid and unpaid losses were estimated to total approximately $400$421 million. Because of the large policy limits reinsured by us, the ultimate amount of incurred but not reported losses and loss adjustment expenses attributable to reinsurers could vary significantly from this estimate; provided, however, absent the inability to collect from reinsurers, such variance would not result in changes in net claim losses incurred by us.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Other than as set forth below, there have been no material changes in the Company's exposure to market risk since the disclosure in the Company's Annual Report on Form 10-K for the year ended December 31, 2019.2020.
Interest Rate Risk
We are exposed to interest rate risk on our fixed income investments. Given the anticipated duration of our liabilities (principally insurance loss and loss expense reserves) relative to investment maturities, a 100 to 200 basis point increase in interest rates would not have a material impact on our ability to conduct daily operations or to meet our obligations and could result in higher investment income in a relatively short period of time, as short-term investments and maturing bonds could be reinvested in higher yielding securities.
The table below summarizes our interest rate risk by illustrating the sensitivity of the fair value of our fixed income investments as of March 31, 20202021 to selected hypothetical changes in interest rates (dollars in thousands).
| | Fair Value | | | Estimated Change in Fair Value | | | Fair Value | | | Estimated Change in Fair Value | |
200 basis point increase | | $ | 707,311 | | | $ | (39,545 | ) | | $ | 860,539 | | | $ | (54,410 | ) |
100 basis point increase | | 727,083 | | | (19,773 | ) | | | 887,744 | | | | (27,205 | ) |
Current fair value | | 746,856 | | | – | | | | 914,949 | | | | – | |
100 basis point decrease | | 766,629 | | | 19,773 | | | | 942,154 | | | | 27,205 | |
200 basis point decrease | | 786,401 | | | 39,545 | | | | 969,359 | | | | 54,410 | |
Our selection of the range of values chosen to represent changes in interest rates should not be construed as our prediction of future market events, but rather as an illustration of the impact of such events should they occur. Several other factors, including but not limited to the financial strength of the issuer, prepayment options, relative values of alternative investments, liquidity of the investment, currency fluctuations for non-U.S. debt holdings and other general market conditions, can impact the fair values of fixed income investments and, therefore, significant variations in market interest rates could produce quite different results from the hypothetical estimates presented above.
ITEM 4. CONTROLS AND PROCEDURES
The Company carried out an evaluation as of March 31, 20202021 under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures as defined in Rule 13a-15(e) adopted by the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, or the "Exchange Act".Act." Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded the disclosure controls and procedures were effective in ensuring that information required to be disclosed in reports that the Company files or submits under the Exchange Act is: (a) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms; and (b) accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures. The Company noted no change in its internal control over financial reporting that occurred during the period covered by this report that materially affected, or is reasonably likely to materially affect, its internal control over financial reporting.
PART II – OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information required with respect to this item can be found in Note 10 - Litigation, Commitments and Contingencies of Notes to Unaudited Condensed Consolidated Financial Statements contained in Part I, Item 1 of this Quarterly Report on Form 10-Q and is incorporated by reference into this Part II, Item 1.
ITEM 1A. RISK FACTORS
In addition to the information set forth in this Quarterly Report on Form 10-Q and before deciding to invest in, or retain, shares of the Company's common stock, you should carefully review and consider the information contained in the Company's other reports and periodic filings that it makes with the Securities and Exchange Commission, including, without limitation, the information contained under the caption Part I, Item 1A, "Risk Factors" in its Annual Report on Form 10-K for the year ended December 31, 2019.2020. Those risk factors could materially affect the Company's business, financial condition and results of operations. There have been no material changes fromto the risk factors previously disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 20192020 other than as described below.
The following risk factor has been added:
The impact of COVID-19 and related risksWe may not consummate our proposed merger with Progressive within the timeframe or in the manner we anticipate, or at all, which could materiallynegatively affect our business and our stock price.
On February 14, 2021, we entered into the Merger Agreement with Progressive and Merger Sub. The Merger Agreement provides for, subject to the satisfaction or waiver of specified conditions, the merger of Merger Sub with and into Protective, whereupon the separate existence of Merger Sub shall cease and Protective shall continue as the surviving corporation and as a wholly-owned indirect subsidiary of Progressive.
Consummation of the Merger remains subject to various conditions, including (i) the receipt of required regulatory approvals, including from the Indiana Department of Insurance; (ii) the absence of any law, injunction or order preventing or prohibiting the consummation of the Merger; (iii) the accuracy of representations and warranties subject to applicable materiality standards; (iv) compliance with all covenants under the Merger Agreement and (v) the absence of a material adverse effect. There can be no assurance that these conditions to the consummation of the Merger will be satisfied or waived or that other events or circumstances will not intervene to delay or result in the termination of the Merger. Subject to certain limitations, either party may terminate the Merger Agreement if the Merger is not consummated by November 14, 2021. If the Merger is not consummated, the price of our common stock may change to the extent that the current market price of our common stock may reflect an assumption that the Merger will be consummated.
Pending the consummation of the Merger, the Merger Agreement also restricts us from engaging in certain actions without Progressive’s consent, which could prevent us from pursuing opportunities that may arise prior to the effective time of the Merger. In addition, if the Merger Agreement is terminated, depending on the circumstances giving rise to termination, we may be required to pay a termination fee of approximately $13.3 million.
Our financial condition, results of operations and cash flows could be adversely impacted as a result of the proposed Merger, regardless of whether it is consummated.
The Merger may cause disruptions to our business or business relationships, which could have an adverse impact on our financial position and/condition, results of operations and cash flows, regardless of whether the Merger is consummated. For example:
the attention of our management and our employees may be directed to Merger-related considerations and may be diverted from the day-to-day operations of our business;
our employees may experience uncertainty about their future roles with us, which might adversely affect our ability to retain and recruit key employees;
customers, suppliers or liquidity.other parties with whom we maintain business relationships may experience uncertainty about our future and seek alternative relationships with third parties or seek to alter their business relationships with us; and
Beginning in March 2020, the global pandemicpending legal proceedings instituted against us and the members of our Board of Directors related to the novel coronavirus COVID-19Merger, and any other legal proceedings instituted against us, our directors and/or our officers with respect to the proposed Merger, will require us to devote [substantial] resources and executive time to defend.
In addition, we have incurred, and will continue to incur, significant costs, fees and expenses for professional services and other costs related economic conditions began to impact the global economyMerger Agreement and our resultsthe Merger, and many of operations. Becausethese costs, fees and expenses are payable by us regardless of whether or not the size and breadth of this pandemic, all of the direct and indirect consequences of COVID-19 are not yet known and may not emerge for some time. Risks presented by the ongoing effects of COVID-19 include the following:Merger is consummated.
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● | Net premiums earned. We expect the impact of COVID-19 on general economic activity may negatively impact our premium volumes. We did not experience a material effect in the first quarter of 2020, but the impact could be more significant in the second quarter of 2020 based on changes in the operations of our insureds including, but not limited to, the reduction in hours worked by insureds with workers' compensation coverages as well as the reduction in miles driven by commercial automobile insureds, which are the basis of premiums we receive. This impact could further persist for the remainder of 2020 and beyond, but the degree of the impact will depend on the extent and duration of the economic contraction.
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●
| Loss and loss expenses incurred. We have not seen a material impact on our loss and loss expenses incurred in the first quarter of 2020, but we may incur higher claim and claim adjustment expenses in certain lines of business as a result of COVID-19 due to increases in frequency and/or severity of claims. For example, we may experience elevated frequency and severity in our workers’ compensation lines related to compensable claims by workers who demonstrate that the injury or illness arose both out of and in the course of their employment. We may also experience elevated frequency and severity in our liability coverages as a result of plaintiffs’ lawyers seeking to generate COVID-19-related claim activity against our insureds. Additionally, the anticipated and unknown risks related to COVID-19 may cause additional uncertainty in the process of estimating claims and claim adjustment expense reserves. For example, the behavior of claimants and policyholders may change in unexpected ways, the disruption to the court system may impact the timing and amounts of claims settlements and the actions taken by governmental bodies, both legislative and regulatory, in reaction to COVID-19 and their related impacts are hard to predict. As a result, our estimated level of claims and claim adjustment expense reserves may change. We are also subject to credit risk in our insurance operations which may be exacerbated in times of economic distress.
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● | Investments. The disruption in the financial markets related to COVID-19 has contributed to net realized and unrealized investment losses, primarily due to the impact of changes in fair value on our equity and fixed income investments. Our corporate fixed income portfolio may be further adversely impacted by ratings downgrades, increased bankruptcies and credit spread widening in distressed industries, such as energy, gaming, lodging and leisure, autos, airlines and retail. Our investment portfolio also includes commercial mortgage-backed securities, which could be adversely impacted by declines in real estate valuations and/or financial market disruption. Further disruptions in global financial markets due to the continuing impact of COVID-19 could result in additional net realized and unrealized investment losses, including potential impairments in our fixed income portfolio. In addition, declines in fixed income yields would result in decreases in net investment income from future investment activity, including re-investments.
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● | Liquidity. Collection of premiums, deductibles or self-insured retentions from our policyholders and reinsurance recoverables from our reinsurers may become increasingly difficult. At the state level, insurance departments throughout the country have issued bulletins and regulations urging or requiring insurers to extend grace periods for the payment of policy premiums and to refrain from canceling or non-renewing policies for the non-payment of policy premiums for policyholders adversely affected by COVID-19. It is uncertain what impact these government mandates may have on our ability to recover unpaid premiums on the affected policies or what our obligations may be for the payment of claims made under policies for which we have not received premium payments.
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● | Adverse Legislative and/or Regulatory Action. Federal, state and local government actions to address and contain the impact of COVID-19 may adversely affect us. A number of states have instituted, and other states are considering instituting, changes designed to effectively expand workers' compensation coverage by creating presumptions of compensability of claims for certain types of workers. Regulatory restrictions or requirements could also impact pricing, risk selection and our rights and obligations with respect to our policies and insureds, including our ability to cancel policies or our right to collect premiums.
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● | Operational Disruptions and Heightened Cybersecurity Risks. Our operations could be disrupted if key members of our senior management or a significant percentage of our workforce or the workforce of our agents, brokers, suppliers or outsourcing providers are unable to continue to work because of illness, government directives or otherwise. In addition, the interruption of our or their system capabilities could result in a deterioration of our ability to write and process new and renewal business, provide customer service, pay claims in a timely manner or perform other necessary business functions. Having shifted to remote working arrangements, we also face a heightened risk of cybersecurity attacks or data security incidents and are more dependent on internet and telecommunications access and capabilities.
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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchases of Equity Securities
| | Total Number of Shares Purchased | | | Average Price Paid per Share | | | Total Number of Shares Purchased Under the Program (1) | | | Remaining Shares Available to be Purchased Under the Program (1) | |
January 1 – January 31 | | | 29,990 | | | $ | 16.05 | | | | 29,990 | | | | 1,472,503 | |
February 1 – February 29 | | | 9,200 | | | | 14.87 | | | | 9,200 | | | | 1,463,303 | |
March 1 – March 31 | | | 87,574 | | | | 13.30 | | | | 87,574 | | | | 1,375,729 | |
Total | | | 126,764 | | | | | | | | 126,764 | | | | | |
The following table presents information related to our repurchases of common stock for the periods indicated:
| | Total Number of Shares Purchased (1) | | | Average Price Paid per Share | | | Total Number of Shares Purchased Under the Program (2) | | | Remaining Shares Available to be Purchased Under the Program (2) | |
January 1 - January 31 | | | - | | | $ | - | | | | - | | | | 1,375,729 | |
February 1 - February 28 | | | - | | | | - | | | | - | | | | 1,375,729 | |
March 1 - March 31 | | | 4,075 | | | | 22.90 | | | | - | | | | 1,375,729 | |
Total | | | 4,075 | | | | | | | | - | | | | | |
(1) | Amounts represent shares withheld by the Company in connection with employee payroll tax withholding upon the vesting of stock awards. Stock amounts in the condensed consolidated statements of shareholders’ equity are shown net of these shares withheld. |
(2) | On August 31, 2017, our Board of Directors authorized the reinstatement of ourthe Company’s share repurchase program for up to 2,464,209 shares of ourits Class A or Class B Common Stock. On August 6, 2019, our Board of Directors reaffirmed our share repurchase program, but also provided that the aggregate dollar amount of shares of our common stock thatThe repurchases may be repurchased undermade in the share repurchase program between August 6, 2019open market or through privately negotiated transactions, from time-to-time, and August 6, 2020 may not exceed $25.0 million, including a limit of up to $6.25 million per quarter. No duration has been placed on our share repurchase program,in accordance with applicable laws, rules and we reserve the right to amend, suspend or discontinue it at any time.regulations. The share repurchase program may be amended, suspended or discontinued at any time and does not commit usthe Company to repurchase any shares of our common stock. We haveits Common Stock. The Company has funded, and intendintends to continue to fund, the share repurchase program from cash on hand. No share repurchases have been made by the Company under the program since March 20, 2020. Additionally, in connection with the Merger Agreement with Progressive, the Company is prohibited from repurchasing any of its Class A or Class B Common Stock under the repurchase program. |
ITEM 5. OTHER INFORMATION
On May 5, 2020, the Board of Directors (the “Board”) of Protective Insurance Corporation (the “Company”) approved a form of indemnification agreement (the “Indemnification Agreement”) between the Company and the individuals who serve or may serve from time to time as directors of the Company (each such person, an “Indemnitee”). Under the Indemnification Agreement, the Company agrees to indemnify the Indemnitees against certain liabilities, including those arising out of, relating to, or in connection with the fact that Indemnitee is or was a director or member of any committee of the Board. The Indemnification Agreement also provides for the advancement of expenses relating to the indemnification obligations. On May 5, 2020, the Company entered into such Indemnification Agreements with each of its directors.
The foregoing summary of the Indemnification Agreement is qualified by reference to the full text of the Indemnification Agreement, a copy of which is filed herewith as Exhibit 10.2 and incorporated herein by reference.
ITEM 6. EXHIBITS
INDEX TO EXHIBITS
Exhibit No. | | Description |
| | |
| | Agreement and Plan of Merger, dated as of February 14, 2021, by and among Protective Insurance Corporation, The Progressive Corporation and Carnation Merger Sub Inc., incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K filed on February 16, 2021. |
| | |
| | Amended and Restated Articles of Incorporation of Protective Insurance Corporation, incorporated by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q filed August 8, 2018. |
| | |
| | |
| | |
| | January 4, 2021. |
| | |
| | |
| | |
| | the Company's shareholders listed therein, incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed on February 16, 2021. |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
101 | | The following materials from Protective Insurance Corporation's Quarterly Report on Form 10-Q for the quarter ended March 31, 2020,2021, formatted in Inline XBRL (eXtensible Business Reporting Language): (1) the Condensed Consolidated Balance Sheets, (2) the Condensed Consolidated Statements of Operations, (3) the Condensed Consolidated Statements of Comprehensive Income (Loss), (4) the Condensed Consolidated Statements of Shareholders' Equity, (5) the Condensed Consolidated Statements of Cash Flows, and (6) the Notes to Unaudited Condensed Consolidated Financial Statements. |
| | |
104 | | Cover Page Interactive Data File (Embedded within the Inline XBRL document and included in Exhibit 101) |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
PROTECTIVE INSURANCE CORPORATION
Date May 6, 20202021
By: | /s/ Jeremy D. Edgecliffe-Johnson | |
| Jeremy D. Edgecliffe-Johnson | |
| Chief Executive Officer | |
Date May 6, 20202021
By: | /s/ John R. Barnett | |
| John R. Barnett | |
| Chief Financial Officer | |
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