ITEM 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This document, including information incorporated by reference, contains “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-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,” “will,” “should,” “target,” “anticipate,” “believe,” “plan,” “estimate,” “expect,” “intend,” “predict,” “project,” and “potential,” or the negative of these words, and other similar expressions, constitute forward-looking statements. We made these statements based on our plans and current analyses of our business and the insurance industry as a whole. We caution that these statements may and often do vary from actual results and the differences between these statements and actual results can be material. Factors that could contribute to these differences include, among other things:
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the failure to receive, on a timely basis or otherwise, the required approvals by our shareholders and third parties in connection with the proposed merger among those parties (the “merger”);
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the risk that a condition to closing of the merger may not be satisfied;
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each company's ability to consummate the merger;
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operating costs and business disruption related to the merger may be greater than expected;
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general economic conditions, weakness of the financial markets and other factors, including 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;
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our ability to obtain adequate premium rates and manage our growth strategy;
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performance of securities markets;
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our ability to attract and retain independent agents and brokers;
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customer response to new products and marketing initiatives;
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tax law and accounting changes;
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increasing competition in the sale of our insurance products and services and the retention of existing customers;
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changes in legal environment;
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legal actions brought against us;
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regulatory changes or actions, including those relating to the regulation of the sale, underwriting and pricing of insurance products and services and capital requirements;
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damage to our reputation;
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levels of natural catastrophes, terrorist events, incidents of war and other major losses;
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technology or network security disruptions;
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adequacy of insurance reserves; and
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availability of reinsurance and ability of reinsurers to pay their obligations.
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The foregoing list of factors is not exhaustive. Additional information about these and other factors can be found in each company's reports filed from time to time with the Securities and Exchange Commission (the “SEC”). There can be no assurance that the merger will in fact be consummated. We caution investors not to unduly rely on any forward-looking statements. All forward-looking statements reflect our good faith beliefs, assumptions and expectations, but they are not guarantees of future performance. Furthermore, the forward-looking statements herein are made only as of the date of this report, and we assume no obligation to publicly update or revise any forward-looking statements to reflect changes in underlying assumptions or factors, of new information, data or methods, future events or other changes.
General
We underwrite and sell traditional and alternative risk transfer (“ART”) property and casualty insurance products primarily to the passenger transportation industry, the trucking industry, moving and storage transportation companies, general commercial insurance to small businesses in Hawaii and Alaska and personal insurance to owners of recreational vehicles throughout the United States.
We have five property and casualty insurance subsidiaries: National Interstate Insurance Company (“NIIC”), Vanliner Insurance Company (“VIC”), National Interstate Insurance Company of Hawaii, Inc. (“NIIC-HI”), Triumphe Casualty Company (“TCC”), and Hudson Indemnity, Ltd. (“HIL”) and six active agency and service subsidiaries. We write our insurance policies on a direct basis through NIIC, VIC, NIIC-HI and TCC. NIIC and VIC are licensed in all 50 states and the District of Columbia. NIIC-HI is licensed in Ohio, Hawaii, Michigan and New Jersey. TCC holds licenses for multiple lines of authority, including auto-related lines, in
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states and the District of Columbia. HIL is domiciled in the Cayman Islands and provides reinsurance for NIIC, VIC, NIIC-HI and TCC, primarily for the ART component. Insurance products are marketed through multiple distribution channels, including independent agents and brokers, program administrators, affiliated agencies and agent internet initiatives. We sell and service our insurance business through our active agency and service subsidiaries.
As of
September 30, 2016
, Great American Insurance Company (“Great American”) owned
51.0%
of our outstanding common shares.
Recent Developments
On July 25, 2016, we announced that we entered into a merger agreement with Great American, a wholly-owned subsidiary of American Financial Group, Inc. (“AFG”), pursuant to which Great American will acquire the approximately 49% of our issued and outstanding common shares that Great American does not presently own.
Under the terms of the proposed merger, our shareholders will receive $32.00 in cash for each common share that they hold. In addition, we will pay a special cash dividend of $0.50 per Common Share upon the closing of the merger. For additional information, refer to Note 15 - “Proposed Merger” in this report.
The merger is expected to close in the fourth quarter of 2016, subject to approval by our shareholders, including approval by a majority of our shareholders other than Great American, and regulatory authorities, as well as the satisfaction or waiver of customary closing conditions. The special meeting of shareholders, at which shareholders will vote on the proposed merger, is scheduled for November 10, 2016.
Results of Operations
Overview
Through the operations of our subsidiaries, we are engaged in property and casualty insurance operations. We focus on niche insurance markets where we offer specialized insurance products, services and programs designed to meet the unique needs of targeted insurance buyers that we believe are underserved by the insurance industry. Our underwriting approach is to price our products to attain an underwriting profit even if we forgo volume as a result.
We derive our revenues primarily from premiums generated by our insurance policies and income from our investment portfolio. Our expenses consist primarily of losses and loss adjustment expenses (“LAE”), commissions and other underwriting expenses and other operating and general expenses.
We use net operating income and net operating income per share, non-GAAP financial measures, as components to assess our performance and as measures to evaluate the results of our business. We believe these measures provide investors and analysts with valuable information relating to ongoing performance that may be obscured by the net effect of realized gains and losses or other items that also tend to be highly variable from period to period, such as the transaction expenses associated with AFG's offer. As such, the following table reconciles net income, determined in accordance with U.S. generally accepted accounting principles (GAAP), to net income from operations, a non-GAAP financial measure. We believe this reconciliation is useful for investors and analysts to evaluate net operating income and net operating income per share along with net income and net income per share when reviewing and evaluating our performance. Net operating income should not be viewed as a substitute for net income as there are inherent material limitations associated with the use of net operating income, the most significant of which is the limitation on the ability of investors to make comparable assessments of net operating income with other companies, particularly as net operating income may be defined or calculated differently by other companies. Therefore, we provide prominence in this quarterly report to use the most comparable GAAP financial measure, net income, which includes the reconciling items in the tables below.
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Three Months Ended September 30,
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2016
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2015
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Amount
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Per Share
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Amount
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Per Share
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(Dollars in thousands, except per share data)
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Net income from operations
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$
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10,137
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$
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0.51
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$
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7,638
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$
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0.39
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After-tax net realized gains (losses) from investments
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1,221
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0.06
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(2,493
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)
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(0.13
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)
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After-tax impact from transaction expenses
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(1,585
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)
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(0.08
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)
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—
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—
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Net income
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$
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9,773
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$
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0.49
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$
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5,145
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$
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0.26
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Nine Months Ended September 30,
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2016
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2015
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Amount
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Per Share
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Amount
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Per Share
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(Dollars in thousands, except per share data)
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Net income from operations
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$
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28,081
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$
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1.40
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$
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20,414
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$
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1.03
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After-tax net realized gains (losses) from investments
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617
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0.03
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(1,518
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)
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(0.08
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)
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After-tax impact from transaction expenses
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(3,036
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)
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(0.15
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)
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—
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—
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Net income
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$
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25,662
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$
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1.28
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$
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18,896
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$
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0.95
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We recorded net income for the three and
nine months ended
September 30, 2016
of
$9.8 million
(
$0.49
per share diluted) and
$25.7 million
(
$1.28
per share diluted), respectively, compared to net income of
$5.1 million
(
$0.26
per share diluted) and
$18.9 million
(
$0.95
per share diluted), respectively, for the same periods in
2015
. The increases in net income were driven by decreases to our loss and LAE ratios for the three and
nine months ended
September 30, 2016
compared to the same periods in 2015. The decrease in the loss and LAE ratio to 77.0% for the three months ended
September 30, 2016
compared to 79.3% for the three month period in 2015 was primarily attributable to improvement in our commercial auto liability line of business. The decrease in the loss and LAE ratio to 76.5% for the
nine
month period ended
September 30, 2016
compared to 78.0% for the same period in 2015 was primarily attributable to improvement in our commercial auto liability line of business, as well as the absence of development on prior year loss reserves compared to unfavorable development reported in the same period last year. The unfavorable development reported last year was concentrated in our commercial auto liability line of business and was primarily attributable to products that we no longer offer or customers that we no longer insure, as well as from assigned risk policies that we are obligated to write as part of the involuntary insurance market. Also contributing to the improvement in net income for both the three and
nine
month periods were increases in net investment income due to higher average invested assets and net realized gains associated with our other invested assets. Net income for both the three and
nine months ended
September 30, 2016
was adversely impacted
by after-tax transaction expenses, primarily consisting of legal and financial advisory fees associated with AFG's proposal to acquire all of the outstanding shares of our Common Stock not already owned by AFG's wholly-owned subsidiary, Great American. No such expenses were incurred during the comparable period in 2015.
Our net income from operations for the
three and nine
months ended
September 30, 2016
was
$10.1 million
(
$0.51
per share diluted) and
$28.1 million
(
$1.40
per share diluted), respectively, compared to net income of
$7.6 million
(
$0.39
per share diluted) and
$20.4 million
(
$1.03
per share diluted), respectively, for the same periods in 2015. The primary drivers for the period-over-period fluctuations are the same as those discussed above for the change in net income for the respective periods.
Gross Premiums Written
We operate our business as one segment, property and casualty insurance. We manage this segment through a product management structure. The following tables set forth an analysis of gross premiums written by the broader business component description, which were determined based primarily on similar economic characteristics, products and services.
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Three Months Ended September 30,
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2016
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2015
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Amount
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Percent
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Amount
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Percent
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(Dollars in thousands)
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Alternative Risk Transfer
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$
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106,458
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58.7
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%
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$
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101,224
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55.3
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%
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Transportation
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57,160
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31.5
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%
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62,663
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34.2
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%
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Specialty Personal Lines
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8,610
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4.7
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%
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8,278
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4.5
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%
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Hawaii and Alaska
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6,993
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3.9
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%
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7,067
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3.9
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%
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Other
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2,195
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1.2
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%
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3,962
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2.1
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%
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Gross premiums written
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$
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181,416
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|
100.0
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%
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$
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183,194
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100.0
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%
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Nine Months Ended September 30,
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2016
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2015
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Amount
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Percent
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Amount
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Percent
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(Dollars in thousands)
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Alternative Risk Transfer
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$
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301,725
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56.8
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%
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$
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291,502
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55.7
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%
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Transportation
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171,016
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32.2
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%
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174,911
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|
33.4
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%
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Specialty Personal Lines
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28,896
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5.4
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%
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27,566
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|
5.3
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%
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|
Hawaii and Alaska
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|
17,785
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3.4
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%
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17,609
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|
3.4
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%
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Other
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11,892
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|
2.2
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%
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11,866
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|
2.2
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%
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|
Gross premiums written
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|
$
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531,314
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|
100.0
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%
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|
$
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523,454
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|
|
100.0
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%
|
Three months ended
September 30, 2016
compared to
September 30, 2015
.
During the three months ended
September 30, 2016
, our gross premiums written decreased $1.8 million, or 1.0%, compared to the same period in 2015, primarily attributable to a decrease in our transportation and other components that was largely offset by growth in our ART component. Gross premiums written in our transportation component decreased $5.5 million, or 8.8%, over the prior period primarily due to rate actions on several large accounts within our traditional passenger transportation business and our excess liability product. Partially offsetting these transportation decreases were average rate increases on renewed business of approximately 6%, as well as new business premium written in our home delivery insurance product. The other component, which is comprised of premium from assigned risk policies that we receive from involuntary state insurance plans from the states in which our insurance company subsidiaries operate and over which we have no control, decreased $1.8 million, or 44.6%, compared to the same period in 2015. Gross premiums written in our ART component increased $5.2 million, or 5.2%, during the current period compared to the same period in 2015 primarily due to average rate increases on renewed business of approximately 6%, as well as new business premium on existing group captive programs and the addition of two new customers to our national account program.
Nine months ended
September 30, 2016
compared to
September 30, 2015
.
During the first
nine
months of
2016
, our gross premiums written increased $7.9 million, or 1.5%, compared to the same period in
2015
primarily due to growth within our ART component, partially offset by a decrease in our transportation component. Gross premiums written in our ART component increased $10.2 million, or 3.5%, primarily due to new business written in several of our group ART captive programs, which includes several former accounts that returned to our company, as well as exposure growth and new customers added to our national account ART program. Also contributing to the ART growth were rate increases on renewed business that averaged approximately 6% through the first nine months of the year. These ART increases were partially offset by the loss of one insured as a result of market consolidation as well as several non-renewals within our national account and group captive programs. Gross premiums written
in our transportation component decreased $3.9 million, or 2.2%, during the first
nine
months of
2016
compared to the same period in
2015
due primarily to rate actions or non-renewals of several large accounts within our traditional passenger transportation and moving and storage businesses and to a lesser extent our decision to no longer write small fleet tow truck business. Partially offsetting these transportation decreases was the addition of new business premium written in our traditional trucking, ambulance and crane and heavy haul insurance products, and excess liability product offered to trucking insureds.
Our ART programs, which focus on specialty or niche businesses, provide various services and coverages tailored to meet specific requirements of defined client groups and their members. These services include risk management consulting, claims administration and handling, loss control and prevention and reinsurance placement, along with providing various types of property and casualty insurance coverage. Insurance coverage is provided primarily to companies with similar risk profiles and to specified classes of business of our agent partners.
As part of our ART programs, we analyze, on a quarterly basis, members’ loss performance on a policy year basis to determine if there would be an assessment premium (loss results are unfavorable to expectations) or if there would be a return of premium (loss results are favorable to expectations) to participants. Assessment premium and return of premium are recorded as adjustments to premiums written (assessments increase premiums written; returns of premium reduce premiums written). For the three months ended
September 30, 2016
and
2015
, we recorded net premium assessments of $3.2 million and $0.8 million, respectively. For the nine months ended
September 30, 2016
and
2015
, we recorded net premium assessments of $6.6 million and $6.0 million, respectively.
Premiums Earned
We operate our business as one segment, property and casualty insurance. We manage this segment through a product management structure. The following tables show premiums earned summarized by the broader business component description, which were determined based primarily on similar economic characteristics, products and services.
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|
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Three Months Ended September 30,
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|
Change
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|
|
|
2016
|
|
2015
|
|
Amount
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|
Percent
|
|
|
|
(Dollars in thousands)
|
|
Premiums earned:
|
|
|
|
|
|
|
|
|
|
Alternative Risk Transfer
|
|
$
|
90,193
|
|
|
$
|
85,915
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|
|
$
|
4,278
|
|
|
5.0
|
%
|
|
Transportation
|
|
45,834
|
|
|
49,163
|
|
|
(3,329
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)
|
|
(6.8
|
)%
|
|
Specialty Personal Lines
|
|
7,753
|
|
|
7,647
|
|
|
106
|
|
|
1.4
|
%
|
|
Hawaii and Alaska
|
|
5,305
|
|
|
5,131
|
|
|
174
|
|
|
3.4
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%
|
|
Other
|
|
2,885
|
|
|
3,627
|
|
|
(742
|
)
|
|
(20.5
|
)%
|
|
Total premiums earned
|
|
$
|
151,970
|
|
|
$
|
151,483
|
|
|
$
|
487
|
|
|
0.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
Change
|
|
|
|
2016
|
|
2015
|
|
Amount
|
|
Percent
|
|
|
|
(Dollars in thousands)
|
|
Premiums earned:
|
|
|
|
|
|
|
|
|
|
Alternative Risk Transfer
|
|
$
|
264,727
|
|
|
$
|
237,149
|
|
|
$
|
27,578
|
|
|
11.6
|
%
|
|
Transportation
|
|
138,068
|
|
|
147,604
|
|
|
(9,536
|
)
|
|
(6.5
|
)%
|
|
Specialty Personal Lines
|
|
22,825
|
|
|
22,835
|
|
|
(10
|
)
|
|
—
|
%
|
|
Hawaii and Alaska
|
|
15,721
|
|
|
14,733
|
|
|
988
|
|
|
6.7
|
%
|
|
Other
|
|
11,484
|
|
|
10,877
|
|
|
607
|
|
|
5.6
|
%
|
|
Total premiums earned
|
|
$
|
452,825
|
|
|
$
|
433,198
|
|
|
$
|
19,627
|
|
|
4.5
|
%
|
Three months ended September 30, 2016
compared to
September 30, 2015
.
Our premiums earned increased $0.5 million, or 0.3%, to $152.0 million during the three months ended
September 30, 2016
compared to $151.5 million for the same period in 2015. The increase in premiums earned was primarily attributable to our ART component mostly offset by decreases in our transportation and other components. Our ART component grew $4.3 million, or 5.0%, due primarily to rate and exposure increases on renewed business, as well as the addition of new participants in our existing ART group captive and national account programs. The decrease in our transportation component of $3.3 million, or 6.8%, was primarily due to rate actions and non-renewals of underperforming business within our traditional passenger transportation and moving and storage businesses. Our other component, which is comprised of premium from assigned risk plans from the states in which our insurance company subsidiaries operate and over which we have no control, decreased $0.7 million, or 20.5%, compared to the same period in 2015.
Nine months ended
September 30, 2016
compared to
September 30, 2015
.
Our premiums earned increased
$19.6 million
, or
4.5%
, to
$452.8 million
during the
nine
months ended
September 30, 2016
compared to
$433.2 million
for the same period in
2015
. The increase in premiums earned was primarily attributable to our ART component, which grew
$27.6 million
, or
11.6%
. Our ART component growth was primarily from the addition of one large customer to our national account program during the third quarter of 2015, as well as rate and exposure increases on renewed business within our group captive and national account programs. This growth was partially offset by a decrease in our transportation component of
$9.5 million
, or
6.5%
, primarily due to rate actions and non-renewals of underperforming business in our traditional trucking and moving and storage and tow insurance products and to a lesser extent the ending of an agency relationship. The increase in our Hawaii and Alaska component of
$1.0 million
, or
6.7%
, is due primarily to rate increases on renewed business and new business written. Our other component, which is comprised of premium from assigned risk plans from the states in which our insurance company subsidiaries operate and over which we have no control, increased
$0.6 million
, or
5.6%
, compared to the same period in
2015
.
Underwriting and Loss Ratio Analysis
Underwriting profitability, as opposed to overall profitability or net earnings, is measured by the combined ratio. The combined ratio is the sum of the loss and LAE ratio and the underwriting expense ratio. A combined ratio under 100% is indicative of a pre-tax underwriting profit.
Losses and LAE are a function of the amount and type of insurance contracts we write and of the loss experience of the underlying risks. We seek to establish case reserves at the maximum probable exposure based on our historical claims experience. Our ability to accurately estimate losses and LAE at the time of pricing our contracts is a critical factor in determining our profitability. The amount reported under losses and LAE in any period includes payments in the period net of the change in reserves for unpaid losses and LAE between the beginning and the end of the period.
Our underwriting expense ratio includes commissions and other underwriting expenses and other operating and general expenses, offset by other income. Commissions and other underwriting expenses consist principally of brokerage and agent commissions reduced by ceding commissions received from reinsurers, and vary depending upon the amount and types of contracts written and, to a lesser extent, premium taxes.
The premium generated by each of our ART insurance programs includes the premium charged related to the development of the participants' loss fund. The loss fund represents the amount of premium needed to cover the participants' expected losses in the layer of risk being ceded to the captive reinsurer. Typically, the premium and losses incurred through the funding of our captive participant's loss layer are comparable period-over-period. However, increased member participation or assessment of premium charged on the loss fund layer through HIL has the potential to unfavorably impact our loss and LAE ratio, and conversely, have a favorable impact on our underwriting expense ratio, when comparing results to a prior period.
Our underwriting approach is to price our products to attain an underwriting profit even if we forgo volume as a result. We continue to achieve rate level increases on renewed business, which have averaged approximately 6% in the current quarter and 5% year-to-date and we are applying the same pricing disciplines to our new business opportunities. We believe that the current rate level increases we are obtaining on renewal business, along with improved pricing on new business, are at levels that adequately consider industry loss cost trends.
Performance measures such as the combined ratio are often used by property and casualty insurers to help users of their financial statements better understand the company's performance. The combined ratio is a statutory (non-GAAP) accounting measurement that has been modified to reflect GAAP accounting. The table below presents our net premiums earned and combined ratios for the periods indicated. The table reconciles the accident year loss and LAE ratio, which is also a non-GAAP measure, to the calendar year loss and LAE ratio, which is the most direct comparable financial GAAP measure. The accident year loss and LAE ratio, which represents the net loss and LAE ratio adjusted for any adverse or favorable development on prior year reserves, is one component used to assess our current year performance and as a measure to evaluate, and if necessary, adjust pricing and underwriting. This is because the net loss and LAE ratio is based on calendar year information and by adjusting this ratio to an accident year basis allows us to evaluate information based on the current year activity. We believe that this measure provides investors and analysts with valuable information for comparison to historical trends and current industry estimates.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
2015
|
|
2016
|
|
2015
|
|
|
|
(Dollars in thousands)
|
|
Gross premiums written
|
|
$
|
181,416
|
|
|
$
|
183,194
|
|
|
$
|
531,314
|
|
|
$
|
523,454
|
|
|
Ceded reinsurance
|
|
(24,976
|
)
|
|
(24,016
|
)
|
|
(99,720
|
)
|
|
(89,841
|
)
|
|
Net premiums written
|
|
156,440
|
|
|
159,178
|
|
|
431,594
|
|
|
433,613
|
|
|
Change in unearned premiums, net of ceded
|
|
(4,470
|
)
|
|
(7,695
|
)
|
|
21,231
|
|
|
(415
|
)
|
|
Total premiums earned
|
|
$
|
151,970
|
|
|
$
|
151,483
|
|
|
$
|
452,825
|
|
|
$
|
433,198
|
|
|
Combined ratios:
|
|
|
|
|
|
|
|
|
|
Loss and LAE ratio excluding prior year development (accident year)
|
|
77.0
|
%
|
|
79.3
|
%
|
|
76.5
|
%
|
|
78.0
|
%
|
|
Prior year loss and LAE development
|
|
—
|
%
|
|
—
|
%
|
|
—
|
%
|
|
1.0
|
%
|
|
Loss and LAE ratio (calendar year) (1)
|
|
77.0
|
%
|
|
79.3
|
%
|
|
76.5
|
%
|
|
79.0
|
%
|
|
Underwriting expense ratio (2)
|
|
19.4
|
%
|
|
19.3
|
%
|
|
20.4
|
%
|
|
20.1
|
%
|
|
Combined ratio (calendar year)
|
|
96.4
|
%
|
|
98.6
|
%
|
|
96.9
|
%
|
|
99.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Accident year combined ratio developed through September 30, 2016
|
|
|
|
|
|
96.9
|
%
|
|
97.9
|
%
|
|
|
|
|
(1)
|
The ratio of losses and LAE to premiums earned.
|
|
|
|
|
(2)
|
The ratio of the sum of commissions and other underwriting expenses and other operating expenses less other income to premiums earned.
|
Three months ended September 30, 2016
compared to
September 30, 2015
.
Our loss and LAE ratio for the three months ended
September 30, 2016
improved 2.3 percentage points to 77.0% compared to 79.3% during the same period in 2015. The current period loss and LAE ratio reflects lower claim frequency in our commercial auto liability line of business compared to the third quarter of 2015. We had no development from prior years' loss reserves for both the three months ended
September 30, 2016
and 2015.
The underwriting expense ratio of 19.4% for the three months ended
September 30, 2016
was comparable to the 2015 ratio of 19.3%.
Nine months ended
September 30, 2016
compared to
September 30, 2015
.
Our loss and LAE ratio for the
nine
months ended
September 30, 2016
improved
2.5
combined ratio points to
76.5%
compared to
79.0%
during the same period in
2015
. Such decrease compared to the prior period was due primarily to improved current accident year loss and LAE results and no development being recorded on prior accident years. Our accident year loss and LAE ratio, which represents our GAAP loss and LAE ratio excluding prior year development, reported during the first
nine
months of
2016
and
2015
was 76.5% and 78.0%, respectively. The current accident year loss and LAE ratio reflects favorable claim severity and frequency in our commercial auto line of business compared to the prior period. For the
nine months ended
September 30, 2016
, we did not record any development on prior years’ loss reserves compared to $4.7 million of unfavorable development, or 1.0 combined ratio points, during the same period last year. The development in the prior period of 2015 was concentrated in our commercial auto liability line of business and was primarily attributable to products that we no longer offer or customers that we no longer insure, as well as from assigned risk policies that we are obligated to write as part of the involuntary insurance market.
Our current accident year loss and LAE ratio at
September 30, 2016
of 76.5% compared to the developed full-year 2015 accident year loss and LAE ratio of 78.1% shows continued improvement from recent accident years and reflects the cumulative impact
of rate increases on renewed business since 2013, as well as improved pricing discipline applied to new business. Our underwriting strategy involves only those business opportunities that meet our stringent pricing and risk selection standards and we continue to take rate actions or other corrective measures on underperforming accounts or businesses. In addition to our underwriting criteria, we continuously seek to enhance our claims management and risk management tools to improve pricing and risk selection, as well as focusing on being disciplined and well managed in our reserving practices.
The underwriting expense ratio for the
nine
month period ended
September 30, 2016
of
20.4%
was comparable to the ratio for the same period in 2015 of
20.1%
.
Net Investment Income
2016 compared to 2015.
Net investment income increased $0.7 million, or 7.2%, to $10.6 million and increased $2.4 million, or 8.2%, to $31.8 million for the three and nine months ended September 30, 2016, respectively, compared to the same periods in 2015. The increase for both periods is primarily due to higher average invested assets.
Net Realized Gains (Losses) on Investments
2016 compared to 2015.
For the three months ended September 30, 2016, pre-tax net realized gains were $1.9 million compared to pre-tax net realized losses of $3.8 million for the same period in 2015. The current quarter gains were generated from net gains associated with other invested assets and the sales or redemptions of securities of $1.7 million and $1.0 million, respectively. Partially offsetting these gains were other-than-temporary impairment charges of $0.8 million on both equity and fixed maturity securities. For the nine months ended September 30, 2016, pre-tax net realized gains were $0.9 million compared to pre-tax net realized losses of $2.3 million for the same period in 2015. Contributing to the current period gains were net gains associated with other invested assets and the sales or redemptions of securities of $5.7 million and $2.7 million, respectively. Offsetting these gains were other-than-temporary impairment charges of $7.5 million on both equity and fixed maturity securities. The increase in net gains associated with other invested assets for both the three and nine months ended September 30, 2016 were primarily due to the strong performance of funds that are either focused on specific opportunities within the distressed debt markets or private equity investments, while the gains on the sales and redemptions of securities were primarily due to favorable market conditions that increased the value of securities over book value. The other-than-temporary impairment charges for both the three and nine months ended September 30, 2016 occurred on securities where management is uncertain of the timing and the extent of ultimate recovery, and were primarily concentrated within the financial services and to a lesser extent, energy related sectors.
The pre-tax net realized losses for the third quarter and first nine months of 2015 were primarily due to other-than-temporary impairment charges of $3.1 million and $4.5 million, respectively, and were primarily from securities related to the energy sector, as well as equity securities within the financial services and, to a lesser extent, other non-energy sectors, where management is uncertain of the timing and the extent of ultimate recovery. In addition, other invested assets produced net losses of $1.3 million for the third quarter of 2015, which were also impacted by the declines in the energy sector. For the nine months ended September 30, 2015, other invested assets generated net gains of $0.1 million. Partially offsetting these losses for both the three and nine months ended September 30, 2015, were gains generated from the sales or redemptions of securities of $0.6 million and $2.1 million, respectively.
Commissions and Other Underwriting Expenses
2016
compared to
2015
.
Commissions and other underwriting expenses were comparable for both the three and
nine
months ended
September 30, 2016
and 2015. For the three month periods such expenses were
$23.2 million
and
$24.2 million
, or 15.3% and 16.0% as a percentage of premiums earned, respectively, while such expenses for the
nine
month periods were $72.7 million and
$70.5 million
, or 16.1% and 16.3% as a percentage of premiums earned, respectively.
Other Operating and General Expenses
2016
compared to
2015
.
For the three and
nine
months ended
September 30, 2016
, other operating and general expenses were $7.1 million and $22.0 million, respectively, compared to
$6.1 million
and
$19.3 million
for the same periods in 2015. The increase in these expenses is primarily attributable to an increase in personnel and information technology resources to support business decisions and to sustain continued growth. As a percentage of premiums earned, such expenses were 4.7% and 4.9% for the three and
nine
months ended
September 30, 2016
, respectively, compared to 4.1% and 4.4% for the same periods in 2015.
Transaction Expenses
2016
compared to
2015
.
For the three and
nine
months ended
September 30, 2016
, we incurred $2.4 and $4.7 million, respectively, of transaction expenses associated with AFG's proposal to acquire all of the outstanding shares of our Common Stock not already owned by AFG's wholly-owned subsidiary, Great American. Transaction expenses primarily consist of legal and financial advisory fees. We incurred no such expense in 2015.
Expense on Amounts Withheld
2016
compared to
2015
.
We invest funds in the participant loss layer for several of our ART programs. We earn investment income and generate realized gains or losses, and incur an equal expense on the amounts owed to ART participants. “Expense on amounts withheld” represents both investment income and realized gains or losses that we remit back to ART participants. The related investment income and realized gains or losses are included in the “Net investment income” and “Net realized gains (losses) on investments” lines, respectively, on our Consolidated Statements of Income. For the three and
nine
months ended
September 30, 2016
, expense on amounts withheld were $1.8 million and $5.5 million, increasing 13.4% and 16.7%, respectively, compared to the
$1.6 million
and
$4.8 million
reported during the same periods in 2015. Such increase was primarily due to growth experienced in our ART programs participant loss layer.
Income Taxes
2016
compared to
2015
.
The effective tax rate for the three and nine months ended
September 30, 2016
was 28.4% and 29.6%, respectively, as compared to 21.2% and 27.1% for the same periods in 2015. The increase in the effective tax rate for both periods is primarily attributed to an increase in income before taxes of $7.1 million and $10.5 million for the three and nine month periods, respectively, resulting in tax-exempt income having a less favorable impact on the effective tax rate.
Financial Condition
Investments
At
September 30, 2016
, our investment portfolio contained $1.1 billion in fixed maturity securities and $86.1 million in equity securities, all carried at fair value with unrealized gains and losses reported as a separate component of shareholders’ equity, and $53.8 million in other invested assets, which are limited partnership investments accounted for in accordance with the equity method. At
September 30, 2016
, we had pre-tax net unrealized gains of $28.6 million on fixed maturities and $7.0 million on equity securities. Consistent with the guidelines in our investment policy, our investment portfolio allocation is based on diversification among primarily high quality fixed maturity investments.
At
September 30, 2016
, 90.1% of our fixed maturity securities were rated “investment grade” (credit rating of AAA to BBB-) by nationally recognized rating agencies. Investment grade securities generally bear lower degrees of risk and corresponding lower yields than those that are unrated or non-investment grade. Although we cannot provide any assurances, we believe that, in normal market conditions, our high quality investment portfolio should generate a stable and predictable investment return.
State and local government obligations were $290.6 million, representing 26.0% of our fixed maturity portfolio at
September 30, 2016
, with $254.4 million, or 87.5%, held in special revenue obligations and the remaining amount held in general obligations. Our state and local government obligations portfolio is high quality, as 97.9% of such securities were rated investment grade at
September 30, 2016
. We had no state and local government obligations for any state, municipality or political subdivision that comprised 10% or more of the total amortized cost or fair value of such obligations at
September 30, 2016
.
Included in fixed maturities at
September 30, 2016
were $223.0 million of residential and commercial mortgage-backed securities (“MBS”). MBS are subject to significant prepayment risk due to the fact that, in periods of declining interest rates, mortgages may be repaid more rapidly than scheduled as borrowers refinance higher rate mortgages to take advantage of lower rates. Summarized information for our MBS at
September 30, 2016
is shown in the table below. Agency-backed securities are those issued by a U.S. government-backed agency; Alt-A mortgages are those with risk profiles between prime and subprime.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortized Cost
|
|
Fair Value
|
|
Fair Value as % of Cost
|
|
Unrealized Gain
|
|
|
|
(Dollars in thousands)
|
|
Collateral Type
|
|
|
|
|
|
|
|
|
|
Residential:
|
|
|
|
|
|
|
|
|
|
Agency-backed
|
|
$
|
125,162
|
|
|
$
|
126,190
|
|
|
100.8
|
%
|
|
$
|
1,028
|
|
|
Non-agency prime
|
|
19,345
|
|
|
20,450
|
|
|
105.7
|
%
|
|
1,105
|
|
|
Alt-A
|
|
28,196
|
|
|
29,636
|
|
|
105.1
|
%
|
|
1,440
|
|
|
Subprime
|
|
28,846
|
|
|
30,831
|
|
|
106.9
|
%
|
|
1,985
|
|
|
Commercial
|
|
15,110
|
|
|
15,921
|
|
|
105.4
|
%
|
|
811
|
|
|
|
|
$
|
216,659
|
|
|
$
|
223,028
|
|
|
102.9
|
%
|
|
$
|
6,369
|
|
The National Association of Insurance Commissioners (“NAIC”) assigns creditworthiness designations on a scale of 1 to 6 with 1 being the highest quality and 6 being the lowest quality. The NAIC retains third-party investment management firms to assist in
the determination of appropriate NAIC designations for MBS based not only on the probability of loss (which is the primary basis of ratings by the major ratings firms), but also on the severity of loss and the statutory carrying value. At
September 30, 2016
, 99.3% (based on a statutory carrying value of $223.0 million) of our MBS had an NAIC designation of 1 or 2.
Certain European countries, including the so-called “peripheral countries” (Greece, Portugal, Ireland, Italy and Spain) have been experiencing varying degrees of financial stress over the past few years. In addition, the United Kingdom voted in 2016 to leave the European Union, known as the “Brexit” vote. There remains uncertainty as to future developments, both from Brexit and these peripheral countries, and the potential impact on global financial markets. At
September 30, 2016
, less than 5% of our investments consisted of European debt and we owned no sovereign debt issued by the peripheral countries.
At
September 30, 2016
, our fixed maturity securities issued by energy and commodity related entities were $50.6 million, or 4.5% of our fixed maturity portfolio, with an unrealized gain of $1.6 million. Approximately 75% of the fair market value of these securities were rated investment grade. Our equity securities portfolio holds $4.2 million, or 4.9%, of energy and commodity related securities with an unrealized gain of $0.4 million.
Summary information for securities with unrealized gains or losses at
September 30, 2016
is shown in the following table. Approximately $7.3 million of fixed maturities and $1.6 million of equity securities had no unrealized gains or losses at
September 30, 2016
.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities with
Unrealized Gains
|
|
Securities with
Unrealized Losses
|
|
|
|
(Dollars in thousands)
|
|
Fixed Maturities:
|
|
|
|
|
|
Fair value of securities
|
|
$
|
933,220
|
|
|
$
|
177,792
|
|
|
Amortized cost of securities
|
|
901,987
|
|
|
180,393
|
|
|
Gross unrealized gain or (loss)
|
|
$
|
31,233
|
|
|
$
|
(2,601
|
)
|
|
Fair value as a % of amortized cost
|
|
103.5
|
%
|
|
98.6
|
%
|
|
Number of security positions held
|
|
855
|
|
|
154
|
|
|
Number individually exceeding $50,000 gain or (loss)
|
|
174
|
|
|
19
|
|
|
Concentration of gains or (losses) by type or industry:
|
|
|
|
|
|
U.S. Government and government agencies
|
|
$
|
1,696
|
|
|
$
|
(28
|
)
|
|
State, municipalities and political subdivisions
|
|
12,247
|
|
|
(115
|
)
|
|
Residential mortgage-backed securities
|
|
6,169
|
|
|
(611
|
)
|
|
Commercial mortgage-backed securities
|
|
819
|
|
|
(8
|
)
|
|
Other debt obligations
|
|
2,022
|
|
|
(1,160
|
)
|
|
Financial institutions, insurance and real estate
|
|
2,571
|
|
|
(298
|
)
|
|
Industrial and other
|
|
5,709
|
|
|
(381
|
)
|
|
Percent rated investment grade (a)
|
|
91.0
|
%
|
|
85.5
|
%
|
|
Equity Securities:
|
|
|
|
|
|
Fair value of securities
|
|
$
|
64,687
|
|
|
$
|
19,859
|
|
|
Cost of securities
|
|
56,163
|
|
|
21,393
|
|
|
Gross unrealized gain or (loss)
|
|
$
|
8,524
|
|
|
$
|
(1,534
|
)
|
|
Fair value as a % of cost
|
|
115.2
|
%
|
|
92.8
|
%
|
|
Number individually exceeding $50,000 gain or (loss)
|
|
57
|
|
|
8
|
|
|
|
|
|
(a)
|
Investment grade of AAA to BBB- by nationally recognized rating agencies.
|
The table below sets forth the scheduled maturities of available-for-sale fixed maturity securities at
September 30, 2016
, based on their fair values. Other debt obligations, which are primarily comprised of asset-backed securities other than mortgage-backed securities, and other securities with sinking funds, are categorized based on their average maturity. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid by the issuers.
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities with
Unrealized Gains
|
|
Securities with
Unrealized Losses
|
|
Maturity:
|
|
|
|
|
|
One year or less
|
|
8.8
|
%
|
|
5.0
|
%
|
|
After one year through five years
|
|
39.1
|
%
|
|
41.1
|
%
|
|
After five years through ten years
|
|
28.8
|
%
|
|
13.6
|
%
|
|
After ten years
|
|
6.7
|
%
|
|
2.0
|
%
|
|
|
|
83.4
|
%
|
|
61.7
|
%
|
|
Mortgage-backed securities
|
|
16.6
|
%
|
|
38.3
|
%
|
|
|
|
100.0
|
%
|
|
100.0
|
%
|
The table below summarizes the unrealized gains and losses on fixed maturities and equity securities by dollar amount.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At September 30, 2016
|
|
|
|
Aggregate
Fair Value
|
|
Aggregate
Unrealized
Gain (Loss)
|
|
Fair Value
as % of
Cost Basis
|
|
|
|
(Dollars in thousands)
|
|
Fixed Maturities:
|
|
|
|
|
|
|
|
Securities with unrealized gains:
|
|
|
|
|
|
|
|
Exceeding $50,000 and for:
|
|
|
|
|
|
|
|
Less than one year (88 issues)
|
|
$
|
125,600
|
|
|
$
|
6,936
|
|
|
105.8
|
%
|
|
One year or longer (86 issues)
|
|
182,452
|
|
|
14,330
|
|
|
108.5
|
%
|
|
$50,000 or less (681 issues)
|
|
625,168
|
|
|
9,967
|
|
|
101.6
|
%
|
|
|
|
$
|
933,220
|
|
|
$
|
31,233
|
|
|
|
|
Securities with unrealized losses:
|
|
|
|
|
|
|
|
Exceeding $50,000 and for:
|
|
|
|
|
|
|
|
Less than one year (16 issues)
|
|
$
|
20,651
|
|
|
$
|
(1,053
|
)
|
|
95.1
|
%
|
|
One year or longer (3 issues)
|
|
3,040
|
|
|
(276
|
)
|
|
91.7
|
%
|
|
$50,000 or less (135 issues)
|
|
154,101
|
|
|
(1,272
|
)
|
|
99.2
|
%
|
|
|
|
$
|
177,792
|
|
|
$
|
(2,601
|
)
|
|
|
|
Equity Securities:
|
|
|
|
|
|
|
|
Securities with unrealized gains:
|
|
|
|
|
|
|
|
Exceeding $50,000 and for:
|
|
|
|
|
|
|
|
Less than one year (48 issues)
|
|
$
|
33,449
|
|
|
$
|
4,956
|
|
|
117.4
|
%
|
|
One year or longer (9 issues)
|
|
8,277
|
|
|
2,356
|
|
|
139.8
|
%
|
|
$50,000 or less (55 issues)
|
|
22,961
|
|
|
1,212
|
|
|
105.6
|
%
|
|
|
|
$
|
64,687
|
|
|
$
|
8,524
|
|
|
|
|
Securities with unrealized losses:
|
|
|
|
|
|
|
|
Exceeding $50,000 and for:
|
|
|
|
|
|
|
|
Less than one year (8 issues)
|
|
$
|
6,967
|
|
|
$
|
(1,274
|
)
|
|
84.5
|
%
|
|
$50,000 or less (27 issues)
|
|
12,892
|
|
|
(260
|
)
|
|
98.0
|
%
|
|
|
|
$
|
19,859
|
|
|
$
|
(1,534
|
)
|
|
|
When a decline in the value of a specific investment is considered to be other-than-temporary, a provision for impairment is charged to earnings (accounted for as a realized loss) and the cost basis of that investment is reduced. The determination of whether unrealized losses are other-than-temporary requires judgment based on subjective, as well as objective factors. Factors considered and resources used by management include those discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Other-Than-Temporary Impairment.”
Liquidity and Capital Resources
Our cash flows from operating, investing and financing activities as detailed in our Consolidated Statements of Cash Flows are shown below (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
2015
|
|
Net cash provided by operating activities
|
|
$
|
69,513
|
|
|
123,223
|
|
|
Net cash used in investing activities
|
|
(52,879
|
)
|
|
(89,035
|
)
|
|
Net cash used in financing activities
|
|
(2,580
|
)
|
|
(6,067
|
)
|
|
Net increase in cash and cash equivalents
|
|
$
|
14,054
|
|
|
$
|
28,121
|
|
The liquidity requirements of our insurance subsidiaries relate primarily to the liabilities associated with their products, as well as operating costs and payments of dividends and taxes to us from insurance subsidiaries. Historically, and during the
nine
months
ended
September 30, 2016
, cash flows from premiums and investment income have provided sufficient funds to meet these requirements without requiring significant liquidation of investments. If our cash flows change dramatically from historical patterns, for example as a result of a decrease in premiums, an increase in claims paid or operating expenses, or financing an acquisition, we may be required to sell securities before their maturity and possibly at a loss. Our insurance subsidiaries generally hold a significant amount of highly liquid, short-term investments or cash and cash equivalents to meet their liquidity needs. Our historic pattern of using receipts from current premium writings for the payment of liabilities incurred in prior periods provides us with the option to extend the maturities of our investment portfolio beyond the estimated settlement date of our loss reserves. Funds received in excess of cash requirements are generally invested in additional marketable securities.
We believe that our insurance subsidiaries maintain sufficient liquidity to pay claims and operating expenses, as well as meet commitments in the event of unforeseen events such as reserve deficiencies, inadequate premium rates or reinsurer insolvencies. Our principal sources of liquidity are our existing cash and cash equivalents. Cash and cash equivalents increased
$14.1 million
from
$71.9 million
at
December 31, 2015
to
$86.0 million
at
September 30, 2016
. We generated net cash from operations of
$69.5 million
for the
nine
months ended
September 30, 2016
, compared to
$123.2 million
during the same period in
2015
. The decrease in cash provided by operating activities is primarily due to an increase in cash payments made for loss and loss adjustment expenses year-over-year partially offset by an increase in cash collected on premiums written.
Net cash used in investing activities was
$52.9 million
and
$89.0 million
for the
nine
months ended
September 30, 2016
and
2015
, respectively. The cash used in investing activities for both periods was due to reinvesting funds in excess of cash requirements. The increase in purchases of fixed maturities was driven by an increase in the proceeds generated from maturities and redemptions of investments. Purchases of fixed maturities were concentrated in residential mortgage-backed securities and other debt obligations in the current period and U.S. government agency bonds and other debt obligations in the prior period.
Net cash used in financing activities was
$2.6 million
and
$6.1 million
for the
nine
months ended
September 30, 2016
and
2015
, respectively. The net cash used in financing activities in the current period was reduced by $6.0 million of additional borrowings on our unsecured line of credit as compared to no such activity in the prior period. Our other financing activities include those related to share-based compensation activity and dividends paid on our common shares.
We have continuing cash needs for administrative expenses, the payment of principal and interest on borrowings, shareholder dividends and taxes. Funds to meet these obligations come primarily from parent company cash, dividends and other payments from our insurance company subsidiaries, or in lieu of such dividends and payments from funds available on our line of credit.
We have a $100.0 million unsecured credit agreement (the “Credit Agreement”) that terminates in November 2017, which includes a sublimit of $10.0 million for letters of credit. We have the ability to increase the line of credit to $125.0 million subject to the Credit Agreement’s accordion feature. Amounts borrowed bear interest at either (1) a LIBOR rate plus an applicable margin ranging from 0.75% to 1.00% based on our A.M. Best insurance group rating, or (2) a rate per annum equal to the greater of (a) the administrative agent’s prime rate, (b) 0.50% in excess of the federal funds effective rate, or (c) 1.00% in excess of the one-month LIBOR rate. At
September 30, 2016
, we had $18.0 million outstanding under the Credit Agreement. Based on our A.M. Best insurance group rating of “A” at September 30, 2016, interest on this debt is payable in two tranches of $6.0 million and $12.0 million and is equal to the one-month and three-month LIBOR (0.527% and 0.702% at September 30, 2016, respectively) plus 87.5 basis points, with interest payments due quarterly.
The Credit Agreement requires us to maintain specified financial covenants measured on a quarterly basis, including a minimum consolidated net worth and a maximum debt to capital ratio. In addition, the Credit Agreement contains certain affirmative and negative covenants customary for facilities of this type, including negative covenants that limit or restrict our ability to, among other things, pay dividends, incur additional indebtedness, effect mergers or consolidations, make investments, enter into asset sales, create liens, enter into transactions with affiliates and other restrictions customarily contained in such agreements. As of
September 30, 2016
, we were in compliance with all covenants. We may terminate the Credit Agreement and repay all outstanding indebtness based upon the outcome of the merger.
We believe that funds generated from operations, including dividends from insurance subsidiaries, parent company cash and funds available under our Credit Agreement, will provide sufficient resources to meet our liquidity requirements for at least the next 12 months. However, if these funds are insufficient to meet fixed charges in any period, we would be required to generate cash through additional borrowings, sale of assets, sale of portfolio securities or similar transactions. If we were required to sell portfolio securities early for liquidity purposes rather than holding them to maturity, we would recognize gains or losses on those securities earlier than anticipated. If we find it necessary to borrow additional funds under our Credit Agreement in order to meet liquidity needs, we would incur additional interest expense, which could have a negative impact on our earnings. Since our ability to meet our obligations in the long-term (beyond a 12-month period) is dependent upon factors such as market changes, insurance regulatory changes and economic conditions, no assurance can be given that the available net cash flow will be sufficient to meet our long-term operating needs. We are not aware of any trends or uncertainties affecting our liquidity, including any significant future reliance on short-term financing arrangements.
Critical Accounting Policies
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect amounts reported in the financial statements. As more information becomes known, these estimates and assumptions could change and impact amounts reported in the future. Management believes that the establishment of losses and LAE reserves and the determination of “other-than-temporary” impairment on investments are the two areas whereby the degree of judgment required in determining amounts recorded in the financial statements make the accounting policies critical. For a more detailed discussion of these policies, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” in our Annual Report on Form 10-K for the year ended
December 31, 2015
.
Loss and Loss Adjustment Expense Reserves
Significant periods of time can elapse between the occurrence of an insured loss, the reporting of that loss to us and our final payment of that loss and its related LAE. To recognize liabilities for unpaid losses, we establish reserves as balance sheet liabilities. At both
September 30, 2016
and
December 31, 2015
, we had approximately
$1 billion
of gross loss and LAE reserves, representing management’s best estimate of the ultimate loss. Management records, on a monthly and quarterly basis, its best estimate of loss reserves.
For purposes of computing the recorded loss and LAE reserves, management utilizes various data inputs as noted below, including analysis that is derived from our internal actuary, as well as a review of quarterly results performed by actuaries employed by Great American. In addition, on an annual basis, actuaries from Great American provide a Statement of Actuarial Opinion, required annually in accordance with state insurance regulations, on the statutory reserves recorded by NIIC, VIC, NIIC-HI and TCC. The actuarial analysis of the aforementioned companies' net reserves as of
September 30, 2016
and
December 31, 2015
reflected point estimates that were within 2% of management’s recorded net reserves as of such dates. Using actuarial data along with other data inputs, management concluded that the recorded reserves appropriately reflect management’s best estimates of the liability as of
September 30, 2016
and
December 31, 2015
.
The quarterly reviews of unpaid loss and LAE reserves by Great American actuaries are prepared using standard actuarial techniques. These may include (but may not be limited to):
|
|
|
|
•
|
the Case Incurred Development Method;
|
|
|
|
|
•
|
the Paid Development Method; and
|
|
|
|
|
•
|
the Bornhuetter-Ferguson Method.
|
The period of time from the occurrence of a loss through the settlement of the liability is referred to as the “tail.” Generally, the same actuarial methods are considered for both short-tail and long-tail lines of business because most of them work properly for both. The methods are designed to incorporate the effects of the differing length of time to settle particular claims. For short-tail lines, more weight tends to be given to the Case Incurred and Paid Development Methods, although the various methods tend to produce similar results. For long-tail lines, more judgment is involved and more weight may be given to the Bornhuetter-Ferguson Method. Liability claims for long-tail lines are more susceptible to litigation and can be significantly affected by changing contract interpretation and the legal environment. Therefore, the estimation of loss reserves for these classes is more complex and subject to a higher degree of variability.
Supplementary statistical information is reviewed by the actuaries to determine which methods are most appropriate and whether adjustments are needed to particular methods. This information includes:
|
|
|
|
•
|
open and closed claim counts;
|
|
|
|
|
•
|
average case reserves and average incurred on open claims;
|
|
|
|
|
•
|
closure rates and statistics related to closed and open claim percentages;
|
|
|
|
|
•
|
average closed claim severity;
|
|
|
|
|
•
|
ultimate claim severity;
|
|
|
|
|
•
|
projected ultimate loss ratios; and
|
Other-Than-Temporary Impairment
Our investments are exposed to at least one of three primary sources of investment risk: credit, interest rate and market valuation risks. The financial statement risks are those associated with the recognition of impairments and income, as well as the determination of fair values. We evaluate whether impairments have occurred on a case-by-case basis. Management considers a wide range of factors about the security issuer and uses its best judgment in evaluating the cause and amount of decline in the estimated fair value of the security and in assessing the prospects for near-term recovery. Inherent in management's evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Considerations that we use in the impairment evaluation process include, but are not limited to:
|
|
|
|
•
|
the length of time and the extent to which the market value has been below amortized cost;
|
|
|
|
|
•
|
whether the issuer is experiencing significant financial difficulties;
|
|
|
|
|
•
|
economic stability of an entire industry sector or subsection;
|
|
|
|
|
•
|
whether the issuer, series of issuers or industry has a catastrophic type of loss;
|
|
|
|
|
•
|
the extent to which the unrealized loss is credit-driven or a result of changes in market interest rates;
|
|
|
|
|
•
|
historical operating, balance sheet and cash flow data;
|
|
|
|
|
•
|
internally and externally generated financial models and forecasts;
|
|
|
|
|
•
|
our ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery in market
|
value; and
|
|
|
|
•
|
other subjective factors, including concentrations and information obtained from regulators and rating agencies.
|
Under other-than-temporary impairment accounting guidance, if management can assert that it does not intend to sell an impaired fixed maturity security and it is not more likely than not that it will have to sell the security before recovery of its amortized cost basis, then an entity may separate the other-than-temporary impairments into two components: 1) the amount related to credit losses (recorded in earnings) and 2) the amount related to all other factors (recorded in other comprehensive income (loss)). The credit related portion of an other-than-temporary impairment is measured by comparing a security's amortized cost to the present value of its current expected cash flows discounted at its effective yield prior to the impairment charge. Both components are required to be shown in the Consolidated Statements of Income. If management intends to sell an impaired security, or it is more likely than not that it will be required to sell the security before recovery, an impairment charge is required to reduce the amortized cost of that security to fair value. Additional disclosures required by this guidance are contained in Note 4 - “Investments.”
We closely monitor each investment that has a fair value that is below its amortized cost and make a determination each quarter for other-than-temporary impairment for each of those investments. During the three and
nine
months ended
September 30, 2016
, we recorded other-than-temporary impairment charges of $0.8 million and $7.5 million, respectively, in earnings on both equity and fixed maturity securities. The impairment charges during the three and
nine
months ended
September 30, 2016
were primarily concentrated within the financial services and, to a lesser extent, the energy related sectors. The impairment charges on equity securities of $0.7 million and $5.4 million for the three and
nine
months ended
September 30, 2016
, respectively, were due to the uncertainty surrounding the timing and extent of ultimate recovery. The impairment charges on fixed maturity securities of $0.1 million and $2.1 million for the three and
nine
months ended
September 30, 2016
, respectively, occurred as management is uncertain of full principal repayment on these securities. During both the three and
nine
months ended
September 30, 2015
, we recorded other-than-temporary impairment charges of $3.1 million and $4.5 million, respectively, in earnings on both equity and fixed maturity securities, primarily within the energy and financial services sectors. The impairment charges on equity securities of $2.0 million and $3.0 million for the three and nine months ended September 30, 2015, respectively, were due to the uncertainty surrounding the timing and extent of ultimate recovery. The impairment charges on fixed maturity securities of $1.1 million and $1.5 million for the three and nine months ended September 30, 2015, respectively, occurred as management is uncertain of full principle repayment on these securities. While it is not possible to accurately predict if or when a specific security will become impaired, given the inherent uncertainty in the market, charges for other-than-temporary impairment could be material to net income in subsequent quarters. Management believes it is not likely that future impairment charges will have a significant effect on our liquidity. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition - Investments.”
Contractual Obligations/Off-Balance Sheet Arrangements
During the first
nine
months of
2016
, our contractual obligations did not change materially from those discussed in our Annual Report on Form 10-K for the year ended
December 31, 2015
.
We do not have any relationships with unconsolidated entities of financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
ITEM 3.
Quantitative and Qualitative Disclosures About Market Risk
As of
September 30, 2016
, there were no material changes to the information provided in our Annual Report on Form 10-K for the year ended
December 31, 2015
under Item 7A “Quantitative and Qualitative Disclosures About Market Risk.”
ITEM 4.
Controls and Procedures
Our management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. Our management, with participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e)) as of
September 30, 2016
. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of
September 30, 2016
, to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s (“SEC”) rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
There have been no changes in our internal controls over financial reporting or in other factors that have occurred during the quarter ended
September 30, 2016
that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.