CONIFER HOLDINGS, INC. The following Management's Discussion and Analysis of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements, related notes and other financial information appearing elsewhere in this Annual Report on Form 10-K, filed with theU. S. Securities and Exchange Commission ("SEC").
Forward-Looking Statements
Certain statements contained in this Annual Report on Form 10-K, which are not statements of historical fact, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, as Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements give current expectations or forecasts of future events or our future financial or operating performance. Words such as "anticipate," "believe," "estimate," "expect," "will," "intend," "may," "plan," "seek" and similar terms and phrases, or the negative thereof, may be used to identify forward-looking statements. The forward-looking statements contained in this report are based on management's good-faith belief and reasonable judgment based on current information. The forward-looking statements are qualified by important factors, risks and uncertainties, many of which are beyond our control, which could cause our actual results to differ materially from those in the forward-looking statements, including those described above in Item 1A Risk Factors and subsequent reports filed with or furnished to theSEC . Any forward-looking statement made by us in this report speaks only as of the date hereof or as of the date specified herein. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by any applicable laws or regulations. Recent Developments COVID-19 COVID-19 (the "Pandemic") caused significant disruption to public health, the global economy, financial markets, and commercial, social and community activity in general. As there has been a significant reduction in reported cases and correspondingly a reduction in government restrictions, we see reduced risk to our business. We continue to monitor potential risks the Pandemic may present including a potential resurgence. Our exposure to the Pandemic is manifold. The majority of our employees continue to work remotely however strict "shelter-in-place" or "stay-at-home" orders have been lifted. A significant portion of our revenues are generated from the hospitality sector within theU.S. which remains under stress due to the threats of resurgence and resource shortages that resulted from the Pandemic. We have continued to provide customer service, process new and renewal business, handle claims and otherwise manage all operations even though the vast majority of the staff is working remotely. To date, we have not seen a major disruption in our business as a result of the Pandemic and currently do not expect to see a material negative impact to our financial position or results of operations as a result of the Pandemic. VSRM Transaction Prior toOctober 13, 2022 , Sycamore owned 50% ofVenture Agency Holdings, Inc. ("Venture") and has accounted for its ownership under the equity method of accounting. OnOctober 13, 2022 , Sycamore purchased the other 50% of Venture from an individual for$9.7 million . Following this purchase, Sycamore owned 100% of Venture, which was then renamed toVSRM, Inc. ("VSRM"). VRSM and its two wholly owned subsidiaries,The Roots Insurance Agency, Inc. ("Roots") andMitzel Insurance Agency, Inc. ("Mitzel") were incorporated into the Company's consolidated financial statements as of the date of the acquisition. The Company recognized Sycamore's purchase of the individual's shares of VSRM as a step acquisition and revalued all assets and liabilities upon the acquisition date. This resulted in the recognition of an$8.8 million non-operating gain reported in the Consolidated Statements of Operations as Gain from VSRM Transaction in the fourth quarter of 2022. The Company also utilized$12.5 million of federal tax net operating losses carried forward and$14.8 million state tax net operating losses 36 -------------------------------------------------------------------------------- carried forward, for a net-of-tax benefit of$9.4 million . VSRM retained$8.9 million of debt, and$9.4 million of tax liabilities, as well as other smaller assets and liabilities that did not go with the transaction. The fair value of the equity interest of VSRM immediately prior to the acquisition by Sycamore was$10.1 million . The fair value techniques used to measure the fair value of VSRM included using the carrying value of all current assets and liabilities as their carrying values approximated their fair values. Intangible assets were reviewed based on recent valuations performed by third party valuation experts and the net realized proceeds received upon the sale of the Security & Alarm Business sold the following day. OnOctober 14, 2022 , VSRM sold all of its security guard and alarm installation insurance brokerage business (the "Security & Alarm Business") to a third party insurance brokerage firm for$38.2 million . As part of the transaction, the individual who previously owned 50% of VSRM transitioned employment to the buyer, along with a team of approximately eight other employees of VSRM. The Company recognized this transaction as the sale of a business. Because all assets and liabilities were just adjusted to fair value from the step acquisition described above, the basis of the net assets sold equaled the net proceeds from the sale, thus there was no gain recognized upon the sale of the Security & Alarm Business. OnDecember 30, 2022 , VSRM contributed its remaining business, including its two wholly owned subsidiaries (Mitzel and Roots) to a new wholly owned subsidiary,Sycamore Specialty Underwriters, LLC ("SSU"). The business contributed to SSU consisted of customer accounts of substantially all of the personal lines business and a small subset of the commercial lines business underwritten by the Insurance Company Subsidiaries, and all of the customer accounts VSRM produced for third-party insurers, other than the security guard and alarm installation brokerage business previously sold. OnDecember 31, 2022 ,Andrew D. Petcoff purchased 50% of SSU fromVSRM, Inc. for$1,000 . As a result, SSU and its two wholly owned subsidiaries, Roots and Mitzel, are no longer consolidated in the Company's consolidated financial statements as ofDecember 31, 2022 , and VSRM's investment in SSU is accounted for using the equity method. The net assets transferred to SSU had a fair value of$0 at the time of the contribution. There was no gain or loss recognized upon the sale of half of SSU toMr. Petcoff . Included in the net assets transferred to SSU was a$1.0 million promissory note payable, a liability that was assumed by SSU. The note payable was an obligation that originated as part of the Venture Transaction described below, and is payable to CIC.
In order to determine the value of the portion of the business contributed to SSU, the Company obtained a third party valuation based on a weighting of discounted cash flows and earnings before interest, taxes, depreciation and amortization (EBITDA) multiple valuation methods. The valuation included significant estimates and assumptions related to (i) forecasted revenue and EBITDA and (ii) the selection of the EBITDA multiple and discount rate.
Sale of Certain Agency Business
OnJune 30, 2021 , Sycamore sold toVenture Agency Holdings, Inc. , a related party, the customer accounts and other related assets of some of its personal and commercial lines of business (the "Venture Transaction"). Sycamore will continue to produce various personal and commercial lines that it did not sell which is substantially all produced for, and underwritten by, our Insurance Company Subsidiaries. We recognized an$8.9 million gain on the sale which is reflected in Other Gains in the Consolidated Statement of Operations. In order to determine the value of the portion of the business sold, the Company obtained a third party valuation based on a weighting of discounted cash flows and earnings before interest, taxes, depreciation and amortization (EBITDA) multiple valuation methods. The valuation included significant estimates and assumptions related to (i) forecasted revenue and EBITDA and (ii) the selection of the EBITDA multiple and discount rate. The purchase price was$10.0 million of which$1.0 million was paid in cash onJune 30, 2021 , and$9.0 million was in the form of two promissory notes (one for$6.0 million and one for$3.0 million ). Both notes require interest-only quarterly payments at a per annum rate of 7.0%, with a five-year maturity. There are no prepayment penalties. OnDecember 14, 2021 , Venture paid off the$3.0 million note. OnOctober 20, 2022 , Venture paid down$5.0 million of the$6.0 million note. 37 --------------------------------------------------------------------------------
The remaining
The assets sold included the customer accounts (mainly agency-related new and renewal rights) of substantially all of the personal lines business and a small subset of the commercial lines business underwritten by ourInsurance Company Subsidiaries, and all of the customer accounts Sycamore produced for third-party insurers. The Venture Transaction included the transition of 21 employees from Conifer to Venture as well as necessary systems and office functions to operate the business. Venture did not assume any in-force business or liabilities. The business transitioned to Venture as it produced new or renewal business effectiveJuly 1, 2021 . Our Insurance Company Subsidiaries continued to underwrite substantially all of the business we sold to Venture that we underwrote prior to the transaction.
Loss Portfolio Transfer
OnNovember 1, 2022 , the Company entered into a loss portfolio transfer ("LPT") reinsurance agreement withFleming Reinsurance Ltd ("Fleming Re"). Under the agreement, Fleming Re will cover an aggregate limit of$66.3 million of paid losses on$40.8 million of stated net reserves as ofJune 30, 2022 , relating to accident years 2019 and prior. This covers substantially all of the commercial liability lines underwritten by the Company. Within the aggregate limit, there is a$5.5 million loss corridor in which the Company retains losses in excess of$40.8 million . Fleming Re is then responsible to cover paid losses in excess of$46.3 million up to$66.3 million . Accordingly, there is$20.0 million of adverse development cover for accident years 2019 and prior. Under the agreement, Fleming Re was paid$40.8 million for stated net reserves as ofJune 30, 2022 , plus a one-time risk fee of$5.4 million . Recoverables due to the Company under this agreement are recorded as reinsurance recoverables. The agreement is between CIC and WPIC and Fleming Re. As ofDecember 31, 2022 , the Company has recorded losses through the$5.5 million corridor and$644,000 into the$20.0 million layer.
The Company paid
OnApril 21, 2022 ,A.M. Best downgraded the Company's Long-Term Issuer Credit Rating (Long-Term ICR) from "bb" (Fair) to "bb-" (Fair), and downgraded the Company's insurance subsidiaries Financial Strength Rating from "B++" (Good) to "B+" (Good) and the Long-Term ICR from "bbb" (Good) to "bbb-" (Good). The outlook assigned to all these ratings byA.M. Best was Stable. We do not believe the rating changes will have a material effect on our business.
Business Overview
We are an insurance holding company that markets and services our product offerings through specialty commercial and specialty personal insurance business lines. Our growth has been significant since our founding in 2009. Currently, we are authorized to write insurance as an excess and surplus lines carrier in 45 states, including theDistrict of Columbia . We are licensed to write insurance as an admitted carrier in 42 states, including theDistrict of Columbia , and we offer our insurance products in all 50 states.
Our revenues are primarily derived from premiums earned from our insurance operations. We also generate other revenues through investment income and other income which mainly consists of: installment fees and policy issuance fees generally related to the policies we write.
Our expenses consist primarily of losses and loss adjustment expenses, agents'
commissions, and other underwriting and administrative expenses. We organize our
operations in three insurance businesses: commercial insurance lines, personal
lines, and agency business. Together, the commercial and personal lines refer to
"underwriting" operations that take insurance risk, and the agency business
refers to non-risk insurance business.
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--------------------------------------------------------------------------------Through our commercial insurance lines, we offer coverage for both commercial property and commercial liability. We also offer coverage for commercial automobiles and workers' compensation. Our insurance policies are sold to targeted small and mid-sized businesses on a single or multiple-coverage basis.
Through our personal insurance lines, we offer homeowners insurance and dwelling fire insurance products to individuals in several states. Our specialty homeowners insurance product line is primarily comprised of low-value dwelling insurance tailored for owners of lower valued homes, which we offer inIllinois ,Indiana andTexas . Through our wholesale agency business segment, we offer commercial and personal lines insurance products for our Insurance Company Subsidiaries as well as third-party insurers. The wholesale agency business segment provides our agents with more insurance product options. However, as a result of the sale of certain agency business onJune 30, 2021 , going forward, our agency segment will not be producing any significant amounts of business for third party insurers and will produce approximately 50% less business for the Insurance Company Subsidiaries.
Critical Accounting Policies and Estimates
General
We identified the accounting estimates below as critical to the understanding of our financial position and results of operations. Critical accounting estimates are defined as those estimates that are both important to the portrayal of our financial condition and results of operations and which require us to exercise significant judgment. We use significant judgment concerning future results and developments in applying these critical accounting estimates and in preparing our consolidated financial statements. These judgments and estimates affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of material contingent assets and liabilities. Actual results may differ materially from the estimates and assumptions used in preparing the consolidated financial statements. We evaluate our estimates regularly using information that we believe to be relevant. See the Consolidated Financial Statements Note 1 ~ Summary of Significant Accounting Policies, for further details.
Unpaid Loss and Loss Adjustment Expense Reserves
Our recorded loss and loss adjustment expenses ("LAE") reserves represent
management's best estimate of unpaid loss and LAE at each balance sheet date,
based on information, facts and circumstances known at such time. Our loss and
LAE reserves reflect our estimates at the balance sheet date of:
•
Case reserves, which are unpaid loss and LAE amounts that have been reported; and
•
Incurred but not reported ("IBNR") reserves, which are (1) unpaid loss and LAE amounts that have been incurred but not yet reported; and (2) the expected development on case reserves.
We do not discount the loss and LAE reserves for the time value of money.
Case reserves are initially set by our claims personnel. When a claim is reported to us, our claims department completes a casebasis valuation and establishes a case reserve for the estimated amount of the probable ultimate losses and LAE associated with that claim. Our claims department updates their casebasis valuations upon receipt of additional information and reduces case reserves as claims are paid. The case reserve is based primarily upon an evaluation of the following factors:
•
The type of loss;
•
The severity of injury or damage;
•
Our knowledge of the circumstances surrounding the claim;
•
The jurisdiction of the occurrence;
•
Policy provisions related to the claim;
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Expenses intended to cover the ultimate cost of settling claims, including investigation and defense of lawsuits resulting from such claims, costs of outside adjusters and experts, and all other expenses which are identified to the case; and
•
Any other information considered pertinent to estimating the indemnity and expense exposure presented by the claim.
IBNR reserves are determined by subtracting case reserves and paid loss and LAE from the estimated ultimate loss and LAE. Our actuarial department develops estimated ultimate loss and LAE on a quarterly basis. Our Reserve Review Committee (which includes our Chief Executive Officer, President, Chief Financial Officer, other members of executive management, and key actuarial, underwriting and claims personnel) meets each quarter to review our actuaries' estimated ultimate expected loss and LAE. We use several generally accepted actuarial methods to develop estimated ultimate loss and LAE estimates by line of business and accident year. This process relies on the basic assumption that past experience, adjusted for the effects of current developments and likely trends, is a reasonable basis for predicting future outcomes. These methods utilize various inputs, including: • Written and earned premiums; •
Paid and reported losses and LAE;
•
Expected initial loss and LAE ratio, which is the ratio of incurred losses and LAE to earned premiums; and
•
Expected claim reporting and payout patterns based on our own loss experience and supplemented with insurance industry data where applicable.
The principal standard actuarial methods used by our actuaries for their comprehensive reviews include:
•
Loss ratio method-This method uses loss and LAE ratios for prior accident years, adjusted for current trends, to determine an appropriate expected loss and LAE ratio for a given accident year;
•
Loss development methods-Loss development methods assume that the losses and LAE yet to emerge for an accident year are proportional to the paid or reported loss and LAE amounts observed todate. The paid loss development method uses losses and LAE paid to date, while the reported loss development method uses losses and LAE reported to date;
•
BornheutterFerguson method-This method is a combination of the loss ratio and loss development methods, where the loss development factor is given more weight as an accident year matures; and
•
Frequency/severity method-This method projects claim counts and average cost per claim on a paid or reported basis for high frequency, low severity products.
Our actuaries give different weights to each of these methods based upon the
amount of historical experience data by line of business and by accident year,
and based on judgment as to what method is believed to result in the most
accurate estimate. The application of each method by line of business and by
accident year may change in the future if it is determined that a different
emphasis for each method would result in more accurate estimates.
Our actuaries also analyze several diagnostic measures by line of business and
accident year, including but not limited to: reported and closed frequency and
severity, claim reporting and claim closing patterns, paid and incurred loss
ratio development, and ratios of paid loss and LAE to incurred loss and LAE.
After the actuarial methods and diagnostic measures have been performed and
analyzed, our actuaries use their judgment and expertise to select an estimated
ultimate loss and LAE by line of business and by accident year.
Our actuaries estimate an IBNR reserve for our unallocated LAE not specifically
identified to a particular claim, namely our internal claims department salaries
and associated general overhead and administrative expenses associated with the
adjustment and processing of claims. These estimates, which are referred to as
unallocated loss adjustment expense
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("ULAE") reserves, are based on internal cost studies and analyses reflecting
the relationship of ULAE paid to actual paid and incurred losses. We select
factors that are applied to case reserves and IBNR reserve estimates in order to
estimate the amount of ULAE reserves applicable to estimated loss reserves at
the balance sheet date.
We allocate the applicable portion of our estimated loss and LAE reserves to
amounts recoverable from reinsurers under reinsurance contracts and report those
amounts separately from our loss and LAE reserves as an asset on our balance
sheet.
The estimation of ultimate liability for losses and LAE is a complex, imprecise
and inherently uncertain process, and therefore involves a considerable degree
of judgment and expertise. Our loss and LAE reserves do not represent an exact
measurement of liability, but are estimates based upon various factors,
including but not limited to:
•
Actuarial projections of what we, at a given time, expect to be the cost of the ultimate settlement and administration of claims reflecting facts and circumstances then known;
•
Estimates of future trends in claims severity and frequency;
•
Assessment of asserted theories of liability; and
•
Analysis of other factors, such as variables in claims handling procedures, economic factors, and judicial and legislative trends and actions.
Most or all of these factors are not directly or precisely quantifiable, particularly on a prospective basis, and are subject to a significant degree of variability over time. In addition, the establishment of loss and LAE reserves makes no provision for the broadening of coverage by legislative action or judicial interpretation or for the extraordinary future emergence of new types of losses not sufficiently represented in our historical experience or which cannot yet be quantified. As a result, an integral component of our loss and LAE reserving process is the use of informed subjective estimates and judgments about our ultimate exposure to losses and LAE. Accordingly, the ultimate liability may vary significantly from the current estimate. The effects of change in the estimated loss and LAE reserves are included in the results of operations in the period in which the estimate is revised. Our reserves consist entirely of reserves for property and liability losses, consistent with the coverages provided for in the insurance policies directly written or assumed by us under reinsurance contracts. Several years may elapse between the occurrence of an insured loss, the reporting of the loss to us and our payment of the loss. The level of IBNR reserves in relation to total reserves depends upon the characteristics of the specific line of business, particularly related to the speed with which claims are reported and outstanding claims are paid. Lines of business for which claims are reported slowly will have a higher percentage of IBNR reserves than lines of business that report and settle claims more quickly.
The following table shows the ratio of IBNR reserves to total reserves net of
reinsurance recoverables as of
Ratio of
IBNR to
Case IBNR Total Total
Line of Business Reserves Reserves Reserves Reserves
Commercial Lines $ 36,354 $ 41,903 $ 78,257 53.5 %
Personal Lines 2,944 1,687 4,631 36.4 %
Total Lines $ 39,298 $ 43,590 $ 82,888 52.6 %
Included in the reinsurance recoverables were reinsurance recoverables from the
LPT which were $24.4 million of reinsurance recoverables on case reserves and
$1.5 million of reinsurance recoverables on IBNR. All of the reinsurance
recoverables from the LPT are included in commercial lines.
Although we believe that our reserve estimates are reasonable, it is possible
that our actual loss and LAE experience may not conform to our assumptions and
may, in fact, vary significantly from our assumptions. Accordingly, the ultimate
settlement of losses and the related LAE may vary significantly from the
estimates included in our financial statements. We continually review our
estimates and adjust them as we believe appropriate as our experience develops
or new information becomes known to us. Such adjustments are included in current
operations.
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Our loss and LAE reserves do not represent an exact measurement of liability,
but are estimates. The most significant assumptions affecting our IBNR reserve
estimates are the loss development factors applied to paid losses and case
reserves to develop IBNR by line of business and accident year. Although
historical loss development provides us with an indication of future loss
development, it typically varies from year to year. Thus, for each accident year
within each line of business we select one loss development factor out of a
range of historical factors.
We generated a sensitivity analysis of our net reserves which represents
reasonably likely levels of variability in our selected loss development
factors. We believe the most meaningful approach to the sensitivity analysis is
to vary the loss development factors that drive the ultimate loss and LAE
estimates. We applied this approach on an accident year basis, reflecting the
reasonably likely differences in variability by level of maturity of the
underlying loss experience for each accident year. Generally, the most recent
accident years are characterized by more unreported losses and less information
available for settling claims, and have more inherent uncertainty than the
reserve estimates for more mature accident years. Therefore, we used variability
factors of plus or minus 10% for the most recent accident year, 5% for the
preceding accident year, and 2.5% for the second preceding accident year. There
is minimal expected variability for accident years at four or more years'
maturity.
The following table displays ultimate net loss and LAE and net loss and LAE
reserves by accident year for the year ended December 31, 2022 . We applied the
sensitivity factors to each accident year amount and have calculated the amount
of potential net loss and LAE reserve change and the impact on 2022 reported
pre-tax income and on net income and shareholders' equity at December 31, 2022 .
We believe it is not appropriate to sum the illustrated amounts as it is not
reasonably likely that each accident year's reserve estimate assumptions will
vary simultaneously in the same direction to the full extent of the sensitivity
factor. The shareholders' equity amounts include an income tax rate assumption
of 21%, however due to the net operating losses ("NOL") available to use against
taxable income and the offsetting valuation allowance, there is no difference
between pre-tax income and shareholders' equity in this schedule. The dollar
amounts in the table are in thousands.
As of December 31,
2022 Impact
Ultimate
Loss and
Net Ultimate Net Loss and LAE
Loss and LAE Sensitivity Pre- Shareholders'
LAE (1) Reserves (1) Factor Tax Income (2) Equity (2)
Increased Ultimate Losses & LAE
Accident Year 2022 $ 57,136 $ 36,262 10.0 % $ (5,714 ) $ (4,514 )
Accident Year 2021 52,152 22,840 5.0 % (2,608 ) (2,060 )
Accident Year 2020 46,128 16,142 2.5 % (1,153 ) (911 )
Prior to 2020 Accident Years - 7,645 - % - -
Decreased Ultimate Losses & LAE
Accident Year 2022 57,136 36,262 (10.0 )% 5,714 4,514
Accident Year 2021 52,152 22,840 (5.0 )% 2,608 2,060
Accident Year 2020 46,128 16,142 (2.5 )% 1,153 911
Prior to 2020 Accident Years - 7,645 - % - -
(1) Represents amounts as of December 31, 2022 .
(2) Represents how pre-tax income and shareholders' equity would change if the
Net Ultimate Loss and LAE were to change by the percentage in the Ultimate Loss
and LAE Sensitivity Factor column.
Investment Valuation and Impairment
We carry debt securities classified as availableforsale at fair value, and
unrealized gains and losses on such securities, net of any deferred taxes, are
reported as a separate component of accumulated other comprehensive income. Our
equity securities that do not result in consolidation and are not accounted for
under the equity method are measured at fair value and any changes in fair value
are recognized in net income. We carry other equity investments that do not have
a readily
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determinable fair value at cost, less impairment and adjusted for observable
price changes under the measurement alternative provided under GAAP. We review
these investments for impairment during each reporting period. We do not have
any securities classified as trading or held to maturity.
We evaluate our availableforsale investments regularly to determine whether
there have been declines in value that are otherthantemporary. Our outside
investment managers assist us in this evaluation. When we determine that a
security has experienced an otherthantemporary impairment, the impairment loss
is recognized as a realized investment loss.
We consider a number of factors in assessing whether an impairment is
otherthantemporary, including (1) the amount and percentage that current fair
value is below cost or amortized cost, (2) the length of time that the fair
value has been below cost or amortized cost and (3) recent corporate
developments or other factors that may impact an issuer's near term prospects.
In addition, for debt securities, we consider the credit quality ratings for the
securities, with a special emphasis on securities downgraded to below investment
grade. We also consider our intent to sell availableforsale debt securities in
an unrealized loss position, and if it is more likely than not that we will be
required to sell these securities before a recovery in fair value to their cost
or amortized cost basis.
Fair values are measured in accordance with ASC 820, Fair Value Measurements.
The guidance establishes a framework for measuring fair value and a threelevel
hierarchy based upon the quality of inputs used to measure fair value. The three
levels of the fair value hierarchy are: (1) Level 1: inputs are based on quoted
prices (unadjusted) in active markets for identical assets or liabilities, (2)
Level 2: inputs are other than quoted prices that are observable for the asset
or liabilities, either directly or indirectly, for substantially the full term
of the asset or liability and (3) Level 3: unobservable inputs that are
supported by little or no market activity. The unobservable inputs represent the
Company's best assumption of how market participants would price the assets or
liabilities. The Company also has investment company limited partnership
investments, which are measured at net asset value (NAV). The fair value of
these investments is based on the capital account balances reported by the
investment funds subject to their management review and adjustment. The capital
account balances reflect the fair value of the investment funds.
The fair values of debt and equity securities have been determined using fair
value prices provided by our investment managers, who utilize internationally
recognized independent pricing services. The prices provided by the independent
pricing services are generally based on observable market data in active markets
(e.g., broker quotes and prices observed for comparable securities).
The values for publiclytraded equity securities are generally based on Level 1
inputs which use the market approach valuation technique. The values for debt
securities generally incorporate significant Level 2 inputs. The carrying value
of cash and shortterm investments approximate their fair values due to their
shortterm maturity.
We review fair value prices provided by our outside investment managers for
reasonableness by comparing the fair values provided by the managers to those
provided by our investment custodian. We also review and monitor changes in
unrealized gains and losses. We obtain an understanding of the methods, models
and inputs used by our investment managers and independent pricing services, and
controls are in place to validate that prices provided represent fair values.
Our control process includes initial and ongoing evaluation of the methodologies
used, a review of specific securities and an assessment for proper
classification within the fair value hierarchy.
Income Taxes
As ofDecember 31, 2022 , we have federal and state income tax NOL carryforwards of$65.6 million and$107.2 million , respectively. Of the NOL carryforwards,$50.4 million will expire in tax years 2030 through 2042 and$15.2 million will never expire. Of the federal NOL amount,$7.6 million are subject to limitations under Section 382 of the Internal Revenue Code. These net NOL carryforwards are limited in the amount that can be utilized in any one year and may expire before they are realized. At this time we do not expect that any of the remaining NOL carryforwards will expire before utilized. A valuation allowance of$21.7 million and$14.6 million has been recorded against the gross deferred tax assets as ofDecember 31, 2022 and 2021, respectively, as the Company has recognized a three-year cumulative loss as ofDecember 31, 2022 which is significant negative evidence to support the lack of recoverability of those deferred tax assets in accordance 43 -------------------------------------------------------------------------------- with ASC 740, Income Taxes. If the$21.7 million valuation allowance as ofDecember 31, 2022 were reversed in the future, it would increase book value by$1.77 per share. The net deferred tax assets were zero as ofDecember 31, 2022 and 2021. If, in the future, we determine we can support the recoverability of a portion or all of the deferred tax assets under the guidance, the tax benefits relating to any reversal of the valuation allowance on deferred tax assets will be accounted for as a reduction of income tax expense and result in an increase in equity. Changes in tax laws and rates may affect recorded deferred tax assets and liabilities and our effective tax rate in the future.
Non-GAAP Financial Measures
Adjusted Operating Income (Loss) and Adjusted Operating Income (Loss) Per Share
Adjusted operating income (loss) and adjusted operating income (loss) per share
are non-GAAP measures that represent net income allocable to common shareholders
excluding net realized investment gains and losses, net of tax, change in fair
value of equity securities, net of tax, the gain from VSRM Transaction, net of
tax, the loss portfolio transfer risk fee, net of tax, and other gains and
losses, net of tax. The most directly comparable financial GAAP measures to
adjusted operating income and adjusted operating income per share are net income
and net income per share, respectively. Adjusted operating income and adjusted
operating income per share are intended as supplemental information and are not
meant to replace net income or net income per share. Adjusted operating income
and adjusted operating income per share should be read in conjunction with the
GAAP financial results. Our definition of adjusted operating income may be
different from that used by other companies. The following is a reconciliation
of net income to adjusted operating income (dollars in thousands), as well as
net income per share to adjusted operating income per share:
For the Years Ended December 31,
2022 2021 2020
Net income (loss) $ (10,681 ) $ (1,094 ) $ 595
Less:
Net realized investment gains (losses), net
of tax (1,505 ) 2,878 8,126
Change in fair value of equity securities,
net of tax 403 (2,020 ) 228
Gain from VSRM Transaction, net of tax 8,810 - -
Loss portfolio transfer risk fee, net of tax (5,400 ) - -
Other gains (losses), net of tax 59 11,664 260
Adjusted operating income (loss) $ (13,048 ) $
(13,616 )
Weighted average common shares, diluted 10,692,090
9,691,998 9,625,059
Diluted income (loss) per common share: Net income (loss)$ (1.00 ) $ (0.11 ) $ 0.06 Less: Net realized investment gains (losses), net of tax (0.14 ) 0.30 0.84 Change in fair value of equity securities, net of tax 0.04 (0.21 ) 0.02 Gain from VSRM Transaction, net of tax 0.82 - - Loss portfolio transfer risk fee, net of tax (0.51 ) - - Other gains (losses), net of tax 0.01 1.20 0.03
Adjusted operating income (loss) per share
We use adjusted operating income and adjusted operating income per share, in
conjunction with other financial measures, to assess our performance and to
evaluate the results of our business. We believe these measures provide
investors with valuable information relating to our ongoing performance that may
be obscured by the effect of investment gains and losses as a result of our
market risk sensitive instruments, which primarily relate to fixed income
securities that are available-for-sale and not held for trading purposes.
Realized investment gains and losses may vary significantly between periods and
are generally driven by external economic developments, such as capital market
conditions. Accordingly, adjusted operating income excludes the effect of items
that tend to be highly variable from period to period and highlights the results
from our ongoing business operations and the underlying loss or profitability of
our business. We believe that it is useful for investors to evaluate adjusted
operating income and adjusted operating income per share, along with net income
and net income per share, when reviewing and evaluating our performance.
44
--------------------------------------------------------------------------------Executive Overview
The Company's gross written premiums increased$5.9 million , or 4.5%, to$138.0 million in 2022, compared to$132.1 million in 2021. This was due to a substantial increase in gross written premiums in our personal lines of business, specifically low-value dwelling. This increase was primarily due to additional exposures and increased rates. Our personal lines gross written premium increased$6.1 million , or 40.8%, to$21.1 million in 2022, compared to$15.0 million in 2021.
The Company reported a net loss of
Adjusted operating loss, a non-GAAP measure, was$13.0 million , or$1.22 per share, for the year endedDecember 31, 2022 , compared to an adjusted operating loss of$13.6 million , or$1.40 per share, for the year endedDecember 31, 2021 . The 2022 results included an$8.8 million non-operating gain in the fourth quarter of 2022 from the step acquisition of VSRM and subsequent sale of its security guard and alarm installation insurance brokerage business to a third party insurance brokerage firm. The Company also recorded a tax benefit of$9.4 million from the utilization of net operating loss tax carryforwards ("NOLs") applied against the taxable gain on the transaction. The deferred tax assets associated with the NOLs had a valuation allowance against it, and thus there was the recognition of the benefit in the period it was used. The Company entered into a loss portfolio transfer reinsurance agreement onNovember 1, 2022 with Fleming Re in order to reduce its exposure to future unfavorable development on its reserves. The Company was charged a one-time risk fee of$5.4 million , which was reflected as a non-operating loss. Fleming Re will cover an aggregate limit of$66.3 million of paid losses on$40.8 million of stated net reserves as ofJune 30, 2022 , relating to accident years 2019 and prior. Within the aggregate limit, there is a$5.5 million loss corridor in which the Company retains losses in excess of$40.8 million . Fleming Re is then responsible to cover paid losses in excess of$46.3 million up to$66.3 million . As ofDecember 31, 2022 , the Company has recorded losses through the$5.5 million corridor and$644,000 into the$20.0 million layer.
In the fourth quarter of 2022, the Company incurred
The 2021 results included an$8.9 million gain from theJune 30, 2021 Venture Transaction, and a$2.8 million gain from the forgiveness of the PPP loan. Both gains are reflected in Other Gains on the Consolidated Statements of Operations. We also saw continued improvement in our current accident year underwriting results as our mix of business and other underwriting changes helped to produce a 2021 accident year combined ratio of 93.3%. These positive results were offset by$19.4 million of adverse development from prior accident years.
The Company experienced
45
--------------------------------------------------------------------------------Results of Operations - 2022 Compared to 2021
The following table summarizes our operating results for the years indicated
(dollars in thousands):
Summary Operating Results
Years Ended December 31,
2022 2021 $ Change % Change
Gross written premiums $ 138,019 $ 132,095 $ 5,924 4.5 %
Net written premiums $ 91,232 $ 101,429 $ (10,197 ) (10.1 %)
Net earned premiums $ 96,711 $ 98,802 $ (2,091 ) (2.1 %)
Other income 2,768 2,671 97 3.6 %
Losses and loss adjustment
expenses, net 81,440 69,861 11,579 16.6 %
Policy acquisition costs 22,179 28,451 (6,272 ) (22.0 %)
Operating expenses 18,789 16,509 2,280 13.8 %
Loss portfolio transfer risk fee 5,400 - 5,400 *
Underwriting gain (loss) (28,329 ) (13,348 ) (14,981 ) (112.2 %)
Net investment income 3,043 1,968 1,075 54.6 %
Net realized investment gains
(losses) (1,505 ) 2,878 (4,383 ) *
Change in fair value of equity
securities 403 (2,020 ) 2,423 *
Gain from VSRM Transaction 8,810 - 8,810 *
Other gains (losses) 59 11,664 (11,605 ) *
Interest expense 2,971 2,852 119 4.2 %
Income (loss) before income taxes (20,490 ) (1,710 ) (18,780 ) *
Equity earnings in Affiliate, net
of tax 368 824 (456 ) (55.3 %)
Income tax expense (9,441 ) 208 (9,649 ) *
Net income (loss) $ (10,681 ) $ (1,094 ) $ (9,587 ) *
Underwriting Ratios:
Loss ratio (1) 83.9 % 70.5 %
Expense ratio (2) 38.4 % 42.4 %
Combined ratio (3) 122.3 % 112.9 %
(1)
The loss ratio is the ratio, expressed as a percentage, of net losses and loss
adjustment expenses to net earned premiums and other income from underwriting
operations.
(2)
The expense ratio is the ratio, expressed as a percentage, of policy acquisition costs and operating expenses to net earned premiums and other income from underwriting operations.
(3)
The combined ratio is the sum of the loss ratio and the expense ratio. A combined ratio under 100% indicates an underwriting profit. A combined ratio over 100% indicates an underwriting loss.
* Percentage change is not meaningful
Premiums
Premiums are earned ratably over the term of the policy, whereas written
premiums are reflected on the effective date of the policy. Almost all
commercial lines and homeowners products have annual policies, under which
premiums are earned evenly over one year. The resulting net earned premiums are
impacted by the gross and ceded written premiums, earned ratably over the terms
of the policies.
46
--------------------------------------------------------------------------------
Our premiums are presented below for the years ended December 31, 2022 and 2021
(dollars in thousands):
Summary of Premium Revenue
Years Ended December 31,
2022 2021 $ Change % Change
Gross written premiums
Commercial lines $ 116,868 $ 117,075 $ (207 ) (0.2 %)
Personal lines 21,151 15,020 6,131 40.8 %
Total $ 138,019 $ 132,095 $ 5,924 4.5 %
Net written premiums
Commercial lines $ 72,318 $ 87,307 $ (14,989 ) (17.2 %)
Personal lines 18,914 14,122 4,792 33.9 %
Total $ 91,232 $ 101,429 $ (10,197 ) (10.1 %)
Net Earned premiums
Commercial lines $ 80,823 $ 87,759 $ (6,936 ) (7.9 %)
Personal lines 15,888 11,043 4,845 43.9 %
Total $ 96,711 $ 98,802 $ (2,091 ) (2.1 %)
Gross written premiums increased by $5.9 million , or 4.5%, to $138.0 million ,
for the year ended December 31, 2022 , compared to $132.1 million for the year
ended December 31, 2021 . The increase was attributable to an increase in written
premium in our small business and low-value dwelling programs, which was offset
by a decrease in written premium in our hospitality programs. Increases in the
personal lines business was primarily attributable to an increase in policies,
but also due to increases in rates.
Commercial lines gross written premiums decreased $207,000 , or 0.2%, to $116.9
million , for the year ended December 31, 2022 , compared to $117.1 million for
the year ended December 31, 2021 . Gross written premiums for our small business
programs increased by $4.5 million , or 5.3%, to $89.9 million , for the year
ended December 31, 2022 , compared to $85.4 million for the year ended December
31, 2021 . This increase was offset by our hospitality programs gross written
premiums, which decreased by $4.7 million , or 14.9%, to $27.0 million , for the
year ended December 31, 2022 , compared to $31.7 million for the year ended
December 31, 2021 .
Personal lines gross written premiums increased $6.1 million , or 40.8%, to $21.1
million , for the year ended December 31, 2022 , compared to $15.0 million for the
year ended December 31, 2021 . This increase was largely driven by our low-value
dwelling business.
Net written premiums decreased $10.2 million , or 10.1%, to $91.2 million , for
the year ended December 31, 2022 , compared to $101.4 million for the year ended
December 31, 2021 . The Company entered into new specific loss reinsurance
treaties on December 31, 2021 and January 1, 2022 , which included a 40% ceding
commission. This increased ceded written premiums by approximately $11.4 million
in 2022. There was no ceding commission on excess of loss treaties during 2021.
Ceded earned premiums also increased due to the new treaties by $8.9 million .
The increase in ceded earned premiums was offset by the same increase in ceding
commissions, which reduced acquisition costs.
Other Income
Other income consists primarily of fees charged to policyholders by the Company for services outside of the premium charge, such as installment billings and policy issuance costs. Other income also includes the interest income from the$6.0 million and$3.0 million promissory notes relating to the Venture Transaction. The$3.0 million promissory note was paid down by Venture onDecember 14, 2021 , and$5.0 million of the$6.0 million promissory note was paid down by Venture onOctober 20, 2022 . Commission income is also received by the Company's insurance agency for writing policies for third-party insurance companies. All of the third-party business was sold to Venture atJune 30, 2021 . Accordingly, other income from that business diminished in 2022 as that business transitioned to Venture. 47 -------------------------------------------------------------------------------- Other income increased by$97,000 , or 3.6%, to$2.8 million for the year endedDecember 31, 2022 , compared to$2.7 million for the year endedDecember 31, 2021 . Other income relating to installment billings and policy issuance costs was lower in 2022 because of the Venture Transaction. This was offset by the interest income received from the$6.0 million promissory note during 2022.
Losses and Loss Adjustment Expenses
The tables below detail our losses and LAE and loss ratios for the years ended
Commercial Personal
Year Ended December 31, 2022 Lines Lines Total
Accident year net losses and LAE
406 24,284
Calendar year net loss and LAE
Accident year loss ratio 57.9 % 64.3 % 58.9 %
Net (favorable) adverse development 29.4 % 2.6 % 25.0 %
Calendar year loss ratio 87.3 % 66.9 % 83.9 %
Commercial Personal
Year Ended December 31, 2021 Lines Lines Total
Accident year net losses and LAE
957 19,432
Calendar year net loss and LAE
Accident year loss ratio 51.6 % 45.0 % 50.9 % Net (favorable) adverse development 21.0 % 8.6 % 19.6 % Calendar year loss ratio 72.6 % 53.6 % 70.5 % Net losses and LAE increased by$11.5 million , or 16.6%, to$81.4 million for the year endedDecember 31, 2022 , compared to$69.9 million for the year endedDecember 31, 2021 . The calendar year loss ratios were 83.9% and 70.5% for the years endedDecember 31, 2022 and 2021, respectively. The Company experienced$24.3 million of adverse development for the year endedDecember 31, 2022 . Of the$24.3 million of adverse development,$23.9 million was related to the Company's commercial lines of business, while$406,000 was related to the Company's personal lines of business. Of the$24.3 million of adverse development,$1.8 million was related to the 2021 accident year,$4.0 million was related to the 2020 accident year,$9.6 million was related to the 2019 accident year,$5.2 million was related to the 2018 accident year, and$3.7 million was related to 2017 and prior accident years. The adverse development was mostly related to the Company's commercial liability lines and was driven by multiple factors including significant social inflation generating higher severity than historical experience, and longer tail exposure than anticipated, particularly in certain jurisdictions. The$19.4 million of adverse development in 2021 consisted of$18.5 million from commercial lines and$957,000 from personal lines and mostly related to the 2019 and prior accident years. Expense Ratio Our expense ratio is a measure of the efficiency and performance of the commercial and personal lines of business (our risk-bearing underwriting operations). It is calculated by dividing the sum of policy acquisition costs and other underwriting expenses by the sum of net earned premiums and other income of the underwriting business. Costs that cannot be readily identifiable as a direct cost of a segment or product line remain in Corporate for segment reporting purposes. The expense ratio excludes wholesale agency and Corporate expenses. 48 --------------------------------------------------------------------------------
The table below provides the expense ratio by major component:
Years Ended December 31,
2022 2021
Commercial Lines
Policy acquisition costs 21.8 % 29.2 %
Operating expenses 16.1 % 13.2 %
Total 37.9 % 42.4 %
Personal Lines
Policy acquisition costs 28.8 % 29.6 %
Operating expenses 12.2 % 12.1 %
Total 41.0 % 41.7 %
Total Underwriting
Policy acquisition costs 23.0 % 29.3 %
Operating expenses 15.4 % 13.1 %
Total 38.4 % 42.4 %
Our expense ratio decreased by 4.0% to 38.4% for the year ended December 31,
2022 , as compared to the same period in 2021. The decrease was largely due to a
reduction in policy acquisition costs attributable to $11.4 million of ceding
commission from new excess of loss reinsurance treaties. There were no
commissions on excess of loss treaties in 2021.
Policy acquisition costs are costs we incur to issue policies, which include
commissions, premium taxes, underwriting reports and underwriter compensation
costs. The Company offsets direct commissions with ceded commissions from
reinsurers. The percentage of policy acquisition costs to net earned premiums
and other income decreased by 6.3%, from 29.3% in 2021, to 23.0% in 2022, mostly
due to the new ceding commission mentioned above.
Operating expenses consist primarily of employee compensation, information
technology and occupancy costs, such as rent and utilities. Operating expenses
as a percent of net earned premiums and other income increased by 2.3%, from
13.1% in 2021, to 15.4% in 2022. The new excess of loss reinsurance treaties
with the ceding commission drove net earned premiums lower, resulting in a
slightly higher operating expense ratio.
Underwriting Results
We measure the performance of our consolidated results, in part, based on our underwriting gain or loss. The following table provides the underwriting gain or loss for the years endedDecember 31, 2022 and 2021 (dollars in thousands): Underwriting Gain (Loss) Years Ended December 31, 2022 2021 Change Commercial Lines$ (25,845 ) $ (13,229 ) $ (12,616 ) Personal Lines (1,248 ) 529 (1,777 ) Total Underwriting (27,093 ) (12,700 ) (14,393 ) Wholesale Agency (554 ) (261 ) (293 ) Corporate (921 ) (757 ) (164 ) Eliminations 239 370
(131 )
Total underwriting income (loss)
49
--------------------------------------------------------------------------------Investment Income
Net investment income increased by$1.0 million , or 54.6%, to$3.0 million for the year endedDecember 31, 2022 , compared to$2.0 million for the year endedDecember 31, 2021 . This increase was due to an increase in interest income in our debt securities due to higher interest rates in 2022. Average invested assets during 2022 were$160.1 million compared to$183.0 million for the same period in 2021. The investment portfolio was comprised of 81.2% debt securities, 3.5% equity securities, and 15.3% short-term investments as ofDecember 31, 2022 . The investment portfolio was comprised of 82.5% debt securities, 7.6% equity securities, and 9.9% short-term investments as ofDecember 31, 2021 . The debt securities portfolio had an average credit quality was AA+ and AA atDecember 31, 2022 and 2021, respectively. The portfolio produced a tax-equivalent book yield of 2.3% and 1.4% for the years endedDecember 31, 2022 and 2021, respectively. The option adjusted duration of the debt securities portfolio was 3.5 years and 3.6 years atDecember 31, 2022 and 2021, respectively.
Realized Investment Gains (Losses)
Net realized investment losses were$1.5 million during 2022, compared to$2.9 million of investment gains in 2021. The$4.4 million decrease was due to the Company repositioning its equity portfolio as well as negative overall market conditions that were experienced during 2022.
Interest Expense
Interest expense was$2.9 million for the years endedDecember 31, 2022 and 2021. We issued$25.3 million of public senior unsecured notes (the "Notes") in 2018. The Company did not repurchase any of the Notes in 2022 and 2021. Interest expense includes the amortization of debt issuance costs relating to the Notes which is$260,000 per annum over the 5-year life of the Notes. The interest expense relating to the amortization of debt issuance costs for the existing$10.5 million of the Subordinated Notes is$51,000 per annum over the 20-year life of the Subordinated Notes. The Company had a$10.0 million line of credit during 2022 and 2021, which it drew upon and paid down at various times. This contributed to the interest expense in 2022 and 2021. The Company had no outstanding balance on its line of credit onDecember 31, 2022 , as the line of credit agreement matured onDecember 1, 2022 . The line of credit agreement was not renewed with the Lender after it matured onDecember 1, 2022 . Income Tax Expense For the year endedDecember 31, 2022 , the Company reported$6,000 of current federal income tax expense and$39,000 of current state income tax expense. The Company reported a deferred tax benefit of$9.4 million and$0 for the years endedDecember 31, 2022 and 2021, respectively. There is a$21.7 million valuation allowance against 100% of the net deferred tax assets atDecember 31, 2022 , which would increase book value by$1.77 per share if reversed in the future. The valuation allowance was$14.6 million as ofDecember 31, 2021 . As ofDecember 31, 2022 , the Company has net operating loss carryforwards for federal income tax purposes of$65.6 million , of which$50.4 million expire in tax years 2030 through 2042 and$15.2 million never expire. Of this amount,$7.6 million are limited in the amount that can be utilized in any one year and may expire before they are realized under Section 382 of the Internal Revenue Code. The Company has state net operating loss carryforwards of$107.2 million , which expire in tax years 2023 through 2042. 50 --------------------------------------------------------------------------------
Results of Operations - 2021 Compared to 2020
The following table summarizes our operating results for the years indicated (dollars in thousands):
Summary Operating Results
Years Ended December 31,
2021 2020 $ Change % Change
Gross written premiums $ 132,095 $ 111,335 $ 20,760 18.6 %
Net written premiums $ 101,429 $ 92,940 $ 8,489 9.1 %
Net earned premiums $ 98,802 $ 89,103 $ 9,699 10.9 %
Other income 2,671 2,615 56 2.1 %
Losses and loss adjustment expenses,
net 69,861 56,228 13,633 24.2 %
Policy acquisition costs 28,451 26,105 2,346 9.0 %
Operating expenses 16,509 18,468 (1,959 ) (10.6 %)
Underwriting gain (loss) (13,348 ) (9,083 ) (4,265 ) (47.0 %)
Net investment income 1,968 3,156 (1,188 ) (37.6 %)
Net realized investment gains 2,878 8,126 (5,248 ) (64.6 %)
Change in fair value of equity
securities (2,020 ) 228 (2,248 ) *
Other gains (losses) 11,664 260 11,404 *
Interest expense 2,852 2,925 (73 ) (2.5 %)
Income (loss) before income taxes (1,710 ) (238 ) (1,472 ) *
Equity earnings (losses) in Affiliate,
net of tax 824 839 (15 ) (1.8 %)
Income tax expense (benefit) 208 6 202 *
Net income (loss) $ (1,094 ) $ 595 $ (1,689 ) *
Underwriting Ratios:
Loss ratio (1) 70.5 % 62.8 %
Expense ratio (2) 42.4 % 45.6 %
Combined ratio (3) 112.9 % 108.4 %
(1)
The loss ratio is the ratio, expressed as a percentage, of net losses and loss
adjustment expenses to net earned premiums and other income from underwriting
operations.
(2)
The expense ratio is the ratio, expressed as a percentage, of policy acquisition costs and operating expenses to net earned premiums and other income from underwriting operations.
(3)
The combined ratio is the sum of the loss ratio and the expense ratio. A combined ratio under 100% indicates an underwriting profit. A combined ratio over 100% indicates an underwriting loss.
* Percentage change is not meaningful
51
--------------------------------------------------------------------------------Premiums
Premiums are earned ratably over the term of the policy, whereas written premiums are reflected on the effective date of the policy. Almost all commercial lines and homeowners products have annual policies, under which premiums are earned evenly over one year. The resulting net earned premiums are impacted by the gross and ceded written premiums, earned ratably over the terms of the policies. Our premiums are presented below for the years endedDecember 31, 2021 and 2020 (dollars in thousands): Summary of Premium Revenue Years Ended December 31, 2021 2020 $ Change % Change Gross written premiums Commercial lines$ 117,075 $ 102,763 $ 14,312 13.9 % Personal lines 15,020 8,572 6,448 75.2 % Total$ 132,095 $ 111,335 $ 20,760 18.6 % Net written premiums Commercial lines$ 87,307 $ 85,385 $ 1,922 2.3 % Personal lines 14,122 7,555 6,567 86.9 % Total$ 101,429 $ 92,940 $ 8,489 9.1 % Net Earned premiums Commercial lines$ 87,759 $ 82,409 $ 5,350 6.5 % Personal lines 11,043 6,694 4,349 65.0 % Total$ 98,802 $ 89,103 $ 9,699 10.9 % Gross written premiums increased by$20.8 million , or 18.6%, to$132.1 million for the year endedDecember 31, 2021 , compared to$111.3 million for the year endedDecember 31, 2020 . The increase was attributable to an increase in written premium in our small business and low-value dwelling programs, which was slightly offset by a decrease in written premium in our hospitality programs. Commercial lines gross written premiums increased$14.3 million , or 13.9%, to$117.1 million , for the year endedDecember 31, 2021 , compared to$102.8 million for the year endedDecember 31, 2020 . Gross written premiums for our small business programs increased by$20.3 million , or 31.1%, to$85.4 million for the year endedDecember 31, 2021 , compared to$65.1 million for the year endedDecember 31, 2020 . This increase was offset by our hospitality programs gross written premiums, which decreased by$5.9 million , or 15.8%, to$31.7 million for the year endedDecember 31, 2021 , compared to$37.7 million for the year endedDecember 31, 2020 . Personal lines gross written premiums increased$6.4 million , or 75.2%, to$15.0 million for the year endedDecember 31, 2021 , compared to$8.6 million for the same period in 2020. This increase was largely driven by our low-value dwelling business. Net written premiums increased$8.5 million , or 9.1%, to$101.4 million , for the year endedDecember 31, 2021 , compared to$92.9 million , for the year endedDecember 31, 2020 . The increase was due to the increase in gross written premium during 2021. However, this increase was reduced by increased reinsurance rates, and the Company entering into a new specific loss commercial liability treaty onDecember 31, 2021 , that included a 40% ceding commission and resulted in an additional$4.4 million of ceded written premiums at the inception of the agreement. Ceding commissions increased by$1.8 million as well. Ceded earned premiums and total acquisition costs were not impacted in 2021 from this new treaty, after taking into account the change in deferred acquisition costs. However, going forward, we would expect to see higher ceded earned premiums and lower acquisition costs as a result of this treaty. 52 --------------------------------------------------------------------------------
Other Income
Other income consists primarily of fees charged to policyholders by the Company for services outside of the premium charge, such as installment billings and policy issuance costs. Other income also includes the interest income from the$6.0 million and$3.0 million promissory notes relating to the Venture Transaction. The$3.0 million promissory note was paid down by Venture onDecember 14, 2021 . Commission income is also received by the Company's insurance agency for writing policies for third-party insurance companies. All of the third-party business was sold to Venture atJune 30, 2021 . Accordingly, other income from that business will diminish over the next few quarters as it transitions over to Venture, and will ultimately no longer occur. Other income increased by$56,000 , or 2.1%, to$2.7 million for the year endedDecember 31, 2021 , compared to$2.6 million in 2020. Other income relating to installment billings and policy issuance costs was lower in the second half of 2021, as the business that was sold to Venture atJune 30, 2021 , no longer produces other income for the Company. This was more than offset by an increase in the interest income in 2021 of$306,000 from the notes payable.
Losses and Loss Adjustment Expenses
The tables below detail our losses and LAE and loss ratios for the years ended
Commercial Personal
Year Ended December 31, 2021 Lines Lines Total
Accident year net losses and LAE
957 19,432
Calendar year net loss and LAE
Accident year loss ratio 51.6 % 45.0 % 50.9 %
Net (favorable) adverse development 21.0 % 8.6 % 19.6 %
Calendar year loss ratio 72.6 % 53.6 % 70.5 %
Commercial Personal
Year Ended December 31, 2020 Lines Lines Total
Accident year net losses and LAE
352 15,594
Calendar year net loss and LAE
Accident year loss ratio 46.0 % 38.2 % 45.4 % Net (favorable) adverse development 18.4 % 5.1 % 17.4 % Calendar year loss ratio 64.4 % 43.3 % 62.8 % Net losses and LAE increased by$13.6 million , or 24.2% to$69.9 million for the year endedDecember 31, 2021 , compared to$56.2 million in 2020. The calendar year loss ratios were 70.5% and 62.8% for the years endedDecember 31, 2021 and 2020, respectively. The$19.4 million of adverse development in 2021 consisted of$18.5 million from commercial lines and$957,000 from personal lines and mostly related to the 2019 and prior accident years. The$15.6 million of adverse development in 2020 consisted of$15.2 million from commercial lines and$352,000 from personal lines and mostly related to the 2018 and 2017 accident years. Expense Ratio Our expense ratio is a measure of the efficiency and performance of the commercial and personal lines of business (our risk-bearing underwriting operations). It is calculated by dividing the sum of policy acquisition costs and other underwriting expenses by the sum of net earned premiums and other income of the underwriting business. Costs that cannot be readily identifiable as a direct cost of a segment or product line remain in Corporate for segment reporting purposes. The expense ratio excludes wholesale agency and Corporate expenses. 53 --------------------------------------------------------------------------------
The table below provides the expense ratio by major component:
Years Ended December 31,
2021 2020
Commercial Lines
Policy acquisition costs 29.2% 30.3%
Operating expenses 13.2% 15.3%
Total 42.4% 45.6%
Personal Lines
Policy acquisition costs 29.6% 29.9%
Operating expenses 12.1% 15.6%
Total 41.7% 45.5%
Total Underwriting
Policy acquisition costs 29.3% 30.3%
Operating expenses 13.1% 15.3%
Total 42.4% 45.6%
Our expense ratio decreased by 3.2%, to 42.4% for the year ended
Policy acquisition costs are costs we incur to issue policies, which include commissions, premium taxes, underwriting reports and underwriter compensation costs. The Company offsets direct commissions with ceded commissions from reinsurers. The percentage of policy acquisition costs to net earned premiums and other income decreased by 1.0%, from 30.3% in 2020, to 29.3% in 2021. Operating expenses consist primarily of employee compensation, information technology and occupancy costs, such as rent and utilities. Operating expenses as a percent of net earned premiums and other income was 13.1% and 15.3% for the years endedDecember 31, 2021 and 2020, respectively. The lower operating expense ratio was largely due to the Venture Transaction, where 21 employees transitioned from Conifer to Venture onJune 30, 2021 .
Underwriting Results
We measure the performance of our consolidated results, in part, based on our underwriting gain or loss. The following table provides the underwriting gain or loss for the years endedDecember 31, 2021 and 2020 (dollars in thousands): Underwriting Gain (Loss) Years Ended December 31, 2021 2020 Change Commercial Lines$ (13,229 ) $ (8,307 ) $ (4,922 ) Personal Lines 529 766 (237 ) Total Underwriting (12,700 ) (7,541 ) (5,159 ) Wholesale Agency (261 ) (474 ) 213 Corporate (757 ) (1,403 ) 646 Eliminations 370 335 35
Total underwriting income (loss)
54
--------------------------------------------------------------------------------Investment Income
Net investment income decreased by$1.2 million , or 37.6%, to$2.0 million for the year endedDecember 31, 2021 , compared to$3.1 million for the year endedDecember 31, 2020 . This decrease was due to a decrease in interest income in our debt securities due to lower interest rates. Average invested assets during 2021 were$183.0 million compared to$176.5 million for the same period in 2020. The investment portfolio was comprised of 82.5% debt securities, 7.6% equity securities, and 9.9% short-term investments as ofDecember 31, 2021 . The investment portfolio was comprised of 80.2% debt securities, 7.1% equity securities and 12.7% short-term investments as ofDecember 31, 2020 . The debt securities portfolio had an average quality was AA and AA+ atDecember 31, 2021 and 2020, respectively. The portfolio produced a tax-equivalent book yield of 1.4% and 1.6% for the years endedDecember 31, 2021 and 2020, respectively. The option adjusted duration of the debt securities portfolio was 3.6 years atDecember 31, 2021 and 2020, respectively.
Realized Investment Gains
Net realized investment gains decreased by$5.3 million , or 64.6%, to$2.9 million for the year endedDecember 31, 2021 , as compared to$8.1 million for the year endedDecember 31, 2020 . The decrease was due to overall market conditions in 2021 that reduced the Company's ability to sell portions of its debt and equity securities for realized gains.
Interest Expense
Interest expense was$2.9 million for the years endedDecember 31, 2021 and 2020. We issued$25.3 million of public senior unsecured notes (the "Notes") in 2018. Proceeds from the Notes were used to pay down$19.5 million of the$30.0 million of subordinated notes that were issued in the third quarter of 2017. The Company did not repurchase any of the Notes in 2021. The Company repurchased 36,761 units of the Notes in the public market in 2020. Interest expense includes the amortization of debt issuance costs relating to the Notes which is$260,000 per annum over the 5-year life of the Notes. The interest expense relating to the amortization of debt issuance costs for the existing$10.5 million of the Subordinated Notes is$51,000 per annum over the 20-year life of the Subordinated Notes. The Company has a$10.0 million line of credit, which it drew upon and paid down at various times throughout 2021, and which contributed to interest expense. The Company had no outstanding balance on its line of credit as ofDecember 31, 2021 .
Income Tax Expense
For the year endedDecember 31, 2021 , the Company reported$5,000 of current federal income tax expense and$203,000 of current state income tax expense. The Company reported a deferred tax benefit of$0 for the years endedDecember 31, 2021 and 2020, respectively. There is a$14.6 million valuation allowance against 100% of the net deferred tax assets atDecember 31, 2021 , which would increase book value by$1.50 per share if reversed in the future. The valuation allowance was$13.3 million as ofDecember 31, 2020 . As ofDecember 31, 2021 , the Company has net operating loss carryforwards for federal income tax purposes of$59.7 million , of which$49.8 million expire in tax years 2028 through 2041 and$9.9 million never expire. Of this amount,$12.8 million are limited in the amount that can be utilized in any one year and may expire before they are realized under Section 382 of the Internal Revenue Code. The Company has state net operating loss carryforwards of$17.0 million , which expire in tax years 2022 through 2041. 55 --------------------------------------------------------------------------------
Liquidity and Capital Resources
Sources and Uses of Funds
AtDecember 31, 2022 , we had$54.0 million in cash, cash equivalents, and short-term investments. Our principal sources of funds are insurance premiums, investment income, proceeds from maturity and sale of invested assets and other income. These funds are primarily used to pay claims, commissions, employee compensation, taxes and other operating expenses, and service debt. Management plans to issue new public debt or sell assets that will provide sufficient cash flow to pay off the senior unsecured notes that are coming due within the next twelve months. We believe it is probable that we will be able to issue new public debt or sell assets and repay the senior unsecured notes bySeptember 30, 2023 . We believe that our existing cash, cash equivalents, short-term investments and investment securities balances will be adequate to meet our operating liquidity needs and the needs of our subsidiaries on a short-term and long-term basis. With the expected execution of the senior debt refinancing, we believe we can meet our capital needs as well over the next twelve months. We believe that our existing cash, cash equivalents, short-term investments and investment securities balances will be adequate to meet our capital and liquidity needs and the needs of our subsidiaries on a short-term and long-term basis. We conduct our business operations primarily through ourInsurance Company Subsidiaries. Our ability to service debt, and pay administrative expenses is primarily reliant upon our intercompany service fees paid by the Insurance Company Subsidiaries to the holding company for management, administrative, and information technology services provided to the Insurance Company Subsidiaries by the Parent Company. Secondarily, the Parent Company may receive dividends from the Insurance Company Subsidiaries; however, this is not the primary means in which the holding company supports its funding as state insurance laws restrict the ability of our Insurance Company Subsidiaries to declare dividends to the Parent Company. Generally, the limitations are based on the greater of statutory net income for the preceding year or 10% of statutory surplus at the end of the preceding year. No dividends were paid from ourInsurance Company Subsidiaries in 2022, 2021 or 2020. We contributed$6.8 million ,$11.4 million and$1.2 million to our Insurance Company Subsidiaries in 2022, 2021 and 2020, respectively. We believe that the current statutory surplus levels and the funds available at the holding company level will provide the necessary statutory capital to support our premium volume growth over the next twelve months. We are aware that our outstanding debt securities are currently trading at a discount to their face amount. In order to reduce future cash interest payments, as well as future amounts due at maturity or upon redemption, we may, from time to time, purchase such debt for cash, in exchange for common stock, or for a combination of cash and common stock, in open market or privately negotiated transactions. We will evaluate any such transactions in light of then-existing market conditions, taking into account our current liquidity and prospects for future access to capital. The amounts involved in such transactions, individually or in the aggregate, may be material.
Cash Flows
Operating Activities. Cash used by operating activities for the year ended
Cash provided by operating activities for the year endedDecember 31, 2021 was$5.4 million , compared to$3.0 million for the same period in 2020. The$2.4 million increase was primarily due to a$12.4 million increase in premiums collected, net of reinsurance premiums. This increase was offset by a$6.6 million increase in paid claims, a$2.7 million increase in acquisition costs paid, and a$1.4 million decrease in investment income received. Investing Activities. Cash provided by investing activities for the year endedDecember 31, 2022 was$56.5 million compared to$1.4 million in 2021. The$55.1 million increase in cash provided by investing activities over the prior year was 56 -------------------------------------------------------------------------------- driven by$34.3 million increase in net proceeds from sale of investments in 2022, compared to the same period in 2021. The Company also experienced an increase of$32.8 million from its sale of agency business in 2022, compared to the same period in 2021. Cash provided by investing activities for the year endedDecember 31, 2021 was$1.4 million . Cash used in investing activities was$7.3 million in 2020. The$8.7 million increase in cash provided by investing activities over the prior year was driven by a reduction in the purchases of investments in 2021, compared to the same period in 2020. There was a significant repositioning of the Company's portfolio during the year ended 2020 from the COVID-19 pandemic, which caused an increase in the purchase of investments. Financing Activities. Cash provided by financing activities for the years endedDecember 31, 2022 , was$2.1 million compared to$5.0 million of cash used by financing activities for years endedDecember 31, 2021 . The$7.1 million increase was largely attributed to the Company raising$5.0 million through the issuance of additional common stock inAugust 2022 . Cash used by financing activities for the years endedDecember 31, 2021 , was$5.0 million compared to$5.1 million of cash provided by financing activities for years endedDecember 31, 2020 . The$10.1 million decrease in cash provided by financing activities was mostly due to the Company paying down$8.0 million on its line of credit during 2021. The Company's borrowings under debt arrangements were also$2.7 million less in 2021 compared to 2020.
Outstanding Debt
OnApril 24, 2020 , the Company received a$2.7 million PPP loan from the line of credit Lender pursuant to the Paycheck Protection Program of the CARES Act administered by the SBA. The Company received notice from the SBA that the loan was 100% forgiven, including accrued interest, onJuly 8, 2021 . This resulted in a$2.8 million gain that is included in Other Gains on the Consolidated Statement of Operations. In 2018, the Company issued$25.3 million of Notes. The Notes bear an interest rate of 6.75% annum, payable quarterly at the end of March, June, September and December and mature onSeptember 30, 2023 . Proceeds from the Notes were used to pay down$19.5 million of the$30.0 million of subordinated notes that were issued in the third quarter of 2017. The Company did not repurchase any of the Notes during 2022 and 2021. The Company repurchased 36,761 units of the Notes in the public market during 2020 with a face value of$919,000 . The Notes were repurchased at a discount to face value, which resulted in a$260,000 gain on extinguishment in 2020. This gain is reflected in the Consolidated Statement of Operations as Other gains. The Company also has outstanding$10.5 million of Subordinated Notes maturing onSeptember 30, 2038 . The Subordinated Notes bear an interest rate of 7.5% per annum untilSeptember 30, 2023 , and 12.5% thereafter, and allow for four quarterly interest payment deferrals. Interest is payable quarterly at the end of March, June, September and December. BeginningSeptember 30, 2021 , the Company may redeem the Subordinated Notes, in whole or in part, for a call premium of$1.1 million . The call premium escalates each quarter to ultimately$1.75 million onSeptember 30, 2023 , then steps up to$3.05 million onDecember 31, 2023 , and increases quarterly at a 12.5% per annum rate thereafter.
The carrying value of the Notes and Subordinated Notes are offset by
The Company maintained a$10.0 million line of credit with a national bank (the "Lender") that matured onDecember 1, 2022 . The line of credit was not renewed after it matured. The line of credit contained interest at the London Interbank rate ("LIBOR") plus 2.75% per annum, payable monthly. 57 --------------------------------------------------------------------------------
Contractual Obligations and Commitments
The following table is a summary of our contractual obligations and commitments
as of
Payments due by period
Less than One to Three to More than
Total one year three years five years five years
Senior unsecured notes $ 24,381 $ 24,381 $ - $ - $ -
Interest on senior unsecured
notes 1,234 1,234 - - -
Subordinated notes 10,500 - - - 10,500
Interest on subordinated notes 20,606 919 2,625 2,625 14,437
Lease obligations 1,634 328 505 432 369
Unpaid loss and loss
adjustment expense (1) 165,539 59,010 66,646 28,890 10,993
Purchase Obligations (2) 1,380 360 720 300 -
Total $ 225,274 $ 86,232 $ 70,496 $ 32,247 $ 36,299
(1)
The estimated unpaid loss and loss adjustment expense payments were made using
estimates based on historical payment patterns. However, future payments may be
different than historical payment patterns.
(2)
Includes estimated future payments under the software license agreement relating to our policy issuance system. This agreement requires minimum monthly payments of$30,000 , and is variable with premium volume. The future payment assumptions are based on the minimum monthly payments. The software license agreement expires onNovember 1, 2026 .
Regulatory and Rating Issues
The NAIC has a RBC formula to be applied to all property and casualty insurance companies. The formula measures required capital and surplus based on an insurance company's products and investment portfolio and is used as a tool to evaluate the capital adequacy of regulated companies. The RBC formula is used by state insurance regulators to monitor trends in statutory capital and surplus for the purpose of initiating regulatory action. In general, an insurance company must submit a calculation of its RBC formula to the insurance department of its state of domicile as of the end of the previous calendar year. These laws require increasing degrees of regulatory oversight and intervention as an insurance company's RBC declines.
At
Insurance operations are subject to various leverage tests (e.g., premium-to-statutory surplus ratios), which are evaluated by regulators and rating agencies. As ofDecember 31, 2022 , on a trailing twelve-month statutory combined basis, the gross written and net written premium leverage ratios were 2.3 to 1.0 and 1.5 to 1.0, respectively. The NAIC's IRIS was developed to assist state insurance departments in executing their statutory mandates to oversee the financial condition of insurance companies operating in their respective states. IRIS identifies thirteen industry ratios and specifies "usual values" for each ratio. State insurance regulators review the IRIS ratio results to determine if an insurer is in need of further regulatory scrutiny or action. While the ratios, individually and collectively, are useful tools for identifying companies that may be experiencing financial difficulty, they are only a guide for regulators and should not be considered an absolute indicator of a Company's financial condition. While inquiries from regulators are not uncommon, our Insurance Company Subsidiaries have not experienced any regulatory actions due to their IRIS ratio results or otherwise.
Recently Issued Accounting Pronouncements
Refer to Note 1 ~ Summary of Significant Accounting Policies: Recently Issued
Accounting Guidance of the Notes to the Consolidated Financial Statements for
detailed information.
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