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CONIFER HOLDINGS, INC. – 10-Q – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the Periods Ended
The following Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements (Unaudited), related notes and other financial information appearing elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K, filed onMarch 10, 2022 with theU. S. Securities and Exchange Commission .
Forward-Looking Statements
Certain statements contained in this Quarterly Report on Form 10-Q, 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," "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, that could cause
our actual results to differ materially from those in the forward-looking
statements, including those described in our Form 10-K ("Item 1A Risk Factors")
filed with the SEC on March 10, 2022 and subsequent reports filed with or
furnished to the SEC . 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 the
U.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.
Sale of Certain Agency Business
OnJune 30, 2021 , our agency (Sycamore Insurance Agency ) 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. 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 24 -------------------------------------------------------------------------------- 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 will transition to Venture as it produces new or renewal business effectiveJuly 1, 2021 . We expect our Insurance Company Subsidiaries will continue to underwrite substantially all of the business we sold to Venture that we underwrote prior to the transaction. We expect Venture to be able to grow both the business we underwrite as well as the third-party business more effectively as a separate entity outside of Conifer. As ofJune 30, 2022 , the Company had a non-controlling 50% interest in Venture. 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 also 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 into three insurance businesses: commercial insurance lines, personal insurance lines, and wholesale agency business. Together, the commercial and personal lines refer to "underwriting" operations that take insurance risk, and the wholesale agency business refers to non-risk insurance business. Through our commercial insurance product 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 product lines, we offer homeowners insurance and dwelling fire insurance policies 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 . Due to recentFlorida -based industry events, we have been de-emphasizing ourFlorida homeowners' business and reducing our exposures in that state, as well as other wind-exposed states likeTexas andHawaii . 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. We have expanded the wholesale agency business to develop more non-risk revenue streams, and provide 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
In certain circumstances, we are required to make estimates and assumptions that affect amounts reported in our consolidated financial statements and related footnotes. We evaluate these estimates and assumptions periodically on an on-going basis based on a variety of factors. There can be no assurance, however, that actual results will not be materially different than our estimates and assumptions, and that reported results of operations will not be affected by accounting adjustments needed to reflect changes in these estimates and assumptions. During the six months endedJune 30, 2022 , there were no material changes to our critical accounting policies and estimating methodologies, which are disclosed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in the Company's Annual Report on Form 10-K filed with theSEC onMarch 10, 2022 .
Executive Overview
The Company reported$37.4 million of gross written premiums in the second quarter of 2022, representing a 7.0% increase as compared to the same period in 2021. Our commercial lines gross written premiums increased by$1.1 million , or 3.6%, to$32.1 million in the second quarter of 2022, compared to$30.9 million for the same period in 2021. Personal lines gross written premiums increased by$1.3 million , or 32.4%, to$5.3 million in the second quarter of 2022, compared to$4.0 million for the same period in 2021. 25 --------------------------------------------------------------------------------
The Company reported
ended
The Company reported a net loss of$8.4 million , or$0.86 per share, and a net loss of$11.3 million , or$1.16 per share, for the three and six months endedJune 30, 2022 , respectively. The Company reported net income of$5.6 million , or$0.57 per share, and net income of$916,000 , or$0.09 per share, for the three and six months endedJune 30, 2021 , respectively. Adjusted operating loss, a non-GAAP measure, was$7.3 million , or$0.75 per share for the three months endedJune 30, 2022 . Adjusted operating loss was$10.4 million , or$1.07 per share for the six months endedJune 30, 2022 . Adjusted operating loss, a non-GAAP measure, was$3.9 million , or$0.40 per share for the three months endedJune 30, 2021 . Adjusted operating loss was$10.9 million , or$1.13 per share for the six months endedJune 30, 2021 .
Our underwriting combined ratio was 129.2% and 121.0% for the three and six
months ended
months ended
Results of Operations For The Three Months Ended
The following table summarizes our operating results for the periods indicated
(dollars in thousands):
Summary of Operating Results
Three Months Ended
June 30,
2022 2021 $ Change % Change
Gross written premiums $ 37,418 $ 34,981 $ 2,437 7.0 %
Net written premiums $ 27,266 $ 28,532 $ (1,266 ) (4.4 %)
Net earned premiums $ 24,576 $ 24,838 $ (262 ) (1.1 )%
Other income 663 666 (3 ) (0.5 %)
Losses and loss adjustment expenses, net 22,251 17,926 4,325 24.1 %
Policy acquisition costs 5,725 6,896 (1,171 ) (17.0 )%
Operating expenses 4,470 4,342 128 2.9 %
Underwriting gain (loss) (7,207 ) (3,660 ) (3,547 ) *
Net investment income 564 503 61 12.1 %
Net realized investment gains (losses) (1,436 ) 1,060 (2,496 )
* Change in fair value of equity securities 317 (525 ) 842 * Other gains (losses) (1 ) 8,910 (8,911 ) * Interest expense 727 732 (5 ) (0.7 )% Income (loss) before equity earnings in Affiliate, net of tax (8,490 ) 5,556 (14,046 ) * Equity earnings in Affiliate, net of tax 93 180 (87 ) * Income tax expense 2 184 (182 ) * Net income (loss)$ (8,399 ) $ 5,552 $ (13,951 ) *
Book value per common share outstanding
Underwriting Ratios: Loss ratio (1) 90.2 % 71.9 % Expense ratio (2) 39.0 % 41.3 % Combined ratio (3) 129.2 % 113.2 %
(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 other underwriting 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.
26 --------------------------------------------------------------------------------
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 three months ended
2021 (dollars in thousands):
Summary of Premium Revenue
Three Months Ended
June 30,
2022 2021 $ Change % Change
Gross written premiums
Commercial lines $ 32,076 $ 30,947 $ 1,129 3.6 %
Personal lines 5,342 4,034 1,308 32.4 %
Total $ 37,418 $ 34,981 $ 2,437 7.0 %
Net written premiums
Commercial lines $ 22,386 $ 24,672 $ (2,286 ) (9.3 )%
Personal lines 4,880 3,860 1,020 26.4 %
Total $ 27,266 $ 28,532 $ (1,266 ) (4.4 )%
Net earned premiums
Commercial lines $ 20,784 $ 22,188 $ (1,404 ) (6.3 )%
Personal lines 3,792 2,650 1,142 43.1 %
Total $ 24,576 $ 24,838 $ (262 ) (1.1 )%
Gross written premiums increased
three months ended
period in 2021.
Commercial lines gross written premiums increased
the second quarter of 2021.
Personal lines gross written premiums increased$1.3 million , or 32.4%, to$5.3 million in the second quarter of 2022, as compared to$4.0 million for the same period in 2021. The increased gross written premiums were due to$950,000 of premium growth in the Company's low-value dwelling book of business. Net written premiums decreased$1.3 million , or 4.4%, to$27.3 million for the three months endedJune 30, 2022 , as compared to$28.5 million for the same period in 2021. The Company entered into new specific loss reinsurance treaties onDecember 31, 2021 andJanuary 1, 2022 , which included a 40% ceding commission. This increased ceded written premiums by$2.2 million in the second quarter of 2022. There was no ceding commission on excess of loss treaties during 2021. Ceded earned premiums also increased due to the new treaties by$2.1 million . The increase in ceded earned premiums was offset by the same increase in ceding commissions, which reduced acquisition costs. Ceded earned premiums also increased by$950,000 in the second quarter of 2022 as compared to 2021 due to growth in umbrella insurance premiums which are 94.0% ceded under existing quota share reinsurance agreements.
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 promissory note receivable from Venture relating to the Venture Transaction. 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 remained consistent quarter-over-quarter and was$663,000 and$666,000 for the three months endedJune 30, 2022 andJune 30, 2021 , respectively. 27 --------------------------------------------------------------------------------
Losses and Loss Adjustment Expenses
The tables below detail our losses and loss adjustment expenses and loss ratios in our underwriting business for the three months endedJune 30, 2022 and 2021 (dollars in thousands). Commercial Personal Three months ended June 30, 2022 Lines Lines
Total
Accident year net losses and LAE
Net (favorable) adverse development 9,256
268
9,524
Calendar year net losses and LAE
Accident year loss ratio 51.1 % 54.4 % 51.6 %
Net (favorable) adverse development 44.4 % 7.0 % 38.6 %
Calendar year loss ratio 95.5 % 61.4 % 90.2 %
Commercial Personal
Three months ended June 30, 2021 Lines Lines
Total
Accident year net losses and LAE
Net (favorable) adverse development 6,186
24
6,210
Calendar year net losses and LAE
Accident year loss ratio 48.4 % 35.7 % 47.0 % Net (favorable) adverse development 27.8 % 0.9 % 24.9 % Calendar year loss ratio 76.2 % 36.6 % 71.9 % Net losses and LAE increased by$4.3 million , or 24.1%, to$22.3 million during the second quarter of 2022, compared to$17.9 million for the same period in 2021. The increase in losses was driven by adverse development in the commercial lines of business that occurred during the second quarter of 2022, of which$4.3 million ,$3.6 million , and$1.6 million occurred in the 2018 and prior, 2019 and 2020 accident years, respectively. The Company experienced$6.2 million of adverse development for the three months endedJune 30, 2021 . Of the$6.2 million in adverse development,$1.9 million was related to 2017 and prior accident years,$2.4 million was related to the 2018 accident year, and$1.9 million was related to the 2019 and 2020 accident years. Substantially all of the development was from the Company's commercial lines of business. 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. 28 --------------------------------------------------------------------------------
The table below provides the expense ratio by major component.
Three Months Ended
June 30,
2022 2021
Commercial Lines
Policy acquisition costs 21.2 % 28.4 %
Operating expenses 16.8 % 12.8 %
Total 38.0 % 41.2 %
Personal Lines
Policy acquisition costs 32.0 % 27.5 %
Operating expenses 12.7 % 14.5 %
Total 44.7 % 42.0 %
Total Underwriting
Policy acquisition costs 22.8 % 28.3 %
Operating expenses 16.2 % 13.0 %
Total 39.0 % 41.3 %
Our expense ratio decreased by 2.3 percentage points in the second quarter of
2022 as compared to the same period in 2021. The decrease was largely due to a
reduction in policy acquisition costs attributable to $2.1 million of ceding
commission from new excess of loss reinsurance treaties. There were no ceding
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 ceding commissions from
reinsurers. The percentage of policy acquisition costs to net earned premiums
and other income decreased by 5.5%, from 28.3% in the second quarter of 2021, to
22.8% for the same period 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 underwriting income increased by
3.2% during the second quarter of 2022 to 16.2%, compared to 13.0% for the same
period in 2021. While overall operating expenses were fairly consistent
quarter-over-quarter, the new excess of loss reinsurance treaties with the
ceding commission drove net earned premiums lower, resulting in a slightly
higher operating expense ratio.
The personal lines operating expense ratio was lower in the second quarter of
2022 due to significant growth in premium volume on substantially the same
operating expense base.
Segment 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 three months endedJune 30, 2022 and 2021 (dollars in thousands): Segment Gain (Loss) Three Months Ended June 30, 2022 2021 $ Change Commercial Lines$ (6,973 ) $ (3,878 ) $ (3,095 ) Personal Lines (234 ) 577 (811 ) Total Underwriting (7,207 ) (3,301 ) (3,906 ) Wholesale Agency 20 (87 ) 107 Corporate (57 ) (255 ) 198 Eliminations 37 (17 ) 54 Total segment gain (loss)$ (7,207 ) $ (3,660 ) $ (3,547 ) 29
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Results of Operations For The Six Months Ended
The following table summarizes our operating results for the periods indicated
(dollars in thousands):
Six months ended
June 30,
2022 2021 $ Change % Change
Gross written premiums $ 70,382 $ 65,354 $ 5,028 7.7 %
Net written premiums $ 45,287 $ 53,015 $ (7,728 ) (14.6 )%
Net earned premiums $ 48,531 $ 47,673 $ 858 1.8 %
Other income 1,361 1,222 139 11.4 %
Losses and loss adjustment expenses, net 40,269 37,288 2,981 8.0 %
Policy acquisition costs 11,189 13,646 (2,457 ) (18.0 )%
Operating expenses 8,630 8,691 (61 ) (0.7 )%
Underwriting gain (loss) (10,196 ) (10,730 ) 534 5.0 %
Net investment income 1,071 1,035 36 3.5 %
Net realized investment gains (1,505 ) 3,984 (5,489 ) *
Change in fair value of equity
securities 597 (1,065 ) 1,662 *
Other gains (6 ) 8,910 (8,916 ) *
Interest expense 1,438 1,453 (15 ) (1.0 )%
Income (loss) before equity earnings in
Affiliate and income taxes (11,477 ) 681 (12,158 ) *
Equity earnings in Affiliate, net of tax 169 428 (259 ) *
Income tax expense (39 ) 193 (232 ) *
Net income (loss) $ (11,269 ) $ 916 $ (12,185 ) *
Book value per common share outstanding
Underwriting Ratios: Loss ratio (1) 82.7 % 77.9 % Expense ratio (2) 38.3 % 42.9 % Combined ratio (3) 121.0 % 120.8 %
(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 other underwriting 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.
30
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Our premiums are presented below for the six months ended June 30, 2022 and 2021
(dollars in thousands):
Six months ended
June 30,
2022 2021 $ Change % Change
Gross written premiums
Commercial lines $ 60,662 $ 58,168 $ 2,494 4.3 %
Personal lines 9,720 7,186 2,534 35.3 %
Total $ 70,382 $ 65,354 $ 5,028 7.7 %
Net written premiums
Commercial lines $ 36,726 $ 46,229 $ (9,503 ) (20.6 )%
Personal lines 8,561 6,786 1,775 26.2 %
Total $ 45,287 $ 53,015 $ (7,728 ) (14.6 )%
Net earned premiums
Commercial lines $ 41,308 $ 42,894 $ (1,586 ) (3.7 )%
Personal lines 7,223 4,779 2,444 51.1 %
Total $ 48,531 $ 47,673 $ 858 1.8 %
Gross written premiums increased $5.0 million , or 7.7%, to $70.4 million for the
six months ended June 30, 2022 , as compared to $65.4 million for the same period
in 2021.
Commercial lines gross written premiums increased $2.5 million , or 4.3%, to
$60.7 million for the six months ended June 30, 2022 , as compared to $58.2
million in the same period of 2021. The increase was due to $4.0 million of
premium growth in the Company's small business programs, partially offset by a
$1.5 million reduction of gross written premium in the Company's hospitality
programs.
Personal lines gross written premiums increased $2.5 million , or 35.3%, to $9.7
million for the six months ended June 30, 2022 , as compared to $7.2 million for
the same period in 2021. The increased gross written premiums were due to $2.0
million of premium growth in the Company's low-value dwelling book of business.
Net written premiums decreased $7.7 million , or 14.6%, to $45.3 million for the
six months ended June 30, 2022 , as compared to $53.0 million for the same period
in 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 $6.6 million
for the six months ended June 30, 2022 . There was no ceding commission on excess
of loss treaties during 2021. Ceded earned premiums also increased due to the
new treaties by $4.3 million . The increase in ceded earned premiums was offset
by the same increase in ceding commissions, which reduced acquisition
costs. Ceded earned premiums also increased by $7.2 million for the six months
ended June 30, 2022 , as compared to the same period in 2021 due to growth in
umbrella insurance premiums which are 94.0% ceded under existing quota share
reinsurance agreements.
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 promissory note receivable from Venture relating to the Venture
Transaction. 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 at June 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
for the six months ended June 30, 2022 , increased by $139,000 , or 11.4%, to $1.4
million as compared to $1.2 million for the same period in 2021. Other income
relating to installment billings and policy issuance costs was lower in the
first six months of 2022, as the business that was sold to Venture at June 30,
2021 , no longer produces other income for the Company. This was more than offset
by an increase in the interest income of $210,000 for the six months ended June
30, 2022 , from the $6.0 promissory note receivable from Venture from the Venture
Transaction.
31
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Losses and Loss Adjustment Expenses
The tables below detail our losses and loss adjustment expenses and loss ratios in our underwriting business for the six months endedJune 30, 2022 and 2021 (dollars in thousands). Commercial Personal Six months ended June 30, 2022 Lines Lines
Total
Accident year net losses and LAE
Net (favorable) adverse development 14,996
49
15,045
Calendar year net losses and LAE
Accident year loss ratio 52.0 % 51.1 % 51.8 %
Net (favorable) adverse development 36.1 % 0.6 % 30.9 %
Calendar year loss ratio 88.1 % 51.7 % 82.7 %
Commercial Personal
Six months ended June 30, 2021 Lines Lines
Total
Accident year net losses and LAE
Net (favorable) adverse development 11,352
636
11,988
Calendar year net losses and LAE
Accident year loss ratio 52.4 % 56.7 % 52.9 % Net (favorable) adverse development 26.4 % 13.1 % 25.0 % Calendar year loss ratio 78.8 % 69.8 % 77.9 % Net losses and LAE decreased by$3.0 million , or 8.0%, to$40.3 million for the six months endedJune 30, 2022 , compared to$37.3 million for the same period in 2021. The increase in losses was driven by adverse development that occurred during the first six months of 2022. The Company experienced$15.0 million of adverse development for the six months endedJune 30, 2022 , as compared to$12.0 million of adverse development for the same period in 2021. Of the$15.0 million of adverse development experienced in the first six months of 2022,$7.1 million was related to 2018 and prior accident years,$4.9 million was related to the 2019 accident year, and$3.1 million was related to the 2020 accident year. Substantially all of the$15.0 million of adverse development was related to the Company's commercial lines of business. Net losses and LAE increased were$37.3 million for the six months endedJune 30, 2021 . The Company experienced$2.0 million of catastrophe losses, net of reinsurance recoverables, during the first quarter of 2021 from Winter Storm Uri. The Company also experienced$12.0 million of adverse development for the six months endedJune 30, 2021 , which increased losses further. Of the$12.0 million in adverse development,$11.4 million was related to commercial lines, while$636,000 was related to personal lines. The adverse development was mostly attributable to the 2018 and 2017 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.
32
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The table below provides the expense ratio by major component.
Six months ended
June 30,
2022 2021
Commercial Lines
Policy acquisition costs 21.1 % 29.4 %
Operating expenses 16.1 % 13.5 %
Total 37.2 % 42.9 %
Personal Lines
Policy acquisition costs 31.9 % 27.6 %
Operating expenses 12.2 % 15.2 %
Total 44.1 % 42.8 %
Total Underwriting
Policy acquisition costs 22.8 % 29.2 %
Operating expenses 15.5 % 13.7 %
Total 38.3 % 42.9 %
Our expense ratio decreased by 4.6 percentage points for the six months ended
June 30, 2022 , as compared to the same period in 2021. The decrease was largely
due to a reduction in policy acquisition costs attributable to $4.3 million of
ceding commission from new excess of loss reinsurance treaties. There were no
commissions on excess of loss treaties in 2021. The expense ratio also decreased
as a result of a $836,000 increase in underwriting revenue for the six months
ended June 30, 2022 , as compared to the same period in 2021, while operating
expenses were slightly higher in 2022.
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 6.4%, from 29.2% in the first six months of 2021,
to 22.8% for the same period 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 underwriting income increased by
1.8% to 15.5% for the six months ended June 30, 2022 , as compared to 13.7% for
the same period in 2021. The new excess of loss reinsurance treaties with the
ceding commission drove net earned premiums lower, resulting in a slightly
higher operating expense ratio.
The personal lines operating expense ratio was lower for the six months ended
June 30, 2022 due to significant growth in premium volume on substantially the
same operating expense base.
Segment 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 six months endedJune 30, 2022 and 2021 (dollars in thousands): Segment Gain (Loss) Six months ended June 30, 2022 2021 $ Change Commercial Lines$ (10,506 ) $ (9,344 ) $ (1,162 ) Personal Lines 300 (610 ) 910 Total Underwriting (10,206 ) (9,954 ) (252 ) Wholesale Agency 82 (232 ) 314 Corporate (215 ) (513 ) 298 Eliminations 143 (31 ) 174 Total segment gain (loss)$ (10,196 ) $ (10,730 ) $ 534 33
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Liquidity and Capital Resources
Sources and Uses of Funds
AtJune 30, 2022 , we had$41.1 million in cash, cash equivalents and short-term investments. Our principal sources of funds are insurance premiums, investment income, proceeds from maturities and sales of invested assets and installment fees. These funds are primarily used to pay claims, commissions, employee compensation, taxes and other operating expenses, and service debt. 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 Parent 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 Parent Company supports its funding as state insurance laws restrict the ability of our Insurance Company Subsidiaries to declare dividends to the Parent Company. There were no dividends paid from ourInsurance Company Subsidiaries during the six months endedJune 30, 2022 and 2021.
Cash Flows
Operating Activities. Cash used in operating activities for the six months endedJune 30, 2022 was$15.5 million compared to$4.5 million for the same period in 2021. The$11.0 million increase was primarily due to a$8.1 million increase in ceded premiums paid during the six months endedJune 30, 2022 , compared to the same period in 2021. This was due to the new specific commercial liability treaty the Company entered into as ofDecember 31, 2021 , which includes a 40% ceding commission. The increase in ceded premiums paid was offset by a$5.1 million decrease in acquisition costs paid for the six months endedJune 30, 2022 , compared to the same period in 2021. This decrease was also related to the new specific commercial liability treaty the Company entered into onDecember 31, 2021 . There was also an$8.5 million increase in paid losses as the Company has accelerated closing claims which resulted in a significant decline in outstanding cases. Investing Activities. Cash provided by investing activities for the six months endedJune 30, 2022 was$13.7 million , compared to$4.9 million in the same period in 2021. The$8.8 million increase of cash provided by investing activities was driven by a$46.4 million increase in the sales of investment during the first six months of 2022, compared to the same period in 2021. This was offset by an increase of$39.0 million increase in the purchases of investment for the six months endedJune 30, 2022 , compared to the same period in 2021. Financing Activities. Cash provided by financing activities for the six months endedJune 30, 2022 was$5.0 million compared to$4.0 million of cash used in the same period in 2021. The$9.0 million increase was driven by the Company paying down a net amount of$0 on the line of credit during the first six months of 2022, compared to the Company paying down a net amount of$4.0 million during the first six months of 2021. The Company also received proceeds of$5.0 million of common equity which was effective onAugust 10, 2022 . The was no balance outstanding on the line of credit as ofJune 30, 2022 .
Our Insurance Company Subsidiaries are required to file quarterly and annual financial reports with state insurance regulators. These financial reports are prepared using statutory accounting practices promulgated by the Insurance Company Subsidiaries' state of domiciliary, rather than GAAP. The Insurance Company Subsidiaries' aggregate statutory capital and surplus (which is a statutory measure of equity) was$58.0 million and$63.9 million atJune 30, 2022 andDecember 31, 2021 , respectively.
Non-GAAP Financial Measures
Adjusted Operating Income and Adjusted Operating Income Per Share
Adjusted operating income and adjusted operating income per share are non-GAAP
measures that represent net income allocable to common shareholders excluding
net realized investment gains or losses, other gains or losses, and changes in
fair value of equity securities; all 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
34
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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 (loss) to adjusted operating income (loss) (dollars in thousands),
as well as net income (loss) per share to adjusted operating income (loss) per
share:
Three Months Ended Six months ended
June 30, June 30,
2022 2021 2022 2021
Net income (loss) $ (8,399 ) $ 5,552 $ (11,269 ) $ 916
Exclude:
Net realized investment gains (losses),
net of tax (1,436 ) 1,060 (1,505 ) 3,984
Other gains (losses), net of tax (1 ) 8,910 (6 ) 8,910
Change in fair value of equity
securities, net of tax 317 (525 ) 597 (1,065 )
Adjusted operating income (loss) $ (7,279 ) $ (3,893 )
Weighted average common shares diluted 9,712,602 9,686,631
9,710,223 9,684,193 Diluted income (loss) per common share: Net income (loss)$ (0.86 ) $ 0.57 $ (1.16 ) $ 0.09 Exclude: Net realized investment gains (losses), net of tax (0.14 ) 0.11 (0.15 ) 0.41 Other gains (losses), net of tax - 0.92 - 0.92 Change in fair value of equity securities, net of tax 0.03 (0.06 ) 0.06 (0.11 ) Adjusted operating income (loss) per share$ (0.75 ) $ (0.40 ) $ (1.07 ) $ (1.13 ) We use adjusted operating income and adjusted operating income per share to assess our performance and to evaluate the results of our overall business. We believe these measures provide investors with valuable information relating to our ongoing performance that may be obscured by the net effect of realized gains and losses as a result of our market risk sensitive instruments, which primarily relate to debt securities that are available for sale and not held for trading purposes. The change in fair value of equity securities and realized 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 results 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.
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 regarding recently issued accounting pronouncements.
35
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Earnings Document
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