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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.
Private Placement
On August 10, 2022 , the Company issued $5.0 million of equity through a private
placement for 2,500,000 shares priced at $2.00 per share. The participants in
the private placement consisted of members of the Company's Board of Directors.
The Company used the proceeds for growth capital in the Company's specialty core
business segments.
Sale of Certain Agency Business
OnOctober 14, 2022 , Venture completed the sale of certain producer business assets withWhitetail Insurance Services, LLC (the "Buyer"), a wholly-owned subsidiary ofAcrisure, LLC ("Acrisure"), for a purchase price of$38.2 million . The effective date of the asset purchase agreement isOctober 1, 2022 . There is no material relationship between the Company or any director or officer of the Company, or any associate of any director or officer of the Company, and the Buyer, other than with respect to the Company's disposition of assets to the Buyer. The assets involved in this transaction relate toVenture Agency Holdings, Inc. insurance brokerage and associated services provided largely to the security sector. This sale, along with related transactions including the cost of the Company purchasing the other 50% of Venture, is expected to generate approximately$8.0 million of non-operating gains for the Company, net of taxes, in the fourth quarter of 2022. 26 -------------------------------------------------------------------------------- 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 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 ofSeptember 30, 2022 , the Company had a non-controlling 50% interest in Venture.
Loss Portfolio Transfer
OnNovember 1, 2022 , the Company entered into an LPT reinsurance agreement with 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. Within the aggregate limit, there is a$5.5 million loss corridor in which the Company and WPIC 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 retains$40.8 million for stated net reserves as ofJune 30, 2022 , plus a one-time risk fee of$5.4 million . The agreement is between CIC and WPIC and Fleming Re.
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.
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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 in Illinois ,
Indiana and Texas . Due to recent Florida -based industry events, we have been
de-emphasizing our Florida homeowners' business and reducing our exposures in
that state, as well as other wind-exposed states like Texas and Hawaii .
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 on
June 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 nine months endedSeptember 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$33.1 million of gross written premiums in the third quarter of 2022, representing a 1.8% decrease as compared to the same period in 2021. Our commercial lines gross written premiums decreased by$2.2 million , or 7.4%, to$27.6 million in the third quarter of 2022, compared to$29.8 million for the same period in 2021. Personal lines gross written premiums increased by$1.6 million , or 41.5%, to$5.5 million in the third quarter of 2022, compared to$3.9 million for the same period in 2021.
The Company reported
months ended
in 2021.
The Company reported a net loss of$1.5 million , or$0.14 per share, and a net loss of$12.8 million , or$1.26 per share, for the three and nine months endedSeptember 30, 2022 , respectively. The Company reported a net loss of$1.2 million , or$0.12 per share, and a net loss of$293,000 , or$0.03 per share, for the three and nine months endedSeptember 30, 2021 , respectively.
Adjusted operating loss, a non-GAAP measure, was
share, and
ended
million
three and nine months ended
Our underwriting combined ratio was 106.5% and 116.0% for the three and nine months endedSeptember 30, 2022 , compared to 106.9 and 116.0% for the three and nine months endedSeptember 30, 2021 , respectively. 28 --------------------------------------------------------------------------------
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
September 30,
2022 2021 $ Change % Change
Gross written premiums $ 33,088 $ 33,704 $ (616 ) (1.8 %)
Net written premiums $ 23,693 $ 26,069 $ (2,376 ) (9.1 %)
Net earned premiums $ 24,958 $ 24,941 $ 17 0.1 %
Other income 603 752 (149 ) (19.8 %)
Losses and loss adjustment expenses, net 16,671 16,159 512 3.2 %
Policy acquisition costs 6,230 7,173 (943 ) (13.1 )%
Operating expenses 4,380 4,077 303 7.4 %
Underwriting gain (loss) (1,720 ) (1,716 ) (4 ) *
Net investment income 860 514 346 67.3 %
Net realized investment gains (losses) - (101 ) 101 *
Change in fair value of equity
securities (151 ) (2,169 ) 2,018 *
Other gains (losses) 66 2,778 (2,712 ) *
Interest expense 778 701 77 11.0 %
Income (loss) before equity earnings in
Affiliate, net of tax (1,723 ) (1,395 ) (328 ) *
Equity earnings in Affiliate, net of tax 199 184 15 *
Income tax expense (1 ) (2 ) 1 *
Net income (loss) $ (1,523 ) $ (1,209 ) $ (314 ) *
Book value per common share outstanding
Underwriting Ratios: Loss ratio (1) 66.6 % 64.6 % Expense ratio (2) 39.9 % 42.3 % Combined ratio (3) 106.5 % 106.9 %
(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 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.
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Our premiums are presented below for the three months ended
and 2021 (dollars in thousands):
Summary of Premium Revenue
Three Months Ended
September 30,
2022 2021 $ Change % Change
Gross written premiums
Commercial lines $ 27,635 $ 29,849 $ (2,214 ) (7.4 )%
Personal lines 5,453 3,855 1,598 41.5 %
Total $ 33,088 $ 33,704 $ (616 ) (1.8 )%
Net written premiums
Commercial lines $ 18,730 $ 22,456 $ (3,726 ) (16.6 )%
Personal lines 4,963 3,613 1,350 37.4 %
Total $ 23,693 $ 26,069 $ (2,376 ) (9.1 )%
Net earned premiums
Commercial lines $ 20,789 $ 21,975 $ (1,186 ) (5.4 )%
Personal lines 4,169 2,966 1,203 40.6 %
Total $ 24,958 $ 24,941 $ 17 0.1 %
Gross written premiums decreased $616,000 , or 1.8%, to $33.1 million for the
three months ended September 30, 2022 , as compared to $33.7 million for the same
period in 2021.
Commercial lines gross written premiums decreased
third quarter of 2021.
Personal lines gross written premiums increased$1.6 million , or 41.5%, to$5.5 million in the third quarter of 2022, as compared to$3.9 million for the same period in 2021. The increased gross written premiums were due to$1.0 million of quarter-over-quarter premium growth in the Company's low-value dwelling book of business. Net written premiums decreased$2.4 million , or 9.1%, to$23.7 million for the three months endedSeptember 30, 2022 , as compared to$26.1 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$1.7 million in the third 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.
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 decreased by$149,000 , or 19.8%, to$603,000 for the three months endedSeptember 30, 2022 , as compared to$752,000 for the same period in 2021. 30 --------------------------------------------------------------------------------
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 endedSeptember 30, 2022 and 2021 (dollars in thousands). Commercial Personal Three months ended September 30, 2022 Lines Lines
Total
Accident year net losses and LAE
Net (favorable) adverse development
2,749 381
3,130
Calendar year net losses and LAE
Accident year loss ratio 50.8 % 70.1 % 54.0 %
Net (favorable) adverse development 13.2 % 9.1 % 12.6 %
Calendar year loss ratio 64.0 % 79.2 % 66.6 %
Commercial Personal
Three months ended September 30, 2021 Lines Lines
Total
Accident year net losses and LAE
Net (favorable) adverse development
3,356 290
3,646
Calendar year net losses and LAE
Accident year loss ratio 51.5 % 39.1 % 50.0 % Net (favorable) adverse development 15.2 % 9.7 % 14.6 % Calendar year loss ratio 66.7 % 48.8 % 64.6 % Net losses and LAE increased by$512,000 , or 3.2%, to$16.7 million during the third quarter of 2022, compared to$16.2 million for the same period in 2021. The increase in losses was driven by current accident year losses increasing by$1.8 million during the third quarter of 2022 in the Company's personal lines, compared to the same period in 2021. The Company experienced$3.1 million of adverse development for the three months endedSeptember 30, 2022 , of which$2.3 million was related to 2019 and prior accident years and$1.8 million was related to the 2021 accident year. This was offset by$958,000 of favorable development experienced in the 2020 accident year. Of the$3.1 million of adverse development,$2.7 million was related to the commercial lines of business, while$381,000 was related to the personal lines of business. The Company experienced$3.6 million of adverse development for the three months endedSeptember 30, 2021 , of which$1.1 million was related to 2017 and prior accident years,$1.4 million was related to the 2018 accident year, and$1.0 million was related to the 2019 accident year. In the third quarter of 2021,$3.4 million of the adverse development was related to the commercial lines of business, mostly from the liability lines, while$290,000 was related to the personal 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. 31 --------------------------------------------------------------------------------
The table below provides the expense ratio by major component.
Three Months Ended
September 30,
2022 2021
Commercial Lines
Policy acquisition costs 23.8 % 29.3 %
Operating expenses 15.8 % 13.4 %
Total 39.6 % 42.7 %
Personal Lines
Policy acquisition costs 28.9 % 28.0 %
Operating expenses 12.4 % 11.2 %
Total 41.3 % 39.2 %
Total Underwriting
Policy acquisition costs 24.6 % 29.2 %
Operating expenses 15.3 % 13.1 %
Total 39.9 % 42.3 %
Our expense ratio decreased by 2.4 percentage points in the third 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 $1.7 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 4.6%, from 29.2% in the third quarter of 2021, to
24.6% 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
2.2% during the third quarter of 2022 to 15.3%, compared to 13.1% 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.
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 endedSeptember 30, 2022 and 2021 (dollars in thousands): Segment Gain (Loss) Three Months Ended September 30, 2022 2021 $ Change Commercial Lines$ (749 ) $ (2,084 ) $ 1,335 Personal Lines (861 ) 359 (1,220 ) Total Underwriting (1,610 ) (1,725 ) 115 Wholesale Agency 50 (43 ) 93 Corporate (206 ) (139 ) (67 ) Eliminations 46 191 (145 ) Total segment gain (loss)$ (1,720 ) $ (1,716 ) $ (4 ) 32
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Results of Operations For The Nine Months Ended
The following table summarizes our operating results for the periods indicated
(dollars in thousands):
Nine months ended
September 30,
2022 2021 $ Change % Change
Gross written premiums $ 103,470 $ 99,058 $ 4,412 4.5 %
Net written premiums $ 68,980 $ 79,084 $ (10,104 ) (12.8 )%
Net earned premiums $ 73,489 $ 72,614 $ 875 1.2 %
Other income 1,964 1,974 (10 ) (0.5 )%
Losses and loss adjustment expenses, net 56,940 53,447 3,493 6.5 %
Policy acquisition costs 17,419 20,819 (3,400 ) (16.3 )%
Operating expenses 13,010 12,768 242 1.9 %
Underwriting gain (loss) (11,916 ) (12,446 ) 530 4.3 %
Net investment income 1,931 1,549 382 24.7 %
Net realized investment gains (losses) (1,505 ) 3,883 (5,388 )
* Change in fair value of equity securities 446 (3,234 ) 3,680 * Other gains 60 11,688 (11,628 ) * Interest expense 2,216 2,154 62 2.9 % Income (loss) before equity earnings in Affiliate and income taxes (13,200 ) (714 ) (12,486 ) * Equity earnings in Affiliate, net of tax 368 612 (244 ) * Income tax expense (40 ) 191 (231 ) * Net income (loss)$ (12,792 ) $ (293 ) $ (12,499 ) *
Book value per common share outstanding
Underwriting Ratios: Loss ratio (1) 77.2 % 73.3 % Expense ratio (2) 38.8 % 42.7 % Combined ratio (3) 116.0 % 116.0 %
(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.
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Our premiums are presented below for the nine months ended
and 2021 (dollars in thousands):
Nine months ended
September 30,
2022 2021 $ Change % Change
Gross written premiums
Commercial lines $ 88,297 $ 88,017 $ 280 0.3 %
Personal lines 15,173 11,041 4,132 37.4 %
Total $ 103,470 $ 99,058 $ 4,412 4.5 %
Net written premiums
Commercial lines $ 55,456 $ 68,685 $ (13,229 ) (19.3 )%
Personal lines 13,524 10,399 3,125 30.1 %
Total $ 68,980 $ 79,084 $ (10,104 ) (12.8 )%
Net earned premiums
Commercial lines $ 62,097 $ 64,869 $ (2,772 ) (4.3 )%
Personal lines 11,392 7,745 3,647 47.1 %
Total $ 73,489 $ 72,614 $ 875 1.2 %
Gross written premiums increased $4.4 million , or 4.5%, to $103.5 million for
the nine months ended September 30, 2022 , as compared to $99.1 million for the
same period in 2021.
Commercial lines gross written premiums increased $280,000 , or 0.3%, and was
$88.3 million for the nine months ended September 30, 2022 , as compared to $88.0
million for the same period in 2021.
Personal lines gross written premiums increased $4.1 million , or 37.4%, to $15.2
million for the nine months ended September 30, 2022 , as compared to $11.0
million for the same period in 2021. The increased gross written premiums were
due to $3.0 million of premium growth in the Company's low-value dwelling book
of business for the nine months ended September 30, 2022 compared to the same
period in 2021.
Net written premiums decreased $10.1 million , or 12.8%, to $69.0 million for the
nine months ended September 30, 2022 , as compared to $79.1 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 $8.4 million
for the nine months ended September 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 $6.3 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 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
remained consistent and was $2.0 million for the nine months ended September 30,
2022 and September 30, 2021 , respectively.
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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 nine months endedSeptember 30, 2022 and 2021 (dollars in thousands). Commercial Personal Nine months ended September 30, 2022 Lines Lines
Total
Accident year net losses and LAE
Net (favorable) adverse development 17,745
430
18,175
Calendar year net losses and LAE
Accident year loss ratio 51.6 % 58.0 % 52.6 %
Net (favorable) adverse development 28.4 % 3.8 % 24.6 %
Calendar year loss ratio 80.0 % 61.8 % 77.2 %
Commercial Personal
Nine months ended September 30, 2021 Lines Lines
Total
Accident year net losses and LAE
Net (favorable) adverse development 14,708
926
15,634
Calendar year net losses and LAE
Accident year loss ratio 52.1 % 50.0 % 51.9 % Net (favorable) adverse development 22.6 % 11.8 % 21.4 % Calendar year loss ratio 74.7 % 61.8 % 73.3 % Net losses and LAE increased by$3.5 million , or 6.5%, to$56.9 million for the nine months endedSeptember 30, 2022 , compared to$53.4 million for the same period in 2021. The increase in losses was driven by adverse development that occurred during the first nine months of 2022. The Company experienced$18.2 million of adverse development for the nine months endedSeptember 30, 2022 , as compared to$15.6 million of adverse development for the same period in 2021. Of the$18.2 million of adverse development experienced in the first nine months of 2022,$14.3 million was related to 2019 and prior accident years,$2.2 million was related to the 2020 accident year, and$1.7 million was related to the 2021 accident year. Substantially all of the$18.2 million of adverse development was related to the Company's commercial lines of business. Net losses and LAE were$53.4 million for the nine months endedSeptember 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$15.6 million of adverse development for the nine months endedSeptember 30, 2021 , which increased losses further. Of the$15.6 million in adverse development,$14.7 million was related to commercial lines, while$926,000 was related to personal lines. The adverse development was mostly attributable to the 2019, 2018 and 2017 and prior accident years, and mostly related to commercial liability lines.
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.
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The table below provides the expense ratio by major component.
Nine months ended
September 30,
2022 2021
Commercial Lines
Policy acquisition costs 22.0 % 29.4 %
Operating expenses 16.0 % 13.5 %
Total 38.0 % 42.9 %
Personal Lines
Policy acquisition costs 30.8 % 27.7 %
Operating expenses 12.3 % 13.7 %
Total 43.1 % 41.4 %
Total Underwriting
Policy acquisition costs 23.4 % 29.2 %
Operating expenses 15.4 % 13.5 %
Total 38.8 % 42.7 %
Our expense ratio decreased by 3.9 percentage points for the nine months ended
September 30, 2022 , as compared to the same period in 2021. The decrease was
largely due to a reduction in policy acquisition costs attributable to $8.4
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 $865,000 increase in underwriting revenue for the
nine months ended September 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 5.8%, from 29.2% in the first nine months of 2021,
to 23.4% 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
1.9% to 15.4% for the nine months ended September 30, 2022 , as compared to 13.5%
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 nine months ended
September 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 nine months endedSeptember 30, 2022 and 2021 (dollars in thousands): Segment Gain (Loss) Nine months ended September 30, 2022 2021 $ Change Commercial Lines$ (11,255 ) $ (11,428 ) $ 173 Personal Lines (561 ) (251 ) (310 ) Total Underwriting (11,816 ) (11,679 ) (137 ) Wholesale Agency 132 (275 ) 407 Corporate (421 ) (652 ) 231 Eliminations 189 160 29 Total segment gain (loss)$ (11,916 ) $ (12,446 ) $ 530 36
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Liquidity and Capital Resources
Sources and Uses of Funds
AtSeptember 30, 2022 , we had$66.0 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. Management plans to issue new public debt 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 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 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 nine months endedSeptember 30, 2022 and 2021. The FHLB ofIndianapolis loan matures onJanuary 9, 2023 . It is 100% collateralized with high quality readily marketable securities and cash. Management plans to repay this debt by year end with existing cash and investments. However, we also believe the FHLB ofIndianapolis would refinance this debt if we chose to keep it for a longer period, due to the very low risk associated with a fully collateralized loan.
Cash Flows
Operating Activities. Cash used in operating activities for the nine months endedSeptember 30, 2022 was$14.1 million compared to$2.0 million for the same period in 2021. The$12.1 million increase was primarily due to a$16.7 million increase in ceded premiums paid during the nine months endedSeptember 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$6.7 million decrease in acquisition costs paid for the nine months endedSeptember 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$8.1 million increase in paid losses as the Company has accelerated closing outstanding claims. Investing Activities. Cash provided by investing activities for the nine months endedSeptember 30, 2022 was$20.1 million , compared to$5.3 million in the same period in 2021. The$14.8 million increase of cash provided by investing activities was driven by a$101.5 million increase in the sales of investment during the first nine months of 2022, compared to the same period in 2021. This was offset by an increase of$85.1 million increase in the purchases of investment for the nine months endedSeptember 30, 2022 , compared to the same period in 2021. Financing Activities. Cash provided by financing activities for the nine months endedSeptember 30, 2022 was$19.5 million compared to$4.0 million of cash used in the same period in 2021. The$23.5 million increase was driven by the Company borrowing an additional$14.5 million related to the FHLB ofIndianapolis loan during the third quarter of 2022. The Company also raised$5.0 million through the issuance of additional common stock onAugust 8, 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$58.9 million and$63.9 million atSeptember 30, 2022 andDecember 31, 2021 , respectively. 37 --------------------------------------------------------------------------------
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 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 Nine months ended
September 30, September 30,
2022 2021 2022 2021
Net income (loss) $ (1,523 ) $ (1,209 ) $ (12,792 ) $ (293 )
Exclude:
Net realized investment gains (losses),
net of tax - (101 ) (1,505 ) 3,883
Other gains (losses), net of tax 66 2,778 60 11,688
Change in fair value of equity
securities, net of tax (151 ) (2,169 ) 446 (3,234 )
Adjusted operating income (loss) $ (1,438 ) $ (1,717 )
Weighted average common shares diluted 11,101,194 9,692,150
10,178,975 9,686,874 Diluted income (loss) per common share: Net income (loss)$ (0.14 ) $ (0.12 ) $ (1.26 ) $ (0.03 ) Exclude: Net realized investment gains (losses), net of tax - (0.01 ) (0.15 ) 0.40 Other gains (losses), net of tax - 0.29 0.01 1.20 Change in fair value of equity securities, net of tax (0.01 ) (0.22 ) 0.04 (0.33 ) Adjusted operating income (loss) per share$ (0.13 ) $ (0.18 ) $ (1.16 ) $ (1.30 ) 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.
38
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PORCH GROUP, INC. – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations
HCI GROUP, INC. – 10-Q – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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