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FEDNAT HOLDING CO – 10-K – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Operating Results Overview - Year Ended
The following table sets forth results of operations for the periods presented:
Year Ended December 31,
2021 % Change 2020
(Dollars in thousands)
Revenues:
Gross premiums written $ 684,777 (5.8) % $ 726,885
Gross premiums earned 708,820 (1.7) % 720,967
Ceded premiums (525,517) 47.3 % (356,833)
Net premiums earned 183,303 (49.7) % 364,134
Net investment income 6,770 (42.6) % 11,786
Net realized and unrealized gains (losses) 11,017 (38.9) %
18,032 Direct written policy fees 13,051 (6.6) % 13,970 Other income 31,408 31.2 % 23,941 Total revenues 245,549 (43.1) % 431,863 Costs and expenses: Losses and loss adjustment expenses 232,760 (38.2) %
376,449
Commissions and other underwriting expenses 81,180 (34.7) %
124,288
General and administrative expenses 24,355 4.0 % 23,420 Interest expense 8,758 14.3 % 7,661 Impairment of intangibles 1,280 (89.1) % 11,699 Total costs and expenses 348,333 (35.9) % 543,517 Income (loss) before income taxes (102,784) NCM (111,654) Income tax expense (benefit) 316 NCM (33,496) Net income (loss)$ (103,100) NCM$ (78,158) Ratios to net premiums earned: Net loss ratio 127.0 % 103.4 % Net expense ratio 57.6 % 40.5 % Combined ratio 184.6 % 143.9 % (1)Net loss ratio is calculated as losses and loss adjustment expenses ("LAE") divided by net premiums earned. (2)Net expense ratio is calculated as all operating expenses less interest expense divided by net premiums earned. (3)Combined ratio is calculated as the sum of losses and LAE and all operating expenses less interest expense divided by net premiums earned. -31- -------------------------------------------------------------------------------- The following table sets forth a reconciliation of GAAP to non-GAAP measures: Year Ended December 31, 2021 2020 (Dollars in thousands) Revenue Total revenues$ 245,549 $ 431,863 Less: Net realized and unrealized investment gains (losses) 1,592 18,032 Adjusted operating revenues$ 243,957 $ 413,831 Net Income (Loss) Net income (loss)$ (103,100) $ (78,158) Less: Net realized and unrealized investment gains (losses) 1,592 10,801 Acquisition and strategic costs (12) (171) Amortization of identifiable intangibles (138) (90) Impairment of intangibles (1,280) (11,417) Adjusted operating income (loss) $
(103,262)
Income tax rate assumed for reconciling items above, excluding impairment of goodwill - % 40.100 % Revenue Total revenue decreased$186.4 million , or 43.1%, to$245.5 million for the year endedDecember 31, 2021 , as compared to$431.9 million for the year endedDecember 31, 2020 . The decrease was driven primarily by increases in ceded premiums from incremental quota-share agreements and higher catastrophe reinsurance costs, as well as lower gross premiums, net investment income and net realized gains, slightly offset by higher other income, all of which are discussed in further detail below.
Gross Premiums Written
The following table sets forth the gross premiums written for the periods
presented:
Year Ended December 31,
2021 2020
(In thousands)
Gross premiums written:
Homeowners Florida $ 428,439 $ 444,576
Homeowners non-Florida 235,278 263,534
Federal flood 21,304 19,022
Non-core (1) (244) (247)
Total gross premiums written $ 684,777 $ 726,885
(1)Reflects exited lines of business.
Gross premiums written decreased$42.1 million , or 5.8%, to$684.8 million for the year endedDecember 31, 2021 , as compared to$726.9 million for the year endedDecember 31, 2020 , which was driven by a reduction in our policies-in-force and exposure across all states, as a result of our rigorous exposure management in response to the challenging litigation environment, partially offset by rate actions that we have taken across our insurance subsidiaries. -32- --------------------------------------------------------------------------------
Gross Premiums Earned
The following table sets forth the gross premiums earned for the periods
presented:
Year Ended December 31,
2021 2020
(In thousands)
Gross premiums earned:
Homeowners Florida $ 434,120 $ 459,511
Homeowners non-Florida 254,740 244,192
Federal flood 20,204 17,511
Non-core (1) (244) (247)
Total gross premiums earned $ 708,820 $ 720,967
(1)Reflects exited lines of business.
Gross premiums earned decreased$12.2 million , or 1.7%, to$708.8 million for the year endedDecember 31, 2021 , as compared to$721.0 million for the year endedDecember 31, 2020 , driven primarily by the same reasons as the decrease in gross premiums written, discussed above.
Ceded Premiums Earned
Ceded premiums earned increased$168.7 million , or 47.3%, to$525.5 million for the year endedDecember 31, 2021 , as compared to$356.8 million for the year endedDecember 31, 2020 . The increase was driven by approximately$124 million of higher quota-share ceded premium:$69 million related to new and incremental quota-share treaties for FNIC'sFlorida book of business and$55 million related to the 80% quota-share treaty for FNIC's non-Florida book of business. Additionally, there was approximately$41 million higher catastrophe reinsurance spend, driven by higher rate-on-line prices in the 2020-2021 catastrophe excess of loss reinsurance program as well as additional purchases of supplemental coverage in that treaty year to backfill layers and gaps in coverage stemming from the non-cascading portion of our reinsurance tower, following the six retention catastrophe events that have occurred sinceJuly 1, 2020 . The increase to ceded premium earned associated with the aforementioned quota-share treaties is largely offset by corresponding reductions in loss and LAE, and commission and other underwriting expenses when comparing the periods. Refer to Note 6 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for additional information regarding these quota-share treaties.
Net Investment Income
Net investment income decreased$5.0 million , or 42.6%, to$6.8 million during the year endedDecember 31, 2021 , as compared to$11.8 million during the year endedDecember 31, 2020 . This decrease was driven by a smaller fixed income portfolio as well as a decline in the associated yield as a result of declining interest rates during the last year. Related to the former, we have been impacted by several catastrophes, hail and wind-related severe weather events and private reinsurers have raised the cost of their coverages. As a result, sales of our portfolio of fixed income securities was a significant source of liquidity over the last year, particularly with respect to funding of retained losses from catastrophe weather events.
Net Realized and Unrealized Gains (Losses)
Net realized and unrealized gains (losses) decreased$7.0 million , to$11.0 million for the year endedDecember 31, 2021 , as compared to$18.0 million for the year endedDecember 31, 2020 . We recognized less than$0.1 million and$(4.1) million in unrealized investment gains (losses) for equity securities during these respective periods. Our current and prior year net realized investment gains are primarily associated with our portfolio managers, under our control, moving out of positions due to both macro and micro conditions, a typical practice in most quarters. Furthermore, to mitigate the potential COVID-19 related adverse impact on the financial stability of the issuers of securities we hold, certain positions were liquidated during 2020. During the first six months of 2021, we purchased additional reinsurance limit for our excess of loss catastrophe reinsurance program for 2020-2021, which we determined had an embedded derivative. For the twelve months endedDecember 31, 2021 , the Company recognized$9.4 million in realized and unrealized embedded derivative gains. Refer to Notes 2, 4, and 6 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report. for further information related to our embedded derivative. -33- --------------------------------------------------------------------------------
Direct Written Policy Fees
Direct written policy fees decreased by$0.9 million , or 6.6%, to$13.1 million for the year endedDecember 31, 2021 , as compared to$14.0 million for the year endedDecember 31, 2020 . The decrease is primarily driven by a reduction in our policies in-force and exposure inFlorida , as a result of our rigorous exposure management in response to the challenging litigation environment.
Other Income
Other income increased$7.5 million , or 31.2%, to$31.4 million for the year endedDecember 31, 2021 , as compared to$23.9 million for the year endedDecember 31, 2020 . Other income included the following for the periods presented: Year Ended December 31, 2021 % Change 2020 (Dollars in thousands) Other income: Commission and other fee income$ 4,584 36.6 %$ 3,357 Brokerage 25,343 33.8 % 18,948 Financing and other revenue 1,481 (9.5) % 1,636 Total other income$ 31,408 31.2 %$ 23,941 The increase in other income was primarily driven by higher brokerage revenue. The brokerage revenue increase is the result of higher excess of loss reinsurance spend from the reinsurance programs in place, including reinstatement premiums and/or additional purchases, during 2021 as compared to 2020. -34-
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Expenses
Losses and LAE
Losses and LAE incurred, net of reinsurance, included the following for the
periods presented:
Year Ended December 31,
2021 2020
Net Loss Net Loss
Amount Ratio Amount Ratio
(In thousands)
Current accident year, excluding
catastrophes:
Homeowners $ 144,782 79.0 % $ 230,602 63.3 %
Non-core (1) - - % - - %
Total current accident year, excluding
catastrophes 144,782 79.0 % 230,602 63.3 %
Current year catastrophes (2):
Florida 26,476 14.4 % 55,533 15.3 %
Texas 46,396 25.3 % 26,204 7.2 %
Louisiana 6,810 3.7 % 44,174 12.1 %
Other states 2,059 1.1 % 2,386 0.7 %
Total current year catastrophes 81,741 44.5 % 128,297 35.3 %
Prior year loss development (redundancy):
Homeowners 7,450 4.1 % (655) (0.2) %
Non-core (1) (1,145) (0.6) % 19,022 5.2 %
Ceded losses subject to offsetting
experience account adjustments (3) (68) - % (816) (0.2) %
Total prior year loss development
(redundancy) 6,237 3.5 % 17,551 4.8 %
Total net losses and LAE $ 232,760 127.0 % $ 376,449 103.4 %
(1)Reflects exited lines of business.
(2)Includes Property Claims Services ("PCS") weather events and other events
impacting multiple insureds for which the Company's insurance carriers
established catastrophe event codes, net of the benefit of claims handling
services. These catastrophe events are typically wind, hail and tornado related
weather events. Any individual catastrophe event with gross losses greater than
$20 million , on a pre-tax basis, are considered significant and specifically
addressed in the commentary below. Excludes any catastrophe related activity
recorded in other financial statement line items, outside of loss and loss
adjustment expenses.
(3)Reflects homeowners losses ceded under retrospective reinsurance treaties to
the extent there is an offsetting experience account adjustment, such that there
is no impact on pre-tax net income (loss).
Losses and LAE decreased $143.6 million , or 38.2%, to $232.8 million for the
year ended December 31, 2021 , as compared to $376.4 million for the year ended
December 31, 2020 driven by higher ceded losses under quota-share reinsurance
treaties and lower net catastrophe losses. The net loss ratio increased 23.6
percentage points, to 127.0% in 2021, as compared to 103.4% in 2020. The higher
loss ratio was primarily the result of higher ceded premiums, as discussed
earlier, which reduces net earned premiums, the denominator on the net loss
ratio calculation.
Net losses and LAE for the year ended December 31, 2021 were driven by
approximately $81.7 million of net catastrophe losses, net of reinsurance and
claims handling fee income, and prior year reserve strengthening of $6.2
million , which was partially offset by $10.7 million of income recognized within
realized and unrealized gains in our consolidated statement of operations (refer
to Notes 2, 4 and 6 for further information). The 2021 weather events were
driven by Hurricane Ida, Winter Storm Uri as well as a number of convective
storm and hail events impacting Louisiana , Florida and Texas . The net
catastrophe losses were adversely impacted by having reached the net loss limit
contained in the FNIC non-Florida quota-share treaty, which reduced the amount
of net losses that we were able to cede in 2021. The 2020 net losses were driven
by net catastrophe losses of $128.3 million and prior period reserve
strengthening of $17.6 million . Additionally, higher ceded losses through our
quota-share treaties and lower attritional losses in FNIC's Florida book of
business drove lower current accident year losses, excluding catastrophes,
compared to the prior year.
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Commissions and Other Underwriting Expenses
The following table sets forth the commissions and other underwriting expenses
for the periods presented:
Year Ended December 31,
2021 2020
(In thousands)
Commissions and other underwriting expenses:
Homeowners Florida $ 47,817 $ 54,043
All other 48,672 49,384
Ceding commissions (77,090) (27,143)
Total commissions 19,399 76,284
Fees 5,367 5,079
Salaries and wages 13,896 13,791
Other underwriting expenses 42,518 29,134
Total commissions and other underwriting expenses
Commissions and other underwriting expenses decreased$43.1 million , or 34.7%, to$81.2 million for the year endedDecember 31, 2021 , as compared to$124.3 million for the year endedDecember 31, 2020 . This decrease was primarily due to higher ceding commission driven primarily by the new quota-share treaties in FNIC'sFlorida and non-Florida books of business. Refer to Ceded Premium Earned above for additional information. The higher ceding commission was partially offset by an increase in other underwriting expenses, which was the result of the benefit from the 50% profit-sharing agreement in the first half of 2020.
The net expense ratio increased 17.1 percentage points to 57.6% in 2021, as
compared to 40.5% in 2020 due primarily to higher ceded reinsurance premiums in
2021. Our gross expense ratio was 25.8% and 24.3% during the 2021 and 2020,
respectively, demonstrating the Company's continued focus on expense control.
General and Administrative Expenses
General and administrative expenses increased$1.0 million , or 4.0%, to$24.4 million for the year endedDecember 31, 2021 , as compared to$23.4 million for the year endedDecember 31, 2020 .
Interest Expense
Interest expense increased$1.1 million to$8.8 million for the year endedDecember 31, 2021 , as compared to$7.7 million for the year endedDecember 31, 2020 . Refer to Note 10 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for information related to changes to our existing debt and new debt issuance, which increased interest expense during 2021 as compared to 2020.
Impairment of Intangibles
EffectiveOctober 1, 2021 , due to the Company's plan to execute an orderly runoff of MIC's insurance operations, management concluded there was an indication of impairment for the identifiable intangible assets established in conjunction with the acquisition of the Maison Companies inDecember 2019 . Therefore, during the fourth quarter of 2021, we performed a discounted cash flow analysis to measure and record a non-cash impairment of$1.3 million , against which there is no tax offset. The impairment was due primarily to a decline in forecasted revenue and a higher discount rate, which lowered the fair value below carrying value. Refer to Overview of Insurance Lines of Business - Non-Florida set forth in Part I, Item 1. Business of this Annual Report, above for additional information on the Company's plan related to MIC. Coinciding with the preparation of the financial statements for the year endedDecember 31, 2020 , the Company's annual goodwill impairment testing resulted in the conclusion that the goodwill intangible asset established in conjunction with the acquisition of the Maison Companies inDecember 2019 was impaired. Therefore, during the fourth quarter of 2020, we recorded a non-cash impairment charge of$11.0 million , against which there was no tax offset, representing the write-off of the full amount of the goodwill -36- -------------------------------------------------------------------------------- asset. The Company's impairment analysis considered the earnings and share price of the Company and comparable companies, as well as projected cash flows. Continued adverse storm activity, higher excess of loss catastrophe reinsurance costs and the unfavorable claims environment in the state ofFlorida that existed at that time reduced the previously modeled fair value of the Company. These impacts, along with other information relevant to the estimated fair value of the Company, including the trading price of our shares, resulted in the impairment conclusion. Correspondingly, effectiveOctober 1, 2020 , we believed there was an indication of impairment for the identifiable intangible assets, and performed a discounted cash flow analysis to measure and record a non-cash impairment of$0.7 million , due primarily to a higher discount rate, which lowered the fair value below carrying value. Refer to Note 8 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for additional information related to our goodwill and identifiable intangible assets.
Income Taxes
Income tax expense (benefit) increased$33.8 million to$0.3 million for the year endedDecember 31, 2021 , as compared to$(33.5) million for the year endedDecember 31, 2020 . Refer to Note 11 of the notes to our Consolidated Financial Statements for information related to the increase in our valuation allowance for 2021 and our effective income tax rate.
Consolidated Company Outlook - Potential Changes in Financial Trends
As discussed under Overview of Insurance Lines of Business - Non-Florida above in "Part I, Item I. Business, Insurance Operations and Related Services" of this annual report, the Company intends to re-focus its operations on itsFlorida homeowners business. The orderly runoff of MIC and the transfer-upon-renewal of FNIC's non-Florida business to alternative insurance carrier partners of SageSure impact forward-looking expectations with respect to financial trends. Such impacts with respect to the Company's non-Florida business include, but are not limited to: •Declines in net written and gross earned premiums; •Declines in loss and loss adjustment expenses as well as in commissions and other underwriting expenses; •Declines in exposure to catastrophe weather losses; •Declines in the expected cost of excess of loss reinsurance coverages over the runoff period; and •Reduced need or potential need for surplus infusions into FNIC and MIC, and corresponding reductions in the Company's overall capital needs. Overall, the Company anticipates lower consolidated earnings. However, if catastrophe losses were to continue at the elevated levels experienced in the past eighteen months, it is expected that the orderly exit of the non-Florida business will have proven beneficial to the Company's earnings over the runoff period. See Going Concern in "Part I, Item I. Business, Insurance Operations and Related Services" of this annual report for discussion of the potential for the Company to be placed into receivership, which would materially impact financial trends in our results of operations -37- --------------------------------------------------------------------------------
Operating Results Overview - Year Ended
The following table sets forth selected results of operations for the periods
presented:
Year Ended December 31,
2020 % Change 2019
(Dollars in thousands)
Revenues:
Gross premiums written $ 726,885 19.0 % $ 610,608
Gross premiums earned 720,967 23.8 % 582,334
Ceded premiums (356,833) 63.2 % (218,682)
Net premiums earned 364,134 0.1 % 363,652
Net investment income 11,786 (25.9) % 15,901
Net realized and unrealized investment gains
(losses) 18,032 154.5 % 7,084
Direct written policy fees 13,970 37.0 % 10,200
Other income 23,941 32.1 % 18,124
Total revenues 431,863 4.1 % 414,961
Costs and expenses:
Losses and LAE 376,449 37.9 % 273,080
Commissions and other underwriting expenses 124,288 16.0 % 107,189
General and administrative expenses 23,420 0.9 % 23,203
Interest expense 7,661 (28.9) % 10,776
Impairment of intangibles 11,699 NCM -
Total costs and expenses 543,517 31.2 % 414,248
Income (loss) before income taxes (111,654) NCM 713
Income tax expense (benefit) (33,496) NCM (298)
Net income (loss) $ (78,158) NCM $ 1,011
Ratios to net premiums earned:
Net loss ratio 103.4 % 75.1 %
Net expense ratio 40.5 % 35.9 %
Combined ratio 143.9 % 111.0 %
(1)Net loss ratio is calculated as losses and LAE divided by net premiums
earned.
(2)Net expense ratio is calculated as all operating expenses less interest
expense divided by net premiums earned.
(3)Combined ratio is calculated as the sum of losses and LAE and all operating
expenses less interest expense divided by net premiums earned.
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The following table sets forth a reconciliation of GAAP to non-GAAP measures:
Year Ended December 31,
2020 2019
(Dollars in thousands)
Revenue
Total revenues $ 431,863 $ 414,961
Less:
Net realized and unrealized investment gains (losses) 18,032 7,084
Adjusted operating revenues $ 413,831 $ 407,877
Net Income (Loss)
Net income (loss) $ (78,158) $ 1,011
Less:
Net realized and unrealized investment gains (losses) 10,801 5,347
Acquisition and strategic costs (171) (1,267)
Amortization of identifiable intangibles (90) (10)
Gain (loss) on early extinguishment of debt - (2,698)
Impairment of intangibles (11,417) -
Adjusted operating income (loss) $
(77,281)
Income tax rate assumed for reconciling items above, excluding
impairment of goodwill
40.100 % 24.522 % Revenue Total revenue increased$16.9 million , or 4.1%, to$431.9 million for the year endedDecember 31, 2020 , as compared to$415.0 million for the year endedDecember 31, 2019 . The increase was primarily driven by higher net investment gains, policy fees and other income, partially offset by lower net investment income, all of which are discussed below.
Gross Premiums Written
The following table sets forth the gross premiums written for the periods
presented:
Year Ended December 31,
2020 2019
(In thousands)
Gross premiums written:
Homeowners Florida $ 444,576 $ 451,856
Homeowners non-Florida 263,534 142,485
Federal flood 19,022 16,413
Non-core (1) (247) (146)
Total gross premiums written $ 726,885 $ 610,608
(1)Reflects exited lines of business.
Gross premiums written increased$116.3 million , or 19.0%, to$726.9 million for the year endedDecember 31, 2020 , as compared to$610.6 million for the year endedDecember 31, 2019 . The gross premiums written increase was driven by our growth in our non-Florida book of business, including$77.8 million from MIC's non-Florida business, as we reduce our exposure in the state ofFlorida , as a result of the challenging litigation environment. Overall, homeowners grew 19.1%. -39- --------------------------------------------------------------------------------
Gross Premiums Earned
The following table sets forth the gross premiums earned for the periods
presented:
Year Ended December 31,
2020 2019
(In thousands)
Gross premiums earned:
Homeowners Florida $ 459,511 $ 452,730
Homeowners non-Florida 244,192 112,836
Federal flood 17,511 15,073
Non-core (1) (247) 1,695
Total gross premiums earned $ 720,967 $ 582,334
(1)Reflects exited lines of business.
Gross premiums earned increased$138.7 million , or 23.8%, to$721.0 million for the year endedDecember 31, 2020 , as compared to$582.3 million for the year endedDecember 31, 2019 . The higher gross premiums earned was primarily driven by higher non-Florida premiums, including$73.3 million from MIC's non-Florida business. Ceded Premiums Earned Ceded premiums earned increased$138.1 million , or 63.2%, to$356.8 million for the year endedDecember 31, 2020 , as compared to$218.7 million for the year endedDecember 31, 2019 . The increase was driven by approximately$91.5 million higher excess of loss reinsurance spend, as prices and overall property exposures increased, including$32.8 million from the Maison Companies acquisition, in the year 2020 as compared to 2019. Additionally, stemming from the non-cascading portion of our reinsurance tower and number of catastrophe events, we purchased supplemental coverage to backfill layers and gaps in coverage, which increased ceded premium earned by$10.4 million when comparing these periods. Furthermore, there was approximately$34.1 million of additional ceded premium related to the 50% quota-share treaty for FNIC's non-Florida book of business that became effectiveJuly 1, 2020 and was subsequently increased to 80% effectiveDecember 1, 2020 . The increase to ceded premium earned associated with the aforementioned quota-share treaties is partially offset by corresponding reductions in loss and LAE, and commission and other underwriting expenses when comparing the periods.
Net Investment Income
Net investment income decreased$4.1 million , or 25.9%, to$11.8 million for the year endedDecember 31, 2020 , as compared to$15.9 million for the year endedDecember 31, 2019 . The decrease was primarily due to the lower interest rate environment in 2020 and elevated second quarter 2019 income earned on debt proceeds that had not yet been deployed on the Maison Companies acquisition, partially offset by fixed income portfolio growth from the Maison Companies acquisition.
Net Realized and Unrealized Investment Gains (Losses)
Net realized and unrealized investment gains (losses) increased$10.9 million , to$18.0 million for the year endedDecember 31, 2020 , as compared to$7.1 million for the year endedDecember 31, 2019 . We recognized$(4.1) million (more than offset by realized gains on sales) and$4.1 million in unrealized investment gains (losses) for equity securities during these respective periods. Our current and prior year net realized gains are primarily associated with our portfolio managers, under our control, moving out of positions due to both macro and micro conditions, a typical practice most quarters. Furthermore, to mitigate the potential COVID-19 related adverse impact on the financial stability of the issuers of securities we hold, certain positions were liquidated during 2020. In addition, to reduce the potential impact of equity market volatility on our capital and liquidity, we sold all of the Company's investments in common stock.
Direct Written Policy Fees
Direct written policy fees increased by$3.8 million , or 37.0%, to$14.0 million for the year endedDecember 31, 2020 , as compared to$10.2 million for the year endedDecember 31, 2019 . The increase is primarily driven by the policy fees generated from MIC's policies in-force and higher fees as a result of FNIC's non-Florida premium growth. -40- --------------------------------------------------------------------------------
Other Income
Other income increased$5.8 million , or 32.1%, to$23.9 million for the year endedDecember 31, 2020 , as compared to$18.1 million for the year endedDecember 31, 2019 . Other income included the following for the periods presented: Year Ended December 31, 2020 % Change 2019 (Dollars in thousands) Other income: Commission income$ 3,357 15.6 %$ 2,904 Brokerage 18,948 39.6 % 13,577 Financing and other revenue 1,636 (0.4) % 1,643 Total other income$ 23,941 32.1 %$ 18,124 The increase in other income was primarily driven by higher brokerage revenue. The brokerage revenue increase is the result of higher excess of loss reinsurance spend from the reinsurance programs in place during 2020 as compared to 2019. Expenses Losses and LAE
Losses and LAE incurred, net of reinsurance, included the following for the
periods presented:
Year Ended December 31,
2020 2019
Net Loss Net Loss
Amount Ratio Amount Ratio
(In thousands)
Current accident year, excluding
catastrophes:
Homeowners $ 230,602 63.3 % $ 207,808 57.1 %
Non-core (1) - - % 1,601 0.4 %
Total current accident year, excluding
catastrophes 230,602 63.3 % 209,409 57.5 %
Current year catastrophes (2):
Florida 55,533 15.3 % 26,250 7.4 %
Texas 26,204 7.2 % 12,400 3.4 %
Louisiana 44,174 12.1 % 8,900 2.4 %
Other states 2,386 0.7 % 5,150 1.4 %
Total current year catastrophes 128,297 35.3 % 52,700 14.6 %
Prior year loss development (redundancy):
Homeowners (655) (0.2) % 615 0.2 %
Non-core (1) 19,022 5.2 % 12,845 3.5 %
Ceded losses subject to offsetting
experience account adjustments (3) (816) (0.2) % (2,489) (0.7) %
Total prior year loss development
(redundancy) 17,551 4.8 % 10,971 3.0 %
Total net losses and LAE $ 376,449 103.4 % $ 273,080 75.1 %
(1)Reflects exited lines of business.
(2)Includes PCS weather events and other events impacting multiple insureds for
which the Company's insurance carriers established catastrophe event codes, net
of the benefit of claims handling services. These catastrophe events are
typically wind, hail and tornado related weather events. Any individual
catastrophe event with gross losses greater than $20 million , on a pre-tax
basis, are considered significant and specifically addressed in the commentary
below.
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(3)Reflects homeowners losses ceded under retrospective reinsurance treaties to
the extent there is an offsetting experience account adjustment, such that there
is no impact on pre-tax net income (loss).
Losses and LAE increased $103.3 million , or 37.9%, to $376.4 million for the
year ended December 31, 2020 , as compared to $273.1 million for the year ended
December 31, 2019 . The net loss ratio increased 28.3 percentage points, to
103.4% in 2020, as compared to 75.1% in 2019. The higher ratio was primarily the
result of higher catastrophe net losses when comparing the periods, as 2020
included $128.3 million , net of reinsurance. Approximately $37 million of
catastrophe net losses from FNIC's non-Florida book of business was subject to a
50% profit-sharing agreement prior to the 50% profit-sharing agreement prior to
the 50% quota share becoming effective on July 1, 2020 and increasing to 80%
effective December 1, 2020 , as discussed above.
The 2020 catastrophe net losses were $109.8 million , net of reinsurance and
profit-share impact described above, which included Hurricanes Laura, Sally,
Delta, Zeta and Eta, as well as a number of hail and wind-related severe weather
events, which impacted Florida , Louisiana , Texas and other states. By
comparison, 2019 catastrophe net losses were $39.5 million , net of reinsurance
and profit-share impact, which primarily included $18.7 million attributed to a
single hail storm in Brevard County, Florida , and hail and wind related events
during the spring months in the southeastern part of the United States . The
remaining variance was the result of higher prior year development, as detailed
in the table above, and higher current year gross losses from a higher volume of
policies, mostly offset by increased ceded losses in FNIC's Florida and
non-Florida books of business as a result of additional quota-share agreements
in place in the second half of 2020 as compared to the second half of 2019.
Commissions and Other Underwriting Expenses
The following table sets forth commissions and other underwriting expenses for
the periods presented:
Year Ended December 31,
2020 2019
(In thousands)
Commissions and other underwriting expenses:
Homeowners Florida $ 54,043 $ 52,962
All others 49,384 25,491
Ceding commissions (27,143) (12,128)
Total commissions and other fees 76,284 66,325
Fees 5,079 3,368
Salaries and wages 13,791 12,114
Other underwriting expenses 29,134 25,382
Total commissions and other underwriting expenses
Commissions and other underwriting expenses increased$17.1 million , or 16.0%, to$124.3 million for the year endedDecember 31, 2020 , as compared to$107.2 million for the year endedDecember 31, 2019 . The increase was primarily driven by higher non-Florida acquisition related costs, which includes gross commissions, fees and other underwriting expenses as a result of premium growth, including from MIC's non-Florida business. When comparing these periods, this increase was partially offset by a higher ceding commission driven in part by the new quota-share treaties in FNIC'sFlorida and non-Florida books of business. Refer to Ceded Premium Earned above for additional information.
The net expense ratio increased 4.6 percentage points to 40.5% in 2020, as
compared to 35.9% in 2019 due primarily to higher excess of loss ceded
reinsurance premiums in 2020.
General and Administrative Expenses
Despite the addition of the Maison Companies and enabled by our rigorous
integration efforts, general and administrative expenses increased only
million
compared to
-42- --------------------------------------------------------------------------------
Interest Expense
Interest expense decreased$3.1 million to$7.7 million for the year endedDecember 31, 2020 , as compared to$10.8 million for the year endedDecember 31, 2019 , which included$3.6 million of prepayment fees, including the write-off of remaining debt issuance costs. This decline was partially offset by the fact that ourMarch 2019 debt offering was only outstanding for a portion of the first quarter of 2019.
Impairment of Intangibles
Coinciding with the preparation of the financial statements for the year endedDecember 31, 2020 , the Company's annual goodwill impairment testing resulted in the conclusion that the goodwill intangible asset established in conjunction with the acquisition of the Maison Companies inDecember 2019 was impaired. Therefore, during the fourth quarter of 2020, we recorded a non-cash impairment charge of$11.0 million , against which there is no tax offset, representing the write-off of the full amount of our goodwill asset. The Company's impairment analysis considered the earnings and share price of the Company and comparable companies, as well as projected cash flows. Continued adverse storm activity, higher excess of loss catastrophe reinsurance costs and the continued unfavorable claims environment in the state ofFlorida reduced the previously modeled fair value of the Company. These impacts, along with other information relevant to the estimated fair value of the Company, including the trading price of our shares, resulted in the impairment conclusion.
Correspondingly, effective as of
indication of impairment for our identifiable intangible assets, therefore we
performed a discounted cash flow analysis to measure and record a non-cash
impairment of
lowered the fair value below carrying value.
Refer to Note 8 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for additional information related to our goodwill and identifiable intangible assets.
Income Taxes
Income tax expense (benefit) decreased$33.2 million to$(33.5) million for the year endedDecember 31, 2020 , as compared to$(0.3) million for the year endedDecember 31, 2019 . The decrease in income tax expense is predominantly the result of the pre-tax loss during the current year as compared to income during 2019. Additionally, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act"), signed into law onMarch 27, 2020 , enabled us to carry back net operating loss to prior years when the statutory federal income tax rate was at 35%, which increased our effective tax rate during 2020. Refer to Note 11 of the notes to our Consolidated Financial Statements for additional information regarding the CARES Act.
LIQUIDITY AND CAPITAL RESOURCES
Overview
Our primary sources of funds are gross written premiums, ceding of claims payments pursuant to reinsurance treaties, investment income, commission income and fee income. Our primary uses of funds are the payment of claims, catastrophe and other reinsurance premiums and operating expenses. As ofDecember 31, 2021 , on a consolidated basis, the Company held$83.5 million in cash and cash equivalents and$333.4 million in investments. As ofDecember 31, 2020 , on a consolidated basis, the Company held$102.4 million in cash and cash equivalents and$491.4 million in investments. Total shareholders' equity decreased$98.8 million , to$59.4 million as ofDecember 31, 2021 , as compared with$158.2 million as ofDecember 31, 2020 , due primarily to a net loss and unrealized losses on our bond portfolio, partially offset by issuance of common stock. The Company believes it has adequate holding company liquidity to accommodate its potential first quarter catastrophe losses, and to maintain regulatory minimum RBC ratios throughout 2022. As described in Going Concern in "Part I, Item I. Business, Insurance Operations and Related Services" of this annual report , the Company believes there is substantial doubt regarding its ability to continue as a going concern. The Company has been notified by Demotech that FNIC has been downgraded from "A" to "S". MNIC's "A" rating was recently affirmed. The Company believes that the downgrade of FNIC's Demotech rating will adversely impact our ability to obtain excess-of-loss reinsurance for coverage beginningJuly 1, 2022 . Absent such coverage, the Company will not be in compliance with requirements communicated by theOffice of Insurance Regulation of the state ofFlorida regarding such coverage, which could ultimately result in the Company being placed into receivership. The Company has outstanding$100 million of 2029 Notes ("2029 Notes"), which at issuance bore interest at the annual rate of 7.50%. In connection with the amendment of the indenture covenants to increase the maximum debt-to-capital ratio applicable to the -43- -------------------------------------------------------------------------------- incurrence of debt to 60% and decreasing the maximum debt-to-capital ratio applicable to restricted payments, including cash dividends on our common stock, to 20%, the interest rate was increased by 0.25% to 7.75% per annum beginningMarch 15, 2021 . Refer to Note 10 of the notes to our Consolidated Financial Statements for additional information regarding the 2029 Notes. The Company has outstanding$21 million of Convertible Senior Unsecured Notes due 2026 ("2026 Notes"), which bear interest at the annual rate of 5.0%. The 2026 Notes are convertible in part or in whole at the option of the holders at any time until the close of business on the second trading day prior to the maturity date onApril 19, 2026 ("Maturity Date") into shares of the Company's common stock at an initial conversion rate of 166.6667 shares of the Company's common stock per$1,000 principal amount of the 2026 Notes (equivalent to an initial conversion price of$6.00 per share), subject to customary adjustments in certain circumstances. The Company will not have the right to redeem the 2026 Notes prior to the Maturity Date. Holders of the 2026 Notes may require the Company to purchase their 2026 Notes upon a change of control at a purchase price equal to 101% of the principal amount thereof, plus accrued and unpaid interest to, but excluding, the date of purchase. If the Company is placed into receivership and/or fails to obtain excess-of-loss reinsurance, such conditions represent potential defaults under our debt indentures that could result in acceleration of repayment of our debt. We cannot provide any assurance that we will be able to comply with certain covenants in our senior note indentures or to make satisfactory alternative arrangements in the event we cannot do so.
The Company's actual debt to capital ratio as of
approximately 66.7%.
OnMarch 15, 2021 , the Company closed an underwritten public offering of 3,500,000 shares of its common stock at a price of$4.75 per share for gross proceeds of$16.6 million . The offering generated net proceeds to the Company of approximately$15.1 million , after deducting the underwriter's discount and offering expenses payable by the Company. InApril 2021 , the Company sold an additional 100,650 shares upon the partial exercise of the underwriter's overallotment option and received net proceeds of$0.4 million . This offering, the offering of 2026 Notes and changes to our 2029 Notes, are part of our ongoing execution of the strategic review process initiated by the Company's Board of Directors announced inNovember 2020 . Historically, we have met our liquidity requirements primarily through cash generated from operations. Beginning in 2020, property and casualty businesses, including FNHC's insurance carriers, have been materially adversely impacted by multiple catastrophes, hail, and wind-related severe weather events and private reinsurers have tightened coverage provisions and raised the cost of their coverages. As a result, sales of our portfolio of fixed income securities was a significant source of liquidity for the Company. Quota-share reinsurance treaties are another liquidity management tool, via the ceding commission the Company receives upon inception and the related reduction to statutory surplus requirements. New quota-share treaties entered or increased were responsive to these purposes, as well as to reduce the Company's exposure to non-named storm catastrophes. Certain of the Company's quota-share treaties contain provisions that give the reinsurer the option to terminate the treaty in the event that our Demotech rating is downgraded or that we are placed into receivership. The termination of any of our quota-share treaties would place additional strain on our statutory surplus. Management continually monitors and adjusts its liquidity and capital plans for FNHC and its subsidiaries in light of the aforementioned challenges to ensure that we have adequate liquidity and capital. The Company's Board and management continue to explore all options to strengthen the Company's capital position. Management is pursuing various financing alternatives to augment our capital and liquidity, including possible equity or debt financings (consistent with our indentures) and possible sales of non-core assets. Continuing occurrences of severe weather events and the current significant economic uncertainty and volatility in the credit and capital markets may impair our ability to raise additional capital. We may not be able to raise sufficient additional capital to avoid a down grade of our Demotech rating, and our other efforts to improve our profitability may not succeed.Statutory Capital and Surplus of our Insurance Subsidiaries As described more fully in Part I, Item 1. Business, Regulation of this Annual Report, the Company's insurance operations are subject to the laws and regulations of the states in which we operate. The OIR and their regulatory counterparts in other states utilize theNational Association of Insurance Commissions ("NAIC") risk-based capital ("RBC") requirements, and the resulting RBC ratio, as a key metric in the exercise of their regulatory oversight. The RBC ratio is a measure of the sufficiency of an insurer's statutory capital and surplus. In addition, the RBC ratio is used by insurance industry ratings services in the determination of the financial strength ratings (i.e., claims paying ability) they assign to insurance companies. Our rating agency for our insurance carriers,Demotech, Inc. requires a minimum RBC ratio of 300%, among other metrics, for a carrier to maintain a Demotech rating. FNIC was recently downgraded from "A" to "S". See Going Concern in "Part I, Item I. Business, Insurance Operations and Related Services" of this annual report for discussion of the loss of FNIC's "A" rating. As ofDecember 31, 2021 , FNIC's statutory surplus, which includes MNIC, was$99.4 million , which included a$17.1 million surplus infusion effectiveDecember 31, 2021 , via the assignment, from FNHC to FNIC, of a surplus note receivable. The surplus note was issued by MIC inDecember 2019 and matures inDecember 2022 . As ofDecember 31, 2021 , MIC's statutory surplus was$30.8 million . MIC'sDecember 31, 2021 surplus reflects a surplus infusion of$4.0 -44- -------------------------------------------------------------------------------- million inFebruary 2022 with an effective date as ofDecember 31, 2021 , as approved by theFlorida regulator. In conjunction with the Company'sNovember 2021 decision to re-focus on itsFlorida homeowners business as discussed under Overview of Insurance Lines of Business - Non-Florida above in "Part I, Item 1. Business, Insurance Operations and Related Services" of this Annual Report, the Company is in the process of executing an orderly runoff of MIC's business. The Company remains committed to maintaining statutory surplus in MIC that satisfies minimum regulatory requirements through the runoff period. As a result of the Company's decision to support MIC to the level of minimum regulatory capital but not to a 300% RBC level, Demotech has withdrawn its rating of MIC. The ratings of FNIC and MNIC remain in place at "S" and "A", respectively, and are independent of this action. Adjusted for the intercompany impacts of the surplus note referenced above, the combined statutory surplus of our insurance carriers is approximately$113 million . As ofDecember 31, 2021 , the Company has approximately$44 million of liquidity in its holding company and non-regulated subsidiaries (collectively referred to "holding company liquidity") that is available for general corporate purposes, including supporting the capital requirements of its insurance subsidiaries. This figure was reduced by$4 million inFebruary 2022 as a result of the surplus infusion described above. As a result, the Company has approximately$40 million of holding company liquidity heading into the first quarter of 2022. We expect that at least some portion of these funds will need to be infused into our insurance carriers as a result of catastrophe weather losses incurred during the first quarter of 2022. The amount of such infusion will be determined in conjunction with our first quarter 2022 accounting and reporting cycle. Based on RBC requirements, the extent of regulatory intervention and action increases as the ratio of an insurer's statutory surplus to its ACL, as calculated under the NAIC's requirements, decreases. The first action level, the Company Action Level, requires an insurer to submit a plan of corrective actions to the insurance regulators if statutory surplus falls below 200% of the ACL amount. The second action level, the Regulatory Action Level, requires an insurer to submit a plan containing corrective actions and permits the insurance regulators to perform an examination or other analysis and issue a corrective order if statutory surplus falls below 150% of the ACL amount. The third action level, ACL, allows the regulators to rehabilitate or liquidate an insurer in addition to the aforementioned actions if statutory surplus falls below the ACL amount. The fourth action level is the Mandatory Control Level, which requires the regulators to rehabilitate or liquidate the insurer if statutory surplus falls below 70% of the ACL amount. Based upon the 2021, 2020 and 2019 statutory financial statements for FNIC, MIC and MNIC, statutory surplus exceeded the regulatory action levels established by the NAIC's RBC requirements. FNIC's ratio of statutory surplus to its ACL was 313% and 303% as ofDecember 31, 2021 and 2020, respectively. MNIC's ratio of statutory surplus to its ACL was 1,152% and 736% as ofDecember 31, 2021 and 2020, respectively. MIC's ratio of statutory surplus to its ACL was 305% and 348% as ofDecember 31, 2021 and 2020, respectively. As described above, the Company intends to maintain no less than the minimum required regulatory capital within MIC, but does not intend to maintain a 300% RBC ratio. The Company will continue to closely coordinate with all applicable state insurance departments with respect to its plan of operation throughout the runoff period. Refer to "Part I, Item 1A., Risk Factors" for more information on how over time, additional weather-related events and actions by reinsurers, including loss limitations in reinsurance treaties and our ability to renew existing reinsurance treaties, could adversely affect the Company's ability to maintain a 300% RBC ratio in FNIC and MNIC (which is critical to maintaining a Demotech rating) and minimum required regulatory capital in MIC or FNHC's ability to contribute necessary capital. In addition, because of the valuation allowance on the Company's NOL deferred tax assets, the insurance carriers will not benefit from immediate tax benefits of any future quarterly losses they incur. As such, any surplus infusions required will be larger than they would have been if our net deferred tax assets were deemed fully realizable.
Cash Flows Discussion
We currently believe that existing cash and investment balances, when combined with anticipated cash flows, will be adequate to meet our expected liquidity needs in both the short-term and the reasonably foreseeable future, including maintaining regulatory minimum capital levels in our insurance carriers. However, our ability to maintain 300% RBC levels in FNIC and MNIC (which is critical to maintaining a Demotech rating) may be dependent on our ability to raise additional capital in the future. There can be no guarantee additional capital will be available to the Company, if needed. Future strategies and catastrophe events would require additional external financing and we may from time to time seek to obtain external financing. We cannot assure that additional sources of financing will be available to us on favorable terms, or at all, or that the terms of any such financing would not negatively impact our results of operations. Operating Activities Net cash provided by (used in) operating activities decreased to$(191.2) million for the year endedDecember 31, 2021 compared to$(91.9) million for the year endedDecember 31, 2020 . This decrease primarily reflects higher reinsurance spend and lower gross written premiums, partially offset by lower expenses from losses and LAE, primarily from reinsurance recoveries. -45- -------------------------------------------------------------------------------- Net cash (used in) operating activities decreased to$(91.9) million for the year endedDecember 31, 2020 compared to net cash provided of$35.3 million for the year endedDecember 31, 2019 . This decrease primarily reflects higher expenses paid, including those related to commissions and underwriting expenses and losses and LAE, including higher net catastrophe losses.
Investing Activities
Net cash provided by (used in) investing activities was$136.9 million for the year endedDecember 31, 2021 , as compared to$76.4 million for the year endedDecember 31, 2020 . The change primarily reflects lower purchases of debt and equity investment securities of$176.3 million for the year endedDecember 31, 2021 , as compared to$585.6 million for the year endedDecember 31, 2020 , partially offset by lower sales, maturities and redemptions of our debt and equity investment securities of$315.1 million in 2021 as compared to$665.3 million in 2020. This drawdown of the investment portfolio was necessary to fund the operating cash outflows described above. Net cash provided by (used in) investing activities was$76.4 million for the year endedDecember 31, 2020 , as compared to$(9.0) million for the year endedDecember 31, 2019 . The change was due to higher proceeds from sales of debt and equity investment securities of$578.5 million the year endedDecember 31, 2020 , as compared to$173.4 million for the year endedDecember 31, 2019 and higher maturities and redemptions of debt investment securities of$86.8 million for 2020, as compared to$43.9 million for the year ended 2019. This was partially offset by higher purchases of debt and equity investment securities of$585.6 million for the year endedDecember 31, 2020 , as compared to$234.7 million for the year endedDecember 31, 2019 .
Financing Activities
Net cash provided by (used in) financing activities was$35.4 million for the year endedDecember 31, 2021 , as compared to$(15.5) million for the year endedDecember 31, 2020 . The change primarily reflects proceeds from issuance of long-term debt of$19.8 million for the year endedDecember 31, 2021 and issuance of shares of our common stock of$15.6 million in our 2021 public offering as compared to repurchases of$10.4 million ofFedNat Holding Company common stock and payment of dividends of$5.1 million in 2020. Net cash provided by (used in) financing activities was$(15.5) million for the year endedDecember 31, 2020 , as compared to$42.6 million for the year endedDecember 31, 2019 . The change was primarily due to proceeds from issuance of long-term debt of$98.4 million for the year endedDecember 31, 2019 and repurchases ofFedNat common stock of$10.4 million in 2020, as compared to$3.4 million in 2019. These changes were partially offset by payment of long-term debt of$48.0 million for the year endedDecember 31, 2019 .
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented herein have
been prepared in accordance with GAAP, which requires the measurement of
financial position and operating results in terms of historical dollars without
considering changes in the relative purchasing power of money over time due to
inflation. Our primary assets and liabilities are monetary in nature. As a
result, interest rates have a more significant impact on performance than the
effects of general levels of inflation. Interest rates do not necessarily move
in the same direction or with the same magnitude as the inflationary effect on
the cost of paying losses and LAE.
Insurance premiums are established before we know the amount of losses and LAE
and the extent to which inflation may affect such expenses. Consequently, we
attempt to anticipate the future impact of inflation when establishing rate
levels. While we attempt to charge adequate premiums, including the use of
third-party vendor "replacement cost estimator" tools when establishing coverage
limits on policies we issue, we may be limited in raising premium levels for
competitive and regulatory reasons. Inflation may also affect the market value
of our investment portfolio and the investment rate of return. Any future
economic changes that result in prolonged and increasing levels of inflation
could cause increases in the dollar amount of incurred losses and LAE and
thereby materially adversely affect future liability requirements.
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CONTRACTUAL OBLIGATIONS
The table sets forth a summary of long-term contractual obligations as of
undiscounted amounts payable over time, as follows:
Payments Due By Period
Less More
than 1 - 3 3 - 5 than
Total 1 Year Years Years 5 Years
(In thousands)
Loss and loss adjustment expense $ 738,794 $ 435,888 $ 221,638 $ 44,328 $ 36,940
reserves (1)
Long-term debt (2) 121,000 - - 21,000 100,000
Operating leases 7,826 1,098 2,295 2,255 2,178
Total long-term contractual $ 867,620 $ 436,986 $ 223,933 $ 67,583 $ 139,118
obligations
(1)Loss and loss adjustment expense reserves do not have contractual maturity
dates; however, based on historical payment patterns, the amount presented is
our estimate of the expected timing of these payments. The timing of payments is
subject to significant uncertainty. We maintain a portfolio of marketable
investments with varying maturities and a substantial amount of cash and cash
equivalents intended to provide adequate cash flows for such payments.
(2)Represents the principal amounts of debt only. See Note 10 of the notes to
our Consolidated Financial Statements set forth in Part II, Item 8. Financial
Statements and Supplementary Data of this Annual Report for additional
information.
CRITICAL ACCOUNTING POLICIES
We prepare our consolidated financial statements in conformity with accounting principles generally accepted inthe United States ("GAAP"), which requires us to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results may materially differ from those estimates. We believe our most critical accounting estimates inherent in the preparation of our financial statements are: (i) fair value measurements of our investments; (ii) accounting for investments; (iii) premium and unearned premium calculation; (iv) reinsurance contracts; (v) the amount and recoverability of deferred acquisition costs and value of business acquired; (vi) goodwill and other intangible assets; (vii) reserve for loss and losses adjustment expenses; and (viii) income taxes. The accounting estimates require the use of assumptions about certain matters that are highly uncertain at the time of estimation. To the extent actual experience differs from the assumptions used, our financial condition, results of operations, and cash flows would be affected.
Fair Value
Fair value is the price that would be received to sell an asset or paid to transfer a liability between market participants in the principal market or in the most advantageous market when no principal market exists. Adjustments to transaction prices or quoted market prices may be required in illiquid or disorderly markets in order to estimate fair value. Alternative valuation techniques may be appropriate under the circumstances to determine the value that would be received to sell an asset or pay to transfer a liability in an orderly transaction. Market participants are assumed to be independent, knowledgeable, able and willing to transact an exchange and not acting under duress. Our nonperformance or credit risk is considered in determining the fair value of liabilities. Considerable judgment may be required in interpreting market data used to develop the estimates of fair value. Accordingly, estimates of fair value presented herein are not necessarily indicative of the amounts that could be realized in a current or future market exchange. Refer to Note 4 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report for additional information.
Investments
Investments consist of debt and equity securities. Debt securities consist of securities with an initial fixed maturity of more than three months, including corporate bonds, municipal bonds andUnited States government bonds. Equity securities generally consist of securities that represent ownership interests in an enterprise. The Company determines the appropriate classification of investments in debt and equity securities at the acquisition date and re-evaluates the classification at each balance sheet date. -47- -------------------------------------------------------------------------------- Our debt securities are classified as available-for-sale and recorded at fair value. Unrealized gains and losses during the year, net of the related tax effect applicable to available-for-sale are excluded from income and reflected in other comprehensive income (loss) as a separate component of shareholders' equity until realized. Prior toJanuary 1, 2020 , if a decline in fair value was deemed to be other-than-temporary, the investment was written down to its fair value and the amount of the write-down is recorded as an other-than-temporary impairment ("OTTI") loss on the statement of operations. As the result of the adoption of Accounting Standards Update ("ASU") 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instrument ("ASU 2016-13") beginning onJanuary 1, 2020 , we instead record an allowance for credit loss. Refer to Note 7 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report for additional information regarding allowances for credit loss. Any portion of the market decline related to debt securities that is believed to arise from factors other than credit is recorded as a component of other comprehensive income (loss) rather than against income. Equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) are measured at fair value with changes in fair value recognized in net income (loss). When we invest in certain companies, such as limited partnerships and limited liability companies, and if we determine we are not the primary beneficiary, we account for them using the equity method to determine the carrying value, which is included in other assets on our Consolidated Balance Sheets. Our maximum exposure to loss is limited to the capital we invest. Net realized gains and losses on investments are determined in accordance with the specific identification method. Net investment income consists primarily of interest income from debt securities, cash and cash equivalents, including any premium amortization or discount accretion and dividend income from equity securities; less expenses related to investments. Refer to Note 5 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report for additional information regarding investments.
Premiums and Unearned Premiums
We recognize premiums as revenue on a pro-rata basis over the term of an insurance policy. Reinsurance premiums written and earned are based on contract terms for excess-of-loss and quota-share contracts. Premiums are earned over the terms of the related coverage.
Unearned premiums and ceded unearned premiums represent the portion of gross
premiums written and ceded premiums written, respectively, relating to the
unexpired terms of such coverage.
Premium receivable balances are reported net of an allowance for estimated uncollectible premium amounts. Such allowance is based upon an ongoing review of amounts outstanding, length of collection periods, the creditworthiness of the insured and other relevant factors. Amounts deemed to be uncollectible are written off against the allowance. Refer to Note 7 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report for additional information allowances for credit loss.
Reinsurance
Reinsurance is used to mitigate the exposure to losses, manage capacity and
protect capital resources. Obtaining adequate catastrophe reinsurance coverage
is critical to the viability of our business model. Reinsuring loss exposures
does not relieve a ceding entity from its obligations to policyholders and
cedants. Reinsurance recoverables (including amounts related to claims incurred
but not reported) and ceded unearned premiums are reported as assets. To
minimize exposure to losses from a reinsurer's inability to pay, the financial
condition of such reinsurer is evaluated initially upon placement of the
reinsurance and periodically thereafter. In addition to considering the
financial condition of the reinsurer, the collectability of the reinsurance
recoverables is evaluated (and where appropriate, whether an allowance for
estimated uncollectible reinsurance recoverables is to be established) based
upon a number of other factors. Such factors include the amounts outstanding,
length of collection periods, disputes, any collateral or letters of credit held
and other relevant factors. Refer to Note 7 of the notes to our Consolidated
Financial Statements set forth in Part II, Item 8. Financial Statements and
Supplementary Data of this Annual Report for additional information regarding
allowances for credit loss.
Ceded premiums written are recorded in accordance with applicable terms of the
various reinsurance contracts and ceded premiums earned are charged against
revenue over the period of the various reinsurance contracts. This also
generally applies to reinstatement premiums paid to a reinsurer, which arise
when contractually-specified ceded loss triggers have been breached. Ceded
commissions reduce commissions, brokerage and other underwriting expenses and
ceded losses incurred reduce net losses and LAE incurred over the applicable
periods of the various reinsurance contracts with third party reinsurers. If
premiums or commissions are subject to adjustment (for example,
retrospectively-rated or experience-rated), the estimated ultimate premium or
commission is recognized over the period of the contract.
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Amounts recoverable from reinsurers are estimated in a manner consistent with
the claim liability associated with the reinsured business and consistent with
the terms of the underlying reinsurance contract.
Deferred Acquisition Costs and Value of Business Acquired
Deferred acquisition costs represent those costs that are incremental and directly related to the successful acquisition of new or renewal of existing insurance contracts. We defer incremental costs that result directly from, and are essential to, the acquisition or renewal of an insurance contract. Such deferred acquisition costs generally include agent or broker commissions, referral fees, premium taxes, medical costs and inspection fees that would not have been incurred if the insurance contract had not been acquired or renewed. Each cost is analyzed to assess whether it is fully deferrable. We also defer a portion of the employee total compensation and payroll-related fringe benefits directly related to time spent performing specific acquisition or renewal activities, including costs associated with the time spent on underwriting, policy issuance and processing, and sales force contract selling. The acquisition costs are deferred and amortized over the period in which the related premiums written are earned, generally twelve months. Deferred acquisition cost balances are grouped consistent with the manner in which the insurance contracts are acquired, serviced and measured for profitability and is reviewed for recoverability based on the profitability of the underlying insurance contracts. Investment income is anticipated in assessing the recoverability of deferred acquisition costs. We assess the recoverability of deferred acquisition costs on an annual basis or more frequently if circumstances indicate impairment may have occurred. As ofDecember 31, 2021 and 2020, the Company had no value of business acquired ("VOBA") reflected on our consolidated balance sheets as during the year endedDecember 31, 2020 , our VOBA balance became fully amortized. VOBA is an asset that reflects the estimated fair value of in-force contracts in an acquisition and represents the portion of the purchase price that is allocated to the value of the right to receive future cash flows from the business in-force at the acquisition date. VOBA is amortized over the period in which the related premiums written are earned, generally twelve months or less for property insurance business. VOBA amortization is reported within commissions and other underwriting expenses on our consolidated statements of operations.
As of
consolidated balance sheets. As of
intangible assets reflected on our consolidated balance sheets.
Goodwill and identifiable intangible assets with indefinite lives are not amortized but are reviewed for impairment annually as ofOctober 1 and more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value below its associated carrying value. Identifiable intangibles that do not have indefinite lives are amortized on a straight-line basis over their estimated useful lives. When we perform a quantitative goodwill impairment test, the fair value of the reporting unit, which we define as consolidated FNHC, is determined and compared to its carrying value. If the carrying value of the reporting unit is greater than the reporting unit's fair value, goodwill is impaired and written down to the reporting unit's fair value; and a charge is reported in impairment of intangibles on our consolidated statements of operations. The fair value of our reporting unit is comprised of the value of in-force (i.e., existing) business and the value of new business. To determine the value of in-force and new business, we use a discounted cash flows technique that applies a discount rate reflecting the market expected, weighted-average rate of return adjusted for the risk factors associated with operations to the projected future cash flow for our reporting unit. For identifiable intangible assets, if there is an indication of impairment, then the discounted cash flow method would be used to measure the impairment, and the carrying value would be adjusted as necessary.
Estimates of fair value are inherently uncertain and represent only management's
reasonable expectation regarding future developments.
Effective as ofOctober 1, 2021 , due to the Company's plan to execute an orderly runoff of MIC's insurance operations, we believed there was an indication of impairment for our identifiable intangible assets established in conjunction with the acquisition of the Maison Companies inDecember 2019 . Therefore, during the fourth quarter of 2021, we performed a discounted cash flow analysis to measure and record a non-cash impairment of$1.3 million , against which there is no tax offset, due primarily to the decline in revenue forecasts and a higher discount rate, which lowered the fair value below carrying value. Refer to Overview of Insurance Lines of Business - -49- --------------------------------------------------------------------------------
Non-
for additional information on the Company's plan related to MIC.
Coinciding with the preparation of the financial statements for the year endedDecember 31, 2020 , the Company's annual goodwill impairment testing has resulted in the conclusion that the goodwill intangible asset established in conjunction with the acquisition of the Maison Companies inDecember 2019 was impaired. Therefore, during the fourth quarter of 2020, we recorded a non-cash impairment charge of$11.0 million , against which there is no tax offset, representing the write-off of the full amount of our goodwill asset. The Company's impairment analysis considered the earnings and share price of the Company and comparable companies, as well as projected cash flows. Continued adverse storm activity, higher excess of loss catastrophe reinsurance costs and the continued unfavorable claims environment in the state ofFlorida reduced the previously modeled fair value of the Company. These impacts, along with other information relevant to the estimated fair value of the Company, including the trading price of our shares, resulted in the impairment conclusion.
Correspondingly, effective as of
indication of impairment for our identifiable intangible assets, therefore we
performed a discounted cash flow analysis to measure and record a non-cash
impairment of
lowered the fair value below carrying value.
Refer to Note 8 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for additional information related to our goodwill and identifiable intangible assets.
Losses and Loss Adjustment Expenses
Overview
The estimation of the liability for unpaid losses and LAE is inherently
difficult and subjective, especially in view of changing legal and economic
environments that impact the development of loss reserves, and therefore,
quantitative techniques frequently have to be supplemented by subjective
considerations and managerial judgment. In addition, trends that have affected
development of liabilities in the past may not necessarily occur or affect
liability development to the same degree in the future.
We establish reserves on our balance sheet for unpaid losses and LAE related to
its property and casualty insurance and related reinsurance contracts. As of any
balance sheet date, there are claims that have not yet been reported, and some
claims may not be reported for many years after the date a loss occurs. As a
result of this historical pattern, the liability for unpaid losses and LAE
includes significant estimates for IBNR claims. Additionally, reported claims
are in various stages of the settlement process. Each claim is settled
individually based upon its merits, and certain claims may take years to settle,
especially if legal action is involved. As a result, the liabilities for unpaid
losses and LAE include significant judgments, assumptions and estimates made by
management relating to the actual ultimate losses that will arise from the
claims. Due to the inherent uncertainties in the process of establishing these
liabilities, the actual ultimate loss from a claim is likely to differ, perhaps
materially, from the liability initially recorded.
The time period between the occurrence of a loss and the time it is settled is
referred to as the "claim tail." In general, actuarial judgments for
shorter-tailed lines of business generally have much less of an effect on the
determination of the loss reserve amount than when those same judgments are made
regarding longer-tailed lines of business. Reported losses for the
shorter-tailed classes, such as property and certain marine, aviation and energy
classes, generally reach the ultimate level of incurred losses in a relatively
short period of time. Rather than having to rely on actuarial assumptions for
many accident years, these assumptions are generally only relevant for the more
recent accident years.
The process of recording quarterly and annual liabilities for unpaid losses and
LAE for short-tail lines is primarily focused on maintaining an appropriate
reserve level for reported claims and IBNR. Specifically, we assess the reserve
adequacy of IBNR in light of such factors as the current levels of reserves for
reported claims and expectations with respect to reporting lags, catastrophe
events, historical data, legal developments, and economic conditions, including
the effects of inflation.
Standard actuarial methodologies employed to estimate ultimate losses
incorporate the inherent lag from the time claims occur to when they are
reported to an insurer and if applicable, to when an insurer reports the claims
to a reinsurer. Certain actuarial methodologies may be more appropriate than
others in instances where this lag may not be consistent from period to period.
Consequently, additional actuarial judgment is employed in the selection of
methodologies to best incorporate the potential impact of this situation.
Our insurance companies provide coverage on both a claims-made and occurrence
basis. Claims-made policies generally require that claims occur and be reported
during the coverage period of the policy. Occurrence policies allow claims which
occur during a policy's coverage period to be reported after the coverage
period, and as a result, these claims can have a very long claim tail,
occasionally
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extending for decades. Casualty claims can have a very long claim tail, in
certain situations extending for many years. In addition, casualty claims are
more susceptible to litigation and the legal environment and can be
significantly affected by changing contract interpretations, all of which
contribute to extending the claim tail. For long-tail casualty lines of
business, estimating the ultimate liabilities for unpaid losses and LAE is a
more complex process and depends on a number of factors, including the line and
volume of the business involved. For these reasons, our insurance companies will
generally use actuarial projections in setting reserves for all casualty lines
of business.
In conformity with GAAP, our insurance companies are not permitted to establish
reserves for catastrophe losses that have not occurred. Therefore, losses
related to a significant catastrophe, or accumulation of catastrophes, in any
reporting period could have a material adverse effect on our results of
operations and financial condition during that period.
We believe that the reserves for unpaid losses and LAE established are adequate
as of December 31, 2021 ; however, additional reserves, which could have a
material impact upon our financial condition, results of operations and cash
flows, may be necessary in the future.
Methodologies and Assumptions
We use a variety of techniques that employ significant judgments and assumptions to establish the liabilities for unpaid losses and LAE recorded at the balance sheet date. These techniques include detailed statistical analyses of past claims reporting, settlement activity, claims frequency, internal loss experience, changes in pricing or coverages and severity data when sufficient information exists to lend statistical credibility to the analyses. More subjective techniques are used when statistical data is insufficient or unavailable. These liabilities also reflect implicit or explicit assumptions regarding the potential effects of future inflation, judicial decisions, changes in laws and recent trends in such factors, as well as a number of actuarial assumptions that vary across our reinsurance and insurance subsidiaries and across lines of business. This data is analyzed by line of business, coverage, accident year or underwriting year and reinsurance contract type, as appropriate. Our loss reserve review processes use actuarial methods that vary by operating subsidiary and line of business and produce point estimates for each class of business. The actuarial methods used include the following methods: •Reported Loss Development Method: A reported loss development pattern is calculated based on historical loss development data, and this pattern is then used to project the latest evaluation of cumulative reported losses for each accident year or underwriting year, as appropriate, to ultimate levels; •Paid Development Method: A paid loss development pattern is calculated based on historical paid loss development data, and this pattern is then used to project the latest evaluation of cumulative paid losses for each accident year or underwriting year, as appropriate, to ultimate levels; •Expected Loss Ratio Method: Expected loss ratios are applied to premiums earned, based on historical company experience, or historical insurance industry results when company experience is deemed not to be sufficient; and •Bornhuetter-Ferguson Method: The results from the Expected Loss Ratio Method are essentially blended with either the Reported Loss Development Method or the Paid Development Method.
The primary actuarial assumptions used include the following:
•Expected loss ratios represent management's expectation of losses, in relation
to earned premium, at the time business is written, before any actual claims
experience has emerged. This expectation is a significant determinant of the
estimate of loss reserves for recently written business where there is little
paid or incurred loss data to consider. Expected loss ratios are generally
derived from historical loss ratios adjusted for the impact of rate changes,
loss cost trends and known changes in the type of risks underwritten. For
certain longer-tailed reinsurance business that are typically lower frequency,
high severity classes, expected loss ratios are often used for the last several
accident years or underwriting years, as appropriate.
•Rate of loss cost inflation (or deflation) represents management's expectation
of the inflation associated with the costs we may incur in the future to settle
claims. Expected loss cost inflation is particularly important for longer-tailed
classes.
•Reported and paid loss emergence patterns represent management's expectation of
how losses will be reported and ultimately paid in the future based on the
historical emergence patterns of reported and paid losses and are derived from
past experience of our subsidiaries, modified for current trends. These
emergence patterns are used to project current reported or paid loss amounts to
their ultimate settlement value.
In the absence of sufficiently credible internally-derived historical
information, each of the above actuarial assumptions may also incorporate data
from the insurance industries as a whole, or peer companies writing
substantially similar coverages. Data from external sources may be used to set
expectations, as well as assumptions regarding loss frequency or severity
relative to an exposure
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unit or claim, among other actuarial parameters. Assumptions regarding the
application or composition of peer group or industry reserving parameters
require substantial judgment.
Loss Frequency and Severity
Loss frequency and severity are measures of loss activity that are considered in determining the key assumptions described above. Loss frequency is a measure of the number of claims per unit of insured exposure, and loss severity is a measure of the average size of claims. Factors affecting loss frequency include the effectiveness of loss controls and safety programs and changes in economic conditions or weather patterns. Factors affecting loss severity include changes in policy limits, retentions, rate of inflation and judicial interpretations. Another factor affecting estimates of loss frequency and severity is the loss reporting lag, which is the period of time between the occurrence of a loss and the date the loss is reported to our insurance companies. The length of the loss reporting lag affects their ability to accurately predict loss frequency (loss frequencies are more predictable for lines with short reporting lags), as well as the amount of reserves needed for IBNR. If the actual level of loss frequency and severity is higher or lower than expected, the ultimate losses will be different than management's estimates.
Prior
We continually evaluate the potential for changes, both favorable and unfavorable, in their estimates of their loss and LAE liabilities and use the results of these evaluations to adjust both recorded liabilities and underwriting criteria. With respect to liabilities for unpaid losses and LAE established in prior years, these liabilities are periodically analyzed and their expected ultimate cost adjusted, where necessary, to reflect favorable or unfavorable development in loss experience and new information, including, for certain catastrophe events, revised industry estimates of the magnitude of a catastrophe. Adjustments to previously recorded liabilities for unpaid losses and LAE, both favorable and unfavorable, are reflected in our financial results in the periods in which these adjustments are made and are referred to as prior accident year reserve development. We adjusted our prior year loss and LAE reserve estimates based on current information that differed from previous assumptions made at the time such loss and LAE reserves were previously estimated. Refer to Note 1 and Note 9 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for additional information regarding our losses and LAE.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss, capital loss and tax-credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income or expense in the period that includes the enactment date. Refer to Note 11 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for additional information regarding our income taxes.
Recent Accounting Pronouncements
Refer to Note 2 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report, for a discussion of recent accounting pronouncements and their effect, if any, on our company.
Off-Balance Sheet Transactions
For the years ended
sheet transactions.
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