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KINSALE CAPITAL GROUP, INC. – 10-K – Management's Discussion and Analysis of Financial Condition and Results of Operations
Edgar Glimpses
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the accompanying notes included elsewhere in this Annual Report. The discussion and analysis below include certain forward-looking statements that are subject to risks, uncertainties and other factors described in "Risk Factors" that could cause actual results to differ materially from those expressed in, or implied by, those forward-looking statements. See "Forward-Looking Statements."
Year ended
For a comparison of years endedDecember 31, 2021 andDecember 2020 , see "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of our annual report on Form 10-K for the fiscal year endedDecember 31, 2021 , which was filed with theSEC onFebruary 25, 2022 .
Overview
Founded in 2009, we are an established and growing specialty insurance company. We focus exclusively on the E&S market in theU.S. , where we use our underwriting expertise to write coverages for hard-to-place, small- to medium-sized business risks and personal lines risks. We market and sell these insurance products in all 50 states, theDistrict of Columbia , theCommonwealth of Puerto Rico and theU.S. Virgin Islands primarily through a network of independent insurance brokers. We have an experienced and cohesive management team that has an average of over 30 years of relevant experience. Many of our employees and members of our management team have also worked together for decades at other E&S insurance companies. We have one reportable segment, ourExcess and Surplus Lines Insurance segment, which offers P&C insurance products through the E&S market. In 2022, the percentage breakdown of our gross written premiums was 77.2% casualty and 22.8% property. Our commercial lines offerings include commercial property, small business casualty, excess casualty, construction, general casualty, allied health, products liability, life sciences, professional liability, energy, management liability, entertainment, small property, environmental, health care, public entity, inland marine, commercial auto, aviation, product recall and ocean marine. We also write a small amount of homeowners insurance in the personal lines market, which in aggregate represented 2.8% of our gross written premiums in 2022. Our goal is to deliver long-term value for our stockholders by growing our business and generating attractive returns. We seek to accomplish this by generating consistent and strong underwriting profits while managing our capital prudently. We believe that we have built a company that is entrepreneurial and highly efficient, using our proprietary technology platform and leveraging the expertise of our highly-experienced employees in our daily operations. We believe our systems and technology are at the digital forefront of the insurance industry, allowing us to quickly collect and analyze data, thereby improving our ability to manage our business and reducing response times for our customers. We believe that we have differentiated ourselves from our competitors by effectively leveraging technology, vigilantly controlling expenses and maintaining control over our underwriting and claims management.
COVID-19
We have been closely monitoring the impact of the COVID-19 pandemic and related economic effects on all aspects of our business, including its impact on premium volume, losses and the fair value of our investment portfolio. Consistent with 2021, the Company's results of operations, financial position and cash flows were not materially impacted by COVID-19 and the related economic effects during the year endedDecember 31, 2022 . 38
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Components of Our Results of Operations Gross written premiums Gross written premiums are the amounts received or to be received for insurance policies written or assumed by us during a specific period of time without reduction for policy acquisition costs, reinsurance costs or other deductions. The volume of our gross written premiums in any given period is generally influenced by:
•New business submissions;
•Conversion of new business submissions into policies;
•Renewals of existing policies; and
•Average size and premium rate of bound policies.
We earn insurance premiums on a pro rata basis over the term of the policy. Our insurance policies generally have a term of one year. Net earned premiums represent the earned portion of our gross written premiums, less that portion of our gross written premiums that is ceded to third-party reinsurers under our reinsurance agreements. Ceded written premiums Ceded written premiums are the amount of gross written premiums ceded to reinsurers. We enter into reinsurance contracts to limit our exposure to potential large losses. Ceded written premiums are earned over the reinsurance contract period in proportion to the period of risk covered. The volume of our ceded written premiums is impacted by the level of our gross written premiums and any decision we make to increase or decrease retention levels.
Losses and loss adjustment expenses
Losses and loss adjustment expenses are a function of the amount and type of insurance contracts we write and the loss experience associated with the underlying coverage. In general, our losses and loss adjustment expenses are affected by:
•Frequency of claims associated with the particular types of insurance contracts
that we write;
•Trends in the average size of losses incurred on a particular type of business;
•Mix of business written by us;
•Changes in the legal or regulatory environment related to the business we
write;
•Trends in legal defense costs;
•Wage inflation;
•Social inflation;
•Inflation in material costs, and
•Inflation in medical costs.
Losses and loss adjustment expenses are based on an actuarial analysis of the estimated losses, including losses incurred during the period and changes in estimates from prior periods. Losses and loss adjustment expenses may be paid out over a period of years.
Underwriting, acquisition and insurance expenses
Underwriting, acquisition and insurance expenses include policy acquisition
costs and other underwriting expenses. Policy acquisition costs are principally
comprised of the commissions we pay our brokers, net of ceding commissions we
receive on business ceded under certain reinsurance contracts. Policy
acquisition costs also include deferred underwriting expenses that are directly
related to the successful acquisition of policies. The amortization of such
policy acquisition costs is charged to expense in proportion to premium earned
over the policy life. Other
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underwriting expenses represent the general and administrative expenses of our insurance business such as employment costs, telecommunication and technology costs, and legal and auditing fees.
Net investment income
Net investment income is an important component of our results of operations. We earn investment income on our portfolio of cash and invested assets. Our cash and invested assets are primarily comprised of fixed-maturity securities, and may also include equity securities, investments in real estate, cash equivalents, and short-term investments. The principal factors that influence the level of net investment income are the size of our investment portfolio and the yield on that portfolio. As measured by amortized cost (which excludes changes in fair value), the size of our investment portfolio is mainly a function of our invested equity capital combined with premiums we receive from our insureds less payments on policyholder claims. Net investment income also includes rental income and depreciation expense from our real estate investment property.
Change in fair value of equity securities
Change in fair value of equity securities represents the increase or decrease in
the fair value of equity securities held during the period.
Net realized investment gains (losses)
Net realized investment gains (losses) are a function of the difference between the amount received by us on the sale of a security and the security's amortized cost. Income tax expense Currently, substantially all of our income tax expense is comprised of federal income taxes. Our insurance subsidiary,Kinsale Insurance Company , is not subject to income taxes in the states in which it operates; however, our non-insurance subsidiaries are subject to state income taxes but have not generated any material taxable income to date. The amount of income tax expense or benefit recorded in future periods will depend on the jurisdictions in which we operate and the tax laws and regulations in effect.
Key metrics
We discuss certain key metrics, described below, which we believe provide useful
information about our business and the operational factors underlying our
financial performance.
Underwriting income is a non-GAAP financial measure. We define underwriting income as net income, excluding net investment income, net change in the fair value of equity securities, net realized investment gains and losses, change in allowance for credit losses on investments, interest expense, other income, other expenses and income tax expense. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to underwriting income. Net operating earnings is a non-GAAP financial measure. We define net operating earnings as net income excluding the net change in the fair value of equity securities, after taxes, net realized investment gains and losses, after taxes and change in allowance for credit losses on investments, after taxes. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to net operating earnings.
Loss ratio, expressed as a percentage, is the ratio of losses and loss
adjustment expenses to earned premiums, net of the effects of reinsurance.
Expense ratio, expressed as a percentage, is the ratio of underwriting,
acquisition and insurance expenses to net earned premiums.
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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.
Return on equity is net income as a percentage of average beginning and ending
total stockholders' equity during the period.
Operating return on equity is a non-GAAP financial measure. We define operating return on equity as net operating earnings expressed as a percentage of average beginning and ending stockholders' equity during the period. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to net operating earnings.
Net retention ratio is the ratio of net written premiums to gross written
premiums.
Gross investment return is investment income from fixed-maturity and equity
securities (and short-term investments, if any), before any deductions for fees
and expenses, expressed as a percentage of the average beginning and ending book
values of those investments during the period.
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Results of Operations
Year ended
The following table summarizes our results of operations for the years endedDecember 31, 2022 and 2021: Year Ended December 31, ($ in thousands) 2022 2021 Change % Change Gross written premiums$ 1,102,092 $ 764,373 $ 337,719 44.2 % Ceded written premiums (165,282) (104,164) (61,118) 58.7 % Net written premiums$ 936,810 $ 660,209 $ 276,601 41.9 % Net earned premiums$ 794,119 $ 582,879 $ 211,240 36.2 % Losses and loss adjustment expenses 457,913 324,415 133,498 41.2 % Underwriting, acquisition and insurance expenses 160,718 124,900 35,818 28.7 % Underwriting income (1) 175,488 133,564 41,924 31.4 % Net investment income 51,282 31,048 20,234 65.2 % Change in fair value of equity securities (27,723) 22,812 (50,535) (221.5) % Net realized investment gains 1,191 2,828 (1,637) (57.9) % Change in allowance for credit losses on investments (366) - (366) NM Interest expense (4,284) (994) (3,290) 331.0 % Other expenses, net (24) (457) 433 (94.7) % Income before taxes 195,564 188,801 6,763 3.6 % Income tax expense 36,450 36,142 308 0.9 % Net income$ 159,114 $ 152,659 $ 6,455 4.2 % Net operating earnings (2)$ 180,363 $ 132,404 $ 47,959 36.2 % Loss ratio 57.7 % 55.7 % Expense ratio 20.2 % 21.4 % Combined ratio 77.9 % 77.1 % Return on equity 22.0 % 23.9 % Operating return on equity (2) 25.0 %
20.8 %
NM - Percentage change is not meaningful
(1) Underwriting income is a non-GAAP financial measure. See "-Reconciliation of
Non-GAAP Financial Measures" for a reconciliation of net income in accordance
with GAAP to underwriting income.
(2) Net operating earnings and operating return on equity are non-GAAP financial
measures. Net operating earnings is defined as net income excluding the net
change in the fair value of equity securities, after taxes, net realized
investment gains and losses, after taxes, and change in allowance for credit
losses on investments, after taxes. Operating return on equity is defined as net
operating earnings expressed as a percentage of average beginning and ending
total stockholders' equity during the period. See "-Reconciliation of Non-GAAP
Financial Measures" for a reconciliation of net income in accordance with GAAP
to net operating earnings.
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Net income was$159.1 million for the year endedDecember 31, 2022 compared to$152.7 million for the year endedDecember 31, 2021 , an increase of$6.5 million , or 4.2%. The increase in net income in 2022 over 2021 was primarily due to strong growth in the business from favorable E&S market conditions and continued rate increases and an increase in investment income year over year driven by higher investment balances. These increases were partially offset by a decline in the fair value of our equity investment portfolio driven by adverse movements in the capital markets during the year and higher catastrophe losses incurred. Our underwriting income was$175.5 million for the year endedDecember 31, 2022 compared to$133.6 million for the year endedDecember 31, 2021 , an increase of$41.9 million , or 31.4%. The increase in our underwriting income was due to a combination of premium growth and favorable rate increases from a strong underwriting environment and lower levels of operating expenses relative to premium growth and management's cost control efforts. These increases were offset in part by higher catastrophe losses incurred. The corresponding combined ratios were 77.9% for the year endedDecember 31, 2022 compared to 77.1% for the year endedDecember 31, 2021 .
Premiums
Gross written premiums were$1.1 billion for the year endedDecember 31, 2022 compared to$764.4 million for the year endedDecember 31, 2021 , an increase of$337.7 million , or 44.2%. The increase in gross written premiums for the year endedDecember 31, 2022 over the prior year was due to higher submission activity from brokers and higher rates across most lines of business, resulting from continued favorable conditions in the E&S market. The average premium per policy written by us was$12,400 in 2022 compared to$10,400 in 2021. Excluding our personal lines insurance, which has relatively low premiums per policy written, the average premium per policy written was$14,700 in 2022 compared to$12,900 in 2021. The increase in the average premium per policy written was due to changes in the mix of business and higher rates on bound accounts during 2022 compared to the prior year. Gross written premiums increased across substantially all of our lines of business for the year endedDecember 31, 2022 and were most notable in the following lines of business: •Commercial Property, which represented approximately 16.8% of our gross written premiums in 2022, increased by$112.3 million , or 154.8%, for the year endedDecember 31, 2022 over the prior year; •Small Business Casualty, which represented approximately 13.6% of our gross written premiums in 2022, increased by$36.8 million , or 32.7%, for the year endedDecember 31, 2022 over the prior year;
•Excess Casualty, which represented approximately 13.4% of our gross written
premiums in 2022, increased by
•Construction, which represented approximately 11.1% of our gross written
premiums in 2022, increased by
•General Casualty, which represented approximately 6.3% of our gross written
premiums in 2022, increased by
Net written premiums increased by$276.6 million , or 41.9%, to$936.8 million for the year endedDecember 31, 2022 from$660.2 million for the year endedDecember 31, 2021 . The increase in net written premiums was largely due to higher gross written premiums for the year endedDecember 31, 2022 . Our net retention ratio was 85.0% for the year endedDecember 31, 2022 compared to 86.4% for the year endedDecember 31, 2021 . The decrease in the net retention ratio was due to higher premiums ceded under the new commercial property quota share reinsurance treaty, effectiveJune 1, 2022 , and a change in the mix of business. Net earned premiums were$794.1 million for the year endedDecember 31, 2022 compared to$582.9 million for the year endedDecember 31, 2021 , an increase of$211.2 million , or 36.2%. As previously discussed, the increase was due to growth in gross written premiums in 2022 compared to 2021. 43
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Loss ratio
Our loss ratio was 57.7% for the year endedDecember 31, 2022 compared to 55.7% for the year endedDecember 31, 2021 . The increase in the loss ratio for the year endedDecember 31, 2022 was due primarily to higher catastrophe losses incurred and lower net favorable development of loss reserves from prior accident years as a percentage of earned premiums. During the year endedDecember 31, 2022 , current year incurred losses and loss adjustment expenses included$26.6 million of net catastrophe losses primarily related to Hurricane Ian. During the year endedDecember 31, 2021 , current year incurred losses and loss adjustment expenses included$8.6 million of net catastrophe losses primarily attributable to Hurricane Ida and the winter storms inTexas . During the year endedDecember 31, 2022 , prior accident years developed favorably by$35.9 million , of which$41.8 million was attributable to the 2020 and 2021 accident years due to lower emergence of reported losses than expected across most lines of business. This favorable development was offset in part by adverse development largely from the 2016 and 2018 accident years due to routine variability in reported losses and modest adjustments in actuarial assumptions. During the year endedDecember 31, 2021 , loss reserves for prior accident years developed favorably by$32.0 million , of which$33.7 million was attributable to the 2020 accident year and was related to a lower-than-expected levels of reported losses. Although we did not have any significant direct COVID-19 exposure, the related disruption in the court system and the general economy created additional uncertainty in estimating loss reserves in 2020. As a result, accident year 2020 actuarial assumptions were adjusted in 2020 to increase IBNR to account for this additional uncertainty. In 2021, our outlook was more favorable than in the prior year and, based on observed trends, we reevaluated and adjusted certain assumptions for accident year 2020 to reflect the favorable experience. In addition,$3.8 million of favorable development was attributable to accident year 2019 due to reported losses emerging at lower levels than expected. This favorable development was offset in part by adverse development, mostly attributable to the 2016 and 2018 accident years due to modest adjustments in actuarial assumptions.
On an inception-to-date basis as of
developed favorably, with the exception of the 2011 accident year.
The following table summarizes the effect of the factors indicated above on the
loss ratios for the years ended
Year Ended December 31,
2022 2021
Losses and Loss Losses and Loss
Adjustment % of Earned Adjustment % of Earned
($ in thousands) Expenses Premiums Expenses Premiums Loss ratio: Current accident year$ 467,182 58.8 %$ 347,761 59.7 % Current accident year - catastrophe losses 26,618 3.4 % 8,640 1.5 % Effect of prior year development (35,887) (4.5) % (31,986) (5.5) % Total$ 457,913 57.7 %$ 324,415 55.7 % 44
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Expense ratio
The following table summarizes the components of the expense ratio for the years
ended
Year Ended December 31,
2022 2021
Underwriting % of Earned Underwriting % of Earned
($ in thousands) Expenses Premiums Expenses Premiums
Commissions incurred:
Direct $ 138,451 17.4 % $ 98,847 16.9 %
Ceding (44,695) (5.6) % (25,702) (4.4) %
Net commissions incurred 93,756 11.8 % 73,145 12.5 %
Other underwriting expenses 66,962 8.4 % 51,755 8.9 %
Underwriting, acquisition, and
insurance expenses $ 160,718 20.2 % $ 124,900 21.4 %
The expense ratio was 20.2% for the year ended December 31, 2022 compared to
21.4% for the year ended December 31, 2021 . The decrease in the expense ratio
was due to lower net commissions incurred and lower other underwriting expenses
as a percentage of earned premiums. The decrease in the net commissions incurred
ratio was largely due to higher ceding commissions resulting from the new
commercial property quota share treaty, effective June 1, 2022 , and a change in
the mix of business. The decrease in the other underwriting expense ratio was
primarily due to higher net earned premiums, without a proportional increase in
the amount of other underwriting expenses, as a result of management's focus on
controlling costs. Direct commissions paid as a percent of gross written
premiums was 14.6% for the years ended December 31, 2022 and 2021.
Investing results
Our net investment income increased by 65.2% to$51.3 million for the year endedDecember 31, 2022 from$31.0 million for the year endedDecember 31, 2021 , primarily due to growth in our investment portfolio balance generated from the investment of strong operating cash flows sinceDecember 31, 2021 and higher interest rates relative to the prior year. 45
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The following table summarizes the components of net investment income, change in the fair value of equity securities, net realized investment gains and change in allowance for credit losses on investments for the years endedDecember 31, 2022 and 2021: Year Ended December 31, ($ in thousands) 2022 2021 Change Interest from fixed-maturity securities$ 48,186 $ 29,155 $ 19,031 Dividends on equity securities 4,406 3,962 444 Cash equivalents and short-term investments 1,251 12 1,239 Real estate investment income 234 - 234 Gross investment income 54,077 33,129 20,948 Investment expenses (2,795) (2,081) (714) Net investment income 51,282 31,048 20,234 Change in the fair value of equity securities (27,723) 22,812 (50,535) Net realized investment gains 1,191 2,828 (1,637) Change in allowance for credit losses on investments (366) - (366) Net unrealized and realized investment gains (26,898) 25,640 (52,538) Total$ 24,384 $ 56,688 $ (32,304)
The weighted average duration of our investment portfolio, including cash
equivalents, was 3.5 years and 4.3 years at
respectively. Our investment portfolio, excluding cash equivalents and
unrealized gains and losses, had a gross investment return of 3.0% as of
During the year endedDecember 31, 2022 , the decrease in fair value of equity securities of$(27.7) million was comprised of higher unrealized losses related to ETF securities of$(19.6) million and higher unrealized losses related to non-redeemable preferred stock of$(8.1) million . The decrease in the fair value of our ETF and common stock portfolio reflected lower valuations in the broaderU.S. stock market during the period. The change in unrealized losses during 2022 attributable to non-redeemable preferred stock reflected a higher interest rate environment. During the year endedDecember 31, 2021 , the increase in the fair value of equity securities of$22.8 million was comprised of unrealized gains related to ETF securities of$23.2 million and unrealized losses related to non-redeemable preferred stock of$0.4 million . The increase in the fair value of our ETF portfolio largely reflected the performance in the broader domestic stock markets. We perform quarterly reviews of all available-for-sale securities within our investment portfolio to determine whether the decline in a security's fair value is deemed to be a credit loss. Based on our review, we recorded an allowance for credit losses of$0.4 million for the year endedDecember 31, 2022 . There were no credit losses recorded for the year endedDecember 31, 2021 . See Note 2 of the notes to the consolidated financial statements for further information regarding credit losses.
Income tax expense
Our effective tax rate was approximately 18.6% for the year endedDecember 31, 2022 compared to 19.1% for the year endedDecember 31, 2021 . The effective tax rate was lower than the federal statutory rate of 21% primarily due to the tax benefits from stock-based compensation and tax-exempt investment income. 46
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Return on equity
Our return on equity was 22.0% for the year endedDecember 31, 2022 compared to 23.9% for the year endedDecember 31, 2021 . Operating return on equity was 25.0% for 2022, an increase from 20.8% for 2021. The increase in the operating return on equity was due primarily to growth in the business from favorable market conditions and rate increases and a decrease in average stockholders' equity driven by the decline in the fair value of investments as a result of the higher interest rate environment. These increases were offset in part by higher catastrophe losses incurred during 2022.
Liquidity and Capital Resources
Sources and uses of funds
We are organized as aDelaware holding company with our operations primarily conducted by our wholly-owned insurance subsidiary,Kinsale Insurance , which is domiciled inArkansas . Accordingly, Kinsale may receive cash through (1) loans from banks, (2) issuance of equity and debt securities, (3) corporate service fees from our insurance subsidiary, (4) payments from our subsidiaries pursuant to our consolidated tax allocation agreement and other transactions and (5) dividends from our insurance subsidiary. We may use the proceeds from these sources to contribute funds toKinsale Insurance in order to support premium growth, reduce our reliance on reinsurance, pay dividends and taxes and for other business purposes. We receive corporate service fees fromKinsale Insurance to reimburse us for most of the operating expenses that we incur. Reimbursement of expenses through corporate service fees is based on the actual costs that we expect to incur with no mark-up above our expected costs. We file a consolidated federal income tax return with our subsidiaries, and under our corporate tax allocation agreement, each participant is charged or refunded taxes according to the amount that the participant would have paid or received had it filed on a separate return basis with the Internal Revenue Service. State insurance laws restrict the ability ofKinsale Insurance to declare stockholder dividends without prior regulatory approval. State insurance regulators require insurance companies to maintain specified levels of statutory capital and surplus. The maximum dividend distributionKinsale Insurance may make absent the approval or non-disapproval of the insurance regulatory authority inArkansas is limited byArkansas law to the greater of (1) 10% of policyholder surplus as ofDecember 31 of the previous year, or (2) net income, not including realized capital gains, for the previous calendar year. TheArkansas statute also requires that dividends and other distributions be paid out of positive unassigned surplus without prior approval. The maximum amount of dividendsKinsale Insurance can pay us during 2023 without regulatory approval is$153.3 million . Insurance regulators have broad powers to ensure that statutory surplus remains at adequate levels, and there is no assurance that dividends of the maximum amount calculated under any applicable formula would be permitted. In the future, state insurance regulatory authorities that have jurisdiction over the payment of dividends byKinsale Insurance may adopt statutory provisions more restrictive than those currently in effect.Kinsale Insurance did not pay dividends to us during 2022. See also "Risk Factors - Risks Related to Our Business and Our Industry - Because we are a holding company and substantially all of our operations are conducted by our insurance subsidiary, our ability to pay dividends depends on our ability to obtain cash dividends or other permitted payments from our insurance subsidiary."
As of
investments, compared to
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Management believes there is sufficient liquidity available at the holding company and in its insurance subsidiary,Kinsale Insurance , as well as in its other operating subsidiaries, to meet its operating cash needs and obligations for the next 12 months.Real Estate Investment In December of 2022, we acquired real estate property adjacent to our current headquarters for$76.6 million . The property is comprised of two office buildings totaling over 580,000 square feet situated on approximately 29 acres of land. The property is expected to provide flexibility for future expansion of our operations as well as serve as an investment opportunity. The acquisition was funded primarily through a draw down on our revolving credit facility. Concurrent with the purchase of the real estate investment property, the Company entered into two operating lease agreements for office space on the property as the lessor. The terms of these two leases are 5 years and 12 years.
Debt
OnJuly 22, 2022 , we entered into a Note Purchase and Private Shelf Agreement (the "Note Purchase Agreement"), which provides for the issuance of senior promissory notes with an aggregate principal amount of up to$150.0 million . Pursuant to the Note Purchase Agreement, onJuly 22, 2022 we issued$125.0 million aggregate principal amount of 5.15% senior promissory notes (the "Series A Notes"), the proceeds of which were used to fund surplus atKinsale Insurance Company , refinance indebtedness and for general corporate purposes. See Note 11 for further information regarding the Note Purchase Agreement. OnJuly 22, 2022 , we entered into an Amended and Restated Credit Agreement, which extended the maturity date toJuly 22, 2027 , and increased the aggregate commitment to$100.0 million , with the option to increase the aggregate commitment by$30.0 million , subject to certain conditions. Borrowings under the Amended and Restated Credit Agreement may be used for general corporate purposes (which may include, without limitation, to fund future growth, to finance working capital needs, to fund capital expenditures, and to refinance, redeem or repay indebtedness). See Note 11 for further information regarding the Amended and Restated Credit Agreement. OnJuly 25, 2022 , a portion of the proceeds from the Series A Notes were used to pay off outstanding loans of$43.0 million , plus accrued interest, under our Amended and Restated Credit Agreement.
Shelf registration
InAugust 2022 , we filed a universal shelf registration statement with theSEC that expires in 2025. We can use this shelf registration to issue an unspecified amount of common stock, preferred stock, depositary shares and warrants. The specific terms of any securities we issue under this registration statement will be provided in the applicable prospectus supplements. InNovember 2022 , we completed an underwritten public offering and sold and issued 155,000 shares of our common stock at a price of$308.30 per share, to the underwriter. We received net proceeds from the offering of$47.5 million , which was used for general corporate purposes, including to fund organic growth.
Cash flows
Our most significant source of cash is from premiums received from our insureds,
which, for most policies, we receive at the beginning of the coverage period.
Our most significant cash outflow is for claims that arise when a policyholder
incurs an insured loss. Because the payment of claims occurs after the receipt
of the premium, often years later, we invest the cash in various investment
securities that earn interest and dividends. We also use cash to pay commissions
to brokers, as well as to pay for ongoing operating expenses such as salaries,
consulting services and taxes. As described under "-Reinsurance" below, we use
reinsurance to manage the risk that we take on our
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policies. We cede, or pay out, part of the premiums we receive to our reinsurers
and collect cash back when losses subject to our reinsurance coverage are paid.
The timing of our cash flows from operating activities can vary among periods due to the timing by which payments are made or received. Some of our payments and receipts, including loss settlements and subsequent reinsurance receipts, can be significant, so their timing can influence cash flows from operating activities in any given period. Management believes that cash receipts from premiums, proceeds from investment sales and redemptions and investment income are sufficient to cover cash outflows in the foreseeable future.
Our cash flows for the years ended
Year Ended December 31,
2022 2021
(in thousands)
Cash and cash equivalents provided by (used in):
Operating activities $ 557,815 $ 407,042
Investing activities (708,573) (351,955)
Financing activities 185,992 (11,140)
Change in cash and cash equivalents $ 35,234
We have historically generated positive operating cash flows allowing our cash and invested assets to grow. The increase in cash provided by operating activities in 2022 compared to 2021 was due primarily to growth in business and the timing of claim payments and reinsurance recoverable balances. For the year endedDecember 31, 2022 , net cash used in investing activities of$708.6 million reflected growth in our business operations. For the year endedDecember 31, 2022 , funds from operations were used to purchase fixed-maturity securities, particularly corporate bonds and asset- and mortgage-backed securities of$713.2 million , and to a lesser extent, municipal bonds of$22.2 million and sovereigns of$16.0 million . During 2022, we received proceeds of$63.1 million from sales of fixed-maturity securities, largely corporate bonds and mortgage- and asset-backed securities and$110.4 million from redemptions of asset- and mortgage-backed securities and corporate bonds. For the year endedDecember 31, 2022 , purchases of common stocks and ETFs were$10.0 million and$1.5 million , respectively. In addition, net purchases of short-term investments of$40.6 million consisted ofU.S. Treasuries and corporate bonds. Net cash used in investing activities also included the purchase of a real estate investment property for$76.6 million in December of 2022 and property and equipment of$6.9 million . For the year endedDecember 31, 2021 , net cash used in investing activities was$352.0 million . For the year endedDecember 31, 2021 , these funds were used to purchase fixed-maturity securities, particularly corporate bonds and asset- and mortgage-backed securities of$633.6 million , and to a lesser extent, municipal bonds of$14.4 million and sovereigns of$6.9 million . During 2021, we received proceeds of$113.0 million from sales of fixed-maturity securities, largely corporate bonds in order to take advantage of favorable valuations. In addition, we received proceeds of$216.1 million from redemptions of asset- and mortgage-backed securities and corporate bonds. For the year endedDecember 31, 2021 , purchases of ETFs and nonredeemable preferred stock were$2.1 million and$22.7 million , respectively. Net cash used in investing activities included purchases of property and equipment of$5.9 million . For the year endedDecember 31, 2022 , net cash provided by financing activities was$186.0 million and reflected proceeds of$125.0 million from the issuance of the Series A Notes onJuly 22, 2022 , a portion of which were used to pay off the outstanding loans of$43.0 million under the Amended and Restated Credit Agreement onJuly 25, 2022 , and proceeds of$47.5 million from our equity offering inNovember 2022 . InDecember 2022 , we drew down 49
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$73.0 million from our revolving credit facility to finance the purchase of our real estate investment property. Financing activities also reflected dividends of$0.52 per common share, or$11.9 million in the aggregate. Proceeds received from our equity compensation plans were$1.1 million , offset by payroll taxes withheld and remitted on restricted stock awards of$3.3 million for the year endedDecember 31, 2022 . For the year endedDecember 31, 2021 , net cash used in financing activities was$11.1 million and reflected dividends of$0.44 per common share, or$10.0 million in the aggregate. Proceeds received from our equity compensation plans were$1.0 million , offset by payroll taxes withheld and remitted on restricted stock awards of$2.1 million for the year endedDecember 31, 2021 .
Reinsurance
We enter into reinsurance contracts to limit our exposure to potential large losses. Our reinsurance is primarily contracted under quota-share reinsurance treaties and excess of loss treaties. In quota-share reinsurance, the reinsurer agrees to assume a specified percentage of the ceding company's losses arising out of a defined class of business in exchange for a corresponding percentage of premiums, net of a ceding commission. In excess of loss reinsurance, the reinsurer agrees to assume all or a portion of the ceding company's losses, in excess of a specified amount. In excess of loss reinsurance, the premium payable to the reinsurer is negotiated by the parties based on their assessment of the amount of risk being ceded to the reinsurer because the reinsurer does not share proportionately in the ceding company's losses. For the year endedDecember 31, 2022 , property insurance represented 22.8% of our gross written premiums. When we write property insurance, we buy reinsurance to significantly mitigate our risk to large losses. We use sophisticated computer models to analyze the risk of severe losses from weather-related events and earthquakes. We measure exposure to these catastrophe losses in terms of PML, which is an estimate of what level of loss we would expect to experience in a windstorm or earthquake event occurring once in every 100 or 250 years. We manage this PML by purchasing catastrophe reinsurance coverage. EffectiveJune 1, 2022 , we purchased catastrophe reinsurance coverage of$75.0 million per event in excess of our$25.0 million per event retention. Our property catastrophe reinsurance includes a reinstatement provision which requires us to pay reinstatement premiums after a loss has occurred in order to preserve coverage. Including the reinstatement provision, the maximum aggregate loss recovery limit is$150 million and is in addition to the per-occurrence coverage provided by our treaty coverages. Reinsurance contracts do not relieve us from our obligations to policyholders. Failure of the reinsurer to honor its obligation could result in losses to us, and therefore, we established an allowance for credit risk based on historical analysis of credit losses for highly rated companies in the insurance industry. The Company evaluates the financial condition of its reinsurers and monitors concentration of credit risk arising from its exposure to individual reinsurers. As ofDecember 31, 2022 ,Kinsale Insurance has only contracted with reinsurers withA.M. Best financial strength ratings of "A-" (Excellent) or better. AtDecember 31, 2022 , the net reinsurance receivable, defined as the sum of paid and unpaid reinsurance recoverables, ceded unearned premiums less reinsurance payables, from five reinsurers represented 67.8% of the total balance. AtDecember 31, 2022 , we recorded an allowance for credit losses of$0.5 million related to our reinsurance balances.
Ratings
Kinsale Insurance has a financial strength rating of "A" (Excellent) fromA.M. Best .A.M. Best assigns ratings to insurance companies, which currently range from "A++" (Superior) to "F" (In Liquidation). "A" (Excellent) is the third highest rating issued byA.M. Best . The "A" (Excellent) rating is assigned to insurers that have, inA.M. Best's opinion, an excellent ability to meet their ongoing obligations to policyholders. This rating is intended to provide an independent opinion of an insurer's ability to meet its obligation to policyholders and is not an evaluation directed at investors. See also "Risk Factors - Risks Related to Our Business and Our Industry - A decline in our financial strength rating may adversely affect the amount of business we write." 50
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The financial strength ratings assigned byA.M. Best have an impact on the ability of the insurance companies to attract and retain agents and brokers and on the risk profiles of the submissions for insurance that the insurance companies receive. The "A" (Excellent) rating obtained byKinsale Insurance is consistent with our business plan and allows us to actively pursue relationships with the agents and brokers identified in our marketing plan.
Contractual obligations and commitments
Reserves for losses and loss adjustment expenses
Reserves for losses and loss adjustment expenses represent our best estimate of the ultimate cost of settling reported and unreported claims and related expenses. The estimation of loss and loss expense reserves is based on various complex and subjective judgments. Actual losses and settlement expenses paid may deviate, perhaps substantially, from the reserve estimates reflected in our consolidated financial statements. Similarly, the timing for payment of our estimated losses is not fixed and is not determinable on an individual or aggregate basis due to the uncertainty inherent in the process of estimating such payments. See Note 7 of the notes to the consolidated financial statements and "-Critical Accounting Estimates" for a discussion of estimates and assumptions related to the reserves for unpaid losses and loss adjustment expenses. Reinsurance balances recoverable on reserves for losses and loss adjustment expenses are reported separately as assets, instead of being netted with the related liabilities, since reinsurance does not discharge us of our liability to policyholders. The method for determining reinsurance recoverables for unpaid losses and loss adjustment expenses involves reviewing actuarial estimates of gross unpaid losses and loss adjustment expenses to determine the Company's ability to cede unpaid losses and loss adjustment expenses under the Company's existing reinsurance contracts.
See Note 8 to the consolidated financial statements and "-Critical Accounting
Estimates" for a discussion of reinsurance recoverables.
Debt
As of
outstanding, net of debt issuance costs. Principal payments are required
annually beginning on
through
payable in arrears.
As ofDecember 31, 2022 , we had$72.5 million outstanding, net of debt issuance costs, under the Amended and Restated Credit Agreement, which has a maturity ofJuly 22, 2027 . Interest on the outstanding amounts is based on 3-month Adjusted Term SOFR plus a margin of 1.625%. Interest accrues over the term of the interest rate and is payable in arrears.
See Note 11 to the consolidated financial statements for further details
regarding our debt obligations.
Financial Condition
Stockholders' equity
AtDecember 31, 2022 , total stockholders' equity was$745.4 million and tangible stockholders' equity was$742.7 million , compared to total stockholders' equity of$699.3 million and tangible stockholders' equity of$696.5 million atDecember 31, 2021 . The increase in both total stockholders' equity and tangible stockholders' equity in 2022 compared to 2021 was primarily due to profits generated during the period, proceeds from our equity offering inNovember 2022 and net activity related to stock-based compensation plans. These increases were offset in part by an increase in unrealized losses on available-for-sale investments, net of taxes, due to the higher interest rate environment and dividends declared during 2022. Tangible stockholders' equity is a non-GAAP financial measure. 51
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See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of
stockholders' equity in accordance with GAAP to tangible stockholders' equity.
See Note 9 to the consolidated financial statements for further details
regarding our stock-based compensation plans.
Dividend declarations
OnFebruary 14, 2022 , the Company's Board of Directors declared a cash dividend of$0.13 per share of common stock. This dividend was paid onMarch 14, 2022 to all stockholders of record onMarch 2, 2022 . OnMay 10, 2022 , the Company's Board of Directors declared a cash dividend of$0.13 per share of common stock. This dividend was paid onJune 13, 2022 to all stockholders of record onMay 31, 2022 . OnAugust 15, 2022 , the Company's Board of Directors declared a cash dividend of$0.13 per share of common stock. This dividend was paid onSeptember 13, 2022 to all stockholders of record onAugust 29, 2022 . OnNovember 15, 2022 , the Company's Board of Directors declared a cash dividend of$0.13 per share of common stock. This dividend was paid onDecember 13, 2022 to all stockholders of record onNovember 30, 2022 . OnFebruary 15, 2023 , the Company's Board of Directors declared a cash dividend of$0.14 per share of common stock. This dividend is payable onMarch 13, 2023 to all stockholders of record onFebruary 28, 2023 .
Investment portfolio
AtDecember 31, 2022 , our cash and invested assets of$2.2 billion consisted of fixed-maturity securities, cash and cash equivalents, equity securities, short-term investments and real estate investments. AtDecember 31, 2022 , the majority of the investment portfolio was comprised of fixed-maturity securities of$1.8 billion that were classified as available-for-sale. Available-for-sale investments are carried at fair value with unrealized gains and losses on those securities, net of applicable taxes, reported as a separate component of accumulated other comprehensive income. AtDecember 31, 2022 , we also held$152.5 million of equity securities, which were comprised of ETFs, common stocks and non-redeemable preferred stock,$156.3 million of cash and cash equivalents,$76.4 million of real estate investments and$41.3 million of short-term investments. Our fixed-maturity securities, including cash equivalents, had a weighted average duration of 3.5 years and an average rating of "AA-" atDecember 31, 2022 . Our investment portfolio, excluding cash equivalents and real estate investments, had a gross investment return of 3.0% as ofDecember 31, 2022 , compared to 2.5% as ofDecember 31, 2021 . 52
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At
fixed-maturity, equity, and short-term investments were as follows:
December 31, 2022
Estimated Fair % of Total Fair
Amortized Cost Value Value
($ in thousands)
Fixed maturities:
U.S. Treasury securities and obligations of U.S.
government agencies $ 17,934 $ 16,741 0.9 %
Obligations of states, municipalities and
political subdivisions 230,746 204,632 10.5 %
Corporate and other securities 909,285 832,892 42.6 %
Asset-backed securities 361,248 353,006 18.1 %
Residential mortgage-backed securities 349,066 293,962 15.0 %
Commercial mortgage-backed securities 65,353 58,867 3.0 %
Total fixed maturities 1,933,632 1,760,100 90.1 %
Equity securities:
Exchange traded funds 70,621 104,202 5.3 %
Nonredeemable preferred stock 45,822 38,162 2.0 %
Common stock 10,035 10,107 0.5 %
Total equity securities 126,478 152,471 7.8 %
Short-term investments 41,349 41,337 2.1 %
Total $ 2,101,459 $ 1,953,908 100.0 %
The table below summarizes the credit quality of our fixed-maturity securities
as of December 31, 2022 , as rated by Standard & Poor's Financial Services, LLC
("Standard & Poor's") or equivalent designation:
December
31, 2022
% of Total
($ in thousands)
AAA $ 452,001 25.7 %
AA 496,761 28.2 %
A 434,388 24.7 %
BBB 313,875 17.8 %
Below BBB 63,075 3.6 %
Total $ 1,760,100 100.0 %
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The amortized cost and estimated fair value of our available-for-sale
investments in fixed-maturity securities summarized by contractual maturity as
of
December 31, 2022
Amortized Estimated Fair
Cost Value % of Fair Value
($ in thousands)
Due in one year or less $ 15,133 $ 14,925 0.9 %
Due after one year through five years 647,263 626,182 35.6 %
Due after five years through ten years 245,670 213,539 12.1 %
Due after ten years 249,899 199,619 11.3 %
Asset-backed securities 361,248 353,006 20.1 %
Residential mortgage-backed securities 349,066 293,962 16.7 %
Commercial mortgage-backed securities 65,353 58,867 3.3 %
Total fixed maturities $ 1,933,632 $ 1,760,100 100.0 %
Expected maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or prepayment
penalties, and the lenders may have the right to put the securities back to the
borrower.
Restricted investments
In order to conduct business in certain states, we are required to maintain
letters of credit or assets on deposit to support state-mandated insurance
regulatory requirements and to comply with certain third-party agreements.
Assets held on deposit or in trust accounts are primarily in the form of cash or
certain high-grade securities. The fair value of our restricted assets was $5.9
million and $6.7 million at December 31, 2022 and 2021, respectively.
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Reconciliation of Non-GAAP Financial Measures
Reconciliation of underwriting income
Underwriting income is a non-GAAP financial measure that we believe is useful in evaluating our underwriting performance without regard to investment income. Underwriting income is defined as net income excluding net investment income, the net change in the fair value of equity securities, net realized investment gains and losses, change in allowance for credit losses on investments, interest expense, other expenses, other income and income tax expense. We use underwriting income as an internal performance measure in the management of our operations because we believe it gives us and users of our financial information useful insight into our results of operations and our underlying business performance. Underwriting income should not be viewed as a substitute for net income calculated in accordance with GAAP, and other companies may define underwriting income differently.
Net income for the years ended
underwriting income as follows:
Year Ended December 31,
($ in thousands) 2022 2021
Net income $ 159,114 $ 152,659
Income tax expense 36,450 36,142
Income before taxes 195,564 188,801
Net investment income (51,282) (31,048)
Change in the fair value of equity securities 27,723 (22,812)
Net realized investment gains (1,191) (2,828)
Change in allowance for credit losses on
investments 366 -
Interest expense 4,284 994
Other expenses (1) 721 669
Other income (697) (212)
Underwriting income $ 175,488 $ 133,564
(1) Other expenses are comprised of corporate expenses not allocated to our
insurance operations.
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Reconciliation of net operating earnings
Net operating earnings is defined as net income excluding the effects of the net change in the fair value of equity securities, after taxes, net realized investment gains and losses, after taxes, and the change in allowance for credit losses on investments, after taxes. Management believes the exclusion of these items provides a useful comparison of the Company's underlying business performance from period to period. Net operating earnings and percentages or calculations using net operating earnings (e.g., operating return on equity) are non-GAAP financial measures. Net operating earnings should not be viewed as a substitute for net income calculated in accordance with GAAP, and other companies may define net operating earnings differently.
Net income for the years ended
operating earnings as follows:
Year Ended December 31,
($ in thousands) 2022 2021
Net income $ 159,114 $ 152,659
Adjustments:
Change in the fair value of equity securities,
before taxes 27,723 (22,812)
Income tax (benefit) expense (1) (5,822) 4,791
Change in the fair value of equity securities,
after taxes 21,901 (18,021)
Net realized investment gains, before taxes (1,191) (2,828)
Income tax expense (1) 250 594
Net realized investment gains, after taxes (941) (2,234)
Change in allowance for credit losses on
investments, before taxes 366 -
Income tax benefit (1) (77) -
Change in allowance for credit losses on
investments, after taxes 289 -
Net operating earnings $ 180,363 $ 132,404
Operating return on equity:
Average equity (2) $ 722,392 $ 637,787
Return on equity (3) 22.0 % 23.9 %
Operating return on equity (4) 25.0 % 20.8 %
(1) Income taxes on adjustments to reconcile net income to net operating
earnings use an effective tax rate of 21%.
(2) Computed by adding the total stockholders' equity as of the date indicated
to the prior year-end total and dividing by two.
(3) Return on equity is net income expressed as a percentage of average
beginning and ending stockholders' equity during the period.
(4) Operating return on equity is net operating earnings expressed as a
percentage of average beginning and ending stockholders' equity during the
period.
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Reconciliation of tangible stockholders' equity
Tangible stockholders' equity is a non-GAAP financial measure. We define tangible stockholders' equity as stockholders' equity less intangible assets, net of deferred taxes. Our definition of tangible stockholders' equity may not be comparable to that of other companies, and it should not be viewed as a substitute for stockholders' equity calculated in accordance with GAAP. We use tangible stockholders' equity internally to evaluate the strength of our balance sheet and to compare returns relative to this measure.
Stockholders' equity at
stockholders' equity as follows:
December 31,
($ in thousands) 2022 2021
Stockholders' equity $ 745,449 $ 699,335
Less: Intangible assets, net of deferred taxes 2,795
2,795
Tangible stockholders' equity $ 742,654
Critical Accounting Estimates
We identified the accounting estimates which are critical to the understanding of our financial position and results of operations. Critical accounting estimates are defined as those estimates that are both important to the portrayal of our financial condition and results of operations and require us to exercise significant judgment. We use significant judgment concerning future results and developments in applying these critical accounting estimates and in preparing our consolidated financial statements. These judgments and estimates affect our reported amounts of assets, liabilities, revenues and expenses and the disclosure of our material contingent assets and liabilities, if any. Actual results may differ materially from the estimates and assumptions used in preparing the consolidated financial statements. We evaluate our estimates regularly using information that we believe to be relevant. For a detailed discussion of our accounting policies, see the "Notes to Consolidated Financial Statements" included in this Annual Report on Form 10-K.
Reserves for unpaid losses and loss adjustment expenses
The reserves for unpaid losses and loss adjustment expenses are the largest and
most complex estimate in our consolidated balance sheet. The reserves for unpaid
losses and loss adjustment expenses represent our estimated ultimate cost of all
unreported and reported but unpaid insured claims and the cost to adjust these
losses that have occurred as of or before the consolidated balance sheet date.
As a relatively new company, our historical loss experience is limited. We
estimate the reserves using individual case-basis valuations of reported claims
and statistical analyses. Those estimates are based on our historical
information, industry information and our estimates of future trends in variable
factors such as loss severity, loss frequency and other factors such as
inflation. We regularly review our estimates and adjust them as necessary as
experience develops or as new information becomes known to us. Such adjustments
are included in current operations. Additionally, during the loss settlement
period, it often becomes necessary to refine and adjust the estimates of
liability on a claim either upward or downward. Even after such adjustments,
ultimate liability may exceed or be less than the revised estimates.
Accordingly, the ultimate settlement of losses and the related loss adjustment
expenses may vary significantly from the estimate included in our consolidated
financial statements.
We categorize our reserves for unpaid losses and loss adjustment expenses into
two types: case reserves and reserves for incurred but not reported losses
("IBNR"). Our gross reserves for losses and loss adjustment expenses at
December 31, 2022 were $1.2 billion , and of this amount, 85.6% related to IBNR.
Our reserves for losses and loss adjustment expenses, net of reinsurance, at
December 31, 2022 were $1.1 billion , and of this amount, 87.0% related
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to IBNR. A 5% change in net IBNR reserves would equate to a$46.1 million change in the reserve for losses and loss adjustment expenses at such date, as well as a$36.5 million change in net income, a 4.9% change in both stockholders' equity and tangible stockholders' equity, in each case at or for the year endedDecember 31, 2022 . The following tables summarize our reserves for unpaid losses and loss adjustment expenses, on a gross basis and net of reinsurance, atDecember 31, 2022 and 2021: December 31, 2022 Gross % of Total Net % of Total ($ in thousands) Case reserves$ 178,216 14.4 %$ 138,486 13.0 % IBNR 1,060,186 85.6 % 922,877 87.0 % Total$ 1,238,402 100.0 %$ 1,061,363 100.0 % December 31, 2021 Gross % of Total Net % of Total ($ in thousands) Case reserves$ 133,748 15.2 %$ 107,340 14.1 % IBNR 747,596 84.8 % 656,443 85.9 % Total$ 881,344 100.0 %$ 763,783 100.0 % Case reserves are established for individual claims that have been reported to us. We are notified of losses by our insureds or their brokers. Based on the information provided, we establish case reserves by estimating the ultimate losses from the claim, including defense costs associated with the ultimate settlement of the claim. Our claims department personnel use their knowledge of the specific claim along with advice from internal and external experts, including underwriters and legal counsel, to estimate the expected ultimate losses. During the life cycle of a particular claim, as more information becomes available, we may revise our estimate of the ultimate value of the claim either upward or downward. The amount of the individual claim reserve is based on the most recent information available.
Methodology
IBNR reserves are determined using actuarial methods to estimate losses that
have occurred but have not yet been reported to us. We principally use the
incurred Bornhuetter-Ferguson actuarial method ("BF method") to arrive at our
loss reserve estimates for each line of business. This method estimates the
reserves based on our initial expected loss ratio and expected reporting
patterns for losses. Because we have a limited number of years of loss
experience compared to the period over which we expect losses to be reported, we
use industry and peer-group data, in addition to our own data, as a basis for
selecting our expected reporting patterns. Since the incurred BF method does not
directly use reported losses in the estimation of IBNR, it is less sensitive to
our level of reported losses than other actuarial methods. This method avoids
some of the distortions that could result from a large loss development factor
being applied to a small base of reported losses to calculate ultimate losses.
However, this method will react more slowly than some other loss development
methods if reported loss experience deviates significantly from our expected
losses.
We reserve for large catastrophes after an event has occurred. Shortly after an
occurrence, we review insured locations exposed to the event, modeled losses for
our portfolio, and industry loss estimates for the event. We also consider
frequency and severity from early claims reports to determine an appropriate
reserve for the catastrophe. These reserves are reviewed frequently to reflect
actual reported losses and changes to our estimates are made to reflect the new
information.
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Our Reserve Committee consists of our Chief Actuary and other select members of senior management. The Reserve Committee meets quarterly to review the actuarial recommendations made by the Chief Actuary. In establishing the actuarial recommendation for the reserves for losses and loss adjustment expenses, our actuary estimates an initial expected ultimate loss ratio for our statutory lines of business by accident year. Input from our underwriting and claims departments, including premium pricing assumptions and historical experience, is considered by our actuary in estimating the initial expected loss ratios. During each quarter, the Reserve Committee reviews the emergence of actual losses relative to expectations by line of business to assess whether the assumptions used in the reserving process continue to form a reasonable basis for the projection of liabilities for those product lines. Our reserving methodology uses a loss reserving model that calculates a point estimate for our ultimate losses. Although we believe that our assumptions and methodology are reasonable, our ultimate payments may vary, potentially materially, from the estimates we have made. In addition, we retain an independent actuary annually to review our reserve levels. The independent actuary is not involved in the establishment and recording of our loss reserve. The actuarial consulting firm prepares its own estimate of our reserves for loss and loss adjustment expenses, and we compare their estimate to the reserves for losses and loss adjustment expenses reviewed and approved by the Reserve Committee in order to gain additional comfort on the adequacy of those reserves. While we believe that loss reserves atDecember 31, 2022 are adequate, new information, events, or circumstances may result in ultimate losses that are materially greater or less than our estimates. As previously noted, there are many factors that may cause reserves to increase or decrease, particularly those related to catastrophe losses and long-tailed lines of business.
Key assumptions
Expected loss ratios are a key assumption in estimates of ultimate losses for
business at an early stage of development. A higher expected loss ratio results
in a higher ultimate loss estimate, and vice versa. Assumed loss development
patterns are another significant assumption in estimating loss reserves.
Accelerating a loss development pattern results in lower ultimate losses, as the
estimated proportion of losses already incurred would be higher. The uncertainty
in estimating the loss development patterns is generally greater for a company
with a relatively limited operating history, therefore, we rely on industry
benchmarks to a certain extent when establishing loss reserve estimates.
Each of the impacts described below is estimated individually, without
consideration for any correlation among key indicators or among lines of
business. Therefore, it would be inappropriate to take each of the amounts
described below and add them together in an attempt to estimate volatility for
our reserves in total. For any one reserving line of business, the estimated
variation in reserves due to changes in key indicators is a reasonable estimate
of possible variation that may occur in the future. The variation discussed is
not meant to be a worst-case scenario and, therefore, it is possible that future
variation may be greater than the amounts shown below.
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The impact of reasonably likely changes in the two key assumptions used to
estimate net loss reserves at
Development Pattern Expected Loss Ratio
Property 10% lower Unchanged 10% higher
($ in millions)
2 months slower $ 10.2 $ 15.8 $ 21.4
Unchanged (3.6) - 3.6
2 months faster (11.0) (8.5) (6.1)
Casualty Occurrence 5% lower Unchanged 5% higher
6 months slower $ 25.2 $ 79.1 $ 133.1
Unchanged (48.3) - 48.3
6 months faster (121.1) (78.4) (35.6)
Casualty Claims-Made 5% lower Unchanged 5% higher
6 months slower $ 21.1 $ 41.8 $ 62.5
Unchanged (17.1) - 17.1
6 months faster (51.9) (38.0) (24.1)
Reserve development
The amount by which estimated losses differ from those originally reported for a
period is known as "development." Development is unfavorable when the losses
ultimately settle for more than the amount reserved or subsequent estimates
indicate a basis for reserve increases on unresolved claims. Development is
favorable when losses ultimately settle for less than the amount reserved or
subsequent estimates indicate a basis for reducing loss reserves on unresolved
claims. We reflect favorable or unfavorable development of loss reserves in the
results of operations in the period the estimates are changed. Refer to Note 7
to the consolidated financial statements for discussion on our reserve
development for the years ended December 31, 2022 and 2021.
Fair value measurements
Like other accounting estimates, fair value measurements may be based on subjective information and generally involve uncertainty and judgment. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Market participants are assumed to be independent, knowledgeable, able and willing to transact an exchange and not acting under duress. Fair value hierarchy disclosures are based on the quality of inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Adjustments to transaction prices or quoted market prices may be required in illiquid or disorderly markets in order to estimate fair value. The three levels of the fair value hierarchy are described below:
Level 1 - Inputs to the valuation methodology are quoted prices (unadjusted) for
identical assets or liabilities traded in active markets.
Level 2 - Inputs to the valuation methodology include quoted prices for similar
assets or liabilities in active markets, quoted prices for identical or similar
assets or liabilities in markets that are not active, inputs other than quoted
prices that are observable for the asset or liability and market-corroborated
inputs.
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Level 3 - Inputs to the valuation methodology are unobservable for the asset or
liability and are significant to the fair value measurement.
When the inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement in its entirety. Thus, a Level 3 fair value measurement may include inputs that are observable (Level 1 and 2) and unobservable (Level 3). The use of valuation methodologies may require a significant amount of judgment. During periods of financial market disruption, including periods of rapidly widening credit spreads or illiquidity, it may be difficult to value certain of our securities if trading becomes less frequent or market data becomes less observable. We review the fair value hierarchy classifications on a quarterly basis. Changes in the observability of valuation inputs may result in a reclassification for certain financial assets and liabilities. Fair values of financial instruments in our investment portfolio are estimated using unadjusted prices obtained by our investment accounting vendor from nationally recognized third-party pricing services, where available. For securities where we are unable to obtain fair values from a pricing service or broker, fair values are estimated using information obtained from our investment accounting vendor. We perform several procedures to ascertain the reasonableness of investment values included in the consolidated financial statements atDecember 31, 2022 , including (1) obtaining and reviewing the internal control report from our investment accounting vendor that obtain fair values from third party pricing services, (2) discussing with our investment accounting vendor their process for reviewing and validating pricing obtained from outside pricing services and (3) reviewing the security pricing received from our investment accounting vendor and monitoring changes in unrealized gains and losses at the individual security level. Investment securities are subject to fluctuations in fair value due to changes in issuer-specific circumstances, such as credit rating, and changes in industry-specific circumstances, such as movements in credit spreads based on the market's perception of industry risks. In addition, fixed maturities are subject to fluctuations in fair value due to changes in interest rates. As a result of these potential fluctuations, it is possible to have significant unrealized gains or losses on a security.
Reinsurance
We enter into reinsurance contracts to limit our exposure to potential large
losses. Reinsurance refers to an arrangement in which a company called a
reinsurer agrees in a contract (often referred to as a treaty) to assume
specified risks written by an insurance company (known as a ceding company) by
paying the insurance company all or a portion of the insurance company's losses
arising under specified classes of insurance policies in return for a share in
premiums.
Reinsurance recoverables recorded on insurance losses ceded under reinsurance
contracts are subject to judgments and uncertainties similar to those involved
in estimating gross loss reserves. In addition to these uncertainties, our
reinsurance recoverables may prove uncollectible if the reinsurers are unable or
unwilling to perform under the reinsurance contracts. In establishing our
reinsurance allowance for credit losses, we evaluate the financial condition of
our reinsurers and monitor concentration of credit risk arising from our
exposure to individual reinsurers. To determine if an allowance is necessary, we
consider, among other factors, published financial information, reports from
rating agencies, payment history, collateral held and our legal right to offset
balances recoverable against balances we may owe. Our reinsurance allowance for
credit losses is subject to uncertainty and volatility due to the time lag
involved in collecting amounts recoverable from reinsurers. Over the period of
time that losses occur, reinsurers are billed and amounts are ultimately
collected, economic conditions, as well as the operational and financial
performance of particular reinsurers may change and these changes may affect the
reinsurers' willingness and ability to meet their contractual obligations to us.
It is difficult to fully evaluate the impact of major catastrophic events on the
financial stability of reinsurers, as well as the access to capital that
reinsurers may have when such
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events occur. The ceding of insurance does not legally discharge us from our primary liability for the full amount of the policies, and we will be required to pay the loss and bear the collection risk if any reinsurer fails to meet its obligations under the reinsurance contracts. We target reinsurers withA.M. Best financial strength ratings of "A-" (Excellent) or better. Based on our evaluation of the factors discussed above, the allowance for credit losses related to reinsurance balances was$0.5 million atDecember 31, 2022 .
Recent Accounting Pronouncements
Refer to Note 1 - "Summary of significant accounting policies" of the Notes to
Consolidated Financial Statements for further discussion.
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United Fire Group, Inc. Declares a Common Stock Quarterly Cash Dividend of $0.16 per Share
HARTFORD FINANCIAL SERVICES GROUP, INC. – 10-K –
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